China: Challenges Ahead
Only the Large Can Survive - Competition for Chinese Consumers Erodes Profit Margins
By Leslie Chang, The Asian Wall Street Journal
Monday, 13 October 2003

Beijing - American businessman Paul Rasch elbows his way through a crowded Carrefour supermarket to the display of Great Lakes fruit juice, the product his family's US company has been selling here for a decade. It is on sale for $2.30 a bottle, but a Chinese competitor, Huiyuan, is offering a bigger bottle at half the price. Mr Rasch walks down an aisle teeming with dozens of fruit-juice brands, reading the state of the marketplace from their cartons. A recent manufacturing date on one means it is selling fast. A deep discount on another suggests that the company is in trouble. Mr. Rasch grabs a three-pack of a rival juice brand, now doing a buy-two-get-one-free promotion, and glares at it.

"You're killing us. You're ruining it for everyone," he moans.

Selling consumer goods in China is getting harder, threatening to squeeze out all but the largest multinationals as foreign corporations face brutal competition from Chinese rivals. Veteran foreign executives now describe the mid-1990s as the golden days, when their products were novelties, consumers were impressionable, and domestic competition trailed.

Complaints then often centered on corrupt officials and uneven enforcement of the rules. But these days foreign firms are being beaten at their own game, often by Chinese rivals competing fair and square and turning out to be better capitalists.

"We wouldn't survive, if we were to start now with the kind of size we have," says Mr Rasch, a fourth-generation fruit grower and the president of Great Lakes Fresh Foods & Juice Co. in China. "Margins are thinner, costs are higher, volumes are bigger. The costs of making a mistake are too high now."

Merrill Lynch & Co. issued a report this year warning multinationals about a bumpier path to profitability as profit margins erode in many sectors due to fierce competition. "It is the most competitive market I've seen in the world, full stop," says Georges Desvaux, a director at consultants McKinsey & Co. in Beijing who follows the consumer-goods market. "Everyone and his brother is here. The number of players who are of good quality, both international and domestic, is huge."

The result: In many industries and in the big cities where competition is fiercest, it appears near impossible for any but the biggest corporations to build a business, given the competition and the need for speed and scale. There appears to be narrowing room for smaller companies, even those like Great Lakes that did most things right.

Great Lakes is at once a success story and a cautionary tale for the many smaller U.S. businesses that may be eyeing the China market as a potential savior. Split from a century-old, family-run apple business on Lake Michigan, Great Lakes entered China in 1993 to make and sell 100% fruit juice, then a novelty. At the time, the market was awash in "fruit tea," a pulpy drink of fruit puree thickened with potato starch, with only a few imported fruit juices for sale.

Great Lakes avoided many of the mistakes of multinationals. It kept costs low, using only second-hand equipment for its factory in Tianjin, a port city near Beijing. It focused on the biggest cities first, where consumers were willing to pay more for pure fruit juice. It sweetened its juices to suit the local palate and put the product in distinctive clear glass bottles to emphasize freshness. The company started making money in 1995.
In 1997, Great Lakes embarked on an ambitious expansion, pouring $4 million into television advertising and expanding distribution into 26 cities. But in China's consumer-goods market, two seismic shifts were under way.

Domestic competition turned fierce, turning out large volumes of good-quality juice at half Great Lakes' price. In addition, modern supermarkets became popular, demanding higher fees for shelf space and turning away small concerns that couldn't deliver. Both shifts favored the big firms.

"We thought we'd make a premium product and do fine. But we didn't have the volume, and local companies came and just kicked our butts," Mr Rasch says. Great Lakes has slashed prices 40% in the past two years in response to domestic competition.

China today may be the most perfectly efficient demonstration of capitalism in the world. Once a product proves popular, a business will unroll it on a national scale if it can. Rivals latch on to innovations instantly. Markets mature extremely rapidly. The fruit-juice market took off in 2001 after three companies - Taiwan archrivals Tingyi Holding Corp. and Uni-President Enterprises Corp., and Coca-Cola Co. - launched fruit drinks with 10% juice content. At half the price of pure juice, such drinks appealed to price-conscious consumers. Many couldn't taste the difference in juice content anyway.

Other juice businesses piled in, then bottled-water concerns. Juice and juice-drink sales hit $1.4 billion last year, a 40% surge from the year earlier, according to market-research firm Gung Ho Intelligence Co. The markets for bottled water and bottled iced tea also zoomed from novelty to ubiquity almost overnight.

"In China, the market lurches. Something can go from being a new category to a big category in a year," says David G Brooks, a veteran Coke executive who has just finished his third China stint. "You have to be ready for the next thing."

The demands for speed and volume favor titans. That includes multinationals like Coke and fast-growing domestic conglomerates like Hangzhou Wahaha Group Co., which saw $1 billion in sales last year selling such things as yogurt drinks, bottled water and fruit juice, and Huiyuan Group Co., China's largest pure-juice maker. In fact, Great Lakes was an early innovator in juice drinks. In 1998, it launched a drink with 20% fruit juice, called
Juicee. Then in 2001, just as juice drinks were gaining ground, Great Lakes launched MingLang, a line of juice drinks at half the price of its Great Lakes line that would build the company's business in smaller cities.

But without a huge marketing and distribution machine, the business has stayed small. In the fruit-juice market that Great Lakes pioneered, it now does $10 million in annual sales; Mr Rasch says sales are growing 20% a year and that the business is profitable. But Tingyi, a relative latecomer to the field, now claims a 20% share of a $1 billion-plus market, while Uni-President, which holds the No. 1 spot, has an even larger business.

Industry executives estimate that Huiyuan leads the pure-juice category with about $100 million in sales. All dwarf Great Lakes in the size of their juice business.

Other pioneers also are struggling. Beijing Seanoble Food Co., a Canadian-invested concern, started selling fruit nectar in restaurants in 1995 under the Rougemont brand and was profitable from its first year. Its innovative strategies included paying distributors a generous markup to fund their marketing and promotions and giving gifts to waitresses based on how much fruit nectar they sold. But business has soured as domestic competition has heated up and the juice trade has moved from restaurants into
supermarkets, where prices are lower.

In April, Seanoble cut prices on a line of drinks by more than half. The company's majority investor, Lassonde Industries Inc., wrote off $9.3 million in operating losses from its China business last year and is negotiating to sell its stake in the company. "What I did then [in the mid-1990s] is not possible anymore," says Gervais Lavoie, who recently left as chief executive of Beijing Seanoble. "There's so much more competition."

Great Lakes, for one, is fighting back. On a recent afternoon, Mr Rasch plots strategy with two top lieutenants in the company's Beijing office, a single large room with a fluorescent light and a gray carpet. They are planning to run promotions in housing compounds to minimize the rising cost of getting shelf space in the big supermarkets. They are in talks with several foreign juice firms that want to use its distribution network and manufacturing base to enter the Chinese market. Moreover, they are cutting costs to the bone: Mr Rasch scans a promotional budget from his marketing director and runs his pen through many items, rejecting even a 20-yuan raise - valued at $2.40 - for a part-time saleswoman.

But winning over China's increasingly jaded consumers isn't easy. At a busy supermarket in the northern city of Tianjin on a recent afternoon, a young Great Lakes saleswoman in a polyester minidress offers what would seem a no-lose proposition: Free samples of fruit drink with bottles selling for a third off the regular price. A bored-looking pregnant woman walks right by.

A mother in a housedress gives half to her teenage daughter and returns the rest.

Even those who do buy a bottle represent mixed victories at best: "Try it, it's Xianchengduo," Kang Yahong wheedles her toddler son, mentioning the name of a rival juice brand which translates as "many fresh oranges." She buys a bottle but only because it is on sale. "It's about the same. It's all orange juice," Ms. Kang says with a shrug.

Retailers are more demanding, too. For Mr Rasch, a tour of the Beijing supermarkets is a reminder of all the promotions Great Lakes used to do that have become too costly. As he heads down an escalator to one store, he points to the slanting ceiling overhead and says, "That used to be a good place to advertise, but it got too expensive." The space is now plastered with billboards for Coke, Pepsi and Sprite.

Even the Carrefour SA display of Great Lakes products is a shadow of its former self: The coveted end-of-the-aisle display space is shared with a Chinese rival. "We used to get the whole row, but it got too expensive," Mr Rasch says. The various fees charged by a store for displays and promotions can amount to a quarter of the sales in that store, he estimates.

"It would be easier to have a lot of money, but this builds a better company, I genuinely believe that," Mr Rasch says, as he wraps up his weekly tour of the stores. But as his taxi weaves and stalls through Friday afternoon traffic, he concedes that he is sometimes daunted by how big the competition has gotten. "I do have my days when I wish we were bigger, but you have to be the big boys to play that game," he says. "There's lots for us to do where we are."