Despite China remaining the sourcing capital of the world, most companies nowadays enter China to sell their products, rather than to source (or produce) them. This is not surprising given China’s demographics: for example, it is already the world’s largest luxury market as well e-commerce market, and according to one study it could have 630 million middle-class consumers by 2022 (McKinsey).
As the landscape is developing so quickly, it is time for a comparison between the different sales channels available to foreign companies today. No doubt, China’s e-commerce opportunities are getting the most press. Still, it is not just about e-commerce: the best strategy is made with an understanding of all the opportunities, and based on the model that fits best with your products, your prospective market, and the resources that you want to invest in making your China strategy a success.
We will share with you the good and bad experiences of over 100 international retailers and brands that we have assisted in conquering the Chinese market. We will also provide you with a useful framework for your China entry decision-making process, based on the entry models that we see most.
A classic and low entry-barrier option is cooperating with a Chinese import agent or distributor, who will be responsible for the sale of the products in China. A distributor will buy your products and sell them on the Chinese market on its account, while an import agent is usually involved when you already have an end-buyer for your products.
These methods are prevalent when a company intends to distribute the product quickly and inexpensively, albeit ones that have several disadvantages as well.
Choosing the right distributor can be problematic, which some of our clients have learnt the hard way:
The proper structuring of sales, agency and distribution contracts is therefore crucial. You are highly advised to get legal advice before you end up like many before you did – having committed to a non-performing distributor without the option to terminate and either appoint a new distributor, or pursue other sales channels. Other disadvantages to watch for: profit margins of this channel will generally be small, while you will have limited control (if any) over marketing and branding.
E-commerce has taken China by storm. Taking TMall and JD as examples, we see that they offer two options for retailers and brands: TMall Classic and JD are for companies that are established in China (a domestic e-commerce), while Tmall Global and JD International give offshore companies the option to sell into China (a cross-border e-commerce).
Setting up a cross-border store seems like an attractive option for foreign companies because they do not need a physical structure in China. However, there are several significant downsides and challenges.
First, operating a store on a cross-border platform is quite expensive, with yearly operating fees of easily $10,000, a commission on every sale which varies between 3-6 % and a one-time fee of around $25,000. Add to this the fixed and commission fees of service providers who create, design, and operate your store, and margins will be limited.
Moreover, cross-border sales only account for a tiny percentage of the total China e-commerce market (some estimate around 5%). Finally, when operating from abroad, companies tend to refrain from or do not know how to engage in relevant marketing activities tailored to the Chinese consumer.
Operating a domestic e-commerce channels has many advantages. The main drawback is the requirement to set up a subsidiary in China to enlist with a platform, and sell goods domestically in China. A secondary issue, at least for some categories of products (e.g. cosmetics), is that the goods to be sold must meet local requirements.
Overall, and unless certain local restrictions prevent domestic sales in China, most companies now tend to use cross-border e-commerce as a stepping stone. Or they skip it altogether and directly focus on domestic e-commerce channels through a newly-established Chinese subsidiary.
Increasingly, companies decide to set up a China office to manage their sales channels more directly and effectively, while retaining various levels of involvement with and control over marketing, branding, customer data, pricing, distribution, and brand proposition.
A China entity offers the opportunity to hire permanent local staff, who can gather local knowledge and share this with headquarters, for a step-by-step development of the optimal sales channels and an overall China strategy. Some companies may still start with growing existing customer and distributor business, while opening new channels with retail, franchise, and e-commerce.
In the long-term, the most profitable channel – but also the costliest to run – seems still to be the brick-and-mortar, physical retail network. Traditionally foreign retailers and brands have often used a franchise model (less control over the marketing, branding, customer base, pricing, and brand proposition) or they set up joint ventures that will invest and help them in the process. But in recent years, many well-known international brands have focused on setting up a 100% Wholly Foreign-Owned Enterprise (WFOE) to open physical stores.
While the downside of this channel is the high investment and operational costs, there are several distinct advantages. First, the profit margins in retail are high (especially if the products are manufactured or sourced in China), as this means saving on transportation, import duties, and taxes. Furthermore, the retailer is in full control of sales, marketing, branding, pricing, brand proposition, and its omnichannel China operations.
Moreover, it presents companies with a unique opportunity to understand the Chinese market and its customers, and use this for a long-term approach to become an established brand in China. Some retailers invest heavily in obtaining brand recognition, and a critical mass (G-Star, Under Armour). In contrast, others choose strategic, affordable locations, and take time to grow their brand (Victoria’s Secret). With its middle-class ever-growing and a clear appetite for foreign products and brands, China is already a mature sales market that can hardly be ignored by Western retailers and brands.
There are plenty of ways to approach the market. Ambitious companies will usually want to combine their physical store retail network, including at least one or more flagship stores, usually connected with at least one major e-commerce channel to allow cross-exposure. More cautious approaches are to find the right distributor that will do the work for you, setting up a local company for domestic e-commerce, or taking an omnichannel approach. For those companies that cannot yet sell into China the cross-border e-commerce model may be the first step, but even then, they are wise to invest in structure, so that they can expand into domestic sales promptly when the time is opportune.