The Dragon Awakens!

Companies should be excited but cautious about market opportunities in China.

By Paul Altaffer & Grant Washington-Smith

“From The Corners Of The World” is dedicating 2007 to the emerging markets of China and India. As the economies grow in the developing world, marked especially by China and India, several important questions are arising: how will these developing countries emerge as consumers; how will they perform as suppliers to the West; will these countries be able to escape the stigma of cheap and poor quality? This column will explore some of these questions, beginning with the emerg-ing consumer market in China. The Dragon Awakens!

Rapid Economic Growth in China

The economic growth in the People’s Republic of China over the last 10 years has been stellar. The Chinese economy has defied economists who thought that growth rates in China, which have been in excess of 10% year on year, were simply unsustainable. Despite the pessimistic forecasts, the Chinese economy has shown remarkable resilience, resulting in a changing lifestyle for the emerging urban middle class. Unfortunately for China, with its emerging Western style prosperity so comes the associated darker side. There are increases in health-related problems due to changing lifestyles, unbalanced diets and environmental toxins, all of which have started to take their toll on the general Chinese population.

In 2002, China conducted the “Fourth Nutrition and Health Survey,” which characterized the extent to which the nutritional imbalance in diet and other environmental and lifestyle factors have increased the incidence in chronic illness. The study showed that sufferers from hypertension and arteriosclerosis both reached totals of 160 million each; diabetics total 20 million; and a corresponding number of 260 million individuals were considered either overweight or obese. This represented an increase in incidence in disease compared to earlier national studies.

Faced with the potential for burgeoning healthcare costs from Western style diseases, the scare of a SARS outbreak in 2003, a similar scare from bird flu in 2005, as well as the concern for a new outbreak of bird flu in 2007, the Chinese are becoming more conscious of these “prosperity induced” health issues and are looking to the West for insight. Consequently, the retail nutraceuticals market has grown rapidly in China due in part to the increase in the incidence of health-related issues and the rising cost of healthcare, all of which continues to drive the Chinese consumer to re-main proactive on health and wellness issues.

While this sounds like a great opportunity, companies considering market development in China should understand that those who don’t learn from history are destined to repeat it. A major factor in the contraction of the U.S. natural products market during the late 1990’s was the consumer skepticism of health claims fueled by adverse media coverage. Parallel to the U.S., as the Chinese consumer demand for the more traditional tonics and nutrient beverages has grown over the past decade, so too has the boldness of the claims being made. The effect of this has been a general disillusionment by Chinese consumers, which has the potential to spill over to other categories of the nutraceuticals market.

According to a November 2006 Euromonitor report on China, “consumers are immature in their consumption patterns, and lack judgment and knowledge regarding the products available. Most are easily swayed by the advertising claims of marketers, and felt cheated by the fact that the products they had purchased did not perform as advertised. As a result, consumer expectations lowered and their trust in tonics and bottled nutritive drinks waned.”

Like any rapidly growing and largely unregulated market, manufacturers delivering inferior quality and unsubstantiated health claims have preyed upon the Chinese consumer. To help regulate growth and provide a level of assurance for its consumers, the Chinese Government’s State Food & Drug Administration (SFDA)—China’s equivalent of the U.S. Food & Drug Administration—finalized its regulations over health food registration at the end of 2005. This is expected to re-invigorate consumer confidence in dietary supplements and functional foods.

In addition, the Natural Products Association (formerly the National Nutritional Foods Association or NNFA) has developed a Chinese branch. According to Pearl Lin, managing director of ACFF (Atlantic Coast Functional Foods), based in Beijing, the Natural Products Association will attempt to work with and influence the Chinese government to develop a regulatory framework that allows for greater growth.

In a summary of recent data from Euromonitor, Table 1 indicates where the expected growth in the Chinese retail nutritional products market will come from.

Still a lot of Growth Potential

In November 2006 during the first health industry expo from China’s Centre for Public Nutrition and Development in Shanghai, the Center’s director, Yu Xiaodong, reported that the Chinese consumer spent an average of $11.53 per year on health foods and supplements. This amount is in contrast with the Japanese consumer, which spends 20 times that amount on nutraceuticals and functional foods. The market implication is that there remains strong growth potential in the Chinese market as noted in Table 1.

Marketing is a key driver for product sales, with some domestic nutra-ceutical companies spending up to 20% of total sales on advertising and promotions. An industry report by Euromonitor suggests that Chinese nutraceutical manufacturers are prepared to pay more for advertising than Western companies. This is particularly true in the case of television commercials, which can account for up to 80% of the total advertising budget. It is believed that advertising strongly influences consumers’ choice of brands. Especially during the initial promotion period, advertising can help new launches achieve a much higher level of awareness in an otherwise crowded market.

Despite its crowded and competitive nature, growth in the Chinese re-tail market is still likely to yield op-portunities in numerous areas for Western brand manufacturers. J. D. Osman, senior brand manager at Alticor Inc. finds that “international companies are moving from a period of importing current products/technologies to developing new products/
technologies specifically for Chinese consumers.” This may signify opportunities in several different fields.

Product Trends & Opportunities

According to ACFF’s Ms. Lin, “functional foods will continue to drive growth in many categories. Functional beverages in particular will create many opportunities for growth. In addition, functional foods and beverages may drive consumer awareness for weight loss and anti-aging products.”

Dairy-based functional foods and beverages are being driven by the growing awareness of benefits from protein and calcium. This market has been growing in China at around 20% since 1999. Despite this growth, however, the per capita consumption of dairy is still less than half that of other Asian countries.

Organic produce is heavily un-der–represented in the Chinese market. While the concept of organic produce in China might seem logical, given the issues around environmental stewardship in some regions, there has been little success at retail. A large format organic supermarket called “Ostore” opened in Shanghai in 2005. Unfortunately by 2007 the store had to close, citing very high premiums for organics as being the primary factor in the demise of its organic retailing business. Organic produce is typically four to five times the price of conventionally grown produce. Ostore has subsequently purchased farmland near Shanghai and changed its business model to growing and exporting organic produce to the West.

Child-specific vitamins and dietary supplements have seen steady growth of nearly 16% over the past few years. And there is every expectation that this trend will continue through to 2010. But, child-specific vitamins and supplements represent less than 6% of the total value of vitamins and dietary supplements. The most popular products within the category include cod liver oil, multivitamins and calcium. Chinese consumers believe that giving cod liver oil to children will make them healthier and stronger, which creates a leveraged opportunity for DHA-based omega 3 fish oils.

Expansion of the consumer base to young professionals is another area of great potential. There are currently three major groups of nutraceutical consumers in China: females, children and the elderly. However, young, upwardly mobile professionals in first-tier cities, such as Shanghai, Beijing and Guangzhou, are experiencing more stress in everyday life, and so further segmentation of targeted products and brands for this group will result in the expansion of consumer spending. An example of this approach was the launch of the premium brand Double X by Amway (China), which is aimed at young professionals, according to product positioning and advertising support.

The Body Mass Index (BMI) for Chinese consumers has been growing steadily for several years, similar to the U.S., especially for those with a BMI between 25-30 (overweight). The similarity ends, however, when one compares the two populations with a BMI of over 30 (obese), with China having a very low proportion of its population holding steady in the obese category. The trend toward weight gain, which is most predominant amongst more affluent and urbanized Chinese, represents an opportunity for nutrition-based weight loss programs that include products like protein bars, beverages and nutritional supplements.

There is no doubt that the Olympics games in Beijing in 2008 will be a catalyst for growth across the nutraceuticals industry in China. One segment expected to benefit from this high profile event, combined with nationalistic pride, will be sports nutrition. The sports nutrition segment of the natural products industry has remained largely underdeveloped, as the Chinese don’t view themselves as active participants in sport, believing in-stead that this is the domain of elite athletes and sportspeople—a perspective on sport which is in contrast with that of the Western world. The category has had some success with Gator-ade, which maintained nearly a 1% share of the total soft drink market in 2003, according to Datamonitor. This penetration by Gatorade is a good indication of the potential sports nutrition market, and generally signals the growing adoption by the mass market for sports beverages. The success of the sports beverage market in China is likely to have a halo effect across the entire sports nutrition category, especially when coupled with a focus on the weight management category, which is growing very quickly.

On the Horizon

It is anticipated that higher priced nutraceuticals, especially international brands, will see strong growth over the coming years. The expectation of continued economic development will see im-proved purchasing power from the urban and affluent Chinese consumers. This will be accompanied by a greater focus on product efficacy and quality.

At the other end of this continuum, as both awareness and cost of healthcare increases throughout China, demand for low-priced nutraceuticals will be generated by the less affluent in third-tier cities, towns and rural areas. Low cost domestic Chinese manufacturers will likely support this market.

These trends toward higher priced products at one end of the market and cheaper offerings at the other will likely result in undifferentiated mid-priced products demonstrating progressively weaker performance over the ensuing periods.

The opportunities in China are vast indeed, but many significant roadblocks stand in the way. According to Alticor’s Mr. Osman, “International supplement companies may find it very frustrating at the time it takes to launch a ‘functional’ product in China. The registration alone takes approximately two years. This is far different from most other countries.” So if your next stop for market development is China, be prepared for a long journey into the dragon’s lair.NW