I found this article in the LA TImes intriguing because from a retailer perspective IKEA is doing everything right - they are drawing people in from a wide trade area, offering an attractive product, providing convenience - but how do they get people to buy?

Actually people are buying. A lot. IKEA knows this which is why they are developing IKEA all across China. IKEA also closely tracks what people are buying which gives them insights into consumer behavior unrivaled by many foreign retailers. Chances are there is something from IKEA in most Western styled Chinese homes in Beijing. Taking this type of data and modeling it into consumer behavior patterns is one of the things we do. Unfortunately we don't provide amusement park crowd control security - yet.

LA TImes: Beijing loves IKEA -- but not for shopping

With all the questions I've fielded recently from the several recent "China visits" by major brands entering this market, I found this excellent Wharton article about luxury brands in China to be a good primer. It's accurate, informative, but unfortunately doesn't go into details about how difficult it is to find the right property - but there is no secret formula for that. That's based on retail experience, property wits, and local knowledge, ie: What we do here at JDD.

Here's the whole article from www.knowledgeatwharton.com.cn

Even as luxury goods consumption has fallen worldwide, China's appetite for high-end retail has shown a strong upward momentum. Italian men's brand Ermenegildo Zegna continues to see a steady flow of new customers through the doors of its 60 retail outlets in China. "More than I expected," says Ken Kress, head of Zegna's China operations. "The bottom line is that the overall economy and diversification of wealth have continued to grow."

Zegna isn't alone. Even while Wall Street was still reeling last November, LVMH (the French luxury group with products ranging from accessories to spirits) reported double-digit sales growth during the third quarter of last year, according to LVMH's 2008 Annual Report. The company has seen "dynamic" growth in China, led by high-end leather goods brand Louis Vuitton (LV). And, while wine and spirit connoisseurs around the world are showing restraint in purchasing pricey bottles, in China LVMH has reported "exceptional" sales of Hennessy cognac, and the country was the largest market for the luxury spirit in 2008.

LV also made news this past July when it dropped product prices between 2% and 7% at all 29 of its China locations, saying it was not offering a discount or special promotion, but rather was reacting to changing rates of currency exchange between the reniminbi and the euro. On July 17th the company opened its fourth flagship store in Shenzhen and has announced plans to open stores in Inner Mongolia, in the north of the country, later this year.

In general, offering discounts on luxury products is a bad strategy, says John Zhang, a Wharton School marketing professor. "[It] can affect customer confidence in the integrity of the brand's pricing, and devalue the brand." Customers who want to treat themselves with an expensive luxury bag aren't likely to be looking for such a small discount, he says, which means it's likely LV is telling the truth about its discount.

LV and Zegna aren't the only luxury companies to expand in China recently. On July 24, Giorgio Armani cosmetics formally launched its own counter in Mei Long Zheng Isetan, a high-end department store in downtown Shanghai, to target the fast-growing number of women consumers in the city.

German luxury carmaker BMW saw sales in China jump by 44% in June of this year, while U.S. sales fell by more than 20%. General Motors sold and exported 3,363 units of its luxury Cadillac-branded vehicles to Chinese buyers in the first half of the year, up from 3,227 units a year earlier. Sales of the recently released Mercedes S600, a vehicle that sells for roughly US$200,000, have increased between 50% and 60% over the last year in China.

And while some sit behind the wheels of their new luxury automobiles, others are taking to the seas. According to global wealth management industry monitor Wealth-Bulletin.com, super-yacht builder Oyster Marine opened an office in Hong Kong earlier this year, and expects sales in China and Hong Kong to grow from less than 10% last year to 30% over the coming few years.

Catching up with China's Fast-growing Wealth

Consumers in China spend well over US$6 billion a year on designer bags, cars, clothes, accessories and cosmetics, with the country recently leapfrogging fashion-conscious Japan to come in second behind the U.S. in consumption of luxury goods, according to World Luxury Association data.

And the fourth-largest population of the world's wealthy will live in China by the year 2015, says a mid-July report by McKinsey, titled, "Understanding China's Wealthy." According to the report, as of 2008, there were 1.6 million families in China with household incomes of over US$80,000. By 2015, it estimates that number will jump to 4.4 million, growing by up to 16% per year over the next five to seven years. "The luxury sector will benefit most if this trend continues," says Jeremy Cheung, managing director (HK) of China luxury consultancy Impact Asia Limited.

In response to continued and growing sales, luxury brands are investing in China. French fashion brand Hermès announced plans late last year to open three to four new stores across the country during the next three years. Italian fashion house Versace is investing more than US$56 million to increase its presence in Asia, with a specific focus on China, and is slated to open 11 new stores across the region this year, according to statements by former chief executive Giancarlo Di Risio. The company gave its first fashion show in mainland China in November last year, at Beijing's Legation Quarter, the former residence of the American ambassador that has been turned into one of Beijing's trendiest venues.

A year earlier, celebrities turned out en masse for Fendi's four-day party on the Great Wall, where part of the former defense shield was fashioned into a catwalk. And between November 2008 and January 2009, more than 60,000 patrons lined up to see Christian Dior's art exhibition at UCCA Beijing, entitled, "Dior and Chinese Contemporary Artists."

"All luxury brands are putting money into promotions and PR," says Cheung. "They know that whoever invests now will get a better market share in the future."

Understanding China's Wealthy

Unlike the singular group often portrayed in media reports, China's newly rich are a varied bunch, but they can be broken down into three general demographics, according to Shaun Rein, managing director of China Market Research, a Shanghai-based consulting firm.

The first are the super-wealthy. With incomes of US$10 million or more, China's super-rich have been buffered from the worst of the current financial storm.

The second group, composed mainly of upper-middle management and white-collar workers making between US$200,000 to US$300,000 per year, are the aspiring rich, and are the apple of the mass luxury market's eye. But this category was the worst hit by company restructuring and downsizing, and these consumers are now more cautious about spending cash on wear-only-once Versace dresses or purchasing expensive Starbucks lattes during office lunch breaks.

Luxury buyers in the third group have salaries that belie their combined purchasing power and are mainly office workers making roughly US$600 or more a month. According to a recent survey conducted by China Market Research, more than 70% of respondents in this demographic said they will open their wallets more in the coming six months versus the last six, according to Rein. The survey's results also indicate at least a 20% increase in market consumption in this demographic, especially in cosmetics.

The majority of China's wealthy are young, with 80% below 45 years old, compared to 30% in the U.S. and 19% in Japan, according to McKinsey. Chinese consumers are also more focused on the functional value of luxury goods, and hesitate to spend on items not suitable for daily use.

The past decade has seen an evolution in both the types of consumers in China and in consumer sentiment, says Kress. When money first began to flow into the country, a handful of Chinese got very rich, very quickly. New to the market, this group was hungry for a chance to display their wealth, but lacked sophistication and knowledge of luxury brands. Assuming that the most expensive meant the best quality, they searched for the highest price tag.

As recently as five years ago, many companies saw China as a dumping ground for last season's styles, says Kress. But as the Chinese started to travel, they quickly learned there was a difference between what they saw on shelves at home and what was on offer in boutiques abroad. Their growing economic power forced luxury brands to take notice. Now, accounting for slight adjustments to suit local tastes, Chinese shoppers in Beijing will find the same clothes hanging on the rack as in designer boutiques in Tokyo.

As the market opened, general knowledge of brands increased and tastes became more sophisticated, Kress notes. People developed an affinity for customized personal items at an impressively fast pace, and luxury brands have had to adjust accordingly. Major designers, such as Chanel, whose recent show in Beijing featured clothing inspired by traditional Chinese dresses, or qipaos, are gearing new lines towards Chinese tastes.

The Chinese market of the future may very well resemble the current market of Japan, which has developed a more individualist, Western way of consumption, Kress adds. Previously brand slaves, Japanese consumers are now mixing and matching Uniqlo and Hermes garments in any way they see fit, an evolution that is indicative of an economy that has developed enough that a significant portion of people make their living from creative industries. These consumers will want to express their individuality through their consumer choices, he says.

The urban sprawls of Beijing, Shanghai, Shenzhen and Guangzhou house about 30% of the country's wealthy as of today, but by 2015, 75% will inhabit cities like Chengdu and Wenzhou and others in non-coastal regions, as money is redirected into China's interior, says the McKinsey report.

Brands also need to understand the significance of Shanghai and Beijing as cultural reference points for the rest of China, says Kress. Some companies have made the mistake of skipping these cities and heading straight for the potentially lucrative second-, third- and fourth-tier city markets, without realizing these markets take their cues on style and consumption from China's major urban centers.

Other brands have bypassed the rest of China completely, focusing only on the Shanghai and Beijing markets and missing lucrative sales in lower-tier cities. These companies forget that to garner loyal customers out of China's fabled one billion, exposure and access to products is essential, says Kress.

Integrated Marketing Strategies

According to Kress, "A wave of new entrants into the luxury brand market three years ago held the belief that if you build it, [consumersE] will come." Jumping in feet first, they neglected to take the necessary time to adequately train staff, or educate consumers. To the detriment of sales, they underestimated the strength of the Chinese need for comfort and functionality in products.

But selling to any consumer base is rarely that simple. Although Chinese consumers may have some distinctive characteristics, certain principles for marketing luxury brands are universal, experts say. Ye Jian, general manager of ING International AD, an advertisement company for luxury brands, says that successful marketing strategies of luxury jewelry brands like Cartier, Piaget and Tiffany include four key points.

First, he says, the brands play up their often centuries-long histories through advertising that highlights connections with royalty and celebrities. Second, they invest in continually creating innovative designs that secure their roles as world leaders in fashion and luxury. Third, these brands use unified visual images to communicate with their intended audience.

Fourth, these jewelry brands are involved in socially responsible projects. In China, Cartier donated generously to charitable activities in Sichuan after the devastating earthquake last May. The company also initiated Cartier Woman's Initiative Award, an international business plan competition awarding women entrepreneurs who lead creative, sustainable and socially responsible companies, and it created a non-profit art fund to sponsor artists and art events worldwide.

These luxury jewelry brands are also constantly on tour in different cities in China, organize online customer clubs and communicate with them regularly by sending art magazines and newsletters -- all effective marketing strategies that other companies can learn from, says Ye.

It certainly takes more than price strategies to win the hearts of China's wealthy. "Luxury brands belong to an exclusive few in any society, and it is especially so in China," says Zhang of Wharton. "Chinese consumers of luxury products are very conscious of their social status and class, and they consume those goods to feel different and sophisticated. They surely can afford to pay for those feelings -- meaning a low price strategy is not the way to go."

The seminar will address the latest retail development trends in China and it will explore the new challenges and opportunities as retail/distribution companies adapt to the current business environment in China.

It will also discuss the impact that the financial crisis is having on retailers' operations best-practices to optimise cost efficiency in the manufacturing process, the supply chain, the establishment of retail shops, in short, the entire value chain.

Registration: Please contact sophie.ji@dlapiper.com for more information.

Agenda
12:00 - 12:30
Lunch and registration

12:30 - 12:45
Introduction: Retail/distribution trends in China,
Speaker: Corbett Wall, China Director, Pacific GeoPro

12:45 - 13:30
Panel - Adapting to today's China: How companies are dealing with the challenges and the opportunities - smart strategies in expansion and downsizing,
Moderator: Ghislain de Mareuil, Partner of DLA Piper Shanghai,
Panelists: Lelio Gavazza, Chief Executive Officer, Sharmoon EZ Garments Co., Ltd., Nicolas Jeanjean, Executive Director, Albatross Global Solutions and Richard Wageman, Of Counsel, DLA Piper Beijing

13:30 - 13:45
Coffee break

13:45-14:30
Break-out workshops

Workshop 1:
Lean Logistics, Moderator: Chris Deans, China Supply Chain Council

Workshop 2:
Real Estate, Moderator: Kit Kwok, Partner of DLA Piper Shanghai

Workshop 3:
Employment, Moderator: Kevin Jones, Of Counsel of DLA Piper Shanghai and Carol YP Zhu, Associate of DLA Piper Shanghai

14:30
Event ends

Recently with some of the mall work we've done, I've heard statements from developers and government officials such as, "Our trade area is 500km. People will come here from the next province." Now you can start to understand why there are so many non-performing assets creating heartburn for asset management companies and banks across China. How do you define wild expectations? A 500km trade area comes to mind.

The link below is a very interesting, though somewhat dry, explanation of how to define trade areas. Do understand that this is geared completely towards an American style retail environment, and it's not the same as China, but the logic is the same. It becomes more entertaining if you imagine the speaker is actually George Castanzas from the Seinfeld TV series.

Video: Creating retail trade areas...

"In tough times, managers instinctively rush to unleash a host of new programs and initiatives—they extend store hours (or cut them back), implement a new staffing system, reallocate store space, introduce or extend loyalty programs, offer “triple point days” and special promotions for big spenders, reorganize store operations or the merchandise or marketing department—even tinker with the parking lot..."

February 12, 2009
By Don Lee

Reporting from Shanghai — Down an alley from a KFC, McDonald's and Pizza Hut in Shanghai, Li Hong sat inside a dingy little storefront that serves full-course dinners for a dollar.

Her tray was filled with cabbage, carrots, potatoes, a chicken leg and rice, plus soup. A Western fast-food meal would have cost her three times that much, said the young woman, who works as a sales clerk. "Why should I go there?" she said.

In the U.S., fast-food chains often thrive in tough times. But not so in China, where Western quick-service food isn't the cheapest stuff in town and, in target markets like Shanghai, there's too much competition. Plus, a growing number of consumers see it as unhealthful.

"Western fast food is still not cheap enough," said Yee Mei Chan, a group-account director at Millward Brown's office in Beijing.

In a recent survey, the marketing research firm found that 78% of Chinese consumers were feeling some effect from the global financial crisis. About half said they were likely to cut down on eating at Western fast-food restaurants.

That might help explain why Yum Brands Inc., China's largest restaurant chain with nearly 2,500 KFCs and 416 Pizza Huts, said same-store sales in the country were up just 1% in the fourth quarter compared with year-earlier growth of 17%.

In the U.S., Yum's same-store sales, an industry measure of branches open at least a year, rose 2% in the latest quarter, ended Dec. 27.

McDonald's Corp. doesn't report such figures for China, where it has about 1,050 stores. But Jeff Schwartz, head of China operations, said, "We had some softening at the latter part of 2008." He noted that sales rebounded in January, rising higher than a year before, but that also reflected an earlier Chinese New Year holiday.

Like many retailers in China, including Wal-Mart, McDonald's cut prices recently, saying it wanted to do its part to keep China's economy growing. Its new "value meals" cost $2.42, a saving of up to one-third for combos such as a double cheeseburger, medium-size French fries (or cup of corn) and a Coke.

Schwartz said he remained "very bullish" on China. McDonald's is on its way to opening 175 stores in China this year, he said, more than anywhere else.

Yum is also planning for another year of high growth in China, which has been increasingly driving the corporation's profits. And other food and beverage retailers, including Burger King, Dunkin' Donuts, Starbucks and Cold Stone Creamery, are bulking up in China as well.

With rising affluence and changes in lifestyle, the pace of China's spending on eating out has been growing by double digits year after year. The China Cuisine Assn. estimates that sales surged 24% last year to $225 billion at the nation's 4 million eating and drinking establishments.

If Western fast-food diners are slipping a bit, it could be that they've "lost some of their freshness," said Xu Yunfei, the association's industry development director.

KFC, which opened its first store in China in 1987 and has since penetrated deep into the nation's heartland, still has a lot of cachet in rural areas, where its restaurants are often packed. But most foreign retailers in China have yet to enter such smaller markets inland, tending to focus instead on young consumers and the middle class in China's urban centers.

Yet once-booming coastal cities such as Guangzhou and Shenzhen are now reeling from a falloff in exports and industrial production. Even in Shanghai, with its large service economy, it isn't hard to find people who are battening down the hatches.

On a recent Friday evening, Wu Lei, 40, and her 11-year-old son were having dinner at a McDonald's in a northeast Shanghai neighborhood. Most of the seats in this two-story restaurant were taken, though plenty of students had only books and papers spread out on the tables.

Wu said she and her husband, both architectural designers, saw a 20% cut in pay between them in the last year because of a lack of work.

"I might come more if it's cheaper," she said, adding that she takes her son to McDonald's and KFC each once a week. On this evening the total tab was about $5.

Other customers at this branch and several others said lower prices wouldn't change their eating-out routine.

"It's fast food; it's not good for you," said a 30-year-old tech worker who identified himself by his English name, Alex Lu.

KFC in particular met with early success in China in part because consumers viewed it as cleaner and offering more-hygienic foods. In recent ads and promotional materials, KFC and McDonald's have been stressing good value, high quality and healthful lifestyles.

Still, more Chinese are showing interest in nutritional and dietary considerations, which could prove a challenge for purveyors of fast food. "I suspect it's more of a long-term trend," said Warren Liu, author of "KFC in China: Secret Recipe for Success."

In many other cases, consumers said they simply preferred Chinese food, including quick-service establishments, of which there's no shortage.

In Shanghai's northeast Yangpu District, an area of 23 square miles, research firm GeoPro counted 4,990 eating and drinking places. About 40% were quick-service, take-out eateries or shops.

"There's immense saturation," said Corbett Wall, GeoPro's China director.

And as the economy has weakened, Chinese fast-food operators too have been engaging in price wars, trying to undercut rivals.

Real Kungfu, a chain of 309 restaurants that uses an image of Bruce Lee in its logo, has introduced a lineup of "extra value meals" that includes rice, meat and vegetables, steamed egg, soybean milk and green-bean soup for about $2.58. Real Kungfu's president, Cai Dabiao, insisted it was a better deal than a Western alternative.

"Rice suits Chinese people better," he said.

don.lee@latimes.com
Click here for article

Problem

With escalating capacity and competition, time and speed to market in untapped territories increase Starbucks’s effort to remain a leader in the Thai marketplace.

Solution

A getchee system to segment different demographics and estimate sales potential of a given area, based on customer visits and expenditure per ticket.

Summary

Company - Starbucks Coffee Thailand, a wholly owned subsidiary of the Starbucks Corporation, with its first store open in July, 1998, is a relatively young presence in Thailand, nevertheless has seen rapid expansion throughout the nation in the past decade. Of the total 131 stores in Thailand, 94 are located in Bangkok. The core Store Development team, made up of 3 people, has their vision to continue expanding within Bangkok, a market that looks saturated at first glance, but is still believed to have great potential. The strategy is to unearth hidden pockets in the city where a primary target audience of 16-44 year olds can be found in high concentrations. A single store generally serves an average of 200-300 customers a day. Malls with a rounded tenant mix are attractors and popular streets with heavy footfall seem like strong locations. Careful store planning is necessary to justify a minimum investment of 250k USD per store.

Challenge - Neighborhood demographic data in emerging markets, including Thailand, retain at a macro level and surveys carried out to increase granularity bear high costs. Traditionally, Starbucks Coffee Thailand had deployed information from paper and digital maps, and assembled data with further support from site surveys to make siting decisions. With added local knowledge and gut feeling, short-listed locations are pretty much set for store execution. With escalating capacity and competition, time and speed to market in untapped territories increase Starbucks’s effort to remain a leader in the Thai marketplace.

“Instead of augmenting our best practices, getchee gives me a quick glance of an area so I have a good sense of the kind of trade area the potential store is in.”

Manual labor, a concerted effort, sees a new light as location intelligence with enhanced data and mapping capabilities added a new dimension to the development process. As a regional effort, getchee, Asia’s only location intelligence mapping tool recommended to the local team by the Asia Pacific head office located in Hong Kong, increased efficiency mainly by saving time on data collection and enhancing siting capabilities by validation of target demographics and location dynamics. “Instead of augmenting our best practices, getchee gives me a quick glance of an area so I have a good sense of the kind of trade area the potential store is in”, says Supoj, Development Manager of Starbucks Thailand. Demographics distilled to a trade area size as small as 200m are made available via quick reports, easily printable or shared through getchee's Enterprise tool.

Result - Based on Starbucks’ specific target audiences, getchee is able to segment the different demographics of the population and estimate the sales potential for a given area based on customer visit frequency and expenditure per ticket.

“We can’t cut and paste U.S. standards of siting in these regions, but with getchee, a pattern can begin to form.”

Furthermore, enriched proprietary data such as day-time and working population gives the team an even more accurate estimation of transactions during the day compared to night-time. Starbucks Thailand gained answers through hard numbers found conveniently via a few clicks on getchee through the Web. Other advantages the team found were the heat maps which they deemed unprecedented in the market. The maps are customized to the relevance of the coffee business and help visually focus on areas that matter. “These intensity or heat maps save me a lot of time when I’m making a search”, Supoj says. Even in the early stages Starbucks Thailand found getchee uncomplicated to use. With the suggestions and tweaks the team freely shares in the process not only reflect on the output, but improves future product enhancements. Overall, the Asia Pacific head office says that the benefits getchee brings are beyond data and numbers. It is in a standardized process they inculcate through the use of getchee that the regional managers can increase expansion and siting methods in the long term via the same platform. “We can’t cut and paste U.S. standards of siting in these regions, but with getchee, a pattern can begin to form,” Supoj explains.

LA-Z-BOY TO CUT 850 JOBS, CLOSE UP TO 20 STORES

"Furniture maker La-Z-Boy Inc. said Thursday it will cut jobs and close stores as orders plunge in response to the economic turmoil."

There's lots of ways to read meaning into that statement. I guess it comes down to less plush seating for plush butts. Think what that will do for TV sales.

And on the other side of the world: I was in a development meeting with a client yesterday (they are the largest retailer at what they do with 1300 stores) and they are in emergency change mode in response to the current domestic consumption drop which they say is about 10-15% across the board for all of their stores.

What struck me the most was their attitude to adversity. They are seeing this as a huge opportunity to grab market share and grow, not reduce workforce and shrink. They estimate that China is in a three year U-shaped down cycle, and that we are not yet to the first corner of the U. Given that their Chairman is one of the richest men in China, they can probably afford to be bold. Besides a complete rebranding, store redistribution, product mix revamp, and operational changes, they want even bigger stores "because when things get bad, people will trust large stores, not small ones."

I think this also says a lot about the past and future...of China.

Here's a summary of my understanding of the most obvious drivers, which will go to HQ in hopefully less than 5 pages. (I've taken out sensitive internal commentary, but you can still get the drift.)

1) Foreign Exchange Reserves

China's cash reserves, now estimated at 1.8 trillion, have grown in large part due to the central government's policy of boosting exports by fixing the value of the yuan to the U.S. dollar. The central bank does this by buying up the dollars brought to China by foreign investors and Chinese exporters. Keeping the yuan cheap has been an important part of China's export oriented policy. If left to market forces, the yuan would be more expensive. The common rationale for a cheaper yuan, is that if the yuan rises too much, China will lose business to other cheaper territories such as Vietnam, India, and Eastern Europe.

With it’s monopoly on currency exchange, the Chinese government has kept the value of the yuan from going to where it should be, providing continuing cheaper exports and more factory jobs, fueling the world's biggest manufacturing machine.

Western governments have diplomatically pressed China to stop buying up so much counterweight dollars, and allow the yuan to float, but China doesn't want to do this, and instead buys foreign bonds, mainly US Treasury and mortgage backed bonds.

2) Credit

For the past year it has been difficult for developers to get loans as Beijing has implemented strict restrictions to ease the impending property bubble and slow down speculation. Those measures worked, too well, and now local developers are scrambling for funds. This credit crunch has humbled many developers, who are now forced to look elsewhere for capital, and foreigners are getting more deal action. But strict foreign investment restrictions for real estate make it more and more difficult for foreign money to reach developer’s pockets. Still, it is possible for foreign investors to buy a stake in an existing project requiring capital, which is not yet restricted.

I've assembled some recent news briefs as a snap shot of the current credit situation, likely to change again at the next National Congress in November.

A) Xinhua recently reported that there was a slowdown in real estate loans during the first half of 2008. "Chinese bankers held loans totaling 5.2 trillion yuan (about 580 billion U.S. dollars) to real estate developers and housing buyers by the end of June, up 22.5 percent year-on-year, the People's Bank of China (PBoC) said Friday. The central bank said the growth rate was two percentage points lower than the same period last year, representing a decline for seven consecutive months since last December. Loans to real estate development stood at 1.9 trillion yuan by June, up 17.7 percent year on year. The growth rate was eight percentage points lower than the same period last year. The country's lenders granted 3.3 trillion yuan to housing buyers buy June, representing an increase of 25.6 percent year on year. The growth rate was 1.8 percentage points higher than the same period last year. Real estate developers and housing buyers received 398.84 billion yuan in loans between January and June, which was 170.66 billion yuan less than the same period last year, said the PBoC. "

B) In an unexpected move, the central bank just this week cut the benchmark lending rate by 0.27 of a percentage point to 7.2 percent, the first time it has reduced the rate since 2002.

C) The most recent (9/17/08) Asian Development Bank report expects bank lending controls to ease beginning in the second half of 2008 to assist small firms and avoid downsizing. Fiscal policy is projected to remain slightly expansionary.

On 9/15/08 PBoC announced it would reduce the benchmark loan interest rate and the reserve requirement ratio for commercial banks to ensure a steady and rapid economic growth. In addition, the ratio of deposit lenders are required to set aside will be down 1 percentage point from Sept. 25. After adjustment, the interest rate for one-year loans in the Chinese currency will be 7.20 percent. The overall reserve requirement ratio will be 16.5 percent, down from a record 17.5 percent after five consecutive increases this year.

The move reflected the government's concern over the slowing economy and was a result of long-time consideration, said Zhuang Jian, a senior economist with the Asian Development Bank Resident Mission in China. "It showed the government was eager to maintain the economic growth as enterprises faced difficulties, especially funding strain. The eased inflationary pressure also provided more room and time for the adjustment."

3) Inflation

Where does China’s inflation come from? It comes via all the dollars from exports needing conversion into RMB. As demand for the yuan increases, Beijing prints new money rather than let the value of the yuan rise too quickly. Even with bonds, China’s monetary system cannot mop up all the extra cash, so prices have risen as a result and the stock and real estate markets have become inflated.

There is a see-saw relationship between inflation and RMB appreciation. The balance hinges on exports. On one side is the Bank of China (PBoC), who argue for RMB appreciation and have made the case that RMB appreciation is important in fighting inflation. On the other side is the Ministry of Commerce (MoFCom), who are strongly pro-export, who argue that RMB appreciation hurts exports. MoFCom has strong allies in the cabinet, including the National Development and Reform Committee (NDRC), the Ministry of Finance (MoF), and the Customs Authority.

However the see-saw tilts, it is generally agreed by economic experts outside of China that the RMB needs to rise in order to slow the inflow of hot money, otherwise domestic monetary expansion will continue.

4) Domestic Consumption and Monetary Expansion

What is monetary expansion? China's large trade surpluses and capital inflows (mainly hot money) lead to domestic monetary expansion as the excess capital is reinvested into industrial production. This results in over-expansion and over-investment. As production outpaces domestic consumption, the trade surplus continues to increase, feeding further monetary expansion, and the cycle repeats itself, over and over. This cycle works as long as a strong economy (which has mainly been the US) can continue buying all these Chinese products. But as the US buys less and less, due to it’s own financial woes, there is the strong possibility of excess production in China. The slowing global economy means that Chinese manufacturers will be forced to turn towards the pre-nascent domestic consumer market, which currently cannot consume nearly as much as the West.

The most recent government figures show that industrial output grew by 12.8% year on year in August, versus 14.7% in July, and 17.5% last August. Nearly all sectors slowed, meaning there will be more pressure on domestic consumption to keep the economy strong.

We already know that the retail market is crowded in China, and getting more crowded every day. Pumping exports fell strongly in line with the old political narrative of "Feed the People." Now that this golden goose is cooked, will the "People Feed Themselves"? If exports drop, millions of jobs will be lost, and if inflation continues, food, clothing, housing will be out of reach for millions.

5) US/China economic coupling

As the Fannie and Freddie fallout has made very clear, China has clearly bankrolled much of the US debt. By supporting the US debt, the Chinese are supporting the US appetite for more Chinese goods, which in turn provides more jobs and a better future for people in China. So in many ways US and China are just different sides of the same coin. One side produces, the other buys. The buy side spends more money, which goes over to the produce side, which in turn sends more money back over to the buy side. It's a relationship that has been working for many years to both countries' advantage until Fannie and Freddie, and the more recent Wall Street meltdown. It turns out that this tag team affair was heavily leveraged on something called derivatives - typically collateralised debt obligations and credit default swaps - which are essentially calculus-esque financial products created by an unregulated Wall Street to make money on product "derived" from actual market indices, but don't really have a shape or form - and are carried OBS, or off balance sheet. Things like loan commitments, futures, forwards, etc. One can think of these derivatives as kind of like selling shares in products called "promises" and "wishful thinking."

6) Out of Control Money Growth

Many economists and world think tanks feel that China will soon have to have a major adjustment - either a sharp rise in inflation or a sudden debt deflation.

For an interesting historical reference, equally valid today, here are Irving Fisher's 9 steps that occur in Debt Deflation, from his “Debt-Deflation Theory of Great Depressions” (1933).
1) Debt liquidation leads to distress selling, and to
2) Contraction of deposit currency, as bank loans are paid off, and to a slowing down of the velocity of circulation. This contraction of deposits and their velocity, precipitated by distress selling, causes
3) A fall in the level of prices, in other words, a swelling of the dollar. Assuming, as above stated, that this fall of prices is not interfered with by reflation or otherwise, there must be
4) A greater fall in the net worth of business, precipitating bankruptcies, and
5) A like fall in profits, which in a "capitalistic," that is private-profit society, leads the concerns which are running at a loss to make
6) A reduction in output, in trade, and in employment of labor. These losses, bankruptcies, and unemployment, lead to
7) Pessimism and loss of confidence, which in turns lead to
8) Hoarding and slowing down still more the velocity of circulation.
The above eight changes cause:
9) Complicated disturbances in the rates of interest, in particular, a fall in the nominal, or money, rates and a rise in the real, or commodity, rates of interest.

Japan is currently dealing with 13 years of this situation, and has an enormous stockpile of NPLs to show for it. The same situation could occur in China if the property bubble continues, exports drop, monetary expansion goes unchecked, and policy continues to see-saw.

7) Implications for foreign property investment in China

Residential
Chinese consumers, banks and corporates are far more heavily invested in real estate than in stocks, and falling prices are already starting to show from Shenzhen up to Shanghai. This momentum coupled with a general slow down fear (stocks, prices, US markets) can potentially create a negative snowball effect in pricing. This is already happening as homeowners are waiting to see what happens, and developers are getting choked, reducing prices dramatically. September/October is the peak home-buying season, and we can expect a slowdown to effect developers dramatically as the sky is falling sentiment grows. It usually takes about 6-12mo for cause to turn into effect, so any potential effect will probably be seen by next summer.

Retail
As the Chinese stock market is still small relative to GDP, it's rapid fall will more than likely only give people the shivers, without seriously impact spending. If things get messy, which is quite possible, and people start having trouble paying their mortgages (people are more invested in property than the stock market), there will be an impact in spending, which will impact retail, and an impact in retail will logically spill over to retail real estate. Yields will become more difficult to achieve as tenants will argue that people are not spending, and there will be too much available stock in the market, as is evident already in Beijing.

Commercial
China is clearly on the world's stage, even more so after the recent Olympics, and businesses will continue to come here, and they will all need offices. The market in 2nd tier cities will more than likely be soft.

In The News
A recent South China Morning Post article reports: "Mainland property developers have resorted to steep price discounting to lure buyers back to the market this month and next, the traditional peak home-buying season....However, the tactic has so far shown no sign of reversing the decline in property sales and analysts do not expect lower prices alone will be enough to restore buyer confidence."

Wang Qing, chief economist for Greater China of Morgan Stanley, said in a report released recently that he's in favor of China's real estate market, and predicted that China would loose its policy on the industry in the first quarter next year, then in a later report released on September 12, he said that since the housing price in big Chinese cities dropped sharply, China's real estate industry is very likely to crush, and may cause significant impact on profit performance of banking industry. MS have now begun unloading properties in Shanghai. Hmm...

To add to the pile, Goldman Sachs said that "the worst time that weak Chinese real estate market striking banking industry has not come yet, and risks induced by the industry's bad loans will emerge in the fourth quarter this year and the first half of 2009."

Today's (9/19/08 ) China Daily reports on a financial forum just held in Beijing, "It is time to lift excessive regulatory restrictions on private sector financing, which could help boost the dynamics of enterprises as well as improve the capital efficiency of the financial industry as a whole," said Wu Xiaoling, vice-chairwoman of the Financial and Economic Committee of the National People's Congress. Wu said encouraging private companies to raise money directly from investors could also help reduce pressure on the government to relax its monetary policy, which is central to the fight against inflation. Wu Xiaoling and other officials agreed that fiscal policies should be further relaxed to help stimulate domestic demand and encourage domestic consumption to offset declining external demand triggered by global economic uncertainties.

The policy winds seem to be blowing towards the domestic consumption side of the see-saw which potentially means less control in the hands of MoFCom and MOF and their allies, and potentially more power in the hands of the PBoC. PBoC by nature wants to stoke domestic consumption, which would require some further softening of the current credit restrictions. Whether a softening will include property developers is another story, as real estate exposure in the banks is a huge worry for the PBoC in case of a slowdown in economic growth, which looks likely to occur.

NOTE: This summary is compiled from many of Michael Pettis’ very informative writings, current news articles in IHT, WSJ, Financial Times, etc, and a wide variety of economic reports and white papers from banks, consultants, and real estate firms.

Hanzhong is definitely out in the sticks. A couple flights in and out a week, and if you're in a hurry, there's a winding four hour bus ride north to Xian.

What I saw there really surprised me. I was expecting a lot of dust, thick pollution, and a scream of motorbikes and peasants. What I saw instead was a comfortable easy going city powered by a strong aviation industry, clear blue skies, and fast retail expansion. Within 500 meters of the city center there were a half dozen or more malls and department stores (current or under construction), a busy pedestrian street, and a dozen or more mobile phone retailers selling the latest Motorola or Nokia handsets. I didn't see any other foreign brands except for sport shoes, the ubiquitous KFC (which was busy), and an empty Starbucks knockoff.

If you wanted to settle down in Hanzhong you could pick up a newly fitted out apartment for less than RMB3000psm, but a pair of Adidas would still cost you RMB650.

It was obvious Hanzhong was on the to-do list of some major developers. Four new malls were sprouting up within shouting distance of each other, strata titled of course to ensure quick returns for the developer but long term chaos for the retailers. Good luck there guys.

My next stop was Xian, historically known as one of the ancient capitals of China for over thirteen dynasties, dating back to 1122BC. Everything in Xian was moving fast, and the pollution was worse than I've seen in Beijing. This was a city overflowing with Chinese tourists and way too many places to spend that slippery tourist money. There were even dueling multi story KFCs right across the street from each other. Along the main strip, you found malls on each corner, along the corridor, and even underground. One hi-end Plaza 66 style mall even parked their customer's BMWs, Mercedes, and Audis out front in a row, luring you in with ostentatiousness. This was all within a 1km radius.

At night it was another form of consumerism. There was an intoxicating giddiness in the air at local clubs, where the under thirty crowd were definitely out to party. This was the kind of partying where people were almost gushing "We're in the money!" No worrying about inflation or the price of oil here. Bartender, open another bottle of Chivas and green tea!

So what does this mean to someone wanting to get in on the action? If you are a foreign retailer entering Xian, you need to ask yourself, isn't it too late already? You could start focusing on defining local sub-markets, building brand loyalty, and really start thinking about getting into the smaller cities now. You also need to tell yourself, HQ, and anyone involved in the decision making process, that Western China is developing faster than you can even plan your China entry or expansion.

Internally it actually works more like this: your operations will probably begin a discussion with international, then bounce over to the data people, then bounce over to finance, then up to management, then back to international. You get the picture. Lots of bounce. By the time the ball has stopped bouncing, the landscape you are looking at has completely changed. But has the target customer changed? Most likely not. They just have more choices, and you as the QSR have to deal with more competition.

In Econ 101 we were taught that competition is a good thing for all the standard reasons - lower prices, better product, more selection, etc. But actually, I'm learning that competition is good because you can actually count it. If you can count it, then you can map it. If you can map it, then you can make predictions. If you can make predictions, then you can model it, and if you can model it, you can build a financial analysis.

So, I was thinking about all this while looking at target customers in terms of how banks, car dealerships, QSRs, appliance stores, sports outlets, etc, were spreading out in different cities to try to reel them in, like fish in a net. Retail naturally follows the movements of the target customer, and in China, as cities expand so quickly, people are really moving around. By following the growing shape of the competitive landscape, you can gain some insight into the way city areas are developing, and most importantly - where the fish are.

After spending all day looking at all these little consumer fishies swimming around my excel sheet, I started playing with different data layers, or sticking with the fishing analogy - trying out different line and lures. I also had access to different types of boats with interesting names. One was Brand Recognition. Another was Social Development. A third was Lifestyle Indicators.

So for my particular experiment, here's how the fishing stacks up around different smaller cities in China. Sorry, I can't tell you what kind of fish or the exact lure I was using. That would be cheating! But we are available for chartered tours.

Small boat, faster lure, light line:

1. Fuzhou
2. Kunming
3. Zhengzhou
4. Wuxi
5. Ningbo
6. Fushan
7. Changsha
8. Qingdao
9. Suzhou

Big boat, slower lure, heavy line:

1. Xiamen
2. Changchun
3. Changsha
4. Ningbo
5. Zhengzhou
6. Qingdao
7. Fushan
8. Xian
9. Wuxi

Medium sized boat, flashy lure, mid-weight line:

1. Qingdao
2. Shijiazhuang
3. Changsha
4. Wuxi
5. Yangzhou
6. Xiamen
7. Dalian
8. Ningbo
9. Changchun

It's a very complicated structure, and you can easily get lost trying to get out, or to your car, or to the third floor, or to the parking pay machine, or to the clubs on the top floor.

I snapped this photo of the sign in front of elevator #6, which read like an IQ test, and was a good lesson in bad mall management.

Can you figure it out?

Quick hint mini-translation:
- Weekdays
- Weekends
- After Hours A
- After Hours B

In the US, with intense competition and fickle shoppers, most retailers, developers, and investors have figured out that in order to be successful, they need to understand their customer. There are so many shopping centers scattered around neighborhoods in the US that the focus is on what the customer wants rather than what the property developer wants.

Now on the other side of the world where I live, it's amazing to me that this equation is turned on it's head. So many investors and developers are building huge hundred million dollar properties across China thinking "I built it, now they will come." This is sort of the retail version of Descartes' "I think therefore I am." I don't know if these local developers understand Descartes, but they definitely understand Louis Vuitton. But do they understand their customers? From what I've seen, it doesn't look like it.

If they did, wouldn't they think about customer experience, tenant improvements, and merchandising mixes? Wouldn't they want to know where these customers were, how often they are likely to shop, how much they are willing to spend, and what kinds of things they are interested in buying? By not paying attention to these things, and fully analyzing their market (ie: understand their customer) these developers are now creating what we call "gui gouwu zhongxin" - or ghost malls.

Out of curiosity I did a quick search for "gui gouwu" and to my surprise found a fantastic article in Time that discusses every issue of why I'm in business. I highly recommend this article to anyone interested in Chinese shopping malls.

Retail: Aspirational Hazard
By KATHLEEN KINGSBURY/BEIJING

Beijing's golden resources mall ought to be a shopper's paradise. Built on the city's outskirts in 2004, the Art Deco-style center boasts a staggering 6 million sq. ft. (560,000 sq m) of retail space, making it the world's second largest mall, 30% bigger than Minnesota's famed Mall of America, once the largest. Golden Resources accommodates more than 1,000 shops, dozens of restaurants, 230 escalators and an ice-skating rink. On its five floors, you can buy everything from fur coats to exercise equipment to pet supplies.

Beyond this burst of attention, Changsha is usually in the top 20 list for 2nd tier cities in terms of economic development, consumer spending, and real estate development. One of our group's clients, a major sportswear brand, has 33 retail outlets there. Their competitors have even more. There are also 26 KFCs and 132 ICBC bank branches. So with 6 million residents, Changsha isn't really a sleepy cow town.

When investors complain that they aren't hitting their IRR anymore in Shanghai and Beijing, they have a couple of options. One, reduce their IRR expectations, or two, take the Wanda/Capitaland litmus test. What's this test all about? Pretty simple. If there's already a Wanda or CapitaLand mall in a city you've never heard of or been to, then you should probably get out there and take a look. You might be surprised, even if you can't order a cappuccino.

Some Changsha news that's come across my desk recently: