Focus: Reaching the Interior

The Sales and Distribution Revolution

Companies in China must constantly reassess their sales and distribution models to keep up with a rapidly changing market

by David C. Michael

Growth and more growth—this is the expectation that global executives place upon their China operations today. Yet for every company, sustaining growth in China is a formidable challenge. Opportunities shift rapidly, and the business model built for one stage of China market growth is often ill-equipped to capture the next stage. This is particularly true in sales and distribution. Companies that fail to significantly reinvent their China sales and distribution model every two to three years are almost certainly missing significant growth opportunities.

The changing shape of Chinese demand

In the consumer sector, demand is rising rapidly and spreading across broader geographic areas, as an increasing number of Chinese consumers have more spending power than ever before. Consumer demand, which was largely limited to China's biggest cities just a few years ago in many product categories, is now spread across hundreds of cities. According to Boston Consulting Group (BCG) analysis, more than half of affluent households (defined as urban households with an annual income greater than $4,300) will reside outside of the top 40 cities by 2008 (see Figure 1). Tier 3 cities will be home to 7 million affluent households, while Tier 4 cities will boast 10.6 million. (Tiers are defined by 2005 population and per capita income.) Reaching these new consumer segments is the key to sustained growth.

In the industrial sector, manufacturers, including a growing number of local private companies, are setting up shop and increasing their presence across China (see Figure 2). Reaching these new industrial customers requires extending the reach of sales and distribution networks.

Changing routes to the customer

As consumer demand changes in China, consumer interfaces are also evolving, particularly at the retail and distributor level. Large, nationwide mass market retail chains are rapidly modernizing and consolidating, and distribution channels are continually changing. For instance, one channel may grow and consolidate quickly, taking up a significant portion of the premium market volume. A good example of this is the emergence of electronics superstores throughout China. Until the early 2000s, the majority of consumer electronics were sold through state-owned department stores and independent "mom-and-pop" retailers. Few organized chain stores existed, and none were national or even regional in scope. Today, consumer electronics chain store groups, such as Guomei Electronic Appliance Co. Ltd. and Suning Appliance Co. Ltd., operate networks of hundreds of stores across China. The emergence of these chains creates an opportunity for foreign companies to work directly with retailers and avoid the use of distributors as intermediaries, which was previously the only viable way to reach thousands of mom-and-pop stores.

As these chains expand their reach to smaller cities, their foreign suppliers can move with them. On the other hand, the rapid rise of such chains also creates serious "channel conflict" dilemmas for the supplier—how to maintain business relationships with retailers that are in decline as new retailers rise, and to what extent to make decisions in areas such as pricing that end up accelerating the rise of such chains.

The Chinese grocery retailer Lianhua Supermarket Holdings Co. Ltd. has adapted its business to become a successful retail chain in the supermarket segment. Until a few years ago, most people did their grocery shopping in the local wet market, but shoppers have shifted toward supermarkets and hypermarkets. These new channels deliver a superior shopping experience, selection, and hygiene. Lianhua, initially a supermarket retailer, entered into a joint venture with a subsidiary of Carrefour Group and expanded its range of store formats to include hypermarkets. In part because of this pairing, Lianhua's revenue from hypermarkets has grown from ¥947,717 ($125,310) in 2002 to ¥8.6 million ($1.1 million) in 2006.

Another change in consumer interfaces is the development of modern distributors. Historically, many Chinese "distributors" were entrepreneurial traders (or even smugglers) who provided little transparency to the company and the end-consumer. A new set of distributors has emerged within the past four years, however. They are more professional and specialize in logistics and distribution services, such as inventory management, customer service, and delivery. Typically, these players focus on a limited set of provinces or market segments and make money based on fees for the distribution services they provide, rather than on price arbitrage of the goods that they buy and sell. These changes in distribution practices and organization have created new routes to market and new channel partners. But because identifying and cultivating such players may not be straightforward, foreign companies that do this well will have an advantage.

New competitive pressures

In most market segments, more foreign companies are entering China, and a growing number of cost-focused domestic companies are emerging (see Figure 3). Various battles loom as the competition intensifies. For example, many goods and services markets in major cities are now intensely competitive—after all, these cities are the easiest ones for foreign players to address and are seen as an increasingly attractive market for local firms. Many markets in lower-tier cities—often the home of local incumbent competitors—have recently attracted more interest from foreign firms.

More generally, a collision of foreign and local players in the "middle segment" markets looms. While foreign companies that traditionally focused on "high-end segments" in China are moving into broader, lower-priced product categories in search of growth, local companies with a traditional focus on "low-end segments" are trying to move up market. In the past year, this phenomenon has occurred in many industrial product sectors in China, including motors, switching components, and construction equipment.

What it takes

A number of diverse issues confront companies in China: how to cover various geographic and customer segments; how to manage the end-customer relationship; how to structure the distributor and sales force; how to streamline processes and boost productivity; and how to manage the shift into broader market segments beyond the "high end." These issues put massive stress on existing sales and distribution models, which need to be reinvented frequently to ensure continued growth in China's changing business environment.

To respond effectively to competitive pressures in China today, companies need to operate multiple distribution models concurrently. Companies should tailor these models to each location and market segment. For example, in one market segment a company may need a sales force to interact directly with its customers, while in another market segment, multiple levels of distribution may be more cost-effective.

Geographically specific solutions China is a large country with many regional markets, each potentially requiring a different sales and distribution model.
Re-evaluation of distribution structure Increasingly, companies directly target end-customers (such as major corporate accounts) or retailers rather than relying on middlemen. Retail consolidation and the rise of large local corporate customers have made this a viable strategy in many situations.
Regional management structure To operate in local markets effectively and correctly gauge local market conditions, companies need a network of offices and organizations in different regions across China. Maintaining a single headquarters in Beijing or Shanghai, or a few regional offices, is no longer sufficient.
Checks and balances To manage a large and geographically dispersed organization successfully, companies must develop and continually improve tools for measuring and monitoring the performance of sales and distribution models.
A dual timeframe approach to management Companies must manage their existing sales and distribution model while developing a new one, recognizing that a new model may be required 12-24 months from now (see Figure 4).

Re-invent—or else

Consumer demand and market segments in China are continually evolving as they spread across a broader geographic area and consumer spending power increases significantly. New competitive pressures from small regional players are emerging, and traditional consumer interfaces are changing. As a result, companies must reevaluate—and change— their sales and distribution models to avoid stagnation and achieve sustained growth in China.

Diagnostic Questions

Companies are often unsure how to start adapting their sales and distribution models. Below is a list of questions to spur thinking on the subject:

What sales and distribution models will your company need in China 24 months from now? How different are those models from your current models? Are you preparing for the change?
Do you have a clear understanding of who your end-customers are, and of their needs? Or is your line of sight blocked by middlemen feeding you limited information?
Do you know what your salespeople in China are doing today? Are you confident that they are being managed effectively? Are they really working in your company's best interests?
Do you know what your competitors' sales and distribution models are? Are you confident that your models are better than theirs? If not, then how will you develop a better approach?
Do you have the right balance of coverage, cost, and control in your China sales and distribution model? Where is the imbalance, and how will you fix it?
What companies in other industries in China follow best practices in sales and distribution? What have you learned from them?

—David C. Michael

Case Studies: Sales and Distribution Strategies

The following cases detail examples of multinational corporations (MNCs) that have faced sales and distribution challenges in China and what they have done to address them.

Consumer electronics

A global consumer electronics company provides a successful example of the rapid evolution of a sales and distribution network in China over four years. In Years 1 and 2, the company started with a target market of Beijing, Guangzhou, Shanghai, Shenzhen, and Tianjin; distribution relationships with three national distributors and agents; a marketing focus on national-level brand marketing via TV; and a small company headquarters in China. In Year 3, it expanded its target market to include the top 50 cities, increased its distribution network to 65 provincial distributors, segmented its marketing focus, and set up five regional offices. In Year 4, the company's target market included more than 200 cities and neighboring countries, and its distribution network included 3,000 retail accounts, 65 distributors, and 400 wholesalers. It also shifted its marketing focus to heavily emphasize point-of-sale influence. Its corporate structure, based in five regions, included more than 8,000 employees. From Year 1 to Year 4, total sales in China more than quadrupled.

Industrial goods

In China's industrial goods sector, customer demand is shifting from high-end to mid-level markets. One global engineering company is a prime example of an MNC that is considering adapting its products and processes to accommodate this evolution. Traditionally, the company focused on high-end, high-margin products but noticed that its customer base is increasingly migrating to mid-level products, which are designed according to more basic specifications than high-end products. Its clients' purchase decisions are changing as local mid-market companies become more competitive throughout China. Customers are becoming more price sensitive as the decision power to purchase industrial products shifts from lower to higher levels of the organization. As a result, the company has begun to offer lower-priced products to compete with the growing number of mid-market local companies. The company also realized that its existing sales model was unsuitable for serving the more diverse and fragmented mid-market customer base and is therefore using a radically different sales model to serve this market. The new model involves using distributors different from those used in the old model to access new types of customers. Under the new model, levels of customer service and sales costs are lowered and products simplified. (Simplified products are marketed under a different brand to avoid undermining the top-end version.)

Apparel

Sales and distribution networks are also evolving in the apparel market, which is becoming more fragmented and growing quickly outside of first-tier cities. An apparel MNC needed to determine how to expand its business quickly through local franchises while developing a key brand in lower-tier cities to drive growth and stay competitive. In response to this growing demand, the company created a new, extensive franchise model and provided the tools and management support to help its franchisees reach these goals.