Targeting key segments of China’s diverse and rapidly emerging middle class will be crucial as household incomes rise

Gone are the days when companies looked at China as a monolithic land of 1 billion potential customers. Companies are now focusing on how to capture small segments of China’s giant market, and none of these segments is as attractive or as full of potential as the country’s rapidly growing—and multifaceted—middle class. As China’s economy continues to grow, more people will migrate to China’s booming metropolises to find better-paying jobs. These working consumers, once among the country’s poorest, will steadily climb the income ladder and join the new middle class. Companies that can effectively understand the composition and needs of this diverse group will be positioned to reap massive rewards.

Why the middle class?

Though many foreign companies have remarked on the importance of China’s middle class as a consumer segment, few realize just how dramatic its ascendance is. From 1995 to 2005, the population of China’s middle class—defined here as households with annual incomes ranging from $6,000 to $25,000—grew from close to zero in 1995 to an estimated 87 million in 2005, according to MasterCard Worldwide, Asia Pacific. China’s middle class will jump to 340 million by 2016 (see Figure 1). The purchasing power—disposable income minus savings—of China’s middle class is also growing. In 2006, around 39 percent of urban households were middle class (see Figure 2). By 2016, that percentage will likely rise to 60 percent. At present, the middle class accounts for 27 percent of China’s total urban disposable income. By 2015, that percentage is expected to rise to more than 40 percent (see Figure 3). Considering its swelling numbers, purchasing power, and trajectory, China’s middle class presents marketing opportunities that companies cannot afford to miss.

What does it mean to be middle class?

Different types of companies have different concepts of exactly what it means to be middle class in China. For example, HSBC Holdings plc and Deutsche Bank AG have used income to differentiate the middle class from the affluent and laboring classes in China. From an investment bank’s perspective, using income level as the defining criterion makes sense. But simply judging a group by income is far from sufficient for marketers of consumer goods. Such marketers trying to reach the middle class have to know more than their salaries: They must know what makes middle class consumers tick.

Income plays a powerful role in most purchasing decisions for any consumer segment, but other elements play a role that is sometimes greater than income. When products are relatively inexpensive, income has little influence on a consumer’s decision making process. Deciding to buy chocolate, for example, depends significantly more on consumers’ emotion and shopping experience—a store’s ambience, for example—than it does on how much money they make. Using income as the only indicator of spending habits allows much information to slip through the cracks. In addition, income is a difficult variable to act upon, in part because the data on income in China tends to be either unavailable or unreliable. Thus, companies must find meaningful alternatives to predict what consumers can afford and what they are willing to pay for certain goods and services. Studies by the Monitor Group indicate that scores of non-income-related hooks—including age, the stage in a consumer’s career, and location of purchase—influence purchase decisions.

The Chinese badminton industry is a good example. Most Chinese school kids who play badminton do so in an outdoor playground with a group of friends, wear non-professional badminton sportswear, and purchase a relatively inexpensive racket in a sports stadium or shop near school. Professionals and businesspeople, however, usually play badminton in indoor badminton clubs, gyms, or stadiums. One of the major reasons they play badminton is to make friends or develop business relationships. They are aware of racket brands and wear professional sportswear to display social status.

The differences between school kids and professionals are mainly due to their disparate life stages and buying power. If a sports equipment and apparel company understands the differences between these two segments, it will use varying products and prices to target them through different channels. Nonetheless, even within the professional segments, consumers exhibit distinct buying behavior based on their occupation and level of career development. For example, engineers usually exhibit different buying behavior from marketing professionals, and senior managers may not care as much about brands as junior managers, who tend to buy famous brands to show their emerging social status.

Purchasing power and how the middle class buys

Of all the challenges that the middle class presents to marketers, understanding the specific needs and purchasing power of the group is of utmost importance. Though middle class consumers have rising purchasing power and are increasingly willing to pay more for higher quality, brand names, and differentiated features, they are still price sensitive. Recognizing differences in behavior within middle class segments is essential to success in the Chinese marketplace.

When Inter IKEA Systems B.V. first entered China in 1998, its strategy was to offer stylish furniture at premium prices. The strategy was a flop. Middle class customers filled IKEA’s stores to look around but bought less than expected.

In the last few years, however, IKEA has repositioned itself as a brand targeting segments with annual household incomes above ¥40,000 ($5,857). Thanks to achievements in localization, the company has been able to cut prices by an average of 54 percent in more than 1,000 categories since 2005. IKEA broke the bottleneck and succeeded in China because it recognized that middle class consumers wanted and would pay for high-quality products, but not at the same premiums as the affluent class.

Meet the middle class

China’s relatively new middle class consists of a rapidly shifting, diverse population. At present, China’s lower middle class accounts for 44 percent of the total middle class. As the middle class matures, however, the number of people in the upper middle class—households that earn $12,000 to $25,000—will spike dramatically. Companies must prepare for the different shopping behaviors of each sub-segment within the middle class. Lower middle class shoppers, for example, tend to buy top-tier products that can display their wealth and status. These middle class consumers sometimes spend a large portion of their income on expensive goods. By contrast, upper middle class shoppers, who are more experienced with different types of brands, will seek out relatively high-quality products without paying as much attention to brands or will pick out products that merely reflect personal tastes.

To differentiate customer segments, Monitor Group has used “action segmentation,” a market analysis strategy that draws on statistical data from a customer survey with several thousand samples and wide coverage. This methodology identifies multiple consumer segments to help companies address core organizational issues, achieve a well-designed marketing mix, reach growth targets, and more effectively engage their market. In the case of China’s middle class, Monitor focused on purchasing behavior and demographic features, rather than income, as the key measures for understanding the middle class.

In one case, Monitor examined the correlation between consumer occupation and purchasing decisions within the tourism industry, the results of which allowed companies to customize their tourist packages more effectively. Monitor found three distinct segments of Chinese tourists: business, leisure, and backpacking travelers. Business travelers have fairly stable travel schedules throughout the year. They are reimbursed for some expenses and tend to spend more than leisure travelers. Leisure travelers enjoy sightseeing and recreational activities and tend to be more cost-conscious and self-organized. Chinese backpackers are willing to spend more and care most about uniqueness and experience. They want more personalized services, such as global positioning systems and specially trained tour guides. Unlike US backpackers, they have money and time and backpack mainly to be fashionable and gain new experiences.

In another case, an examination of the different levels of daily exercise among men and women revealed that although men tend to exercise at a more or less constant rate throughout their lives, women exercise less after marriage and still less after having children. This information helped sportswear companies identify which demographic segments were most profitable to target.

Applying the action segmentation methodology to the Chinese middle class, Monitor identified six sub-segments within the group, each with its own unique needs and consumption patterns. These include Early Heavy Buyers, the Smarts, the Quality-Oriented, Trend Followers, Driven Businesspeople, and Value Seekers.

To serve the specific needs of China’s diverse middle class, companies must understand the desires of these six sub-segments and learn how to reach them. Early Heavy Buyers are energetic consumers, consisting primarily of professionals in tertiary industries and junior managers at multinational corporations. They tend to be young and well-educated, with an interest in and exposure to the world outside China. As consumers, they are early adopters of the latest products and aggressively seek out fashion that can help them stand out from their peers. Because they serve as trendsetters, members of this group actively search for information online and share that information with peers. They predominantly make purchases online or by mail order and have a high willingness to spend, especially on discretionary goods such as fashion items and lifestyle products and services. This group of trendsetters stands out from Trend Followers, who attempt to emulate Early Heavy Buyers in certain ways but approach purchasing decisions differently. Trend Followers tend to be junior white-collar workers and civil servants who have some leisure time and a stable salary but are new to the middle class and have less room for discretionary spending. They are less well-informed than Early Heavy Buyers and consequently place more emphasis on the shopping experience. They are also more price sensitive. Though Early Heavy Buyers may be more concerned with being the first to get a new product, Trend Followers will wait for discounts and tend to take advantage of promotions.

Like Trend Followers, Value Seekers are usually junior white collar office workers or government employees. As their incomes rise, they increasingly demand better quality and service, but remain sensitive to price. Though they purchase some goods from relatively inexpensive luxury brands to help show their status, they remain more concerned about value than other middle class segments. Trend Followers may choose products that are in fashion, while Value Seekers tend to look for the best quality-to-price ratio regardless of how popular the item may be at the time.

The final three—the Smarts, the Quality-Oriented, and Driven Businesspeople—tend to be older and to have been in the middle class longer. The Smarts are usually more sophisticated shoppers who prefer to buy from specialty stores and boutiques instead of major outlets. They regularly order business and fashion magazines to stay on top of trends but also rely on word of mouth.

Like the Smarts, Driven Businesspeople are willing to pay premiums for convenience. Driven Businesspeople are relatively wealthy and lead extremely busy lives. They do not have much time to gather information and compare different brands or clothes, but they have higher purchasing power. They usually trust friends’ recommendations, develop brand preferences before they buy, and are not price sensitive. They are experienced consumers with high degrees of brand loyalty, especially in fashion. For this group, product and service quality are much more important than price.

The Quality-Oriented share much in common with the Smarts and Driven Businesspeople but tend to have more leisure time. More than either of those groups, family is a priority for the Quality-Oriented and has a strong influence on their purchasing decisions. For example, large markets and department stores that carry a range of products important to a family are the major purchasing channels for the Quality-Oriented, and television is their dominant information resource for new products.

Monitor helped a sportswear client target two of the six middle class segments—Driven Businesspeople and Value Seekers—by understanding different buying habits. To better target Driven Businesspeople, Monitor recommended that its client market products in mid-range to high-end gyms and fitness clubs, where many businesspeople usually go, to develop brand awareness and attract customers. Monitor also recommended that its client place mid-to-high-end products in department stores and flagship shops, where Driven Businesspeople usually go to buy sportswear. By contrast, to target Value Seekers, Monitor recommended that the client become more aware of Value Seekers’ tendency to spend time comparing products, shopping at hypermarkets, and buying less expensive products.

What it means for your business

There is no denying the enormous benefit that companies can gain from a better understanding of China’s emerging middle class. Marketing effectively to any group of middle class consumers requires an understanding of the needs of specific segments and the recognition of which segments provide the greatest potential profitability for a particular product.

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Case Study: Foreign-Invested Beer Company

A client from the beer industry approached Monitor Group in 2005 for help identifying and marketing to new consumer segments. The client, a European beer brand with operations in China, had been relatively successful in attracting one segment of the middle class—Early Heavy Buyers. The client’s products were popular in entertainment venues, including bars, clubs, and concert halls, but were less successful in other venues, such as restaurants and places where business meetings are held.

Applying the action segmentation methodology, Monitor analyzed customer buying behavior and customer segmentation based on a large consumer survey that included 1,142 consumers in 11 cities across China. The analysis identified 12 distinct consumer segments with varying profitability and strategic importance to the client. The study found that senior managers drink foreign premium brand beer and that their favorite places to drink were restaurants and entertainment venues. In addition, survey results showed that sales of the client’s brand were highly correlated with sales venue—highest in high-end entertainment and premium restaurants, where Driven Businesspeople tend to develop their business and social networks, and relatively high in low-end entertainment, where the Smarts go to have fun.

Monitor developed strategies to reach the most important and potentially profitable consumer segments: Driven Businesspeople and Smarts. For the Driven Businesspeople, the company had to focus on winning more customers. For the Smarts, the key was capturing spillover clients from advertising primarily directed at Driven Businesspeople.

By reinterpreting its market and changing the ways it reached customers, the company was able to focus on the consumer groups that offered the highest levels of profitability and simultaneously attract segments that had previously been unresponsive.

—Allison Cui and Kheehong Song

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Kheehong Song is partner of Monitor Group, head of M2C (Monitor’s marketing practice) Asia, and managing director of Monitor’s Shanghai office.
Allison Cui is a senior consultant for Monitor Group based in Shanghai.
Monitor consultants Angela Wang, Moon Heo Koo, Min Tian, James Bian, and Wendy Yu also contributed to this article.

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Posted by Kheehong Song and Allison Cui