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Consumer and Shopper Insights

May 2012

Inside Chinas hypermarkets: Past and prospects

Chinese consumers love to shop. More than a third of Chinese (36%), according to
McKinsey research, say that shopping with friends and family is one of their favorite
activities. Retailers like the sound of that. But consider: Three years ago, that figure
was 45%.
By Louise Herring, Daniel Hui, Paul Morgan and Caroline Tufft
The gap indicates an important point: For
retailers big and small, foreign or Chinese,
the days of wine and roses are over. The
future is going to be much more difficult.
Specifically, McKinsey has taken a
close look at the hypermarket model.
Hypermarkets are very big spaces that
combine supermarkets and department
stores and they have been a big hit in
China. By 2010, the country had almost
2,400 of them, concentrated in the big,
prosperous Tier 1 and Tier 2 cities. Within
established retail chains, hypermarkets are
the dominant format. And all this happened
in a blink of an eye, in economic terms. In
1997, hypermarkets barely existed. Between
then and 2003, revenues grew an average of
70% a year; since then, growth has averaged
about 20%.
But now things are about to get much
tougher; the low-hanging fruit has been
picked. Not only is the competition
tightening, but retail dynamics are
changing.. To win, players need to
understand the Chinese market, and then

learn how to operate in a way to meet the


market on its own terms.

the hard way, Chinese consumers use


hypermarkets distinctively.

As many retailers, particularly nonChinese multinationals, have learned

1. Food versus non-food: Outside


China, hypermarkets devote the great
majority of their space to household goods

Exhibit 1:

Hypergrowth
Sales
RMB (billion)

CAGR
1997-03 2003-10

470
417
363
314
267

Other
Supermarkets &
Neighbourhood stores

139%

12%

N/A

32%

Supermarkets

86%

5%

Superstores
Hypermarkets &
superstores

N/A

15%

N/A

27%

Hypermarkets

70%

21%

241
195
158
120

42
4

62

85

1997 98 99 2000 01

02

SOURCE: Planet Retail, McKinsey

03 04

05 06

07

08

09

10

and durables. Inside China, the reverse


is true, with most operators devoting
most of their space to food. The food-andbeverage category is also, by far, the most
important generator of foot traffic.
Its a stark difference, and one that speaks
to enduring cultural attributes that
show little sign of changing. Specifically,
Chinese consumers are used to shopping
almost every day for fresh food; the
average hypermarket shopper visits five
times a week. And just because they can
now do this in really big spaces doesnt
mean they will change their habits. At
least they havent so far. The categories
that generate the most traffic and profits
(measured by gross margin per square
meter) are the likes of beverage, packaged
food, other food staples, and fresh food.
That is why all hypermarkets in China
have high-quality wet markets-- like
offerings for fish and produce and why
many even kill chickens on-site.
Second, when it comes to nonfood
purchases, Chinese consumers are very
brand-conscious. They either go for
bargains or go for the most prestigious
brand they can afford. If a product is
somewhere in between good enough
it doesnt fly very high in China, and
that is where the typical offerings of
developed-market hypermarkets tend to
be. Specialty stores in China, for example,
far outpace hypermarkets in apparel,
refrigerators and flat-panel TVs, because
they offer the brands sought after by
consumers.
2. A really big convenience store:
Thats the way Chinese consumers use
hypermarkets. When Westerners go
to hypermarkets, they typically get into
their cars, spend a good long time and a
wad of money then load up their trunks.
And they do this perhaps once a week.
Chinese, on the other hand, pop into and
out of their local hypermarket as if it was
a corner bodega. Therefore, the average

basket size in China tends to be small,


ranging from $10 to $30.
Part of this has to do with the near-daily
shopping for fresh food. Another factor is
logistics. Chinese homes tend to be small
an average kitchen is less than 60 square
feet -- so even if consumers wanted to bulk
up, they cant. Moreover, comparatively
few Chinese consumers have cars, so
they have to carry what they buy: Even in
Tier 1 and Tier 2 cities, 40% of shopping
trips are on foot, 30% by bus and 20% by
bike. McKinsey was curious whether this
behavior changed with people did get cars.
So far, we found, it has not there has
been little correlation observed between
car ownership and frequency of shopping.
Consumers just drive to their daily fix.
The only significant difference is that
drivers spend a bit more than non-drivers.
Only 5% of Chinese consumers shop
once a week or less. So it is not surprising
that, after quality, ease of access is the
most important reason consumers pick a
hypermarket.
3. Big stores, not-so-big sales: Stores
in China tend to be big, encouraged by
the fact that hypermarkets typically rent
their space; therefore, they have more
flexibility in adjusting space, and even
exiting if they need to. This is different
from conditions in the west, where
operators have to buy their land or are
locked in by very long leases.
Chinese hypermarkets average around
100,000 square feet (10,000 square
meters), much bigger than elsewhere. But
big does not necessarily translate into
better, something that multinationals in
particular can attest to. Foreign retailers
have tended to build as big as they
plausibly can, and have found limitations
to that approach. Chinas RT Mart, one of
the top hypermarket players, has about
40% of the square footage of the biggest
foreign retailer and 70% more sales. Or
consider central Shanghai: Walk around

and it looks positively saturated with big


stores and more keep opening due to the
flexible lease arrangements that support
aggressive expansion. Even in China,
there is a law of diminishing returns; not
all square footage is created equal.
According to Planet Retail, Chinese
hypermarkets average $2,161 in sales
per square meter. Thats 40% of the US
average and one-ninth that of Britain.
As competition stiffens, those kinds
of numbers will probably no longer
deliver profits. Margins for Chinese
hypermarkets are thin already return
on invested capital is typically less than
8%, compared to 20%+ for comparable
US firms despite the fact that labor and
other costs are much cheaper in China.
So that is the story right now for the 11
chains (three of them foreign Carrefour,
Wal-Mart and Tesco) that account for
the majority of Chinese hypermarket
sales. Its a tale of growth and progress
that many an industry would love to be
able to tell, but the next few chapters look
more difficult. Specifically, McKinsey
believes that future growth will come
increasingly from Tier 3 and 4 cities; these
are less prosperous and less familiar to
retailers. At the same time, competition is
intensifying, including from the Internet,,
The winners, McKinsey believes, will not
be those who expand fastest or grab the
most land: It will be those who hone their
operating skills to squeeze out higher
sales per square meter and thus higher
margins. Without such improvements,
and challenged by the increasingly
competitive environment and escalating
labor and rental costs, we predict that
return-on-invested-capital will fall by
almost half, to 3.9%, and that EBITDA
could sink to just 0.5%, down from the
already-meager 4% in 2010.
For weaker operators, the perils of
complacency are truly dangerous. In

the past few years, most hypermarkets


in China have experienced like-for-like
growth in the region of 5% to 8%. If this
continues, players at the lower end of that
scale will likely fail to maintain current
levels of profitability, even with some
operational improvements. And they will
start losing significant money if they dont
do things better (see chart).

Exhibit 2:

Operating room
EBITDA margin
% of sales; 2015
Sales density
improvement
0%
3%
5%

We believe there are three operational


priorities:
1. Optimize category management:
Right now, it is suppliers who drive
assortment; the general framework is
of decentralized decision-making and
a localized range of goods. In a country
as big and diverse as China, there is
certainly room for local tastes. Still, a
more centralized, scientific process that
optimizes category arrangement could
boost sales as much as 20%. Having
the right goods on the shelves will play
an important role as more Chinese
consumers trade up their spending
to higher value goods. Only by riding
the trading-up wave can hypermarkets
increase their gross margins.
2. Reduce purchasing costs: Since so
much of procurement is local or regional
in nature, purchasing costs are often
higher than they need be, due to reduced
economies of scale. Smart centralization
should deliver 2% to 5% reduction in the
cost of goods. In a broad sense, the realestate portfolio is the ultimate purchasing
cost, as leases/rents are a major expense.
Removing underperforming stores (or
reducing their space via subletting) is a
critical component in cutting costs and
unlocking value.
3. Improve in-store operations,
particularly inventory
management and the use of
staff time: In our analysis of Chinas
hypermarkets, we have noticed that
inventory systems are limited; many

6%

assuming no
operational improvement

after operational
improvement
-0.6

-5.7

1.9

-2.7

3.4

-1.0

4.0

-0.2

7%

4.6

0.5

8%

5.2

1.2

10%

2.5

6.3

1 Footnote
SOURCE:Source
Team Analysis
SOURCE:

decisions are still essentially intuitive.


That might work if everyone making those
decisions was a retail genius. But that is
not the case. In fact, staff capabilities are
generally mediocre (at best) and there
are few incentive systems to boost their
performance. This often goes unnoticed
because there are also few IT systems that
actually measure employee performance.
Getting up to something closer to world
standards could improve inventory
utilization by 10 days and staff time as
much as 15%.
Right now, Chinas RT Mart is the largest
hypermarket chain in China, with a
market share of 10.8%; Frances Carrefour
is second (8.9%) and Wal-Mart third
(6.3%) Looking ahead to 2020, its not
obvious who is going to lead the pack.
Foreign multinationals in China are
thoroughly localized; domestic players
are thoroughly globalized. And many
players are experimenting with new
formats, both on- and off-line.
So McKinsey is not going to pick winners.
What we will say is that it will be a
fascinating battle to watch.

http://csi.mckinsey.com
Daniel Hui is an associate principal
in Hong Kong. Louise Herring is an
engagement manager in London, where
Paul Morgan is an associate principal and
Caroline Tufft is a principal.

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