Pricing: A Moment of the Truth

Either Your Customers or Not Your Customers, and Nothing in Between

       When play tennis, there is a clear line between someone who know how to play and someone who don’t. For people who know, they can be a world champion or just a beginner.  However, for people don’t get the essences of tennis playing, they basically spend most of time to pick up the ball.  That is also the situation on ‘pricing products’ in China.  It may sound strange to compare tennis playing to pricing, but they do have much similarity especially in China.

       China is not an evolving market like America is.  America spent several hundreds years to get where it is now. In its history, the free market keeps the market balanced with minimum governmental intervention. On the contrary, for highly government regularized China, it skids the most of ‘evolving’ part of modernization and artificially inherits the western business models and ideologies, like someone who watched many world-class tennis matches even without an idea what top spin means.

       This would be a problem for many companies coming to China. In an evolving market, pricing is also an evolving process with historical and concurrent price references and various benchmarks. But in China, business entities artificially categorize Chinese customers into so called middle class, white collars, and so on as what they have done in their own more mature home countries with a price reference not rooted in China’s domestic buying power but referenced to the price of their own countries. McDonald’s price indicator may not work for all countries and for all commercial products. For the most of time, the end results of pricing tend to be way above the acceptable range of their targeted customers.  After spend tons of money on strategic planning and business development, the argument may be as simple as this: for 1.3 billion of consumers, if 25% of them buy one item a year, the business would be in good shape. However, sometimes, it is all or nothing.  People either buy, or not buy at all.  When they perceive a product is not priced in their league, no matter how bright and established a brand is, people would simply write the brand off their buying list.  This is particular astute in China’s consumer market. Unlike technology sector, where the choices are fewer and intellectual properties are more important, Chinese customers have to buy at high price.  For consumer market, the competition is very much not in favor of western companies because the pricing always tends to be higher for wrong argument.

       Coffee market is one of the best examples.  The whole coffee market in China has been in limbo for the past twenty years because of the high pricing. For instance, GuoMao is the most well-known office building in Beijing, hosting some of most well known Fortune 500 companies.  The average Chinese salary working in the building is also one of the highest in China. Its coffee shops also have one of highest revenues in China. However, the problem is that the coffee shops’ high revenue is due to large number of foreigners working in the building.  The overwhelming majority of Chinese in the building never visit the coffee shops, most of them not even once per year. The high price is already beyond what they can consider coffee as a beverage. When that mentality is settled in, they write off coffee and coffee house entirely.

       So is true for clothing stores.  Levi’s and Nick are all more expensive in China than in the US when China has yet to have a clothing chain compatible to Americans’ GAP, or Foot Locker.  The market is open and large for grab, but unlikely to happen if international companies cannot get their pricing right. The important thing is not how much to profit from per item sold, but what the bottom line is and how many items to be sold, which is particularly true to a 1.3 billion consumers market.

       For any non-luxury products brands, if its intention is to gain the top 5% of income consumer group, it may not gain even 0.1% of the whole consumers. People’s mentality is either to buy, or not buy at all, either in my league or not in my league.  If and when market entry pricing is right, there can be a series of products set on different price, and then there is a play. After all, a company needs to have a battle ground before to have a battle.  Otherwise, they may very likely be fighting for imaginary customers when the customers are not theirs at the first place.

1.3 Billion of Chinese Consumers or its Top 5%

To Realize What True Advantages of International Companies Are in China

       For many international companies entering China’s market, especially in consumer market such as retail and restaurant chain, are attracted to China’s 1.3 billion of consumers when their market strategies are actually to target its top 5% or even top 1% of consumer group. As said of a popular Chinese wisecrack, their strategy is to ‘turn on right light, but make left turn’.  For some of luxury brands, it may work; but for most of others, their chance to succeed is slim.  After all, it is 1.3 billions of customers are really what they need, and not everybody is LV bag.

The ubiquitous manifestation for this kind of practice is these companies’ high pricing strategies. Nike is more expensive in China than in US, so is Starbucks.  Both of them would lose to domestic brands if they don't realize it is 1.3 billions they want.  Before Gap, people bought things in Woolworth.  China’s real per capita GDP today is only equivalent to American’s in their 1955. It is important to reshape the way of thinking – whenever international companies think of China, they should think of America 100 years ago but with higher real estate.

The problem for the international companies is that they may not realize what their advantages really are.

The strengths of foreign companies are not just their brand, especially not their current product lines, but their management depth, financial capability, innovation, know-how and supply chain.  They have the mighty power to sell good products at very reasonable and acceptable prices to a large percentage of urban Chinese, especially these pocket-low middle class.  Their brand name and financials can secure them the most profitable locations when most of domestic or small players have no chances on competition.  Their management can weather one of the most challenging market environment, China.

       Supply chain is another advantage.  Most of China's domestic companies  is limited in scale (as new comers) and don't have much leverage in buying power, reputation and buying channels.  For most of established domestic manufactures, they also prefer export to domestic channels for the simplicity in dealing with foreign companies even for fewer margins but fewer headaches too. When you can buy cheap, why not sell cheap and sell a lot?  Woolworth would be working the best in China today though it died in American market 20 years ago.  Assumption is that international companies want that 1.3 billion consumers to buy them for next 100 years. Nowadays, the quality is always a relative term, but used repeatedly as an excuse for high price by many companies, foreign or domestic.

Another true advantage for international companies is innovation and the conveyance from innovation to the consumers. Chinese companies would lose the battles because they simply give up on the innovation and prefer to copy all the way. Technology, design and business model innovation are the unchallenged fronts in China.

International companies in the consumer market have unchallenged advantages in China, but those advantages are not in their products or their brand name, but their know-how, management, supply chain, and innovation. They have to think China as 1.3 billion people with a shallow pocket.  No matter what, 1.3 billion is still 1.3 billion.  Also, they have to think the way as Americans think in 1955.  Because of China’s domestic political environment, it provides the best market entry for established international companies.  It is up to international companies to realize their advantages.

Irony of the Starbucks’ Success

Reinvent Coffee Experience or Invent Coffee Experience


Starbucks’ success is that it has created a new market for current coffee drinkers, but the other side of this success is that it is unable to enlarge coffee share in beverage market and unable to attract non-coffee drinkers to coffee.

In twenty years, Starbucks Coffee has become the biggest coffee retail giant in the world with presence in 55 countries.  Thanks to Howard Schultz, the ingenious creator and Chairman of today’s Starbucks Coffee, Starbucks has reinvented coffee experience by providing better quality of coffee, adding espresso drinks and offering comfortable environment in the US.  No doubt, Starbucks has changed the mentality toward coffee and coffee house among many American traditional coffee-drinkers and has turned coffee house into popular and fashionable place.  However, for the amount of publicity it has generated, Starbucks Coffee has little impact on overall rate of coffee consumption in both America and other regions.  Despite Starbucks has gained shares in existing coffee market from the competitors especially from food retails and created new coffee drinking patterns (buying from coffee house), it cannot expand coffee market as a whole and cannot create coffee habits to new consumers, which, unlike Coca Cola, McDonald’s and KFC, will render its difficulties to expand in emerging markets where there is no existing coffee consumer base.

For America, though still the biggest coffee importer of the world, the per capita coffee consumption had been constantly declining over last several decades since its glory era in 1960’s, partly attributed to the bad coffee quality.  By providing better quality of both coffee and coffee house, Starbucks swiftly increases its shares by winning more and more consumers from others.  Nevertheless, we can hardly overlook the fact that the continuing decrease in coffee per capita consumption is in parallel with Starbuck’s growth in the last two decades.  Somehow, Starbucks’ business formula cannot transform its brand popularity and phenomenal growth into coffee consumption growth.

Japan is Starbucks’ second largest market and also has the highest per capita consumption in East Asia.  As happened in America, Starbucks immediately gained popularity in Japan since it’s opening in 1996.  However, also as happened in America, Starbucks’ instant success in Japan gained itself a lot of current coffee drinkers, expanded a great deal of the share in Japan’s coffee market, but is incapable to accelerate the growth rate of coffee consumption there.  When majority of people perceive going Starbucks Coffee as a lifestyle, coffee becomes secondary. 

China is another good example to illustrate Starbucks’ pattern. China’s coffee house market had evolved from coffee-drinking foreigners living in China.  When the coffee was a rare commodity with a considerably wealthy consumer group, the prices at coffee house were expensive and have been kept high ever since.  The coffee prices at coffee house are so high that basically alienated 95% of Chinese from considering coffee house as a place for coffee.  High coffee price is the major hurdle in China’s coffee consumption growth, and someone has to challenge that if to expect any significant growth of new coffee consumers.  Nevertheless, Starbucks inherits China’s pricing mentality since the essence of its business formula is to gain the existing consumer base not developing one.  Starbucks has again successfully accomplished this goal and easily established its supremacy just in five years in China when China’s per capita coffee consumption grows at a turtle-moving speed.

Starbucks’ magic is that it is able to gain more customers from existing coffee drinkers’ pool than to expand coffee market as a whole.  In traditional coffee consuming countries without a strong coffee house tradition, Starbucks benefits consumers for better coffee and environment.  In non-traditional coffee consuming regions, when local coffee business eyed Starbucks for guidance, its business formula may point to a wrong direction in long run although it makes sense for short-term.


For a consumer product in an emerging market with vast potential customer base, the whole point is about how to build new customers.  It requires a different strategy to Starbucks' current business formula.  Among all coffee shop chains, Starbucks belongs to such a very few companies who has the will, brand name, financials and management to establish such a new customer base just like what it had done twenty years ago to the American market.  It is no longer 'reinvent coffee experience', but invent coffee experience in the new land.

Restaurant Franchising In China

-- Franchise out Unprofitability

In China,  the profitable restaurant chains hardly franchise out their stores (company owned instead) or begin to scale back on the franchise; on the contrary, unprofitable or unproven model restaurants are eager to franchise out for short term profit.

Restaurant franchising in America is an evolving concept in the past 80 years, established on market competition, gradual business development, business opportunities and visions of its leaders such as Ray Kroc, William Rosenberg and Fred De Luca.  The franchisers gain from franchisees out of franchise fee, annual fee, real estate, materials supply, and some of obvious advantages in overall buying powers, higher customer recognition, better location and so on for their company own stores.  To become a franchiser, it requires to show the record of profitability and duplicability.  For franchisees, most of them would make profits or have better chance to succeed than running on their own concept.  In general, it is a reciprocal relationship between franchiser and franchisee in the US.  

Restaurant franchising in China is mostly an abstract concept because of short history of China’s commercialization.  Nevertheless, China has the most franchises in the world.  Even more interesting scenario is that the profitable restaurant chain hardly franchise out their stores (company owned instead) or begin to scale back on the franchise; on the contrary, unprofitable or unproven model restaurants are eager to franchise out for short term profit.  Therefore, the relationship between two is a zero-sum game and will not last long for any meaningful brand building.

Franchising system is a mixed product of legal system, modern logistics & information, food production, corporate management, and consumerism. At this stage, China's legal system can not provide a fair playground for a franchise system in addition of too many governmental regulations becoming impractical for small-medium size companies to implement; the sizable food production is still immature and is export-oriented; consumerism is just starting to take a foothold in this emerging market; logistics evolvment can never follow up with unruled and unpredictable urbanization orchestrated by governmental bodies. Corporate management for food business is far behind what America had in its 1950's.

How would the franchisers make money from the franchisees in China?  

Real estate is bizarrely high and inflexible for any franchiser to buy/rent property and then rent to their franchisee.  McDonalds’ and Tim Hortons models don’t work in China.  Annual fees are hard to collect within China’s legal system.  Therefore, most of franchisers can only make long term profit from selling material goods, which requires franchisers to establish food processing factories, a huge investment in itself and a distraction from focusing on their core restaurant business. The legal system in China is most unimplementable to restrict franchisee from buying outside of agreed supply channels.  This would deteriorates the profit of franchisers and certainly seeds the problem for quality of foods in follow.  

The franchise fees and construction/consultant fee in the initial stage become the most reliable revenues resources for a franchise.  No wonder China is full of the opportunist franchises looking for quick money when more established restaurant chains shun away from franchise.  Opportunist franchise don’t care if franchisee make money.  In China, McDonald’s don’t franchise, and KFC only franchises to remote areas.

Management capability is always a big problem across all sectors in China’s restaurant and retail business.  Management is how one can build a strong brand, how to innovate the products for market needs, how to build the confidence in the franchisees to stick with the company, how to take the initiatives for the next step.  In China, because of general opportunist environment, most of restaurant chains look for quick gain and very likely run by the family.  Management development is viewed as a tool not as backbone.  

The opportunist mentality overwhelms China’s restaurant sector (also China as well), which can be a good chance for international company looking for long term establishment in China.  One interesting scenario is that many of top restaurant chains are founded and run by women in China.  So many men, when they have certain success, would use the money to invest on quicker money machine, such as real estate, manufactures and so on.  

In China’s restaurant franchising system, it has no market leader, and not even a success story to be as a reference.   The staggering development of franchise sector would certainly slow the management development and professionalism in restaurant business, innovation, and most importantly, supply chain and food production business.  In the coming decade, consumer service will play a more and more important role in China’s economy.  It would be interesting to see how China’s restaurant chain will evolve in the coming years.