Winning the battle for the Chinese consumer electronics market

2007-11-1 16:43:39 Source: http://www.mckinseyquarterly.com by Ingo Beyer von Morgenstern and Chris Shu

A wave of consolidation is changing the way both foreign and Chinese consumer electronics players compete in China.

Competing in mainland China's consumer electronics market has never been easy: rampant price wars caused by overcapacity have squeezed profit margins to some of the lowest levels in the world. And as if things weren't bad enough for manufacturers, a new wave of consolidation among electronics retailers is turning up the heat.

We recently saw the acquisition of China Paradise Electronics Retail by Gome Electrical Appliances Holding, China's leading electronics speciality chain. That came fresh on the heels of an alliance struck—then put on hold—between China Paradise and Dazhong Electrical Appliance. In April, US-based Best Buy acquired Jiangsu Five Star. All this activity occured within the space of a few months.

Retail chains dominate the consumer electronics landscape: a handful of these players control as much as 40 percent of sales in first-tier cities like Shanghai and Beijing. They dominate even more in some product categories: the new giant forged from the imminent merger of Gome and China Paradise will control 60 to 70 percent of TV sales in Shanghai.

Unless consumer electronics players—whether Chinese or foreign—rethink their strategies, they risk losing the battle for the wallets of millions of mainland consumers. A lot is at stake: the mainland's consumer electronics market has been growing at a compound rate of 12 percent a year and is expected to reach about 1 trillion yuan ($125 billion) by 2010, up from 590 billion yuan this year.

This market will account for 25 percent of the global market by 2010. Carving out a share of it has ranked high on the agendas of many of the world's consumer electronics companies for some time. Many of the world's best-known brands already have a sizable presence in China. But price wars—triggered in part by the rise of the electronics retail chains and overcapacity—have pushed profit margins on TVs and other white goods to below 3 percent.

Amid the proliferation of brands, many manufacturers are having a harder time competing for shelf space in the major electronics retail chains. A growing number of second-tier brands, both foreign and domestic, are being pushed off the shelves in favor of better-known and faster-selling ones. Moreover, the trend among European and US retailers to sell products under their own labels will catch on in mainland China. Gome already has its own brand, Idell, while China Paradise recently introduced a line under the brand name Yole. These private-label brands will compete head-on with established ones.

So how should consumer electronics players compete on the mainland? First, manufacturers need to form win-win partnerships with the large retail chains, helping them build capabilities in marketing strategy, in-store promotions, and supply chain and inventory management. Retailers in more developed markets may take these critical capabilities for granted, but many mainland retailers still lack them. Companies that help retailers build these skills will secure their position as "strategic vendors" to the major retail chains.

Surprisingly, not all consumer electronics companies on the mainland are equipped to serve the needs of the large retail chains. Many lack dedicated teams to focus on the major retail chains that comprise the bulk of their sales. Others have individual sales teams for each of their product categories: in one case we observed, a manufacturer had five different sales teams calling on the same retail-chain account.

For most consumer electronics players, working more closely with these new retail giants will be an essential part of staying in the game. Some, however, may want to fight fire with fire, and consider opening their own branded stores. Sony and Zhuhai-based Gree have already opened hundreds of branded stores throughout the mainland, selling directly to the consumer and playing an important role in shaping the buyers' experience with their brand.

The trick, however, will lie in coinvesting with dealers at the city level—to share the investment risk—while exercising direct management control over these stores to maximize sales and manage the brand properly. For example, Sony coinvests with local dealers to build its shops. But it directly manages the in-store sales teams to ensure that targets are met, inventory is tracked, and valuable information on customer buying behavior is collected.

Finally, two trends may play to the advantage of foreign players in the consumer electronics sector: the opening of mainland China's distribution sector in line with its World Trade Organization commitments and the growing presence of large, sophisticated foreign electronics distributors such as Ingram Micro and Trend Micro. Through existing global relationships with these large distributors, foreign manufacturers can gain access to hard-to-reach geographic markets and distribution channels. These include regional department stores and small, independent speciality stores.

Competing in the mainland's consumer electronics market may be tougher these days because of the wave of consolidation reshaping the landscape. But the players that figure out a strategy for collaborating with these new electronics retail giants—without becoming too dependent on them—will have a better chance at succeeding in this dynamic marketplace.