Foreign Market Servicing Strategies - the METROGroup in China

Table of Contents

List of Figures

List of Tables

List of Abbreviations

Abstract

1 Introduction

2 China – The Global Domestic Market
2.1 Background Information
2.2 The Chinese Retail Market
2.2.1 Market Development
2.2.2 Market Profile
2.2.3 The Rural Retail Market
2.2.4 The Retail Style Development
2.3 Existing Problems
2.4 The Competitors
2.4.1 Wal-Mart
2.4.2 Carrefour

3 METRO Group – The Company

4 Modes of Entry
4.1 Exporting
4.2 Licensing/ Franchising
4.3 Foreign Direct Investment (FDI)
4.3.1 Foreign Founded Enterprises
4.3.2 Processing and Assembly Agreements
4.3.3 Compensation Trade
4.3.4 Joint Ventures
4.3.4.1 Equity Joint Ventures
4.3.4.2 Contractual Joint Ventures

5 Recommendation for a Foreign Market Servicing Strategy

6 Summary

Bibliography

Appendix

List of Figures page

Figure 1: The Structure of China´s Government Administration

Figure 2: Expansion on Retail Outlets

Figure 3: Asian Retail Turnover

Figure 4: METROGroup Structure

Figure 5: Distribution of FDI in China by 2002

Figure 6: The OLI Paradigm

List of Tables

Table 1: China at a glance

Table 2: Foreign Retailers in Beijing

Table 3: Sources of Foreign Capital in China 1979 - 1993

List of Abbreviations

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Abstract

Multinational Retailers seek ways of expanding abroad. They search for markets, products to sell, cheap labour or resources. Several foreign markets have been served so far but only recently, China was discovered as future marketplace for foreign retailers.

Like others, the German based METRO Group seeks expansion there. They weigh the pros and cons and finally adopt FDI as their foreign market servicing strategy as it seems to meet their philosophy of doing business abroad best.

1. Introduction

According to the World Bank, China is the world´s largest economic power. The People´s Republic of China (PRC) already ranks among the “elite group of the world´s ten largest exporters and the development of a true international market, with hundreds of millions of customers, may well revolutionise the economy of the entire planet”^[1].

Interest in China started to evolve from the late 1970s – early 1980s period on where firms started to build up enterprises. This explosion of involvement which is also known as the ´Westchester Syndrome`^[2] couldn´t be ignored – of course – from German companies seeking for ways of expanding abroad.

This report therefore deals with foreign market servicing strategies (FMSS) and its application to the METRO Group, the biggest German Retailer. It tries to identify the pros and cons of expanding into the Chinese Market as well as identifying the strategy for the METRO Group in order to expand and contextualise its products and market.

The basis for this study are primarily theoretical approaches taken from text books, and information from further secondary literature such as webpages and other internet sources. A full bibliography can be found at the end of the main part.

2. China – The Global Domestic Market

2.1. Background Information

The years after the Second World War became one of the most isolated times in Chinese history in an economic sense. Because of the strict communist orientated governmental policy and its attitude towards capitalist countries. China didn´t play an important part in terms of being attractive to foreign companies. Thus, the analyse will focus on the reform period^[4] initiated at the end of the 1970s.^[3]

It was introduced under the leadership of Deng Xiaoping who launched a package of reforms that sought for radical changes in both the domestic economy and the relationship to the world economy and its global institutions. China's productive forces have witnessed immense growth since that. Its comprehensive national strength has grown rapidly^[5].

Especially China's industrial sector has witnessed rapid growth. In 1998, the total industrial output value was increased by 8.9% over 1997.

China has forged trade relations with more than 220 countries and regions. On the world economic stage today, China has become a well-recognised political and economic power that plays a vital role in international affairs.

China's rural economy has achieved a great development, with the output of farm products growing steadily. Since initiating reforms and opening up, China's rural industry has evolved rapidly. Construction of small cites and towns has started, enabling about 150 million rural labourers to be employed in other sectors and helping more than 200 million rural residents to shake off poverty and to move towards a relatively comfortable and affluent life.

In the past five decades, the living standard of China's urban and rural residents has jumped over several levels, with changes in quality taking place. The per capita income of rural residents rose by 48%. The actual per-capita annual consumption of urban and rural residents rose from RMB 80 in 1952 to RMB 2,973 in 1998. The saving deposits of urban and rural residents soared from RMB 860 million in 1952 to RMB 5,340.8 billion. The per-capita net income of rural families in 1998 reached RMB 2,162 and the per-capita disposable income of urban families RMB 5,425.

China's external trade suffert in 1998 from the adverse effects of the Asian financial crisis. The growth of China's exports slowed down considerably. Its imports also fell as a result of the decreasing domestic demand and other factors. The total import and export value was down by 0.4% from the previous year. The export of general merchandise dropped 4.8%. The total import value was down at 1.5%.

Since 1999, China has raised export tax refunding rates and adopted a series of policies to accelerate export tax refunding. Furthermore, the economies of its neighbouring countries have started to recover and the impact of the Asian financial crisis is diminishing. In the second half of 1999, China's exports stopped the downward turn and began to rebound. In the first 11 months of 1999, China's trade surplus was USD 26.4 billion and the FDI in the country was USD 37.09 billion.

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Table 1: China at a glance

(Source: METRO Cash & Carry Presentation, 2003)

But what are the big dangers in China?^[6] Most people seem to think the potential problems are political. The Chinese will start a war, revert to communism or have an internal upheaval. Anything is possible, of course, but not probable.

The real danger is financial. There are five very large State-owned banks where the labourers keep almost all of their savings. The problem is that these banks lend money in ways make no economic sense. That spells hundreds of billions of dollars of bad loans. The government is not about to risk the upheaval that would result from people not getting their money from the banks, so the alternative is to print enough. With all the consequences^[7].

Furthermore, looking at the growing unemployment rate in China, the ever growing disparity between the rich and poor, the irregular and unconventional features of the Chinese economy, as well as other related economic data, some economists predicted that the Chinese economy will collapse in the next five years.

Additionally, although the Chinese government has opened itself and became more western-orientated in terms of the economic system, one has to bear in mind that China is still a socialist country.

Thus, the economic system that can be found nowadays tends to be a hybrid one: On the one hand – and not only because Hongkong now belongs to China –pieces of pure capitalism can be found mainly in the coastal regions^[8] because of the influences of FDI inflows. On the other hand the ruling political party (CPC) still rejects the pure transformation into a capitalist and therfore free market system. Still, the ´leftovers` of former socialism/ communism dominate the day-to-day life of the ordinary Chinese.

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Figure 1: The Structure of China´s Government Administration

(Source: China Handbook; Appendix 4)

2.2. The Chinese Retail Market

“The State Economic and Trade Commission (SETC) is working to bring foreign retailers closer to Chinese suppliers. [...]. Since China joined the World Trade Organisation multinational retailers have shown greater interests in goods made in China.^[9] ”^[10]

Foreign retail groups purchased commodities valued at USD 30 billion from the Chinese mainland in 2002. This represented 12% of the mainland total commodity exports for the year^[11].

China's retail industry will be fully opened to foreigners now that the country has joined the World Trade Organisation (WTO). There are 7,685 chain stores in China, and the total sales volume of the top 100 reached 98.2 billion yuan (USD11.8 billion) in 2002.

Last year, the world's two leading retailers - US-based Wal-Mart^[12] and France-based Carrefour - sped up their expansion in the Chinese market.

China is remarkable both for the speed of its growth and the economy of the market. With the various new types of retail outlets operating, retail sales have increased rapidly. As competition increases, traditional family-run business structures have come under pressure to adapt to more sophisticated business models. China's total domestic consumer retail volume continues at a high level as a result of revisions in its economic policies concerning the retail sector that began in 1981.

In the past few years, thousands of new retail outlets have been built in both urban and rural areas. Most of the retail shops are directed at the local population in the immediate area and generally lack good management.

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Table 2: Foreign Retailers in Beijing

(Source:www.china-embassy.is/eng/49883.html)

2.2.1. Market Development

During 1991 to 1995, China´s retail consumption increased at a growth rate of 28%, while prices for the same period rose only 15.64%.

In 1998, over 120 district and regional retail markets each moved sales volumes of over RMB 100 million. Most existing stores have reconstructed or altered to become multi-functional shopping malls, thereby creating more varied shops, leisure centres with restaurants, and even hotels. These have become a new shopping attraction in this highly competitive retail market. The number of hired employees in the new and refurbished establishments province-wide has seen an annual increase of around 15% during the past three years.

2.2.2. Market Profile

The new types of retail markets - including the latest hypermarkets, fast food chains, warehouse stores, specialty stores offering the latest products from overseas - have all been major hits locally^[13].

In the early 1990's, China provided more preferential policies for foreign investors in a variety of retail markets. Foreign retailers came into the country to set up retail stores as stipulated by the policies then in force. Targeting an entry into the local retail market, these overseas retail enterprises provided a wide range of new merchandise in addition to satisfying services. This new style of sales, which introduced modern marketing strategies as well as competitive prices, has opposed pressure on existing retail enterprises such as state-owned department stores, small convenience stores, and state-run supermarkets. Most state-run retail markets still exist as the subsidiaries of governmental authorities, which tend to be reform-shy, and thereby are not able to satisfy the demands of the newly more aware consumer.

Guangzhou Nan Fang Department Store is the only state-owned retail enterprise which has opened a warehouse market, ´Guang Ke Long`, to compete with the new styles of retail enterprises. Most other state-run department stores have retained their traditional structure and methods, and are losing market share. Some small and medium-sized retail establishments and foreign invested retail firms have introduced the supermarket chain store idea to improve the scale of their operations, and gain back market share. Given the fierce market competition, many large-sized retail markets and newly opened retail markets could not survive, and have been driven out of business. China´s supermarket chains and department stores, even the state-owned ones, do not receive special government support any longer and must make a profit to survive.

2.2.3. The Rural Retail Market

The 1999 the national retail strategic plan aimed at developing the urban and rural retail market rapidly. As farmers' living standards and income improves^[14], the demand for various shops keeps growing. Existing shops are generally small, scattered outlets with simple items and poor facilities, offering no choice for the customer. This has limited further increase in economic development and living standards in rural areas.

2.2.4. The Retail Style Development

The basic traditional retail business types are department store, grocery store, and food market. Daily-use commodities have generally been controlled by department stores. People had gotten used to purchasing in department stores before the introduction of convenience stores, but that is now changing. In the late 1980's, following the provincial government's commercial strategic objective to ramp up the provincial retail market for promoting circulation of provincial products, multi-style retail businesses have been seen to be the strategy to be adopted in developing provincial retail enterprises by introducing multi-style foreign retail businesses. In this environment, vast supermarkets, convenience stores, specialty stores, warehouse discount stores, and so forth, have been established.

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Figure2: Expansion of Retail Outlets

Source: Chinese Chamber of Commerce

There are seven^[15] types of retail stores in China:

1. department stores;
2. supermarket stores;
3. speciality stores;
4. brand-name stores;
5. warehouse stores;
6. transaction markets;
7. mom and pop shops.

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Figure3: Asian Retai Turnover 2001

(Source: M+M Planet Retail, Figures in %)

2.3. Existing Problems

China's retail market is attracting an increasing numbers of major foreign investors which have demonstrated a strong managerial quality compared to the local retail stores. Since new styles of retail business are so quickly introduced, there is a growing interest in how a foreign retail venture affects various retail styles provincially. The existing domestic retail principals to foreign retail ventures lag far behind the other industries. Foreign retailers came with strong financial resources, and management experience in the local market. But to register a foreign retail store is extremely difficult^[16].

Another issue of concern is that the retail market still has not standardised its investors' cooperative laws and insolvency laws, neither for domestic nor for foreign retailers. The Department of Internal Trade has issued new legislation covering retail activities, but they have still not sorted out how to best implement those laws in a manner which will protect both the foreign investors and the domestic partners^[17].

2.4. The Competitors

2.4.1. Wal-Mart

Wal-Mart is the world´s number one in retailing. When it entered the Chinese market in 1996, it decided to make Shenzhen its first focus. During the past four years, Wal-Mart has set up eight chain stores in such cities as Shenzhen, Dongguan, Dalian and Kunming. Compared with Carrefour, which has opened twenty-six chain stores, Wal-Mart seems to have been conservative in the past four years, but that trend will soon change. Wal Mart revealed in October 2000 that it will invest USD 85 million to add eight stores to its network in China.

2.4.2. Carrefour

Carrefour is the world´s number two in retailing and has established twenty-six chain stores in fourteen Chinese cities in five years, making it the third largest retailer in China.

Carrefour established its China office in the China International Exhibition Center in 1995. Since then, Carrefour has continuously set up new chain stores throughout China.

3. METRO Group – The Company

Created in 1996 by a merger of several important retailing companies the METRO Group today is a modern, internationally operating, high performance trading and retailing group with more than 2,300 locations in 28 countries. It ranks among the Top 3 in the industry worldwide.

With its continuous growth more than 235,000 employees generated sales of almost EUR 52 billion in the year 2002 for the METRO Group, more than 46% of which abroad.

All retail formats of the METRO Group are characterised by a high level of innovation and performance. This clearly structured portfolio consists of six sales divisions that operate independently in the marketplace with their own specific merchandising concepts. Cross-divisional service compa-nies provide pooled services to the entire group.

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Figure 4:METROGroup Structure

(Source:;Annual Report 2002, METRO Group)

With Metro Cash & Carry^[18] the METRO Group operates in around 460 self-service wholesale stores in 26 countries under the brand names Metro and Makro. They generate 46.5% of group sales. In 2002 some 72,000 employees produced total sales of EUR 24 billion – three quarters of which abroad.

The priority areas of international expansion are Eastern Europe and Asia. The product offering is exclusively addressed at commercial customers including up to 17,000 food and up to 30,000 non-food items.

The advantage of the METRO Cash & Carry^[19] merchandising concept is that it can be implemented in all foreign markets and adjusted to specific national market conditions and customer needs in terms of assortment and customer appeal. Thus, they generelly spread their business via ´green field site´ expansion which means that they usually build new stores in former abandoned and newly developed economic areas.

METRO now employs 5,000 people in China in its 18 Cash & Carry markets. Its turnover has reached EUR 600 million (USD 706 million) in China, slightly more than 1% of the group's entire annual turnover.

[...]

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^[1] Club de Bruxelles: The Chinese Economy and Relations with the European Union, 1994, page 1

^[2] for more information: adapted from Beamish; Spiess; in: Kelly; Shenkar: International Business in China; page 152

^[3] taken from: Howell, J.: Foreign Trade Reform and Relations with International Economic Institutions; in: Hudson, Christopher (Ed.): The China Handbook; 1997

^[4] taken from: DekaBank, Economics Department, Emerging Markets Outlook China; 1999

^[5] gross domestic product (GDP) rising to RMB 7,955.3 billion in 1998 from RMB 362.4 billion in 1978

(RMB 100.00 ≈ GBP 8.00)

^[6] taken from: DekaBank; Economics Department; Emerging Markets Outlook China; 2002

^[7] only inflation should be mentioned here

^[8] see also Figure 4

^[9] taken from: www.china.org.cn/english/BAT/

25630.htm

^[10] www.clearharmony.net/articles/200308/14724.html

^[11] according to the World Bank

^[12] After a successful introduction to the Beijing market, Wal-Mart China Co Ltd will open seven more stores in China. Wal-Mart will move its global purchasing center to Shenzhen. Also, an agreement inked by Carrefour and the State Economic and Trade Commission (SETC) granted business approval to the retailer to put an end to a half-year restriction on its expansion in China. Carrefour plans to open 10 chain stores every year and organize 10 purchasing centers in China.

^[13] according to the German-Chinese Chamber of Commerce

^[14] The retail business in China´s rural market is undergoing an extensive transformation. In 1995, the net income nation-wide for an individual farmer was RMB 1577.74 (USD 200), but for instance in the Guangdong Province it was RMB 2,699 yuan, and in the Pearl River Delta it reached RMB 4,340 yuan.

^[15] See appendix 2 for further definitions

^[16] Presently, only the central government has the right to issue a commercial license for a retail operation

^[17] For example, when Wal-Mart opened its two stores in Shenzhen in 1994, traditional retail enterprises in that city suffered average 5% to 10% decrease in turnover. Wal-Mart intends to open another 20 big-size supermarkets in China in the next few years, which will probably have the same effect on the smaller retail establishments in the vicinity. As a means of attracting foreign investors in the retail sector, the government has made available to them special tax advantages that are not available to Chinese firms. This has created an unfair competitive advantage to the foreign firms, which the government recognises, but for which they have not yet been able to devise a solution. The enterprise income tax rate for a foreign retail venture is 30%, and local income tax is 3%.

^[18] see also: www.metro-cc.com

^[19] “The term ´Cash & Carry` means that customers do their own order picking, pay in cash and carry the merchandise away. The advantages over traditional wholesale operations are the better price/ performance rate, the scope of the food and nonfood assortments, the immediate availability of the merchandise and the longer business hours per week. The stores each offer a food assortment of up to 17,000 items as well as some 30,000 items in the nonfood segment.” www.metrogroup.de/servlet/ PB/menu/1000091_l2/index.html