Managing Director & Senior Partner
Last year, China experienced a decline in GDP growth, along with a steep drop in consumer sentiment exacerbated by an anticorruption campaign that dampened the intention to spend in lower-tier cities in particular. This year, although business activity was slow in the first quarter, the economy has shown signs of stabilizing, with improved consumption growth. After dropping to a five-year low in January and February, total retail-sales growth increased in May to 12.5 percent, its fastest pace since December of 2013.
Chinese consumers, it seems, have accepted the new economic reality and adjusted accordingly. Our latest survey of 1,000 consumers in 12 cities, conducted in April by BCG’s China Center for Consumer and Customer Insight, shows that the number of people who believe the economy will improve remains the same as last year. But general consumer sentiment and levels of security are on the upswing.
As a result, the intention to spend has recovered significantly as well. This year, 31 percent of consumers plan to increase their discretionary spending over the next 12 months. That’s only 4 percentage points more than last year and quite a bit less than the high of 38 percent in 2012, but this year’s results mean that the number of consumers who intend to spend more once again exceeds the number who intend to spend less.
The recovery is playing out differently in different parts of the country. In lower-tier cities, the intention to spend among middle-class and affluent consumers (MACs) increased 8 percentage points from last year, from 26 percent to 34 percent. (MACs are consumers with more than RMB 7,200 per month in income.) But in higher-tier cities, the intention to spend among these consumers deteriorated by 3 percentage points from last year and by 7 percentage points over the past three years (See Exhibit 1.) MACs from small cities, then, are responsible for the overall improvement in consumer sentiment and the intention to spend.
There are several reasons for this trend. Last year, small-city MACs took the biggest hit from a government anticorruption campaign that reduced subsidies and discretionary spending among officials and business people. Because MACs in small cities are more likely than those in large cities to be entrepreneurs, civil servants, and employees of small and medium-size enterprises, they are more sensitive to such policy changes. (See “A Change of Pace in Chinese Consumer Sentiment,” BCG article, June 2013.) However, while these policy shifts had a significant impact on consumer sentiment in the short term, consumers in small cities have bounced back. Small-city MACs also live more carefree lives than their counterparts in large cities. While respondents to our survey from all geographic areas said they are under less stress, feel less anxiety about the future, and are less worried about losing their jobs than they were last year, rebounds were far stronger among MACs in small cities. For example, 32 percent of big-city MACs said they experience a great deal of stress in their lives, compared with 21 percent of small-city MACs. And small-city MACs are not only less anxious than their big-city counterparts but also show a far more pronounced change from last year. Reports of high stress were about equal for both groups in 2013 (40 percent and 44 percent, respectively, for big-city and small-city MACs). Thus, the number of small-city MACs who feel stressed about life fell by 23 percentage points this year, compared with an 8 percentage-point drop for big-city MACs. We found a similar dynamic in people’s anxiety about the future and worries about job loss: less concern among small-city MACs and a more pronounced reduction from last year.
Small-city MACs are more optimistic about the future, and their attitudes toward consumption show it. In our survey, 66 percent of respondents agreed that “every year, there are more things I want to buy,” representing a 6 percentage-point increase from last year. By contrast, only 57 percent of big-city MACs agreed with that statement, representing a drop of 2 percentage points from last year.
In the midst of the good news about small-city MACs, it should not be forgotten that big-city MACs are still important, representing more than half of today’s total MAC population. The intention to spend has not dropped drastically among these consumers, but they are cautious. And the reasons for their caution have changed. All this has implications for where and how brands should concentrate their efforts in different categories and locations.
Last year, big-city MACs saved primarily in order to build a buffer for the future. This year, that sense of caution has declined by 14 percentage points, dropping to number five on the list of reasons to save (it was at number two a year ago). Now big-city MACs are saving for big purchases: 39 percent of our respondents said they are saving to buy real estate, 32 percent are saving to pay for their children’s education and development, and 28 percent are saving to buy a car.
Big-city MACs are managing their spending more carefully. They’re planning to make not only big-ticket purchases but higher-quality purchases as well. Among the big-city MACs we surveyed this year, 78 percent said that they value quality over quantity, especially in the categories that matter most to them. And they show steady increases in overall intention to trade up: 46 percent plan to trade up this year—3 percentage points more than last year and 4 percentage points more than in 2012.
This increasing intention to trade up does not apply universally in all categories, however. We looked at 67 categories of fast-moving consumer goods and found that big-city MACs are focusing their spending on a few high-priority categories. In fact, their willingness to trade up has declined since last year in nearly half the categories we surveyed. (See Exhibit 2.) In other words, they are becoming more selective, concentrating their spending—and spending more—in fewer categories than in the past.
In contrast, small-city MACs showed a dip in the intention to trade up last year, but this year they returned to the same level as in 2012. These consumers report that they still intend to trade up in most categories. Overall they want to spend more, and they have more money to spend on better quality in a larger number of categories.
In which categories do big-city MACs want to spend more? They are prioritizing baby-related purchases above all, followed by big-ticket purchases like cars and houses, by spending on fresh produce, and by lifestyle spending on such things as travel, home décor, and furniture. In these categories, they’re willing to spend more for better quality. In fact, consumers throughout China show a strong willingness to spend in those categories, making the outlook strong for players active in these spaces.
The willingness of big-city MACs to trade up on nonessential items, especially packaged food and beverages and entertainment, has declined. This means that in higher-tier cities, market growth for brands in those categories will likely slow down, while the market will become more competitive. In this environment, it is essential for brands to differentiate themselves and come up with unique, appealing propositions. Companies will need to work harder to convince consumers to open their wallets.
Nevertheless, strong growth potential remains for nonessential items among small-city MACs, who still view them as priorities. These consumers also show a continually growing desire to trade up in these categories. For example, we found that the willingness to trade up among big-city MACs declined 2 percentage points for juice and 6 percentage points for sugar confectionary, but rose 12 and 9 percentage points, respectively, among small-city MACs.
It is important for brands and retailers in these categories to expand their footprint and capture the next growth frontier represented by lower-tier cities. Some companies focused on this opportunity have already benefited from the improved consumer sentiment among small-city MACs. For example, we looked at nine local department stores with a regional focus and broad coverage of smaller cities or counties. Their average growth rate during the first quarter of this year was significantly better than that of their counterparts in top-tier cities: on average, 5 percent compared with –6 percent, a difference of nearly 10 percentage points.
The overall picture is positive. Certainly, consumption-led growth is more volatile than investment-led growth, which China relied on in the past. After all, the spending habits of fickle consumers are more difficult to control than credit and investments in state-owned enterprises. Companies should expect a bumpier road in the years ahead. To stay ahead of the curve, they should closely monitor how consumer sentiment and preferences are changing, and act fast to capture growth opportunities in different consumer segments. But overall, consumers are relaxed and feel secure. Sentiment is improving, and the intention to spend is ticking up.
The following are some key trends worth remembering:
Brands that respond swiftly and appropriately to these changing dynamics can expect a smooth ride ahead.