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Why China’s Retail Prices Are Surprisingly High

August 30th, 2010 6 comments

Ming Dynasty porcelain detail from China First CApital blog post

Making things in China is cheap. Buying things in China is not.

People living elsewhere, or ones like me who move here, will be rather surprised  to find out how expensive prices are for many of the more familiar brand-name products on sale in China. At current exchange rate of 6.78 renminbi to the dollar, many goods and services in China are sold at prices similar to the US.

Years ago, the Economist came up with their “Big Mac Index” as a way to measure real exchange rates. In their most recent survey, the renminbi looks 48% undervalued, because a Big Mac costs $1.95 in China, compared to $3.73 in the USA.


Big Mac Index
Source: The Economist

Of course, those prices tell only part of the story. Chinese wages are about 1/15th America’s. So, while it takes an average working American about ten minutes to earn the money to buy a Big Mac, in China, a reasonably well-paid office worker would need to toil about about four times as long to earn the Rmb 13 needed to buy a Big Mac. By this measure, the price of a Big Mac in China, to truly equal the price in the US, should be about 33 cents, and therefore the exchange rate should be over Rmb35 to the dollar.

Of course, the renminbi is never going to get that low. In fact, the overwhelming likelihood is that renminbi will get much stronger than the current rate of 6.78 to the dollar. Upward pressure comes from China’s $2 trillion in foreign exchange reserves and large balance of trade surplus with the US. As the renminbi rises in value, the prices of many goods in China will become even higher, when translated into dollars, than those in the US.

How expensive are things in China? To find out, I did a little comparison shopping at the Wal-Mart closest to my office in Shenzhen. As in the US, Wal-Mart in China is highly successful, and got that way by offering “low everyday prices”. Considering the big gap in income levels between US and China, it would be a fair assumption that prices at Wal-Mart in China would be appreciably lower than those at Wal-Mart in the US.

But, that assumption would be wrong, for the most part. Here’s a rundown of prices on some popular branded products at my local Shenzhen Wal-Mart — prices below are in renminbi and current dollar equivalent at prevailing exchange rate. Quite a few are Procter & Gamble products. P&G are very strong in China, and its products are often market leaders. As in the US, P&G enjoys a close relationship with Wal-Mart.

 

PricesSource: Peter’s Shopping

 

A few days after my visit to Wal-Mart in Shenzhen I flew to New York on business. In between meetings, I did some comparison shopping. 

Wal-Mart is the largest retailer in the US, but does not have any stores in New York. One reason is New York City’s unfriendly labor laws that would make it hard for Wal-Mart to operate in New York without unionized workers. Instead, I checked prices at local Food Emporium supermarket, Walgreens and CVS

While there are some pretty good deals in China, for example Heinz Ketchup and Coke, most things on the list are in line with prices in the US.  In other words, they do not reflect the vast differences in average earnings and therefore purchasing power.

Chinese workers manufacture wholesale, but buy retail.

Prices in China are high, in part, because there is a VAT of 13% on most things. More important, retailing in China is not nearly as efficient as it is in the US. While Wal-Mart is successful in China, it doesn’t enjoy anything like the market share it does in the US. Smaller, but my guess is, far more profitable. Wal-Mart faces very limited low-price competition in China. Most stores are of the Mom-and-Pop variety, which keeps overall prices high. Urban real estate is also expensive, and that also has an underlying impact on consumer prices.

In China, it’s easier to make money selling than manufacturing. Retail margins are higher and less squeezed than they are in the US. This will likely be true for many years to come. For Chinese consumers, especially the +40% who live in cities, they will likely continue to pay prices on par with those in the US, while earning appreciably less.


Local Governments Are Key to Growth Across China

August 22nd, 2010 1 comment

fahua censer from China First Capital blog post

Two factors are paramount in explaining the phenomenal economic success of China over the last thirty years: smart government policies and the abundant ingenuity, hard work, talent and entrepreneurial drive of the Chinese people.

A day doesn’t go by without me seeing at first hand that entrepreneurial genius at work in China. The inner workings of government, however, are generally invisible to me as an outsider.

During a recent trip to Shandong, however, I had the privilege of seeing part of China’s government up close, doing what it often does best – constructing and carrying out policies that allow businesses to thrive in China.

In all countries, governments makes the rules and sets the conditions under which business succeed and fail. China is no different. One obvious difference: China’s government clearly must be doing a lot right for the country to deliver the greatest sustained period of economic growth ever recorded.  How was this achieved? The simple answer is that China’s government began 30 years ago to scrap a rigid socialist system for a free market economy.

“Socialism with Chinese characteristics” is the official phrase. It’s no set doctrine, but mainly a pragmatic pursuit of policies to foster global competitiveness, employment and rising living standards in China. China government invites its citizens to evaluate it on this basis, using statistics, to judge how well it manages the economy.

Most would agree, including me,  the government is doing an outstanding job. How it does so,  however, is very much of a mystery.

Over the course of four days, I met with the mayors and Communist Party Secretaries of three of Shandong’s larger and more prosperous cities: Weifang, Laiwu and Linyi. These were working meetings, not diplomatic meet-and-greets. I was the only non-Chinese in these meetings. I was traveling at the invitation of the chairman of one of our clients. This client already has extensive and highly-successful operations in Shandong, with revenues there in the last two years of over Rmb 1 billion.

“We are here to serve you”. This is the statement I heard repeated in each city by the Party Secretary and the Mayor.  This is neither an idle boast nor an empty promise. In every instance where I’ve been in meetings with senior figures in the Chinese government, I’ve been deeply impressed by their competence, directness and sense of purpose in offering to do whatever it takes to help improve the conditions for investment and so raise local living standards.

The meetings with Shandong political leadership had an overlapping two-way purpose: to facilitate my client’s expansion plans in Shandong, and to allow the Party Secretary and Mayor of each city to lay out in plain language the economic development agenda for the next few years. They did this confidently, effectively, forcefully.

I’ve never before heard political leaders speak with such a single-minded focus, as well as evident sincerity,  on their priorities to improve the life, work and leisure of their citizens. There was no self-aggrandizement, no insincere black-slapping, no empty platitudes, indeed nothing that could be construed as expressions of naked self-interest, or the exclusive interest of the party they represent.

There is a good reason for this: political careers in China are made and lost in part on how well the local economy performs, as measured by objective statistics. The metrics include not just local gdp growth, but also the growth in living and recreation space per person, the completion of large local infrastructure projects on time and on budget, urban beautification programs like planting trees and cleaning up local waterways.

Political success in China must be tangible, measureable. And the improvements must come quickly enough – generally within 2-3 years – to boost an official’s chance to continue to climb the rungs.

Arguably, most political careers, including in the US, are determined by how well political leaders deliver for their citizens.  The clear difference in China, from what I can see,  is that it’s a much more data-driven process, more like how management are rewarded or penalized inside a big company. As Peter Drucker, perhaps the wisest thinker about management famously said, “You can only manage what you can measure.”

China is often run by the Communist Party  like one large centralized corporation. The command-and-control methods of management appear similar. While a vastly oversimplifies things, the meetings I attended with political leaders in Shandong were very familiar in many respects to business meetings I’ve attended. The local leaders articulated the goal, which in each case is to keep local gdp growing at well above China’s national average. All three cities are now doing so.

The infrastructure would need to be continuously upgraded to achieve this. As each city gets richer, of course, it gets correspondingly harder to generate such large annual leaps in output. So, projects grow in scale to the truly monumental. In Weifang, for example, the Party Secretary outlines plans to build a new greenfield port and industrial center outside the city that would one day house over one million people in spacious new apartment buildings.

In each city, the planning goals were uniformly ambitious. The political leaders left no doubt that private business should and must play a big part in the process.  They pledged not just help removing any administrative obstacles, but also to make land available at concessionary prices for private sector projects that would create large number of jobs.

The three cities I visited – Weifang, Laiwu and Linyi – are all thriving, not just economically, but also in these more human terms. The cities are for the most part clean, pretty, with newly-built urban infrastructure of roads, housing, parks.

Many outside China have likely never heard of these places. But, Linyi and Weifang, with populations of 11 million and 8 million respectively,  are both larger than any city in the US and Europe.

Laiwu, is smaller, with a population of just over 1 million. However, it does like to do things in a big way. At lunch with the Party Secretary and Mayor, I sat at the largest round dining table I’ve ever seen. Sixteen of us ate at a table that was over four meters in diameter – so large that each person was served lunch individually, one small helping at a time, by a large team of waiters. 

Corruption and political chicanery exist in China, of course, as they do in US, Europe, Japan and everywhere else political officials with control over valuable resources interact with businessmen. But, in my experience during my three days meeting officials in Shandong, the local government is far more intent on lending a helping hand, rather than looking for back-handers.

China’s one-party political system is not to the taste of many Americans or Europeans.  But, if judged by standards of effectiveness, rather than electoral accountability, local governments in China routinely outperform their counterparts in the US.  For all the pretentions to public service, accountability and incorruptibility, US politics, especially at the local level, is infested by influence-peddling and political bribery in form of campaign contributions.

As I saw living for many years in Los Angeles, the second biggest city in the US, local officials act mainly in ways that favor a select few, and deliver only scant benefits to the society as a whole. LA is now teetering on the edge of bankruptcy, with degraded infrastructure, failing schools, punishingly high taxes. LA, like China, is also run as a one-party system, with a Democratic machine that pushed through election rules that make it all but impossible for the opposition Republic Party to gain control, no matter how badly the Democratic Party politicians mess up.

Given a choice, I’d take Shandong’s local bosses anytime. They are held to a higher, more transparent standard. Over the course of a four-to-five year term in office, they will often preside over real material improvements in citizens’ lives that few American politicians will deliver over the course of a career.


China’s Booming Hami Economy

August 12th, 2010 1 comment

dude with Hami

Xinjiang is a big place, with a land mass the size of Western Europe. It occupies 1/6th of China’s territory, yet contributes only 1.5% of its population. I think I now know why it’s so empty. All that space must be devoted to growing Hami Melons.

This fruit is Xinjiang’s most popular export to the rest of China. It’s high season now. Even here in Shenzhen, as far as one can travel from the melon-growing precints near the Gobi Desert in Xinjiang, the large Hami melons are pervasive – in fruit stores, supermarkets, pushcarts. You can also find them piled high on many streets all over the city, with each Hami hoard minded by a guy from Xinjiang with a long sharp knife and a small scale.

guy

The melons are generally oval-shaped and weigh about 10 pounds each. I’ve bought segments of ones weighing twice that. The most popular way to eat the melon is as a snack on the street. A tall thin slice on a wooden skewer sells for Rmb 1.

For those who haven’t had the pleasure, a Hami tastes a lot like cantaloupe, but the flesh is much crunchier, almost like an apple’s.

This time of year, across China, Hami crowds every other fruit out of the marketplace. I can’t find any statistics on Xinjiang’s total production, but my guess would be it runs to the millions of tons. Imagine the logistics: a market of 1.4 billion all simultaneously ravenous for your perishable product, grown on the fringe of a desert in one of the most distant, infrastructure-starved corners of the country.

Just to supply the Chinese market must occupy the full-time summertime efforts of tens of thousands of farmers, packers, and shippers. The melons are grown, boxed and then shipped by road and rail to every corner of China. It seems like for every 100 melons exported from Xinjiang, one local Uighur must accompany the shipment, to run the impromptu sidewalk stalls selling the fruit.

If other parts of China also grow the melon, I’m not aware of it. To find buyers, they would probably have to falsely label their melons as coming from Xinjiang. In China, Hami belongs to Xinjiang the way champagne belongs to the Champagne region of northern France.

Shenzhen probably has a larger market for Hami, on average, than many other parts of China. It’s a rich city, and Hami melon is not cheap. Bought by the kilo, the price runs to around Rmb8 to Rmb 12, or about 70-90 cents a pound. I’m buying around 10 kilos a week.

You can also find Hami this time of year in Los Angeles, usually at Persian grocery stores. Parts of Southern California’s desert are similar to Xinjiang’s Hami growing region. But, the fruit is very much a minority taste in the US. It’s likely to remain that way. As big as it is, Xinjiang will never be able produce enough Hami to satisfy fully Chinese tastes, let alone an export market.



How PE Firms Can Add – or Subtract – Value: the New CFC Research Report

August 8th, 2010 1 comment

China First Capital research report

CFC has just published its latest Chinese-language research report. The title is 《私募基金如何创造价值》, which I’d translate as “How PE Firms Add Value ”.

You can download a copy here:  How PE Firms Add Value — CFC Report

China is awash, as nowhere else in the world is,  in private equity capital. New funds are launched weekly, and older successful ones top up their bank balance. Just this week, CDH, generally considered the leading China-focused PE firm in the world, closed its fourth fund with $1.46 billion of new capital. Over $50 billion has been raised over the last four years for PE investment in China. 

In other words, money is not in short supply. Equity investment experience, know-how and savvy are. There’s a saying in the US venture capital industry, “all money spends the same”. The implication is that for a company, investment capital is of equal value regardless of the source. In the US, there may be some truth to this. In China, most definitely not. 

In Chinese business, there is no more perilous transition than the one from a fully-private, entrepreneur-founded and led company to one that can IPO successfully, either on China’s stock markets, or abroad. The reason: many private companies, especially the most successful ones, are growing explosively, often doubling in size every year.

They can barely catch their breath, let alone put in place the management and financial systems needed to manage a larger, more complex business. This is inevitable consequence of operating in a market growing as fast as China’s, and generating so many new opportunities for expansion. 

A basic management principle, also for many good private companies, is: “grab the money today, and worry about the consequences tomorrow”. This means that running a company in China often requires more improvising than long-term planning. I know this, personally, from running a small but fast-growing company. Improvisation can be great. It means a business can respond quickly to new opportunities, with a minimum of bureaucracy. 

But, as a business grows, and particularly once it brings in outside investors, the improvisation, and the success it creates, can cause problems. Is company cash being managed properly and most efficiently? Are customers receiving the same degree of attention and follow-up they did when the business was smaller? Does the production department know what the sales department is doing and promising customers? What steps are competitors taking to try to steal business away? 

These are, of course, the best kind of problems any company can have. They are the problems caused by success, rather than impending bankruptcy.

These problems are a core aspect of the private equity process in China. It’s good companies that get PE finance, not failed ones. Once the PE capital enters a company, the PE firm is going to take steps to protect its investment. This inevitably means making sure systems are put in place that can improve the daily management and long-term planning at the company. 

It’s often a monumental adjustment for an entrepreneur-led company. Accountability supplants improvisation. Up to the moment PE finance arrives, the boss has never had to answer to anyone, or to justify and defend his decisions to any outsider. PE firms, at a minimum, will create a Board of Directors and insist, contractually, that the Board then meet at least four times a year to review quarterly financials, discuss strategy and approve any significant investments. 

Whether this change helps or hurts the company will depend, often, on the experience and knowledge of the PE firm involved.  The good PE firms will offer real help wherever the entrepreneur needs it – strengthening marketing, financial team, international expansion and strategic alliances. They are, in the jargon of our industry, “value-add investors”.

Lesser quality PE firms will transfer the money, attend a quarterly banquet and wait for word that the company is staging an IPO. This is dumb money that too often becomes lost money, as the entrepreneur loses discipline, focus and even an interest in his business once he has a big pile of someone else’s money in his bank account.   

Our new report focuses on this disparity, between good and bad PE investment, between value-add and valueless. Our intended audience is Chinese entrepreneurs. We hope, aptly enough, that they determine our report is value-add, not valueless. The key graphic in the report is this one, which illustrates the specific ways in which a PE firm can add value to a business.  In this case, the PE investment helps achieve a four-fold increase. That’s outstanding. But, we’ve seen examples in our work of even larger increases after a PE round.

chart1

The second part of the report takes on a related topic, with particular relevance for Chinese companies: the way PE firms can help navigate the minefield of getting approval for an IPO in China.  It’s an eleven-step process. Many companies try, but only a small percentage will succeed. The odds are improved exponentially when a company has a PE firm alongside, as both an investor and guide.

While taking PE investment is not technically a prerequisite, in practice, it operates like one. The most recent data I’ve seen show that 90% of companies going public on the new Chinext exchange have had pre-IPO PE investment. 

In part, this is because Chinese firms with PE investment tend to have better corporate governance and more reliable financial reporting. Both these factors are weighed by the CSRC in deciding which companies are allowed to IPO. 

At their best, PE firms can serve as indispensible partners for a great entrepreneur. At their worst, they do far more harm than good by lavishing money without lavishing attention. 

The report is illustrated with details from imperial blue-and-white porcelains from the time of the Xuande Emperor, in the Ming Dynasty.