Distribution in China: a perspective from leading retailers

Distribution in China: a perspective from leading retailers With vast geographical span and huge regional differences, distribution 1 in China has long been complicated. Often, goods have to pass through multi-layers of distributors before reaching the hands of consumers. As China strives to build a more consumption-driven economy, the country s distribution sector is gaining increasing attention these days, both from businesses and the government. Eyeing the huge potential of the burgeoning consumer market, many manufacturers and retailers have been keen to expand distribution network as well as to improve supply chain efficiency over the past years; urbanization and fast development of transportation infrastructure are also rapidly changing China s distribution sector. China s wholesale distribution landscape has witnessed significant transformation. Exciting changes are taking place. Hoping to shed light on the latest development in China s distribution sector, the China Chain Store and Franchise Association (CCFA) and the had jointly conducted a study on China s distribution landscape in 2009 to interview 30 prominent Chinese retailers - including convenience stores, supermarket and hypermarket operators - on their distribution practices. We aim to have a closer look into China s distribution sector from the perspective of retailers. Indeed, businesses home and abroad today are casting their eyes on China. Building demand-driven supply chains is crucial for business success. We hope our study can help enterprises interested in expanding domestic sales. I. Background - several observations on China s distribution sector 1. Growing pressure of disintermediation In the past years, we have witnessed much streamlined and shortened retail supply chains in China, thanks to more centralized sourcing and distribution strategies of retail chain operators and the emergence of retail formats such as manufacturer direct-sale. The bargaining power and survival of distributors, especially those traditional players serving solely as a middleman between manufacturers and retailers without much value-added services, are under a lot of pressure. Discussion of disintermediation, which refers to the removal of intermediaries in supply chains or cutting out of the middlemen, is catching attention. 1 We refer distribution to operating activities involved as goods relayed from manufacturers to retailers; key players comprise manufacturers, wholesalers and retailers; there may be title transfer of product ownerships during distribution. 1

In fact, China s distribution sector is highly fragmented. Competition is particularly intense in the lower spectrum of the market and many who cannot offer higher value-added services to clients often have to resort to price-cuttings, eroding these players profitability. Besides, business costs such as labor, energy, raw materials, and logistics have been rising. Many players just manage to earn razor-thin margins. 2. Retail chain operators have gained power over their suppliers Owing to market liberalization, retail chain operators have been rapidly expanding their influence in China in the past decade. The total sales revenue of China s Top 100 retail chain operators (hereafter the Top 100s ) reached RMB 1,360 billion in 2009, up by 13.5% year-on-year (yoy). The market share of the Top 100s in the country s total retail sales of consumer goods has climbed from 3.8% in 2001 to 10.9% in 2009. Their total number of stores was 137,000, rising by 18.9% yoy. Unlike in the early days of reform, product distribution today is no longer supply-driven. We witness a significant shift in power in China s retail supply chains. Retail chain operators in China have gained power over their suppliers because of huge purchase volume. Indeed, many retailers have taken advantage of their strong market power many introduce cumbersome charges such as entrance fees, promotion and marketing charges, listing fees for new products and launch different rebate and commission schemes to suppliers. Many wholesale players have reflected huge cost of entry into modern trade retailers and called for more stringent regulations on retailers behavior - retailers introducing heavy fees does not only eat into the profits of wholesale players, but also makes lesser-known brands harder to compete for shelf space, limiting consumers choices and may lead to fraudulent activities as well. Some retailers in China frequently extend payment of payables to suppliers, using it as a major source of funding for working capitals. Many suppliers are wary of payment defaults. Tension between retailers and suppliers in China has been a top industry concern. 3. Closer collaboration among supply chain partners in recent years The mistrust among supply chain members in China has hampered information sharing in the entire value chain, leading to bullwhip effects and has posed major barriers in enhancing supply chain efficiencies. This has hampered retailers to react quickly to market demand. More and more retailers are now aware of the repercussions and are hoping to change the picture. 2

Thanks to the concerted efforts between government, industry organizations, suppliers and retailers, retailer-supplier relationship has shown signs of gradual improvements. Retailers now pay more attention to improve their operating performances and seek better collaboration with their suppliers. For instance, China s largest foreign retailer RT-Mart has offered supports to their suppliers on areas such as logistics operations and backend information systems in order to drive quicker responses to consumer needs. Watsons has joined hands with suppliers to co-launch advanced information management system in an attempt to reduce inventories. According to a study conducted by Shanghai Business.net and the FMCG Research Centre, suppliers were more satisfied with retailers in 2009. Another survey by the CCFA also showed that the supplier satisfaction index and manufacturer satisfaction index have risen from 57% and 33% in 2008 to 82% and 62% in 2009. 4. More diversified distribution models Many retailers have embarked on multi-channel strategy to lower operation costs and to achieve wider customer reach in China. Online retailing, telephone retailing, television retailing and catalogues sales are becoming more popular. More diversified distribution models now emerge in China with increasing popularity of multi-channel retailing. For instance, among the Top 100s in China, 31 had set up their online front stores; of which, one-third had started their online businesses in 2009 and 2010. Not limited to the retailers, some traditional wholesalers such as Yiwu wholesale market in Zhejiang have established online trading platforms. Merchandisers can now conduct business negotiations and transactions conveniently through the platform. Today, China s distribution models are more diversified with the emergence of multi-channel retailing and wholesaling. 3

II. Looking into China s distribution sector: a perspective from leading retailers To understand the latest development in China s distribution sector, the CCFA and the had jointly conducted a study in 2009. The study aimed to collect first-hand quantitative information from leading retailers in China. Our study covered 3 different retail formats: convenience stores, supermarkets and hypermarkets. A total of 30 retailers in China, which include state-owned enterprises, solely-owned foreign enterprises, Chinese private enterprises, joint ventures, state-invested enterprises and shareholding companies were surveyed. 25 of the retailers (83.33%) in our survey were among the Top 100s in 2008. All retailers achieved annual sales revenue of RMB 100 million or above; of which 37.93% of the retailers achieved annual sales revenue of RMB 10 billion or above in 2009. See Exhibit I and 2 for the company types and sales revenue of the retailers. Exhibit 1: Company type Company type Number Percentage State-owned enterprises 6 20.69% Solely-owned foreign enterprises 5 17.24% Chinese private enterprises 14 48.27% Joint ventures 1 3.45% State-invested enterprises 1 3.45% Share-holding companies 2 6.90% Total 29 100% 4

Exhibit 2: Annual sales revenue, 2009 Annual sales revenue (RMB) Number Percentage Below 100 million - - 100 million to 1 billion 3 10.34% 1 billion to 3 billion 5 17.24% 3 billion to 5 billion 7 24.14% 5 billion to 10 billion 3 10.34% 10 billion or above 11 37.93% Total 29 100% The key findings of the survey are as follows: 1. Wholesale distributors still play an indispensable role According to the survey, more than 60% of the products in retail stores were sourced from distributors or agents while the remaining were sourced directly from manufacturers. We also observe that the larger the scale of the retailers, the smaller the proportion of goods they sourced from distributors or agents (the smallest share in the survey is 45%). On the contrary, the smaller the scale of the retailers, the larger the proportion they sourced from middleman (the largest share in the survey is 82%). Despite growing discussion about disintermediation, the findings suggest that distributors and agents still play an important role in the supply chains. We believe wholesale distributors will continue to play an indispensable role in China. The reasons are three-fold. Firstly, despite rapid growth of chain operation in the past decade, China s retail market remains highly fragmented. Second, the vast geographical span of China offers a lot of development room for distributors, especially in some inner regions and the rural hinterland; many companies simply do not have the skill sets and resources in developing own distribution channels in these regions. Besides, as brands rush to sell in China like bees to honey, many do not have the know-how in marketing and distribution and need a distribution partner. Indeed, China is both a fast-growth and high-risk market. As brand principals seek to manage their fixed costs, there is still huge room for wholesale players to grow. 5

2. Consignment sales are popular Consignment sales are popular in China. According to our study, 82.05% of the products were under consignment sales arrangements, while 11.22% were bound by buy-out agreements. For the remaining 6.28%, manufacturers/ suppliers and distributors adopt the concession model. Distributors bear great risks in consignment sales model as they receive no money until the goods are sold. Therefore they must have sufficient cash flow to survive extended periods for payments of merchandise sold. Cash flow problem is a particular challenge for smaller distributors. 3. Nearly 60% of products were distributed to retail stores by suppliers On average, 59.56% of the products were distributed to retail stores by suppliers; 31.87% of the products were handled by retailers own distribution centers; only 8.57% was handled by third-party logistics service providers. Usually, smaller retailers would rely more on logistics services provided by suppliers; meanwhile, larger retailers are more likely to have the goods handled by their own distribution facilities. Exhibit 3: Product distribution methods 9% Logistics services provided by suppliers 32% 59% Through retailers'own distribution centers Through third-party logistics service provders 2 Consignment (, ) occurs when suppliers (the consignor) provide goods to a reseller (the consignee) for sale within a period agreed upon by both parties. There is no title transfer of product ownerships and the consignee has the right to return any products that are unsold. 3 There is title transfer of product ownerships in buy-out ( ) transactions. Payment has to be settled immediately when the retailers receive merchandise. Retailers cannot return the products unless there are quality problems. 4 Retailers/ distributors lease the retail sites to suppliers/ manufacturers and offer relevant management expertise and guidelines in return for rental income and commission fee. Meanwhile, suppliers and manufacturers will send sales representatives to the retail sites, and are responsible for merchandising, pricing, logistics, promotion activities and after-sale services. Retailers/ distributors typically will not purchase any goods from the suppliers and manufacturers. 6

4. Online retailing strategy is increasingly popular, bringing new changes to distribution landscape Online retailing has been increasingly popular in China, especially among the tech-savvy and young population. According to iresearch, China s online transaction value reached RMB 263 billion in 2009, representing a stellar year-on-year growth of 105.2%. Eyeing the huge market potential, a number of retailers have embarked on click-and-mortar strategy. According to our survey, 12 out of the 30 retailers (40%) had established their online retailing platforms. And most of the online stores were developed and run independently. Another 27% of the retailers had planned to develop their online retailing platforms in the next few years. Exhibit 4: Launching online retailing platforms 40% 33% No online platform with no plan to build one No online platform; but with plan to build one Have online retailing platform 27% We are positive on the long-term growth prospect of e-commerce in China. Online platform is today an effective doorway to tap China s growing number of online shoppers. Nevertheless, logistics and fulfillment remain one of the challenges. China s online retailers have invested huge sums of money to improve these areas. Growing popularity of the bricks-and-clicks model is quickly transforming China s distribution landscape. 5. Retailers said relationship with suppliers is satisfactory Retailer-supplier relationship is crucial for the healthy development of the retail sector. Better collaboration between retailers and suppliers is a key element in building demand-driven supply chains. 7

In view of this, our study asked retailers to evaluate their suppliers according to their satisfaction level: unsatisfactory (1), relatively unsatisfactory (2), average (3), relatively satisfactory (4) and satisfactory (5). The overall score for supplier-retailer cooperation was 3.93 (see Exhibit 5) We measured the satisfaction level towards suppliers in four major areas, i.e. 1) strategic cooperation, 2) sales cooperation, 3) supply chain collaboration and 4) after-sale service. Among the four areas, retailer-supplier s sales cooperation received the highest score of 4.43. Exhibit 5: Satisfaction with suppliers Score 5 4.5 3.5 4 2.5 3 2 1.5 0.5 1 0 3.93 3.87 4.43 3.63 3.57 Overall Strategic cooperation Sales cooperation Supply chain collaboration After-sale service A regression analysis which tested the sensitivity against satisfaction level was also carried out with the strategic cooperation, sales cooperation, supply chain collaboration and after-sale service obtaining the coefficients of 0.071, 0.110, 0.184 and 0.181 respectively. Supply chain cooperation and after-sale service were highly and positively correlated with the satisfaction level of retailers; suppliers and retailers should pay more attention in these areas. Scores had also been assigned to a total of 16 brand suppliers covering toiletries, food and beverages and sanitary products. According to our survey, retailers had the best relationship with toiletries brand owners (4.02), followed by brand owners of food and beverages (3.89) and sanitary products (3.76) (see Exhibit 6). 8

Exhibit 6: Scores given by retailers for suppliers of different products Score 4.05 4 3.95 3.9 3.85 3.8 3.75 3.7 3.65 3.6 4.02 3.89 3.76 Toiletries Food and beverages Sanitary products 6. Degree of cooperation among supply chain partners To understand the degree of cooperation between supply chain partners, retailers were asked to assign a score from 1 to 5 on areas including strategic cooperation, sales cooperation and supply chain collaboration with suppliers ( 1 represents no cooperation; 5 represents very close cooperation). The scores were relatively high at 4.21, 4.22 and 4.26 respectively (see Exhibit 7). Exhibit 7: Degree of cooperation with suppliers Score 4.28 4.26 4.24 4.22 4.2 4.18 4.21 Strategic cooperation 4.22 Sales cooperation 4.26 Supply chain collaboration 9

Exhibit 8 details the degree of cooperation in 3 major areas. Exhibit 8: degree of cooperation in 3 major areas Cooperation areas Indicators Degree cooperation of Importance weight (%) Average Score 1. Understanding the business strategy of your company with regular high-level 4.27 12.82 meetings 2. Formulating business plan with your company with quality business evaluation 4.30 28.21 3. Launching projects jointly with your company in areas such as consumer behavior analysis, joint sales promotion, 4.17 15.38 supply chain optimization and loss Strategic cooperation prevention 4. Taking initiatives to increase profitability 4.21 of both parties and maximizing common 4.07 17.95 interest 5. Embarking on different sales strategies according to different retail format 4.10 7.69 operations of your company 6. Providing products and services according to your company s needs; helping your company increase sales and 4.27 17.95 profitability 7. Providing regular analysis on Sales cooperation consumption behavior; assisting your 4.30 22.86 4.22 company to understand consumer s need 8. Working closely with your company on category management 4.03 14.29 9. Sharing market data with your company and providing recommendations 4.00 17.14 accordingly 10

10. Frequently updating with your company on new product launch, pricing changes and promotion plans; making 4.30 22.86 sales forecasts and formulating promotion strategy with your company 11. Providing recommendations on how to improve customer traffic and consumer 4.27 11.43 loyalty; launching joint promotion 12. Providing training to salespersons and helping your company reduce human 4.33 11.43 resources and management cost 13. Sharing with your company on the operations of its supply chain as well as Supply collaboration chain core performance indicators; setting common targets in areas of inventory 4.33 25.00 4.26 turnover, out-of-stock ratio and logistic cost 14. Making sales forecast with your company 4.23 19.44 15. Providing updated, accurate and comprehensive market data for your company to enhance information flow in 4.13 11.11 the supply chain 16. Delivering the right quantities of products to the right place at the right 4.40 13.89 time 17. Offering solutions to your company should there be supply problems 4.27 25.00 18. Taking measures to prevent loss and damages in daily operations; formulating loss prevention scheme with your 3.80 0 company 11

19.Increasing logistics efficiency by continuous improvement of technology and data management 3.97 5.56 7. Private label development will continue to be one of the highlights in retailer-supplier relationship An increasing number of retailers in China such as Hualian ( ), Wal-Mart and Watsons have launched their own private labels products in recent years to improve profitability and strengthen core competencies. In our survey, 90% of the retailers had developed their own labels and of which, 86.67% planned to put more efforts and resources on this area (see Exhibit 9). Exhibit 9: Launching of private labels 10% Yes No 90% Having said that, private label penetration remains far lower than international average. As retailers strive to differentiate themselves from the rest, we believe retailers will continue to place more resources on developing private labels. Private label developments will be one of the highlights in retailer-supplier relationship. 12

Special highlight: China s export-oriented enterprises embarking on domestic sales a distribution challenge The financial crisis that swept through the globe since the later half of 2008 has brought synchronized recession in major economies and tremendous changes in international trade dynamics. Many retailers in the United States and Europe have suffered from softening retail sales and tightening credit lines. On the other hand, many retailers in China are fortunate enough to witness strong market resilience. China s ever-expanding domestic market is gaining increasing attention from the country s many export-oriented manufacturers. More and more manufacturing enterprises now employ a twin-pronged strategy or so-called walking on two legs, by engaging in both domestic and foreign trade sectors. Having said that, selling to the source is no easy task. Many export-oriented enterprises lack the experience, know-how, and resources tapping the domestic potential. Selling to the source is particularly difficult for traditional processing trade factories (TFPs), as most of them have for a long time been engaged chiefly in original equipment manufacturing (OEM) activities, earning a razor-thin margin. Many have little, if not no experience in design, product development, branding, selling, and marketing. Without much market recognition of their products, tapping the already crowded domestic retail scene is a huge challenge. Indeed, there are huge differences between domestic and foreign trade engagements in terms of method of payment, mode of operation, business registration, applicable regulations, and so on. Exhibit 10 summarizes the major differences. Foreign orders are typically larger in size with product specifications provided by clients. Payments are better secured and TFPs are exempt from paying value-added tax (VAT) and tariffs. This explains why some exporters still adopt a wait-and-watch approach in tapping the domestic market potential. Tapping the domestic market, to many, is in itself a distribution challenge. 13

Exhibit 10: Domestic trade vs. foreign trade Domestic trade Foreign trade Order volume Smaller order volume, but orders are Larger order volume generally placed in a more frequent manner. Method of payment Case by case for each manufacturer. Use the letter of credit, which is Usually late payments by clients. internationally accepted. Buyers usually pay a deposit in advance and pay in full upon delivery of products. Operation Buyers require the manufacturers to Buyers provide the manufacturers with produce the products first and then designs and other technical determine the order volume after requirements when placing orders. examining the products. It increases risks such as excessive inventory to the manufacturers. Marketing & after-sale Buyers require the manufacturers to Manufacturers are not involved in services work together for better sales aspects such as marketing and after-sale performance by asking them to take services. part in promotion and advertising, which involves manpower and financial resources. Source: Compiled by As chain retailers expand their scale in China, it is suggested that chain retailers could have a bigger role to play by introducing the made-to-export products to the Chinese consumers. It is true that the order volume involved in domestic trade is typically much smaller than their overseas counterparts, but chain retailers can increase the purchase volume through central sourcing. In fact, some leading retailers have launched a series of initiatives in the past two years to help export-oriented 14

enterprise sell to the source. For instance, since April 2009, Wal-Mart has partnered with local governments to launch the Program Supporting Export-oriented Enterprises in Developing Domestic Market (PSEE) in Guangdong, Jiangsu, Zhejiang, Fujian and other regions where export-oriented enterprises are concentrated. It has sponsored 7 PSEE activities and took part in 9 related exhibitions and symposiums organized by central and local governments. More than 1,000 enterprises attended PSEE trainings, and over 60 enterprises have successfully signed contracts with Wal-Mart to put their products on the retail shelves, driving total sales of over RMB 50 million. Some other domestic retailers in China such as Wumart ( ), Hunan Better Life Commercial ( ), and Shandong Liqun Group (!"#%$ ) have also taken measures to facilitate the domestic sales of export products, for instance, sourcing from the factory backlog and employing the idle production facilities of the factory to develop and manufacture private label products for their chains. Besides, some shopping mall operators such as Solana (&'() ) in Beijing have also held sales fairs selling the made-to-export products. As mentioned, difference in payment methods has been a major concern as well. Today, the payment period for China s domestic sales can be up to two to three months. There are high incidences of payment defaults as well, adding to the risks of suppliers. On the contrary, for exporters engaging in foreign trade activities, payments are better secured by Letter of Credits and different exports insurance. These have deterred China s export-oriented enterprises from selling domestically. Attempts are being made to ease the financial pressures of suppliers. It is reported that some retailers, suppliers and banks have worked together in pilot supply chain financing projects in which retailers in China will act as guarantors and banks will pay the suppliers some of the money for the merchandise first; retailers will later pay the parties the proceeds from sales minus charges such as commission, service fees, etc. The efforts are much appreciated; however, many measures launched are short-term without truly addressing the historical legacy problem of separation of domestic and foreign trade sectors in China. To boost China s domestic private consumption, as well as to help millions of exporters expand their domestic sales, some longer-term mechanism to facilitate domestic distribution of export products will be needed. 15

III. Outlook 1. Growing calls for the government to improve the distribution sector Boosting domestic private consumption today tops the agenda of the Chinese government. Apart from initiatives that help boost domestic demand, e.g., accelerating income redistribution and improving social security system, there are growing calls that the Chinese government should eliminate bottlenecks that hamper efficient and low-cost product delivery in order to improve distribution in China, so that both businesses and consumers can benefit from more responsive supply chains. We will introduce several major suggestions for the government to improve the country s distribution sector. In fact, it is widely anticipated that the Chinese government will seek to improve the distribution sector in the forthcoming Twelve Five-Year Plan. Enhancing retail industry developments In the past decades, retail industry in China has witnessed impressive growth. However, retailers in China still lag far behind their overseas counterparts in many areas such as management, branding, and information technology applications. As retailers gained power over suppliers, many have transferred excessive risks or unexpected costs onto their suppliers; unscrupulous practices are common. Retailers relying heavily on slotting fees or harsh sales terms on suppliers is detrimental to the health of China s distribution sector, and is not sustainable in the long run. To boost the developments of China s distribution sector, the Chinese government should promote better regulatory environment for domestic distribution. The government has launched The Management Rules on Fair Transaction between Retailers and Suppliers (*+,-.,/0213 4526 7 ) in 2006 and the Credit Management Technical Specification for Commercial Enterprises (,89:<;2=45>?@A ) in 2008. However, there remains much improvement room on enforcement fronts. Relevant authorities should strengthen its monitoring on industry players. Strengthening distribution in rural areas The relatively underdeveloped distribution network and logistics infrastructure has hampered the distribution in the rural areas. This does not only hurt the livelihood of rural households but also put consumption safety at risks. The Chinese government has strived to improve distribution efficiency in rural areas in the past years. Launched by the Ministry of Commerce (MOFCOM) in 2006, the Agricultural Produce Wholesale Market and Distribution Company Development Project (BCDEF ) aims to facilitate the distribution of agricultural produce to 16

markets through restructuring large-scale modern agricultural produce wholesale markets as well as nurturing large-scale agricultural produce distribution enterprises. The MOFCOM has selected 100 agricultural produce wholesale markets with extensive distribution coverage and helped them modernize and upgrade their logistics and information system, warehouse facilities, quality assurance and food recall mechanism. It has also chosen another 100 large-scale agricultural produce distribution enterprises and trained the operators to modernize their operation and cold storage system, as well as ways to market to various modern retail channels. It is suggested that the government should further utilize the platforms and expand the scope of the project to cover categories not limited to agricultural produce but also the consumer products. Promoting direct-farm sourcing to shorten retail supply chains Retailer direct-farm sourcing is increasingly popular in China. First introduced in the country by Carrefour in 2007, many foreign retailers such as Wal-Mart, Tesco, Lotus and RT Mart soon embarked on similar initiatives to save logistics and merchandising cost by streamlining distribution. Retailer direct-farm sourcing has significant implications in China. It benefits farmers, retailers and consumers; and helps promote sustainable developments in the long run. China s agricultural development is lagging behind. Many small-scale farm producers have long relied on layers upon layers of middlemen to sell their products; distribution cost is high. As the agricultural product supply chains are shortened, farmers will likely be benefited from higher purchasing price. Besides, establishing long-term stable contractual relationship with retailers helps farmers improve sales and facilitate future planning. Rural households sharing better profits will promote healthy developments of China s agricultural sector. Government efforts to further promote retailer direct-farm sourcing will be much appreciated. Accelerating the integration of domestic and foreign trade sectors As mentioned, enterprises engaged in China s domestic and foreign trade sectors are governed by differential policies; the later is often said to enjoy more favorable government treatments, such as export tax rebates. Enterprises selling to domestic markets also need to pay VAT. To help reduce the country s reliance on exports, the Chinese government may consider adjusting its trade policies to offer more incentives for enterprises switching to domestic sales. Initiatives include also financial supports to the developments of online and offline wholesale platforms, and providing financial incentives to export-enterprises engaging in domestic sales. Enhancing the competitiveness of China s wholesale distributors can help facilitate the integration of domestic and foreign trade sectors as well. For instance, the government may encourage wholesale distributors with strong domestic networks to play a more active role in helping export-oriented enterprises tap the domestic market, for example, by 17

offering advice on the latest consumer trends and alleviating capital or communication bottlenecks. Indeed, facilitating domestic sales of made-to-export products can enrich the merchandise variety and mix in China, benefiting the Chinese consumers. This is conducive to China to build a more consumption-led economy. The central government can leverage on the close connection and proximity of the Pearl River Delta Region with Hong Kong and use it as a testing ground of new policies to facilitate export-oriented enterprises engaging in domestic sales. For example, the Guangdong and Hong Kong governments can work together to put in place a mutual recognition and information-sharing mechanism in testing and certification services to the effect that test reports issued by accredited testing and certification agencies of the China National Accreditation Service for Conformity Assessment and the Hong Kong Accreditation Service can be recognized by regulatory authorities of the two places. 5 This will greatly reduce the enterprises costs and enhance efficiency. It can also ensure that the mainland standards are aligned with the international ones. Further, the Chinese government can consider establishing long-term mechanisms to facilitate domestic sales. Previously, export processing enterprises intending to transform into foreign-invested enterprises, which can operate business of domestic sale, needed to go through very complicated and time-consuming formalities. At present, individual cities have introduced more simplified measures, including provision of all-in-one services, to speed up the processing time. It is hoped that more similar measures can be provided. Besides, city governments such as Shenzhen and Dongguan have organized a number of trade fairs after the financial tsunami to promote domestic sales. The two places also implemented a trial practice of taxation after sale, which was widely welcomed by enterprises and brought immense business opportunities to both cities. In view of this, the Chinese government should study the possibility of extending similar measures in other cities and provinces. 2. Retailers in China will pay more attention to improve operations China s retail competition is fierce. To win the hearts of increasingly discerning Chinese consumers, growing numbers of retailers in China now hope to break away from current operating model by offering more innovative product and services. They are now paying increasing attention to improve different aspects of their operations. These have profound implications on China s distribution sector. 5 Under the new arrangements of CEPA 7, accredited testing organizations in Hong Kong are allowed to cooperate with designated Mainland organizations to undertake testing of selected products listed in the China Compulsory Certification (CCC) Catalogue and processed in Hong Kong. This arrangement which is considered as a breakthrough could facilitate HK enterprises entry into the Mainland domestic market.. 18

For instance, retailers are spending greater efforts to improve their retailing brand image to win consumer preference. The lack of sophisticated retail merchandise knowledge is taking its toll on retailers many have resorted to price cuts as competition intensifies. Retailers growingly recognize that they should improve differentiation and brand management, such as through unique product assortment and the launch of private labels to enhance shopping experiences. Some are trying to take a more active role in merchandising practices. However, inventory risks, heavy initial capital outlays and the lack of experience in sourcing remain common concerns. In this regard, retailers may explore new profit- and risk-sharing schemes to work with suppliers or other professional supply chain companies to improve merchandising. And as mentioned, more and more retailers have embarked on bricks-and-clicks strategy. To improve time to market response, many retailers have invested large sums of money in areas such as information technology, logistics and fulfillment. We believe distribution efficiency in China to continue to increase. 3. Export-oriented enterprises will put more resources on domestic sales The trend for export-oriented enterprises to employ a twin-pronged strategy will continue, as the purchasing power of Chinese consumers increases. Growing number of enterprises are now trying to move up the value ladder and have put more resources on brand building and sales and marketing. Nevertheless, the cost of getting into the domestic channels is likely to remain high; we expect online sales portals will be one of the most popular channels for these enterprises to test the water in China. 19

About the Organizations The Founded in 1997, the (CCFA) is an official representative of the retailing and franchise industry in China. Currently, there are 900 enterprise members with 160,000 outlets, including domestic & overseas retailers, franchisers, suppliers, and relevant organizations. The total sales of China s Top 100 retail chain operators, which are part of the members of the CCFA, exceeded RMB 1.36 trillion in 2009, with more than 137,000 stores in total. CCFA participates in policymaking and coordination, safeguards the interests of industry and members, provides a series of professional trainings and industry information and data for its members and establishes platforms for exchange and cooperation. Li & Fung Group The Li & Fung Group is a Hong Kong-based multinational company with three distinct core businesses: export sourcing, distribution and logistics, and retailing. Founded in Guangzhou in 1906, the Li & Fung Group achieved an annual turnover of around US$16.0 billion in 2009. Today, the Li & Fung Group operates in some 40 countries and regions and employs over 33,000 people worldwide. One of its core competencies is Supply Chain Management (SCM). is the research institute of the Li & Fung Group. It serves as a knowledge bank on China's economy, industries, logistics and distribution sector, with its research scope covering the whole spectrum of the entire supply chain, from ideas, production, distribution, retailing to consumers. It also offers research analyses and consulting services to colleagues and clients to assist them in their day-to-day decision-making. Copyright 2010 and the (CCFA). All rights reserved. Though and CCFA endeavor to have information presented in this document as accurate and updated as possible, it accepts no responsibility for any error, omission or misrepresentation., CCFA and/or their associates accept no responsibility for any direct, indirect or consequential loss that may arise from the use of information contained in this document. Reproduction or redistribution of this material without and CCFA s prior written consent is prohibited. 20