Chinese Consumers Like Safety, Too

It's a fine time for multinationals to deepen their stakes in China, as faith in the quality of foreign products has never been higher

This has been the year of product recalls—highlighting quality control and safety concerns with exports from China. No sector has been left untarnished. From tainted ginger to carcinogenic toothpaste to GHB in toys, the issue of substandard quality control in China's production process and supply chains has become a constant dinnertime topic as Americans gear up for the holiday season.

However, Americans are not the only consumers increasingly concerned about the "Made in China" label. Chinese consumers also worry that poor quality products and inferior or toxic materials will harm themselves and their families.

A recent report by McKinsey & Co. postulates that Chinese consumers trust and prefer local brands over foreign ones in the face of growing fears over product safety. McKinsey qualifies this by saying that Chinese view the 50 largest multinational corporations (MNCs) operating in China as local.

My firm, the China Market Research Group, has conducted more than 1,500 in-depth interviews with consumers in first- and second-tier cities over the past four months. Our findings run counter to McKinsey's. We have found that in light of the quality-control problems in China, the trust that Chinese consumers place in foreign brands is at an all-time high and increasing. Nearly 75% of consumers said they would prefer a multinational's product if they could afford it and if the product directly affected their health.

As one 26-year-old man in Chengdu told us: "A foreign company is not going to use cheap ingredients to cheat us; a domestic company might, which is a concern if we ingest or smell the product." Moreover, Chinese consumers are rabidly brand conscious and want to know the provenance of a brand. They do not mistake Procter & Gamble (PG) or Unilever for a local brand, even if these companies have done a great job at localizing their operations and tapping into the minds of Chinese consumers.

The concern that Chinese have over the safety of what they buy combined with increasing trust in foreign brands and rising disposable incomes has created a huge opportunity that multinationals can leverage. The market is clearly shifting toward the premium segment. By emphasizing that their products are safer and premium, foreign companies will continue to tap into China's emerging 250-million-strong middle class.

A Premium History

Traditionally, MNCs have occupied the premium segment of the market in China. For most sectors aside from luxury, this was largely a function of having higher fixed costs than domestic counterparts.

As a result, sales of most products offered by MNCs sputtered until just the past few years as price-sensitive Chinese consumers did not splurge. China's emerging middle class, however, has fueled a shift in fortunes for MNCs as disposable income has skyrocketed along with China's booming stock and real estate markets. Now more than 50% of MNCs are making money in China by selling into the local market rather than relying on the country primarily as a base for production from which to export. Foreign businesses can no longer regard China as just a place to find cheap labor. Rather, China now needs to become a strategic market to sell into for most companies. Many MNCs have realized how to do this.

Case in point is DuPont (DD), which provides a comprehensive set of products and services used for construction and home decoration, including ingredients used in coating and countertop materials. DuPont did a good job forecasting the trend by Chinese consumers to seek better guarantees of health and safety from the products they were purchasing for home decoration.

Unlike in the U.S., where the developer oversees the construction and renovation of homes, most homes in China are sold unfinished, as empty concrete shells.

Homeowners have to choose products, from which paint to put on the walls to which pipes and tiles to install. Consumers have an especially high level of input in the decoration and construction process.

By positioning their offerings around value, quality and safety instead of commoditizing their offerings and competing solely on price, DuPont has positioned itself strategically for long-term gains. The results are clear. The last earnings report showed that sales into China have become a major driver of growth for DuPont worldwide. As one 37-year-old woman from Beijing told us: "I will spend whatever it takes to buy whatever safe materials there are for my family. Safety is paramount."

Learning from LG

Like with home construction and decoration products, the trend in the digital appliance sector for products such as washing machines, televisions, and air conditioners is also moving toward the safety and quality side of the value scale.

LG Electronics is an example of an MNC that has positioned its brand as premium to Chinese brands in terms of design, quality, and safety. The numbers show the success of this long-term strategy. LG is on track to sell $10 billion in the China region by next year, with 50% of sales generated from premium products.

As one 38-year-old textile entrepreneur from Wenzhou told us: "I only want to buy LG products like a flat-screen TV for my home because it is of the best quality. I have worked hard for my money and want to enjoy my life by buying only the best. I am willing to pay more for that."

Many consumers in their interviews with us voiced concerns that air conditioners would "spew out toxic pollutants," that refrigerators would "contaminate food," and that washing machines wouldn't "clean all the dirt out." If safety and wanting better quality in products was their only consideration, 75% of respondents were willing to pay a 20% to 30% premium if they could ensure the air conditioners or refrigerators or other home appliances they bought were safe.

By investing in industrial design, positioning itself as premium quality, and refusing to engage in price wars with Chinese competitors, LG has ensured that it will continue to sell successfully to a consumer base becoming increasingly wealthy.

The success of MNC hypermarkets like Thai-owned Lotus and French retailer Carrefour in the food sectors shows that Chinese consumers are buying safer and better quality products. The reason these retailers have been so successful is that consumers believe that their sourcing processes are better than those of local chains or of the wet markets and fruit stalls that line China's streets. Carrefour's sales in China will grow 22% a year, and they have more than 100 stores in the country. JPMorgan Chase (JPM) estimates that Carrefour's sales in China will reach $5.5 billion by 2010.

Trusting Outsiders

When consumers go to Carrefour to buy food, they trust that this international chain has taken the necessary precautions to ensure food safety, something that they do not believe local chains have done. As one 33-year-old Shanghai homemaker said: "I will buy meat here for my family. I trust that Carrefour does a better job of buying better quality meat and then storing it than local butchers."

One senior executive at Lotus told us; "Shoppers are demanding higher and higher standards of oversight in the food quality-control process. We oversee the entire quality-control process for food procurement. We even give the seeds to the farmers so that we have control over food safety every step of the way until the produce leaves our doors." That type of attention to food safety and quality is in stark contrast to the fruit stalls lining China's streets, where buzzing flies and exhaust from automobiles linger among the produce of the day.

At some point, Chinese companies will have to improve quality control because of market demands and increasingly sophisticated management teams. However, it will be a long time before those changes take effect on a widespread scale.

In the meantime, in the face of all the quality-control scares, multinationals should make good use of their reputation as offering better quality and safer products to continue to shape the market toward the premium segment. That is the competitive advantage MNCs have over domestic Chinese firms.

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