Pricing Retail Right to Win Chinese Consumers: It's Complicated

By Kristin Graham, CFA  MAR 27, 2013 3:00 PM

Chinese consumers hold a different view on product value, often relating the quality of a product to its price.

 


A few weeks ago, I dined at a mid-end Hunan restaurant in Shanghai with a Shanghainese friend who treated me to a bottle of wine. When given the wine list, he said he wasn’t familiar with the selection, but suggested one of the more expensive bottles.

He ended up paying the equivalent of USD $100 to treat me to a bottle of Carlo Rossi wine. The same wine that can be had for about USD $10 a jug in the US.  I politely accepted the beverage. I recognize that alcoholic beverages are marked up in any establishment, but this experience provides a good example of how products are sold and branded in China. It exemplifies how Chinese consumers lack a strong sense of value in comparison to consumers in more developed markets. 

Understanding the value of a product is correlated with the sophistication of consumers. Fifteen years ago, China had few foreign products and very little Western influence. Even up until a few years ago, foreign-branded stores were limited to flashy big-name luxury brands. Despite plentiful luxury malls in major cities and the mass flood of new foreign brands entering the market these days, consumerism remains new and immature.
 
With so many new products being offered in the market, it is often the case that Chinese consumers do not understand or know what a product is because it’s never been offered before in their lifetime or it only recently has become available. This often results in shoppers making a direct connection between price and quality: the higher the price, the better the product. This phenomenon occurs across many sectors of China.
 
Thus, in many bars and restaurants, owners find that patrons will simply order the most expensive wine or beer on the menu. While Chinese people associate drinking wine with having Western sophistication and class, they cannot distinguish the difference between a 20 RMB bottle of wine and a 500 RMB bottle of wine according to taste.

In the US, the Trader Joe’s 'Two-Buck Chuck' wine has become the infamous cheap but decent-tasting wine that even upper-middle-class consumers have no shame admitting they consume. This is because American consumers understand wine as a product, and are willing to look for wine that tastes good at an attractive price. In other words, they seek value. In China, such a concept would fail. Choosing an inexpensive bottle of wine, particularly in the presence of others, would cause embarrassment.
 
Because Chinese consumers are often unable to perceive the value of a product based on physical quality alone, many brands have been able to position themselves as higher-ended label in China compared to their home countries, notably Calvin Klein (NYSE:PVH), Coach (NYSE:COH), and L’Oreal (PINK:LRLCY).
 
Within Mainland China, many Chinese still equate cheaper prices with lower quality or fake products. When the quality of a product matters, Chinese hesitate to purchase on discount. Whereas Americans flock to discount outlet Marshalls (NYSE:TJX) for brand-name products at deep discounts, Chinese consumers immediately label such low-priced products as fake.
 
In a society where counterfeit products are so prevalent, this concern is not unwarranted. But it again demonstrates the immaturity of consumers who are unable to determine if a product is real. A good friend recently bought Diageo’s (NYSE:DEO) Bailey Irish Crème Liquor from China’s online giant, Taobao, after I introduced her to the drink. Purchasing at a discount to brick-and-mortar prices and having self-awareness regarding her unfamiliarity with the product, she asked me to taste test and evaluate if the product was indeed real or fake. Without a foreign evaluator, there was no way for her to know if she got the real deal.
 
All of this said, an understanding of value is beginning to emerge in Shanghai, China’s most developed retail market. Destination shopping (see Cancel Your Sell Order, Retail Investors: The China Ride Isn't Over Yet) and e-commerce is changing consumers as these trends help educate consumers on value. When evaluating products on Taobao, for example, shoppers are learning to examine the fabrics used for clothing before making a purchase decision. Outlet shopping malls in the US, which have become hot tourist destinations for Chinese visitors, demonstrate how branded products need not be purchased at such high prices. Furthermore, the rapid entrance of new products and brands continues to help shoppers become more sophisticated. 
 
Drawing conclusions at this point seems appropriate. However, stopping here, I would fall short of providing the full story of Chinese consumers and their perception of value. And one would assume from this reading that pricing higher always wins in China. It’s unfortunately not as simple as that. 
 
Chinese shoppers are notoriously cheap when it comes to non-Western branded products, everyday household necessities, and electronics -- in other words, products they are familiar with and can better associate value with. 
 
RT-Mart (OTC:SURRF) has become a successful hypermarket by pricing staple products such as soy sauce below cost to beat out Wal-Mart (NYSE:WMT). Watsons, a drugs store, is also becoming well-known for its weekly promotional items. My entire office sprinted to a nearby Watsons when it became known they were selling a 10 RMB bag of M&Ms and a matching plastic case.
 
Thus, the Chinese do in fact love discounts and freebies. But this love is restricted to certain product categories, namely, those they are familiar with and comfortable buying on sale.
 
Like much of China, the retail sector will continue to grow far more quickly externally than it does internally; by this I mean that investors should not let the physical presence of high-end retail stores mask the maturity of shoppers.
 
For foreign retailers investing in China, it's evident that pricing is evermore important. Retailers need to understand the level of sophistication Chinese consumers have for the product they are selling: There is clearly no one answer to pricing strategy in this market.
 
Kristin Graham, CFA, is currently a consultant partnered with CRG, a multi-channel retail services company that assists retailers entering and expanding in China. She lives in Shanghai.
No positions in stocks mentioned.

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