Any discussion of China’s top investment destinations immediately brings to mind the mega-cities of Beijing and Shanghai. However, this mood is changing. Today, businesses in China’s biggest cities must contend with surging costs and intense competition. As a result, more companies are looking beyond the horizon of first-tier cities and towards secondand third-tier locations. Hermès, the French luxury brand, is a case in point. It chose to open its first watch boutique in Kunming city of Yunnan province, rather than Beijing or Shanghai.
Rank and file
According to a report by Knight Frank, a global property consultancy, there are 661 cities in China. While there remains no universal definition, it is useful to categorise Chinese cities by administrative rank, population size and GDP. Chinese local governments rank from province to prefecture and then county.
First-tier cities include municipalities with provincial autonomy, special economic zones and the capitals of coastal provinces. Among them, Shanghai has the biggest population of more than 19 million, and the highest income per capita, which has exceeded $10,000. Following Shanghai in prominence are Beijing and Guangzhou. Other first-tier cities include Tianjin, Chongqing, Dalian, Harbin, Hangzhou and Wuhan. These cities have long been the prime magnets of FDI.
Moving down the list are second- and thirdtier cities at the prefectural and county levels. They make up more than 95% of China’s cities. Some examples of prefecture-level cities include Weihai (in Shandong province), Shantou (Guangdong), Wuxi (Jiangsu), Sanya (Hainan), Ningbo (Zhejiang), Kunming (Yunnan), Nanchang (Jiangxi) and Tangshan (Hebei).
Meanwhile, county-level cities, also known as fourth-tier, are rapidly catching up in size and development. An influential list of China’s top 100 counties, ranked by economic competitiveness and issued annually by a Chinese governmental think tank, provides a useful roadmap. In 2009, the top 10 counties were Jiangyin (in Jiangsu province), Kunshan (Jiangsu), Zhangjiagang (Jiangsu), Changshu (Jiangsu), Jinjiang (Fujiang), Wujiang (Jiangsu), Cixi (Zhejiang), Shaoxing (Zhejiang), Yixing (Jiangsu) and Rongcheng (Shandong). On average, the top 100 counties had more than 800,000 residents and an annual GDP per capita of $7217, not far off Shanghai’s economic level.
Second- and third-tier cities are grabbing the attention of investors because of fast-rising growth, rapid urbanisation, infrastructural investment and less competition. Most notably, middle-class purchasing power is growing more quickly in these areas than in their privileged first-tier counterparts.
As shown in a report published by Access Asia, per capita retail sales in China grew fastest in second-tier markets, such as Dalian, Shenyang and Wuhan, in 2008. Surprisingly, the province of Inner Mongolia boasted the strongest per capita retail sales growth, largely thanks to its new-found wealth from mining. With rising standards of living and convenient transportation, residents outside first-tier zones are demanding more consumer goods.
Already, luxury brands have gravitated towards second-tier cities. Louis Vuitton opened its first boutique in Beijing in 1992. It now has 26 stores in China, recently opening in Wenzhou, Chengdu and Shenyang. Christopher Zanardi-Landi, CEO of Louis Vuitton China, says the company plans to expand to two new cities in the country each year. Other luxury brands are following suit. Prada has stores in 10 Chinese cities, including one in central Shenyang that stocks its winter collection.
Automobile companies are also experiencing a sales boom in second-tier cities. According to a Chinese media source, Auto.qq.com, between 2007 and 2009, the proportion of car sales in first-tier cities, compared to secondand third-tier cities, dropped from 44% to 34%. In terms of proportion, sales in second- and third-tier cities grew 2% and 8%, respectively.
Handan, a third-tier city in Hebei province, illustrates the impressive growth in car sales among smaller cities. On average, 250 new cars are bought in the city every day. At the end of the year and during holidays, car sales can top 400 per day. Among those newly added vehicles, about 80% are purchased by private consumers.
Along with retailers, property developers have flocked to second-tier cities. Knight Frank reports that residential property development has been particularly attractive in second-tier cities because of rapid urbanisation. Hong Kong developers have ventured into cities of lowerincome provinces. The New World Group, for example, has acquired a 1.67 million-squaremetre site in Guiyang of Guizhou province. The municipality of Chongqing, boosted by a central government policy to develop the region, has attracted eager property developers.
First come, first served
The rise of second and third-tier cities has some important implications for companies and investors. First, firms need to think seriously about moving into these regions quickly and establishing a foothold. Consider this example. In an interview with the China Daily, Lars Larsen, the managing director of Hugo Boss Hong Kong, expressed the company’s strategy in three words: “Be the first.” Firms that enter secondary markets early can build up brand loyalty and have more time to learn the intricacies of each location.
However, as Jing Ulrich, managing director and chairman of JPMorgan’s Chinese equities and commodities business, points out, domestic retailers already enjoy first-mover advantage in many second-tier cities. She says: “Domestic retailers typically sell at a lower price point, have a stronger understanding of Chinese consumer preferences and better distribution networks in second and third-tier cities.” Foreign investors who venture into secondary markets will need to be prepared to compete with Chinese firms armed with local knowledge.
Domestic retailers typically
sell at a lower price point,
have a better understanding
of Chinese consumer
preferences and better
distribution networks in
second and third-tier cities
The second point to take into consideration is that firms should be aware that consumers in second-tier cities have tastes and needs that are different from clients in first-tier cities. A survey conducted by Bates 141, a marketing communications firm, found that consumers in smaller county-level cities prioritise quality, durability and services when making purchasing decisions. Bates 141 recommends that retailers underline value for money when marketing products in these areas.
Third, consumer preferences may differ widely from place to place because of the large number of secondary cities, and companies should take regional variations into account. Retailers should consider localising products not only for China but for regional blocs within China. Cuisine is one example. In western China, in areas such as Sichuan, residents regularly consume spicy food, but consumers in the southern parts of the country, such as Jiangsu and Shanghai, do not.
Companies seeking to secure the Chinese market will need to develop a wider vocabulary of Chinese cities. It is no longer sufficient to have Shanghai and Beijing on business radar screens; China-savvy executives should have smaller cities such as Shenyang, Urumqi, Suzhou, Kunming and Hefei on their strategic maps. It is in these cities with less familiar names where the potential of China’s domestic market awaits excavation.