Wholesale Distribution Changes for a Winning China … Distribution Changes for a Winning China Strategy ... the direct modeland the distributor model. ... The Advantages and Challenges

Opportunities for Action in Consumer Markets

Wholesale Distribution Changesfor a Winning China Strategy

Wholesale Distribution Changes for a Winning China Strategy

Hypermarkets, supermarkets, and convenience storesare blanketing China—or so it seems. Global playersCarrefour and Wal-Mart are opening new stores at anaggressive pace. Local retailer Lianhua has amassedsome 2,000 new outlets in 16 provinces. And regionalchain Hongqi has more than 200 supermarkets inSichuan province alone. During the past few years,sales in the new retail formats have grown more than50 percent a year. Nevertheless, this modern tradeaccounts for less than 30 percent of retail sales inChina, and it serves only one-quarter of the 500 mil-lion consumers who live in or near China’s more than3,000 cities and 20,000 towns. These consumers, whoare reaching threshold spending levels for manyproducts, represent a market with huge growth poten-tial. And because most of them still shop at mom-and-pop markets and small, local department stores, tradi-tional trade channels will remain a significant part ofthe economy for at least the next decade.

Yet only a small fraction of Western consumer-goodscompanies in China have fully explored traditionaltrade beyond the largest cities. Despite the greatpotential for profits, most global players have beendiscouraged by the difficulty of controlling distribu-tion in those channels. Companies that are able toclear this hurdle will find that traditional trade offersan important source of growth, with superior eco-nomics and decisive competitive advantage. Of thevarious methods for dealing with the distributionchallenge, active management of the wholesale chan-nel—an approach that has been underleveraged byglobal consumer-goods companies—presents anopportunity well worth considering.

Wholesale May 04 5/5/04 9:55 AM Page 3

Approaches to Sales and Distribution in China

Most Western consumer-goods companies have em-braced China’s modern-trade channel, and they’vebrought to it management experience with key ac-counts in other countries. But outside the largestcities, China’s vast, heterogeneous markets make thesales and distribution of consumer goods problemat-ic. The expense and resources required for retainingfirm control of selling and promotional activitiesacross a broad geographic area with a fragmentedretail structure force most companies to choose eitherfocus or breadth.

For a few premium categories, such as cosmetics andimported wines, the tradeoff is easy since demand isconcentrated in major cities among affluent con-sumers. But for most consumer products—snacks andready-to-drink beverages, home-care and personal-care products, and durables, such as television setsand microwave ovens—at least half of the demandcomes from the highly fragmented traditional chan-nels. (See Exhibit 1.) Yet even in those categories,most global companies in China give up broad cover-age and penetration in favor of control. Usually, theychoose between two types of sales and distributionmodels: the direct model and the distributor model.Sometimes they combine the two.

The direct model focuses on managing key accountsand provides the most assurance to manufacturers,since they remain in full control of the sales force andselling activities. Depending on the category and sizeof the business, however, the direct model is only cost-effective for targeting modern trade in the top citiesin China. Western companies in small categories or


Category

Personal careproducts

Durables

Home care products

Ready-to-drinkbeverages

Snacks

Example

Shampoo

TV sets,microwave ovens

Laundry detergent

Carbonated soft drinks

Rice crackers

Percentage of salesthrough moderntrade channels

50

30 to 35

30

25

15

Percentage of salesthrough traditional

trade channels

50

65 to 70

70

75

85

SOURCE: BCG analysis.

Exhibit 1. Most of the Demand in China Comes from Traditional Trade

with more modest ambitions in China tend to choosethis model.

Larger global companies in China often deploy thedistributor model to serve traditional trade. Althoughthis model has been quite effective in Westernmarkets, it has not yielded the same results in China.In most developed markets, distributors are profes-sional-services companies that assume selling andother value-added activities on behalf of the manufac-turer. In China, however, most distributors are passiveand have little experience in sales or service. (SeeExhibit 2.)

For this reason, many manufacturers have investedconsiderable time and money in upgrading thecapabilities of their Chinese distributors—providingthem with training (classes and trips), tools (trucksand personal computers), and sales resources (subsi-


dized sales reps, merchandisers, and promoters). Butsince most distributors refuse to work exclusively withone company, some of the training and resourcesgiven to them also benefits the competition. Othermanufacturers use their own sales teams and promo-tions to generate downstream demand. Yet that hasthe effect of reducing Chinese distributors to “boxmovers.”

What’s more, it is extremely difficult to piece togethera distributor network for covering smaller cities—letalone towns. As a result, the distributor model inChina turns out to be less effective and more expen-sive than manufacturers anticipated. Not surprisingly,some companies that have chosen the distributormodel are now rethinking their decision, whereas oth-

Chinese distributors

Provide value-added activities

Have strong selling and promotion capabilities

Are interested in long-term relationships

Have large-scale businesses—$5 million to$10 million—with broadproduct portfolios

Have IT capabilities, such aselectronic data interchange,to provide up-to-dateinformation

Western distributors

Are less focused on sales and service

Have skills limited to order taking, stock keeping, and physical delivery

Are not interested in exclusive relationships

Have relatively small businesses—$1 millionto $2 million—with limitedworking capital and productrange

Have few IT capabilities: poor data make it difficultto measure distributorperformance


Exhibit 2. How Chinese Distributors Compare with Their Western Counterparts


ers are struggling to find a way to make the currentmodel work.

The Advantages and Challenges of the Wholesale Channel

The wholesale channel, which has been largelyignored by global companies, is a far-reaching multi-layered structure built up over decades of centralstate planning. The wholesale structure replicates thehierarchy of cities in China, with products flowingfrom first-tier wholesalers located in provincial capi-tals and large prefecture cities, to second-tier whole-salers supplying small prefecture cities and county-level cities, to third-tier wholesalers in towns, most ofwhich also supply nearby villages. During the past tenyears, the state planning apparatus has evolved to thepoint where many of today’s more successful whole-salers are private enterprises. (See Exhibit 3.)

Provincial capitalsLarge prefecture cities

Small prefecture citiesCounty-level cities

Towns

Villages

3130 to 50

250

3,000

20,000

Unknown

Manufacturer

First-tierwholesalers

Second-tier wholesalers

Third-tier wholesalers

Keyaccounts

Rural consumers

Approximate number in 2002


Exhibit 3. The Wholesale Channel StructureReplicates China’s Hierarchy of Cities and Towns


Pilot: Getting it right Rollout: Getting on with it

Design sales anddistribution model

Designoperations

Prepare rollout Roll it out

1. Create model for regions and customer segments

1. Develop clear pilot objectives

2. Select representative cities and regions

3. Determine pilot duration and resource allocation

4. Plan reporting process to ensure high project visibility

1. Monitor salesturnover

2. Watch coverage andpenetration

3. Check price stability

4. Scrutinize margins

5. Examine sales teamperformance

1. Determine sequencing andtiming

2. Plan resource allocation

3. Document lessons andprocedures from pilot

1. Map the process

2. Set trade terms and targets

3. Monitor the systems, rules, and penalties

4. Align the organization with performance indicators and incentives

5. Plan logistics and administrative support

Execute pilot

Observe key factors


Exhibit 4. A Pilot Program Ensures Effective Implementation


The wholesale channel offers several unique advan-tages:

• It is, arguably, the only channel that can deliverhigh penetration into traditional retail outletsacross almost all of China.

• It is the only economically viable way to serveChina’s many cities and towns (and, depending onthe product, even some rural villages).

• It is by far the lowest-cost channel. There is asmuch as a 20 to 30 percent difference in costsbetween the wholesale-channel and distributorapproaches. The savings are driven by lower salesand marketing costs (fewer sales reps and promot-ers, lower trade spending) and higher price realiza-tion (fewer discounts and returns).

Consider the example of Want Want, a leading snack-foods player in China with revenues reaching $450 million in 2003. It has leveraged the wholesalechannel and achieved operating margins of 22 per-cent. Today this channel contributes more than 70percent of the company’s total business, with distribu-tion and selling costs accounting for approximately 25 percent of its overall cost structure.

Given these benefits, why haven’t more global compa-nies taken advantage of the wholesale channel? Webelieve it has been neglected because of misconcep-tions Western managers might harbor about whole-sale in China. We’ve encountered arguments like thefollowing:

• The majority of wholesalers have sales turnovers ofless than $100,000 per month and serve a relativelylimited geographic area. How can we manage hun-


dreds of wholesalers when we can’t even manage afew dozen distributors?

• We have absolutely no control over product flow.Once we sell our products to the first-tier whole-saler, we have no way of telling whether they actual-ly flow to the county and town levels as intended orwhether they are simply sold off at a low price with-in the large cities.

• Wholesalers don’t care about margins—they justwant fast product turns. We tried to motivate themwith higher margins, but rather than keep theextra profits, they pass them on to the next tier ofwholesalers. That completely destroys our pricingstructure.

• The more we sell into the wholesale channel, themore likely we are to encounter problems with fakeproducts. Modern trade retailers would never jeopardize their relationship with us by carryingfake products.

• Our sales reps have never dealt directly with whole-salers before. We’re not sure they can do it.

Although these perceptions and doubts are not com-pletely unfounded, the challenges of managing thewholesale channel can still be overcome.

The Managed Wholesale Approach

From many years of experience helping companieswith sales and distribution of consumer products inChina, we have identified five critical factors for suc-ceeding in the wholesale channel. Although anyapproach will vary according to product category, the


general principles we outline are universal and havebeen tried and tested.

Map the process. Mapping consists of identifying anetwork of the best wholesalers and putting themtogether to provide maximum coverage for a particu-lar region. The map details how products flow fromfirst-tier wholesalers at the provincial-capital and pre-fecture levels to second- and third-tier wholesalers incounties and towns, and from wholesalers to retailers.One big advantage of mapping is that it identifiesrelationships in which trust has been establishedamong wholesalers across the different tiers. Mappingalso helps you avoid signing up more wholesalersthan can be accounted for. In fact, it is preferable towork with only one or two wholesalers in each territo-ry—even if it means occasionally bypassing a low-value-added first-tier wholesaler and selling directly tothe second tier. Otherwise, competition among whole-salers could lead to a price war.

For the inexperienced, however, mapping can be anextremely daunting undertaking. One food manufac-turer took three months and six sales reps to compileseveral thick binders profiling all the wholesalers injust one province. (Data included number of sales permonth, sales to the top 25 retail customers, and salesto the top 10 cities and towns.) A key factor in suc-cessful mapping is to collect the right level of infor-mation and avoid wasting time and resources. Formanagers unfamiliar with the mapping process, werecommend first testing and refining the mappingapproach in a few selected locations.

Set trade terms and targets. Setting trade terms is oneof the trickiest elements in wholesale. Your goalshould be to maintain a consistent market price andnot to use higher margins or volume incentives to try


to motivate wholesalers. Prices in the wholesale mar-kets are highly transparent, and they are sensitive toeven the slightest movements. Therefore, unless youplay an active role in monitoring and controllingwholesale prices, wholesalers’ margins can be compet-ed away. Volume-based incentives can be particularlydamaging because wholesalers are often willing to sellat a loss in order to achieve their monthly or quarter-ly targets and earn rebates. Some manufacturerscompound the problem by following the commonWestern practice of setting stretch targets. In China,this often has the unintended consequence ofencouraging wholesalers to cut prices rather thanincrease their selling efforts to reach their targets.

Monitor the systems, rules, and penalties. You need toensure that wholesalers comply with their designatedterritories and prescribed pricing structure. Thatrequires systems to monitor for infractions and strictrules and penalties (at the extreme, termination ofthe contract) to punish frequent offenders. PepsiCo,for example, has sales reps whose sole responsibility isto monitor the movement of prices in wholesale mar-kets and track down wholesalers who undercut theagreed prices. Other companies use markings orstamps to trace products flowing out of their pre-scribed territory. Unilever even has a SWAT teamwhose role is to investigate and report counterfeitingactivities.

Align the organization with performance indicators andincentives. A company must have the right capabilitiesto make a successful transition to the wholesalemodel. We have found that with the proper trainingand tools, it is possible for most sales representativesto work well with wholesalers. The key is to determineearly on whether reps are capable of adapting to thenew system and to replace the ones who cannot.


Fortunately, there are plenty of reps in China who areexperienced and skilled in dealing with wholesalers.Most work for local Chinese companies. For them tosucceed in a global company, you must provide orien-tation and training programs.

Plan logistics and administrative support. Many com-panies don’t do the kind of thorough preparationthat can mitigate implementation risks. Given the vastdifferences across China’s huge territory, anyapproach to implementation must accommodatelocal variations of the model. Our experience suggeststhat it is much better to test and tweak the approachwith a few pilots. Exhibit 4 illustrates how a pilotmight “go around the loop” a few times before a pro-gram is rolled out across the country. We recommendthat you assign a small team with experience in salesand business analysis to the pilot for its duration. Theteam can then become the core resource for dis-seminating knowledge from the pilots during therollout phase.

Because it takes time to design and implement a goodwholesale approach, most companies can create a sus-tainable advantage over their competitors by gettingan early start, which would include finding and lock-ing up the most capable wholesalers to form the bestnetwork. In the longer term, the additional profitsgenerated through this high-volume, higher-marginchannel can be invested to create brand pull—furtherreinforcing the “push” and “pull” elements of thispromising model.

* * *

Tackling the wholesale channel is not for the faint ofheart. Focusing instead on effectively managing therapidly growing modern-trade channels is certainly a


viable strategy. But even as modern trade continues togrow 20 percent a year, traditional trade will accountfor more than half of retail sales for at least the nextfive years. For companies with broad ambitions inChina, the wholesale channel is simply too large aprize to ignore.

Jim HemerlingHubert Hsu

Alvin Lam

Jim Hemerling is a vice president and director in theShanghai office of The Boston Consulting Group. HubertHsu is a vice president and director, and Alvin Lam amanager, in the firm’s Hong Kong office.

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© The Boston Consulting Group, Inc. 2004. All rights reserved.


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Wholesale Distribution Changes for a Winning China … Distribution Changes for a Winning China Strategy ... the direct modeland the distributor model. ... The Advantages and Challenges