Rise of China's Middle Class

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Increasing prosperity among the Chinese populace is creating a new market for Western retailers who previously envisioned China solely as a supplier of goods. The burgeoning Chinese middle class also creates opportunities for Western financial services providers and insurance companies, automobile manufacturers, and affordable luxury goods producers, such as cosmetics companies.

For investors, the middle class signifies those Chinese with their own capital to invest – a phenomenon that is heating stock markets around the world. See Table 1.

China: Lifestyle Indicators
  2003 2004 2005 2006 2007
Consumer expenditure on food (US$ million)197,818213,312232,803264,965276,255
Internet users ('000)79,500094,000121,354153,431189,419
New registrations of passenger cars ('000)1,9722,3262,6032,761 
Consumer electronics (RMB million)160,355173,934188,535202,470213,832
Dog and cat food (RMB million)1,4181,5991,7972,0072,223
Source: Euromonitor

Table 1


Who Benefits from the Rise of the Middle Class?

Opportunities for Retailers

As more Chinese households have disposable income in excess of their basic necessities, a substantial share will likely be spent on food, apparel, household products, and personal products. These four categories could grow 3x from a market of 1.9 trillion renminbi ($232 billion) in 2006 to a market size of 7.7 trillion renminbi in 2025. Retailers of these products are likely to benefit. Chinese consumers still spend a fraction of what shoppers in other developed markets spend, but retail sales are increasing 15 percent annually. China can generate $860 billion in retail sales by 2009. In December 2004, China removed remaining investment restrictions on its retail industry, allowing overseas companies to operate without a local partner and in any city.

Wal-Mart, Best Buy, Home Depot, and Tesco have expanded into China by investing in or establishing a joint-venture with local retail chains. In order to double its presence in China, Wal-Mart spent $1 billion in October 2006 to acquire the Taiwanese big-box retail chain Trust-Mart, which was already well-established in Mainland China. At the time of the acquisition, Wal-Mart operated 66 stores in China, while Trust-Mart had about 100 outlets and 30,000 employees. Trust-Mart stores are largely low-end supermarket chains, and are located in twenty of China’s thirty-four provinces and regions.

  • Wal-Mart first entered China in 1996 with a Wal-Mart Supercenter and a Sam's Club in Shenzhen. At present, the average Chinese shopper spends about $4 at Wal-Mart, compared with $20 spent by the average U.S. Wal-Mart shopper. Despite its large investment in China, Wal-Mart still trails both French retailer Carrefour, as well as several large Chinese-owned retailing chains that have been consolidating. Carrefour already has more than 200 stores in China and had sales in 2005 of about $2.4 billion. The two largest Chinese retailers, China Resources and the Shanghai Brilliance Group, each have over $3 billion in sales, and over 8,000 stores combined. These “hypermarkets”, such as Carrefours, have been a huge success in urban China. For example, in Shanghai, about 63 percent of the entire retail trade is done at modern hypermarkets.
  • Home Depot also announced the $100 million acquisition of a major Chinese chain: Home Way, a home improvement retailer with 12 stores in Northern China of approximately 90,000 square feet each. China’s home improvement market is fastest growing in the world - $50 billion in sales in 2005 and increasing at 12% a year. This trend is fueled by the fact that homeownership has skyrocketed in the past twenty years, as China’s housing stock has changed from entirely state-owned to nearly 70% privately-owned today. In March 2007, the National People’s Congress contributed to a furtherance of this trend by enacting China’s first law to protect private property.
    • In China, Home Depot is competing with other foreign players, like Kingfisher’s B&Q chain from the UK, the largest Do-It-Yourself retailer in Europe and the third-largest in world, which offer both hardware and complete installation services and focused on the many new apartments that are sold as empty shell units. In 2005, B&Q sales rose nearly 48 percent to £313 million ($611 million), its sixth consecutive year of double-digit growth since it entered China in 1999.
  • IKEA Group entered China in 1998 by opening its first store in Shanghai. All IKEA stores in China operate as joint ventures. It later replaced this store with a 33,000 square meter (108,00 square foot) location that attracted 80,000 visitors on its opening day, offers more than 7,000 products, as well as a children's playground and 500-seat restaurant. IKEA opened its first Beijing store in early 1999 and expects to have ten large stores in China by 2010. IKEA learned that price-elasticity is a critical component of retailing to the middle class in China. After lowering prices nearly 10 percent, IKEA's China sales rose 35 percent in 2003 and 50 percent in the first quarter of 2004. Even though 25% of its products are made in China, IKEA is another example that foreign retailers can profit, regardless of the source of their goods.

A typical IKEA customer earns about 3,300 renminbi ($399) per month – significantly above the national average – and buys 300 renminbi ($36) of merchandise per visit. The typical customer is 20 to 35 years old – particularly families with children or are double-income, well-educated couples with no children. About seventy percent of IKEA customers are female. Because labor is cheap in China, the Do-It-Yourself product has not taken hold, so Chinese customers use IKEA's assembly services more than customers in other countries.

Home Depot, IKEA, B&Q, and their competitors all see additional opportunities as the average amount of living space per person in China continues to increase. Historically, Chinese apartments averaged 130 square feet, however Beijing and Shanghai apartments now average 260 square feet. This means several things: Chinese residents need more furnishings and, because consumers are buying more gadgets, they need more storage containers and facilities.

Educational Investment

The intense competition for relatively scarce slots at leading schools already results in intense pressure on children and young adults to invest their energy into education. Under the one-child policy, the aspirations of two and four grandparents are all pinned on one student. As per capita household income rises, it is likely that a disproportionate share of income will be spent on additional education. The rising salaries that accompany advanced education will reinforce this trend.

  • Just as Japan boasts an entire industry of “cram schools” for college aspirants and India features scores of for-profit computer programming schools, China will be a fertile market for education businesses, such as the Washington Post's Stanley Kaplan and Princeton Review.
  • Textbook publishers, to the extent they overcome piracy of their products, will also benefit.

Consumer Credit

China boasts the highest savings rate of any major country, thereby demonstrating the fiscally conservative nature of its citizens. Further, China is still predominantly a cash society, with most cards used solely for ATM or debit purposes. Chinese consumers are much less leveraged than their peers in emerging and developed economies. Total outstanding consumer loans in China as a percentage of personal disposable income was estimated at 27% as of 2003, compared with 55% in Taiwan, and 94% in the US. Further, these loans are only 13% of total bank deposits held by Chinese consumers.

The middle class has started using credit cards, however. Due to a lessening of government restrictions on the consumer credit industry, combined growing merchant coverage by credit card acquirer networks, and increased foreign travel, the Chinese credit card market is growing rapidly. By April 2006, the International Herald Tribune reported that 40 million credit cards had been issued in China. A recent study by AC Nielsen indicates that consumers between the age of 25 and 34 have the highest credit card possession rate, with over 35% of them possessing one or more card.

Among the many credit cards issued by Chinese and overseas banks, the most popular card was the Peony Card issued by the Industrial and Commercial Bank of China (ICBC), which was owned by 13 percent of all credit card users. The closest competitors to the ICBC Peony Card were the China Construction Bank’s (CCB) Long Card and the Bank of China’s (BOC) Great Wall Card, owned by 9 percent and 6 percent of credit card users, respectively. Major foreign joint-ventures include London-based HSBC, which owns 20 percent of Bank of Communications, and Citigroup, which offers co-branded cards with Shanghai Pudong Development Bank.

It should be noted that, as of 2006, only two percent of Chinese cardholders frequently roll over their bills, as opposed to paying in full each month. This compares a 56% rollover rate in the United States, according to 2004 figures from the Federal Reserve. Roll over create large income streams for credit card issuers.

By comparison, non-credit card based personal loans showed far less growth. The same ACNielsen survey revealed that, on average, only 7% of people Guangzhou, Shanghai, and Beijing used Personal Loans in the past 12 months.

Insurance

As China’s population becomes more affluent, the life insurance market growing by 30 percent per year, and China will soon become the world's fourth-largest market. A study by ACNielsen revealed that 36% of consumers in China’s three most developed cities said they purchased life insurance. Rapid growth of the market will propel it to more than $100 billion in premiums by 2008, making it a larger life insurance market than France and Germany.

  • Ping An and China Life are well-positioned domestic players in the China life insurance market. ACNielsen determined that Ping An was the leading life insurer in Beijing and Shanghai, with 11% and 20% of people as policy holders. In Guangzhou, however, China Life beat Ping An by 4%, grabbing a market share of 12%. Overall, China Life, which employs 640,000 exclusive agents in 12,000 field offices, boasts a 44% share of the national market, while Ping An holds a 16% share.

Automobiles

As the middle class expands, car sales in China are skyrocketing. Analysts estimate that that 4.1 million passenger cars sold in China in 2006, representing a 25 percent increase over 2005. This means that there are more than 10 million private cars in China now - about one car for every 120 people. Now many large cities are banning motorcycles in urban areas, which further fuels this trend. In Beijing, a city of nearly 15 million people, 1,000 new cars hit the road every day, causing round-the-clock traffic jams and pollution. One of Shanghai’s efforts to mitigate congestion is to auctions just 2,000 lifetime license per month, with the current price of 40,000 yuan ($5,100).

  • General Motors' Wuling Sunshine Minivan and Chevrolet Spark are strong sellers in China. GM sold 650,000 vehicles in 2005. Already, there is heavy competition from China's own domestic brands such as the Chery QQ. Notably, this has sparked concerns with Chery stealing the design from GM.
  • Volkswagen comes in second behind GM in auto sales in China with 500,000 in 2005. It's specialty diesel cars might gain traction if China pushes hard on its new regulations to clean emissions from its energy usage.
  • Toyota is not as well-positioned in China. Despite being the world's largest carmaker, it is a distant third in China with only 179,000 vehicles sold in 2005.

Luxury Goods

Due perhaps to the surplus of fake luxury goods, the Chinese often attach a premium to the real thing and will pay 30 to 40 percent more for luxury brands than what is charged in New York. Some estimate that China's luxury market is growing by 50 to 60 percent per year an already represents 12 percent of world demand for luxury goods. At this rate, Goldman Sachs predicts that China reach a 29 percent share of all luxury goods sold worldwide by 2015 – and thus surpassing Japan as the world's top consumer luxury market.

  • Estée Lauder, Chanel, Dior, L'Oreal, Procter & Gamble, and Shiseido benefit as many Chinese women enter the middle class, they start to purchase "affordable" luxuries, like skin creams and cosmetics. The cosmetics market is estimated to be $5.5 billion per year and grow at an annual rate of 10 to 15 percent until 2010.

For more on the sale of luxury goods in China – see Luxury Consumption in China

Airline/Travel

Chinese tourism is on the rise. In 2006, over 34 million Chinese went abroad. In the first quarter of 2007, 9.7 million Chinese have visited another country. Domestic travel has also risen dramatically. The Chinese Spring Festival is usually a peak travel period with people visiting their homes or other tourist spots - a record 56.5 million people traveled this time.

What is “Middle Class”?

Present estimates of “middle class” in China range from 100 million to 247 million, depending on how much income renders one “middle class.” Assuming that an income of about$9000 is necessary to be considered middle class, China could have over 600 million middle class citizens by 2015. The China State Information Center, by contrast, considers those earning 50,000 yuan ($6,227) per year to be middle class – and expects 25% of the populace to qualify by 2010. Of course, the level of affluence commanded by each tier depends on where the household is situated. For example, to be considered middle class in Shanghai, China's most expensive city, a family would need to have a higher income than if it were living inland in Chengdu or Chongqing. Roughly 13.5 percent of the China’s population now belongs to the middle class.

While China will still possess a lower average per capita income than the United States, it should be noted that disposable income stretches farther in China, on average, than it does in the United States or Europe. A significant portion of household budgets are expended on services, ranging from hair salons to meal at restaurants to travel. Services are usually labor-intensive tasks whose cost is attuned, in part, to the prevailing wage. In China, due to the vast supply of labor, wages are significantly lower than in the West. Thus, the cost of providing many services is lower and, as a result, prices for many services are lower. A visit to the manicurist might cost $1-2 in China, when a similar visit in the United States might cost $10 or more. Thus, smaller incomes in China can provide a standard of living equivalent to those with a far larger income in the West.

Estimates of the size and growth rate of China’s middle class vary. Roughly half of China's projected urban population will be middle class in 2025. Unlike the United States, where income typically peaks between the ages of 45 to 54, it is predicted that the wealthiest consumers in China will be between 25 to 44 years old because the younger generation will be more highly educated.

The meteoric rise in China’s middle class is tied to dramatic increases in its per capita income, which is growing at a nearly unprecedented rate. The first industrial revolution created a 250% increase in per capita income over a 100 year period. The second industrial revolution triggered 350% per capita income growth over 60 years. By comparison, China is on track to create a 700% growth in per capita income in just 20 years.

Chinese households currently save 25% of their post-tax income, according to the China Statistical Yearbook. A survey by McKinsey indicated that this high savings rate was driven, in part, by Chinese citizens’ belief that they need to set aside funds for retirement and healthcare expenses. If these expenses do not rise as rapidly as income levels, then Chinese consumers may have a surplus of funds that they are willing to spend. And, if health care costs do rise, the Chinese healthcare sector may be an attractive investment.

The World Bank defines “higher middle income” economies as those where per capita annual income exceeds $3000 to $4000. Once annual incomes cross this $3000 threshold, there tends to be an accelerated growth in that country’s middle class. This would result in a middle class six times higher than today, representing 28% of total Chinese population. It will not be until 2050 that China is predicted to reach a per capita net income of $30,000, the level of most Western countries today.

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