ey greater china consumer products and retail sector ... · pdf filewith the winter issue of...

EY Greater China Consumer Products and Retail Sector Journal

January 2016

1 EY Greater China Consumer Products and Retail Sector Journal |


Eric Chia

Partner Greater China Consumer Products Sector Co-Leader

Arnold Sun

Partner

Greater China Consumer Products Sector Co-Leader


Dear Friends,

With the Winter issue of Greater China Consumer Products and Retail (CPR) Journal coming out, we are

celebrating our first anniversary of the Journal.

I recall that, in our opening note for the first issue, we were expecting a lot of the uncertainties during the year –

intriguing to see how quickly and phenomenally that changes are taking places in the world. On one hand,

mainland China has started to see the “New Normal” in place – with a GDP growth rate under 7% for the first time

in the past 2 decades – and lots of pressure on the traditional brick-and-mortars to re-think their business and

operating models; on the other hand, a shift in focus to “consumerism” has, in part at least, resulted in a set of

themes in the CPR sector, including the booming of O2O, growing in number and value of inbound and outbound

investments.

In this issue, we are glad to share with you three of our perspectives that address some of the key developments

in the China CPR sector:

► “Tapping into China’s New Consumers: Getting Sales Channels and Logistics Strategies Right to Drive

Profitable Growth” (By Alan Beebe, Director; Penny J Cao, Senior; Grant Lin Senior, Advisory services of EY

Advisory) – New opportunities emerge with evolving economy development patterns and consumer behaviors.

So do challenges. Lin has rightly pointed out five distinctive trends in the sales and logistics arenas for

consumer products companies and proposed compatible strategies that ultimately drive profitable growth for

the consumer products companies in the mainland China market.

► “New Integration Era for Consumer Produce and Retail Sector in China” (By Hsuan Chen, Executive Director,

TAS Services of EY Huaming LLP )

► – While the inbound investment in the CPR sector continues its way of growth, multi-national corporates are

certainly facing new threats during the integration phase in the China context, including stronger local

competitors, difficulties in “going down” to lower tier markets, etc. Chen has called for a new strategy in

integration: a “Best of Breed” approach that will assist the acquirers to retain the most appropriate of the

transactions.

► “Digital Luxury strategy capturing the Chinese mass market” (By Lilly L Cheung, Senior Manager, Tax

Services of EY Huaming LLP ) – Inspired by the success of newly coined festivals 11-11, and 12-12, the

Operating Model Effectiveness team at EY has completed a deep dive study into the digital market strategy,

operating model and operational transformation needs in the retail sector. In this report, the team has

articulated a broad spectrum of findings in both strategies and operations, with a clear layout of different

options for market leader to consider.


Tapping into China’s New Consumers: Getting Sales Channels and Logistics Strategies Right to Drive Profitable Growth Alan Beebe

Director, Advisory Services

[email protected]

Penny J Cao

Senior, Advisory Services

[email protected]

Grant Lin

Senior, Advisory Services

[email protected]


Introduction

China’s economy is transitioning from three decades of

manufacturing and infrastructure-led growth to a

fundamentally new growth model driven by consumer spending

and services. Growth in discretionary income is rapidly

spreading from large coastal cities to hundreds of urbanizing

cities across the country, bringing unprecedented

opportunities for consumer product companies. But with these

market opportunities come enormous sales and logistics

challenges. To enable profitable growth, consumer products

companies need to align sales growth aspirations with

innovative operating models featuring complex distribution

channels and logistics solutions.

EY has identified five major trends that will shape the

strategies of consumer products over the next three to five

years.



Shifts in modern retail changing consumer behaviour and

trade practices

Today’s Chinese consumers have abundant product choices

and use diverse channels to spend their hard earned income.

While e-commerce is an important emerging channel,

accounting for 12% of total retail sales, it is new store

formats such as convenience stores and supermarkets that

are driving sales. Between 2000 and 2010, traditional

formats such as independent retailers and discounters had

higher growth levels than supermarkets, hypermarkets and

convenience stores. In just five years, the situation reversed:

supermarkets, convenience stores and hypermarkets showed

rapid growth from 2010 to 2015 while the growth of

traditional retailers is stagnating or even declining. Based on

EY experience, however, in China’s fast moving markets

these numbers do not tell the whole story. In the past year,

we have observed some hypermarkets coming under

pressure and slowing their growth plans.

China grocery retail growth rates by format,

2000 to 2015 3, 4

Grocery Retail Format 2000-2010 2010-2015E

Hypermarkets 15.4% 37.9%

Convenience stores 12.6% 23.3%

Supermarkets 9.9% 22.3%

Food, drink and tobacco outlets 15.3% 12.0%

Traditional discount outlets 13.7% 0%

All grocery retail 9.1% 11.3%

More than ever, busy Chinese consumers are looking for

convenience. Convenience stores in high-traffic areas and

neighborhoods are growing rapidly. In 2014, there were

more than 4,000 convenience stores nationwide. Based on

rapid growth rates of China’s leading convenience store

operators, mainly based in the east and south, EY

anticipates continued growth in the coming years.

Convenience store operators, such as Sinopec Group’s

Easyjoy with nearly 24,000 stores in 2014 and

PetroChina’s uSmile with 15,000 stores, are increasingly

important channels for consumer products companies

battling for valuable shelf space.

Rapid urbanization and disposable income growth in

hundreds of cities

China’s new consumers with ample discretionary income

are no longer confined to “tier1 and 2” cities in the coastal

provinces of China. Based on the government’s extensive

2014 household survey covering 660 cities and rural

regions, national per capita disposable income now exceeds

20,000 yuan, growing by 8% in real terms from 2013 to

2014. Between 2010 and 2014, urban disposable income

grew by 50% and rural incomes doubled1.

Of the top 20 provinces EY ranked by disposable income, 9

are in eastern provinces with a total population over 500

million. Beijing, Shanghai and all of Guangdong ranked first,

second and seventh respectively in disposable income, but

represent only 11% of China’s total population. Hundreds of

large and small urbanizing cities in eastern and central

provinces now have sufficient consumer spending power to

become attractive customers for consumer product

companies. In fact, in 2014 over two-thirds of fast moving

consumer product sales were outside of Beijing, Shanghai,

Guangzhou and Shenzhen. With China’s total retail sales of

consumer goods exceeding 26 trillion yuan in 2014,

companies can no longer afford to focus on established

coastal cities without clear sales and logistics strategies to

take advantage of China’s next wave of consumer growth2.

Major Trends Shaping China Sales and Logistics Strategies

1

Rapid

urbanization

and

disposable

income

growth in

hundreds of

cities

2

Shifts in

modern

retail

changing

consumer

behavior

and trade

practices

3

Evolving

sales and

distribution

channels to

reach

China’s next

wave of

consumers

4

Surging

e-commerce

sales

transforming

channels and

consumer

behavior

5

Investments

in modern

logistics

enabling

broader and

lower-cost

geographic

coverage


China’s Evolving Sales and Distribution Channels

Surging e-commerce sales are transforming channels and

consumer behavior

E-commerce in China is booming as urban and rural

consumers across the country take advantage of

unparalleled access and convenience to endless choices of

international and Chinese consumer products from fresh

food to trendy electronics.

In 2014, e-commerce sales reached 3.2trillion RMB,

accounting for 12% of total retail sales. E-commerce sales

are expected to more than triple to 10.7trillion RMB within

the next three years, accounting for 29% of total retail sales

by 20186.

Alibaba, JD.com and other e-commerce players are

investing heavily in logistics infrastructure and services to

reach consumers whether in the largest cities or smallest

rural villages.

For example, Cainiao, the logistics subsidiary of Alibaba, has

recently launched three fresh food distribution centers to

provide cold chain delivery services within 24 hours to 18

cities with plans to expand to 50 cities by the end of 20157.

JD.com owns and operates seven fulfillment centers and

166 warehouses in 44 cities across China. Complementing

this logistics backbone are 4,142 delivery stations serving

over 2,000 counties and districts across the country8.

While it remains to be seen how the logistics of e-commerce

companies will evolve, this much is clear: the rise of e-

commerce will fundamentally alter today’s traditional sales

channels and how consumer products companies engage

with consumers.

In China, the number of convenience stores per million

populations is only 54, compared to 388 in Japan and 425

in Taiwan5. Companies should therefore look to these and

other markets for inspiration, but their models will need to

be adapted for China’s unique sales and operating

environment.

To tap into the growth of convenience stores, many

consumer products companies will require new sales and

logistics strategies – including national direct sales

coverage, decentralized warehousing, and flexible fleets for

multiple deliveries each day.

Sales and distribution channels are evolving to reach

China’s next wave of consumers

Most consumer product companies have historically relied

on traditional multi-layer channels to reach more

consumers, minimize operational complexity, and reduce

working capital requirements. However, the emergence of

modern retail and e-commerce is challenging the landscape

for consumer product companies, distributors and retailers

alike. Hybrid models are rapidly emerging as companies

work to broaden national coverage, get closer to consumers

and expand into e-commerce. While the trend towards fewer

and fewer distribution layers is clear, EY expects the

evolution to be a gradual one as consumer product

companies consider the advantages and disadvantages of

different channel structures for distinct product, markets

and geographic segments. Tapping into lower tier cities, in

particular, will likely continue to require traditional multi-

layer distribution channels.

To succeed, consumer products will need to excel in

managing operating complexity. Sales strategies and sales

force effectiveness must be refined, sales channel and

distributor partnerships deepened and, importantly, the

right logistics infrastructure must be in place to support

sales growth.


GLP, with the largest warehouse space in operation in 35

cities, is one of the leading providers of modern logistics

solutions to end users. It has total 11.8 million square

meters of warehouses in operation and 21.8 million square

meters under construction or in land reserve. Its continuous

investment in China will keep its market leader position in

the logistics warehouse space. Blogis is the second largest

modern warehouse provider in China with 1.4 million square

meters warehouse space in operation. It plans to add 0.72

million square meters of space per year in the next five

years to reach 5 million square meters9.

BPHL is focusing on cold chain and bonded logistics

services. It currently has 5 warehouses in operation and

plans to add 0.3 million square meters of space per year in

next five years9. Besides BPHL, China Merchants-Americold

is also investing in new cold storage facilities with capacity

of 50000 tons12. Swire Group has 4 cold storage

warehouses currently in operation with a total pallet

capacity of 137,000. It also plans to invest in 13 modern

cold storage facilities by 2020 to serve 2/3 of China’s

population13.

EY anticipates that ongoing investment in logistics

infrastructure will be a key enabler for greater sales

expansion. Cold chain, particularly, will outperform other

sectors as the new highlight. The fast development of

infrastructure will provide consumer products companies

with an ever broader customer reach and at increasingly

lower cost.

Investment in modern logistics infrastructure and services

enables broader and lower-cost geographic coverage

Strong sales growth of consumer products drives the need

for modern logistics infrastructure and services. Today,

China’s logistics industry remains in the early stages of

development – only 11% of China’s warehouses are up to

global standards. This is driving significant investments and

plans by specialized logistics companies, e-commerce

companies and other investors. Global Logistics Properties

(GLP), as a leading logistics developer, has 10 million square

meters of warehouses under development. The second

largest modern warehouse player, Blogis, plans to expand

its current warehouse land bank to 5 million square meters

by 2019. Beijing Properties (Holdings) Limited (BPHL) aims

to manage 3 million square meters of warehouses by 20199.

Furthermore, EY have seen significant investments being

made in cold chain infrastructure. In 2014 alone, total

investment in cold chain infrastructure exceeded 410 billion

RMB, with nearly 25% for the construction of 40 cold chain

logistics parks10.

Shun Feng Express (SF), one of the leading companies in

express delivery in China, owns 91 warehouses nationwide

with a total capacity of 0.75 million square meters. It

operates over 12,000 service centers and approximately

16,000 vehicles across its broad China network and plans to

open a major cold storage hub in Wuhan in 2016. Once

finished, it will serve as a central network covering 6 major

regions within the radius of Beijing, Shanghai, Guangzhou,

Xi’an, Chengdu and Xiamen11.


References:

1. China’s Economy Realized a New Normal of Stable Growth in

2014, 2015, www.stats.gov.cn

2. Annual per capita disposable income of rural and urban

households in China from 1990 to 2013 (in yuan),

www.statista.com

3. Average annual grocery retail growth rate in China from 2000

to 2010, with a forecast until 2015, by type of store,

www.statista.com

4. Total sales of Commodities of Integrated Retail Report,

www.stats.gov.cn

5. Development report of China convenience store 2014,

www.ccfa.org.cn

6. China to Become Largest E-commerce Market in 2015, 2015,

www.chinainternetwatch.com

7. Cainiao Launches Three Fresh Food Distribution Centers,

www.alibaba.com

8. Tmall, Yihaodian and JD: A Comparison of China’s E-commerce

Platforms for Foreign Enterprises, 2015, www.china-

briefing.com

9. Industry Focus-China Warehouse sector，2015， DBS

VICKERS SECURITIES

10. Review of Chain Cold Chain Development in 2014,

www.cnlenglian.com

11. Introduction to SF Express Co., Ltd. 2015

12. China Logistics and Purchasing, 2010, www.cnki.net

13. Swire Group Introduction, www.spcschina.com

Conclusion

Consumer products companies looking to tap into China’s

next wave of consumers will require the right sales,

distribution and logistics strategies to ensure profitable

growth. While the broad trends are clear, company

strategies will need to be adapted regionally, and even

within cities, to account for significant differences in the

distribution practices and logistics infrastructure across the

country.


New Integration Era for Consumer Products and Retail Sector in China

Hsuan Chen

Executive Director

Transaction Advisory Service

[email protected]


“A dream Market”

According to the 2014 data released by the National Bureau of

Statistics of the People’s Republic of China, China currently has

around 1.4 billion people (~19% of the world’s population), 200

language dialects and 57 ethnic groups. ‘The China market’ has

become a crucial engine of global growth – a dream market.

Almost half of all survey on 2011 found that many global

companies had raised their expectations for China after the

2008 financial crisis.

Although China’s economy slowed to 7.4% GDP growth in 2014

– the lowest rate since the 1990s, China remains among one of

the top 10 fastest growing economies in the world.



However, based on Bain and Kantar Worldpanel's study,

Winning Over Shoppers in China's ‘New Normal', the overall

China market growth for consumer product and retail

(“CPR”) categories is showing a continued deceleration

from nearly 12 percent in 2011-2012 to 4.4 percent during

the first quarter of 2015.

The report also indicated that in China's lower tier cities,

the impact of the slow-down was minimal – 8 percent in Tier

1 cities vs. 2 percent in Tier 2 cities.

With the shifting market dynamics, multinational companies

(MNCs) in the CPR sector today face a range of new

challenges in the China market:

► Strong competition from local players: In China’s CPR

market, MNCs competitive advantages are eroding due

to the strong local competitors. There are two types of

Chinese competitors: (a) powerful state-owned

enterprises (“SOE”) with government background, and

(b) highly competitive and dynamic Chinese-owned

companies

► Changes in behavior: Consumers are now becoming

more flexible in brand loyalty, shopping habits,

preferences, and media consumption. Furthermore, e-

commerce is beginning to reign supreme in China.

Online shoppers have expanded their purchases from

high-priced products to categories with lower average

selling prices

► Difficulties to penetrate into lower tier cities: Foreign

CPR companies face a set of challenges as they expand

into less developed areas: limited knowledge of local

markets, insufficient infrastructure and poor distribution

channels, and cultural differences. Private label

competition from retailers is also playing a road block to

MNCs

MNCs in the CPR sector are essentially competing with local

rivals that have lower costs and stronger distribution

networks in China.

Chinese brands are the leaders in China

Kantar Worldpanel’s 2015 Brand Footprint ranking reveals

that the top CPR brands in China are Chinese brands or

brands with Chinese origins. The ranking was established

based on a metric to indicate frequency and location of a

brand being consumed by Chinese consumers.

According to the report, the top three players - Master

Kong, Yili and Mengniu - were chosen by Chinese shoppers

more than 1 billion times in 2014. Among the top 10 brands,

Shuanghui, Bright and Haday have also advanced in the

ranking from 2013.

Rank Name of the company % of penetration Frequency

1 Master Kong 90.2 8.8

2 Yili group 88.1 7.7

3 Mangniu Group 87.6 7.4

4 Want Want China 73 5.4

5 Shuanghui Group 65.6 5

6 Bright Food Group 47.5 6.8

7 Unit president China

Holdings LTD 68.7 4.7

8 Wahaha Group 63 4.5

9 Haday Group 64.5 3.9

10 Liby group 67.8 3.7

In the market, local brands have been strengthening their

engagement with consumers by providing both online and

offline promotions, and by promoting propositions of

convenience, quality and a healthy lifestyle.

In response, Chinese consumers, with their increased

disposable incomes, are more willing to buy high quality and

innovative local brands. Chinese brands have apparently

outpaced a number of major global names in the past few

years.


Newly formed business circumstances

In a country where local brands are generally reacting faster

to the market changes, MNC brands need to develop a higher

level of agility. However, MNC operations, particularly for

those global names, commonly do not allow rapid changes to

their strategy.

First of all, it is very typical for MNCs to have complicated

and long decision-making metrics and processes. Various

levels of leadership must approve the new products or

strategies. And by the time they come to introduce a new

product or a marketing strategy, it may have already been

launched or adopted by a local competitor.

Secondly, in the growing remote areas of China, distribution

assumes an even greater marketing significance. Local

brand growth comes from concentrating on outlets in lower

tier cities where global brands are less likely to be found.

Chinese toothpaste brand Saky, for instance, has grown by

being well-distributed and highly visible on local store

shelves.

Additionally, MNCs now do not appear to have the advantage

of attracting the top talent, and it is even harder to recruit

talent in remote areas to help penetrate the market. HR

consultancy reports reveal that the local talent is

increasingly gravitating towards mainland companies.

So how can CPR MNCs survive in China going forward?

A new business culture is emerging!

In the past few years, we have seen the best local know-how

and entrepreneurial skills combine with western managerial

expertise. MNCs either form a joint-venture with a Chinese

company or directly acquire a local brand. The objective of

the transaction is no longer a “full take-over”; instead, a

“Best of Breed” approach has evolved, i.e., ensure the best

of both companies is retained.

Integrate the “Best of Breed”

In the context of a transaction, "Best of Breed" is a

strategy of selecting the best practices of the acquirer and

acquiree, rather than selecting one large integrated

solution from a single entity. We have now seen this

principle widely adopted by MNCs: from their M&A strategy

planning to post-deal integration.

In these cases, deals give the MNC access to the edges of a

domestic player such as important government contracts,

upstream activities, intellectual property (“IP”)

contributions, distribution channels, and core capabilities

sharing, and other means of advancing in China.

But finding the right acquisition candidate is just the

beginning: The planning and execution of integration can

make or break a deal.

Historically, post-deal integration has been considered as

“changing” and “restructuring” the acquired business. The

objective was mostly narrowed to “operational alignment”

instead of focusing on “value creation”. It is like a married

couple busy at setting out the house rules rather than

creating family values after signing that piece of paper.


► Create a brand image with affordable price but high

MNC quality:

Due to their increasing disposable income, Chinese

consumers are able to trade-up from the low-end

products they previously purchased. At the same time,

higher-income consumers are moving away from pricey

foreign brands and accepting less expensive, locally

produced alternatives that have reasonable quality.

► Develop innovative products by using local resources of

the acquired company:

New pathways to innovation are made possible for

MNCs by leveraging core strengths derived from the

country-specific capabilities of the acquired company.

These opportunities enable MNCs to lower their cost

structures, enhance their innovation capabilities, and

generate more revenue and profit by acquiring a local

cutting-edge company.

Now, as they are facing rivals scattered across China, MNCs

no longer only focus on operational stabilization and finance

controls during the integration. Savvy acquirers are taking

action to design an explicit and pragmatic integration blueprint

which will enable the new organization to be more than the

sum of its parts.

Essentially, MNC players in the CPR sector should focus on

five areas during their post-deal integration:

► Leverage the extensive local distribution network of the

acquired company: While higher-tier cities are fairly mature

markets for players both domestic and foreign, Chinese

companies often have superior sales channels in the faster-

growth, lower-tier cities

► Quickly equip a salesforce with an integrated portfolio of

brands:

Commonly the products for a foreign CPR brand are high-

end and more expensive. MNCs can consider creating a

merged product portfolio to make efficient of the mid to

low-end products of the acquired company attracting new

customers and channels.

► Adopt localized marketing and branding strategy:

The Chinese CRP market is very fragmented and

regulations may not be sufficient to deter certain unlawful

competition. Marketing and branding strategies

successfully realized in western countries may not have

the same effect in China. A leading European furniture

company is a good example in localizing its marketing and

branding strategy. Firstly the company is leveraging

Chinese social media and micro-blogging website Weibo to

target urban youth. They have also adjusted their store

location strategy: The company established its outlets on

the outskirts of cities which are connected by rail and

metro networks. This allows the local people to access

their stores by public transportation.


Conclusion

It is imperative for an MNC in China’s CPR sector to work

with a local company when attempting to lower costs for

both domestic production and export, and when trying to

fill portfolio gaps, expand the distribution channel, and

provide high-quality innovative products to impress the

consumers.

However, this cannot be achieved by just selecting a

leading local company and letting it run separately. It’s

essential now to maintain the edges of the acquired

company, to secure the deal value, and to combine the best

from the two.

As China is a market which cannot be neglected, MNCs

should prepare to take advantage of the increasing

capabilities of local companies and to capture the benefits

garnered from transactions. The most experienced

acquirers will bring a tailored approach to integration, and

be savvy enough to adopt the local marketing strategies,

and ensure financial control - but without slowing the

operations of the acquired company.

Recent cases

Several major CPR MNCs appear to be growing their market

shares by following the “Best of Breed” approach.

A world-leading consumer goods supplier acquired a

majority stake in its Chinese competitor in 2014, the largest

acquisition by the company in China in over a decade.

According to the company, the deal doubled the size of their

targeted business in China and will bring together

complementing technology from both sides. In the

meantime, the MNC can leverage the acquired company’s

local marketing insight, manufacturing and distribution

strengths.

The deal is expected to bring together innovation,

technology, design and manufacturing capabilities. Each

company has a broader range of product portfolio in the

targeted business that covers a range of performances and

price points. Hence the “Best of Breed” integration focus

was to bring together the better aspects of the two in the

areas of distribution channel, manufacturing, R&D,

marketing strategy, and people.

Another world-leading MNC company, a cosmetics maker,

also made an astute investment: The company acquired a

leading Chinese company in 2013 to expand in a market

where sales growth had been outpacing that of the

company.

The acquisition has helped the MNC gain access to the

consumers over which the domestic companies have a

better hold: the low-end to mid-range ones. Rigorous

planning of the portfolio of brands and products is the key

post-deal.


Digital Luxury strategy capturing the Chinese mass market

Lilly L Cheung

Senior Manager, Tax Services

[email protected]


11-11…12-12… What’s next? These numbers are imprinted in

the minds of every shopper and company operating in China. According to Chinadaily, the renowned China ‘Single’s Day’

sales in 2015 resulted in $14.3 billion, of which over 70% percent of the volume was generated from mobile channels, such as smartphones and tablets. (Source: China Daily, Dec 18, 2015, http://www.chinadaily.com.cn/business/tech/2015-11/11/content_22427826.htm)

This is already a sign that a mobile flagship store should be even more geared up standing out on these magical days of the year, as 11-11 has proven in success cases, to generate 4 months of physical store sales. Yet the rumor was over 50% of all purchases were returned due to inferior quality. (Source: 中国商业报道网 December 3, 2015)


The paradox has been should luxury adapt to the digital world? If eCommerce is the secret weapon to save luxury brands from losing market shares or public interests, what is then the success road for a digital luxury strategy?

In order to have an in-depth understanding of eCommerce business in China, EY’s Operating Model Effectiveness group interviewed 33

companies in mainland China between April - August 2015 and investigated the digital market strategy, operating model, and operational transformation needs, of the retail, apparel, luxury, super- and hyper-market, and food chains in a first phase, with a deep dive in the luxury sector in a second phase as they were either not playing or playing a different ballgame.

1

2

3

4

There is a mix of commercial, operation, tax and legal considerations for setting up a sustainable and profitable eCommerce business in China.

► How does the online market look like?

The industries have been plotted in the graph based on the interview results. The following graph was the result of the conducted research. The vertical axis describes the online market share as part of the total market share of a company. The horizontal axis describes the online customer base.

Four digital strategies

Self-owned webshop

3rd party owned webshop

no webshop

Slow movers refer to the industries, i.e. super/hyper

markets and large retailers, in the lower right quadrant.

They have websites presenting their products and services

as they gradually build new delivery options. The DCs and

logistics network are in place and, sometimes, they also sell

their company-branded products.

Strategy: Slow movers in mainland China are renewing their

eCommerce strategies; increasing their capabilities in

marketing, IT and logistics; and upgrading their existing

eCommerce platforms. The next step is to provide their

online shop with more O2O delivery options such as home

delivery, store and DC pickup.

In order to increase customer traffic and influence buying

behavior, large companies look for ecosystem-

complementary collaboration partners to increase their

product portfolio. They form alliances with large merchants,

integrate their systems and build consistency across the

different sales channels. Their strategy focuses on shifting

upward in our model by adding up the market share of other

large companies through collaboration. Arrow #2 in the

graph above

► Bold movers’ strategy: Navigate members through O2O

experience

Bold movers refers to the industries where services plays an

important role, i.e. food chains and luxury brands, in the

lower left quadrant in the graph.

Customer centricity is key in the digital strategy. In

particular, the barriers for luxury brands to enter

eCommerce is based on the assumption that they lose the

customer because of the fact that eCommerce will create a

lower customer experience. This positive experience is

essential to demand premium prices. They seem to use “trial

and error” to create a “buzz” derived from a bold move, like

Chanel with the global pricing alignment and the launch of

Cartier’s eCommerce platform without any advance

announcement. They both created the talk of town this

year.

Strategy: A flawless online-offline experience, triggered by a

“buzz” is an important part of enticing a customer to make

an impulsive buy. Their digital strategy is shifting up and to

the right. See arrow #3, where the bold movers work

together with other companies to enhance the customer

experience.

Based on the 33 research results, a remarkable observation

is that all players try to design their own mass market

strategy, and the luxury brands are the only group that

focus on the customer experience journey. This is the

reason why we took a closer look into Luxury brands in the

remaining part of this article.

In general, most companies in the dark grey colored circles

have their own platform. The yellow colored circles are

available on a third party eMarketplace. The light yellow

colored circles have a relatively lower eCommerce

marketshare, and are either on an eMarketplace or not

available on eCommerce.

The chosen strategies within the industries in the scope of

this research can be divided into four groups:

► Early movers’ strategy: Maximize traffic and explore new

markets

Early movers refer to the eMarketplaces, depicted in the

upper right quadrant in the graph. They were the early

movers in the Chinese eCommerce market and consequently

have a high online market share and a large digital customer

base. They now are used like search engines, and provide

convenience, low-priced commodities and fast delivery

services.

Strategy: their strategy is based on the fact that they want

to stay in this quadrant. In order to achieve the high level

online market share and customer base, they have to

activate online traffic through increased and complementary

offerings and increased coverage. They expand their

logistics hubs and network to lower tier and rural mainland

China, and acquire new innovations faster than their

competitors.

► Fast movers’ strategy: Create a brand-presence on a

third-party platform and attract traffic

Fast movers refer to the industries, i.e. scalable retailers and

apparel companies, in the upper left quadrant in the graph.

They sell products through eMarket places created by the

platform giants. However, their (online) customer base is

still relatively low.

Strategy: They try to upsell themselves by brand building

through differentiation strategy, to ‘stand out from the

crowd’. Their challenge is the fact that they are dependent

on the eMarketplaces, they have relatively low negotiation

power, and limited information on the new group of

customers that are diverted to then through the

eMarketplaces. They want to shift to the right in the graph

above. See arrow # 1 in the graph

► Slow movers’ strategy: Activate existing clients through

online-to-offline (O2O) collaboration with ecosystem-

complementary partners


The key finding #1: is that ‘the digitally

conservative’ luxury brands focus on a ‘seamless

customer experience journey’, while ‘the digitally

mad’ focuses on ‘convenience, fast, and cheap’.

What obstructs Luxury brands to follow the digital

madness?

► Image: Online shopping is seen as shopping on a market

place for cheap buys, fast and conveniently. This can

damage the luxury image

► Touch point: Loosing the contact with the customer who

is eager to receive special treatment in physical shops

► Governance: The behavior of third parties with the

customer is uncontrollable, especially in the last mile

delivery where a third party logistic provider is having

the touchpoint with the customer

► Grey market/fake/daigou: Luxury brands do not wish to

be associated with fake goods being sold on the eMarket

places through unauthorized channels. Legal action is an

important way of fighting counterfeiting

► IT and supply chain capabilities: Digital that heavily

leverages the marketing, customer services, supply

chain and IT functions of a company, are only partly in

place with luxury companies. Luxury brands in China

mostly have their supply chain and IT outsourced. They

have the challenge whether to build these capabilities

for the longterm and/or having their own luxury online

platform

► Pricing: eCommerce triggered global transparency on

product information and the pricing. Luxury brands,

eMarketplaces, flagship stores on and offline, have to

consider global pricing alignment, in order to balance

brand’s omnichannel strategy. There are doubts on how

the retail price can be balanced with the internal

transferprice between different entities, and ensuring

shareholder value is maximized

► Tax: Bonded logistical crossborder eCommerce zones

are popping up in different provinces to attract foreign

investment. Import duties on luxury goods are changing,

therefore, how sustainable is the operating model

The key finding #2: The current offline market is

saturated. In order to grow, exploring the online

market is a must as digital is the only way to reach a

larger market share of both on and offline

customers.

How should you change your organization as an effect of

‘going digital’?

The organizational change has been lagging behind the

customer behavioral change.

Companies are renewing their eCommerce strategies and

considering essential strategic choices regarding the main

functions within the company. One of these choices is the

decision on which new capabilities to be built in-house for

the future.

The continuum depicted below, shows the amount in

investments and business impact in needed capabilities to

be built from scalable to large companies. The focus is on

the four type of strategies indicated earlier. In principle,

there is no difference in terms of optimum situation

between small and large firms, however, clearly large

companies have the resources to make needed choices

easier to provide customers the O2O experience.

This continuum shows that all companies should at least

strengthen their marketing and their innovation

department,that leverages social media to improve the

customer stickiness. Acquiring a new eCommerce customer

and good customer retention, can enlarge the life time

customer value that generates an extended turnover (for

lifetime). IT and supply chain are areas that companies have

to build inhouse, the more they grow online.


Organizational capabalities development

What obstructs Luxury brands to follow the digital

madness?

Capabilities build inhouse versus outsourcing:

A. IT: big data analytics to achieve predictive modeling and

personalization

B. Supply chain logistics: increased control on quality at

touch points with the customer in the “last mile

delivery,” improved vendor management

and omnichannel logistics, reorganization of DCs and

physical store inventory

C. Marketing: brand and online content management

D. Customer service: improved training and personalization

in product as well as customer knowledge

E. Innovation/ social media: transforming innovative

branding ideas and delivering this through an

omnichannel

The answer of which are the different functions that need to

be developed inhouse, depends on the level of maturity, the

industry and the size of the company.

eCommerce Maturity in China

Merchandizing

and pricing

Price

determination

Digital asset

production

Product

listing

Customer

services

Order

processing

Inventory level

determination

Warehouse

location

selection

Order and

inventory

Inventory

replenishment

Boldmover

Boldmover

Fastmover

Fastmover

Fastmover

Slowmover

Pioneer

Growth

Saturation

Market-entry

eCommerce

MATURITY

Merchandizing and pricing Operation & sales Inventory management

Order

handling

Pick and

pack

Shipment Return

goods

handling

Tax and

customs

declaration

Data

analytics

and

reporting

Brand

communica

tion

UI design Search

engine

marketing

Marketplace

promotion

activities

Search

engine and

social

media

Online

media

relationship

Online /

offline

marketing

campaign

Brand site

development

Hosting and

maintenance

Source code

ownership

Boldmover

Boldmover

Fastmover

Fastmover

Fastmover

Slowmover

Pioneer

Growth

Saturation

Market-entry

IT-related

eCommerce

MATURITY

eFullfillment Marketing-related


Based on the EY research, the companies in different

maturity phases show changes in inhouse organizational

capabilities. This table can only be seen as a benchmark and

reference. For luxury brands, the bold movers, you see that

merchandizing, pricing and mostly the marketing related

activities should happen in house, at least for the strategic

decisionmaking. However, if we look at the other groups,

fastmover, slowmovers and pioneers, there is an

operational transformation need in order to execute the

digital strategy. The transformation relates in this case in

the choice in-house versus outsourcing.

Companies do merchandizing and pricing always inhouse.

► Market entry phase: functional activities that can be

outsourced through eMarketplace are the online

operations, order taking, sales, order replenishment

► Growth phase: Logistics and IT can mostly be

outsourced, however, the more the companies grow

online, the more functions should happen inhouse.

Marketing is a function that should be strengthened, but

will always remain a collaborative effort, where the

decisionmaking happens inhouse and the execution

happens with third parties. Nevertheless, big data should

in all cases be generated inhouse in order to better

predict company’s key customer behavior

► Saturation phase: During this phase, all organizational

capabilities should be built in house already. In logistics

and IT, there are limited companies that make use of

third parties

The key finding #3: ‘Going and being digital’ means

the key drivers and touchpoints with customers

should be controlled.

The organizational capabilities being impacted are mainly

marketing – to attract the customer; supply chain should be

restructured (previously you sent a batch to the store, now

you send 1 item across China); customer service to deal

with returns and questions that could be prevented when

the items was bought online; IT capabilities to integrate the

different systems to ensure one view of truth of the order

(i.e. integrating the system of the web and mobile portal,

the order management system, with the warehouse

management system and the logistics provider system).

Customers strategies diverge; buy cheaper and buy more

luxury. Customers that have access to global pricing, save

money through buying online, mainly through

eMarketplaces. This additional saving can in turn be used to

buy luxury goods in order to upgrade themselves for their

image and pride.

Company strategies converge; Companies that pursued the

mass market previously, are trying to ‘upsell’ their brand,

since the new digital customers from lower tier cities, might

just learned about the brand. Luxury brands introduce new

lines that are capturing the new online market customers, in

order to prevent ‘downselling’ their original brand. Luxury

exclusive is no longer defined as scarce, but characterized

as having a long unique authentic brand story of

craftmanship. Other

A digital strategy for luxury brands has two implications for

the companies operating in this industry. First, the need for

consumer centricity and the need to govern consumer

experience especially in the touchpoints, makes it necessary

to build in house capabilities much more than in other

sectors. Secondly, and related to this, there is high urgency

to make resources available to invest in these in-house

capabilities.


We present our key considerations as follows according to

the key constraints and feasibility of market entry: Legal,

Advisory, Tax (Customs, China tax, and transfer pricing).

Can we and how to set up ecommerce in china legally?

Legal

► Legal structure: Can the brand make use of their own

WFOE to set-up eCommerce or should they set-up

eCommerce with a Chinese partner? How should the

holding structure look like?

► License to operate: Does the brand need to register or

file for an ICP license with the Ministry of Internet

Information Technology? This is based on the province

where the eCommerce platform is located whether they

define the brands’ online activities as ‘commercial’

Internet Information Service (IIS) activity. The definition

of ‘commercial’ differs between the 30 provinces in

China. What registrations does the brand and/or the

distributor need to get?

► Material limitations: What products can be imported into

China, which and how to apply for these licenses?

► Sustainability: What are the legal requirements to ensure

the O2O Operating model in China is sustainable

What and how to set up ecommerce from business

strategy and operational feasibility point of view?

Advisory

► Brand image: How to localize while maintaining your

brand image? How to recruit talents with brand

experience and innovate on the brand?

► O2O strategy: How to bring a seamless online and offline

experience to a customer in China? Competitors are

setting up O2O in lower tier cities, should brands follow

this pattern?

► Big data/ eCRM: How to use big data analysis to

personalize and predict customer preference? How to

engage customers through different online and offline

channels?

► Channel strategy: Should brands choose to have their

webshop on their own brand site, a third party

eMarketplace, or a wechat - shop? Should brands choose

to have a mobile app? Which social media channels

should brands be on in China?

► Sales: How to drive Chinese customer traffic online?

How can brands convert online traffic into sales?

► Pricing strategy: How to globally align prices with

distributors on and offline, and with transferprices?

► Products strategy: Which products should brands put

online and which one offline? What do other brands do?

► Inhouse /outsourcing: Should brands operate the

eCommerce themselves or should they outsource part of

this? What is the balance?

► Logistic and supply chain model: Should brands make

use of a third party warehouse? If yes, from a sales

distributors’ or a logistical provider? Should this

warehouse be located in a Free Trade Zone? Should this

be a bonded warehouse setup or a local warehouse?

How to organize the return logistics through on and

offline channels. How to improve the touch points with

the customers on their last mile delivery?

► Inventory management: Should you integrate your

inventory management of your online and offline

channel? How to have real time visibility and governance

of inventory between physical store DCs and other

central DCs in or outside of China?

► Payment: Which payment provider should brands make

use of? What options are there to integrate local

payment providers into brands’s current system and

eCommerce platform?

► IT strategy: Should brands leverage their existing

eCommerce platform or build a local platform? What is

the best location to place the server? Can the server be

placed on a tax efficient location? How to guarantee

data safety?


What and how to set up ecommerce from a tax compliance

and efficiency point of view?

Transfer Pricing

► Intangible assets: What intangible assets (e.g.,

trademark/brand, trade name, technology, know-how,

eCommerce platform, etc.) will be deployed in carrying

out the eCommerce business in China?

► Ownership of the intangibles: Which entity performs the

developing, enhancing, maintaining, protecting,

exploiting and promoting of the intangible assets

deployed in the China market and bears the relevant

costs?

► Local marketing-intangible: Which entity is responsible

for determining the marketing strategy in promoting

brands/images in the China market? Which entity is

responsible for executing these strategies? What

activities are performed by these entities?

► Value chain: What is the functional profile (e.g., from

limited risk to full-fledge)? How does each entity position

themselves in the value chain related to the eCommerce

business in China?

► Transfer pricing policy: What related party transactions

will be engaged by each entity related to the eCommerce

business in China? What are the possible charging

mechanism (e.g., royalty, service, commission, etc.)?

How can brands determine the relevant pricing policy?

How to import and set up the warehouse tax efficiently?

Indirect Tax (Customs/VAT)

► Free Trade Zones (FTZ): Brands have branches in

Chinese cities where Free Trade Zones have eCommerce

incentives. Where should brands set up eCommerce in

China?

► FTZ partners: What registrations should brands and

related online partners i.e payment firm, logistics

enterprise, operator of customs supervised areas, make

with the customs authorities to store/import/sell

branded products?

► FTZ Warehouse: Should brands use a bonded warehouse

from a third party provider of build their own

warehouse?

► FTZ Incentives: How can brands leverage the Free Trade

Zone incentives? Is the tax preferential treatment for

the eCommerce business in the Free Trade Zones? Is the

financial subsidy for the eCommerce business in the Free

Trade Zones applicable?

► FTZ Procedures: What are the required standard

procedures to set up the eCommerce company in the

Free Trade Zones? How should we report the 3 flows

information (cash flow /sales flow /goods flow) be

reported to Customs authorities correctly and timely?

How to ensure the reporting of import information, e.g.

item name, price, quantity, HS codes and etc. to

Customs authorities happen correctly?

► FTZ Tax implications: What are the tax implications of

conducting the eCommerce business in the Free Trade

Zones? Are there other considerations from China tax

perspective the management should be aware of?

► Free Trade Agreements: Have the free trade agreements

been utilized to mitigate duty rate with appropriate

supporting documents for products imported into China

from oversea?

► Regional Customs polices/practice: As eCommerce is

permitted in 9 pilot cities, some selected free trade

zones and pilot zones/areas, which may be under

different regional customs authorities in China, does

brands have approached these Customs offices to

understand the regional customs policies and practice on

eCommerce model requirement and imported goods?

► VAT implications: What are the VAT implications of

selling to private consumers?


How to structure tax efficiently?

General China Taxes

► Permanent Establishment (PE): Will brands create a PE

in China under the new business structure especially

eCommerce in terms of the location of the ‘Server’?

► Treaty Protection: Are brands qualified for treaty

benefits? How could brands mitigate those challenges

from different perspectives (i.e. contractual terms,

origination and negotiation, execution,

management/authentication, title transfer, income and

etc) on eligibility of enjoying the treaty benefits? What’s

the application procedure?

► Impact of BEPS: What’s the view of the China tax bureau

on brands’s eCommerce business in China (i.e. funds

flow, goods, services, people authentication, information

and etc) ?

► Consumption Tax: What’s the consumption tax on the

goods of brands? Any opportunity to minimize the

consumption tax which is only taxed on certain goods?

► Withholding Tax Liability: Is brands the tax withholding

agent of the individual consumers who buy products

through eCommerce platform? How should brands fulfill

its withholding obligations?

► The market is transforming due to rapid consumer

behavior change, internet & mobility empowered

consumers. “Go digital Or die” is not just a slogan.

eCommerce strategy determines the operating model.

EY provides a turnkey operating model covering all

functional fields to deliver integrated services.

EY | Assurance | Tax | Transactions | Advisory About EY

EY is a global leader in assurance, tax, transaction and advisory services. The insights and quality services we deliver help build trust and confidence in the capital markets and in economies the world over. We develop outstanding leaders who team to deliver on our promises to all of our stakeholders. In so doing, we play a critical role in building a better working world for our people, for our clients and for our communities. EY refers to the global organization, and may refer to one or more, of the member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young Global Limited, a UK company limited by guarantee, does not provide services to clients. For more information about our organization, please visit ey.com. © 2016 Ernst & Young (China) Advisory Limited. All Rights Reserved. APAC no.03002931 ED None.

This material has been prepared for general informational purposes only

and is not intended to be relied upon as accounting, tax, or other

professional advice. Please refer to your advisors for specific advice.

ey.com

Contact us Eric Chia Partner

Advisory Services

+ 86 21 2228 3388

[email protected]

Alfred Yin Partner

Assurance Services

+ 86 21 2228 2152

[email protected]

Arnold Sun Partner

Transaction Services

+ 86 21 2228 5235

[email protected]

Audrie Xia Partner

Tax Services

+ 86 21 2228 2886

[email protected]

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