China: Where Retail Dinosaurs Are Thriving

Retailers in the U.S. have wistfully packed Santa off to the North Pole, but the holiday season is just beginning for Chinese department-store chain PCD. In the runup to Chinese New Year on Feb. 14, PCD is prospering: A December sale attracted so many customers that Beijing police had to step in to control traffic. "The love affair of the Chinese consumer with luxury products is growing," says PCD Chairman Alfred Chan.

Unlike most of the developed world, that affair is more often happening at the local equivalent of Macy's (M) or Bloomingdale's. While Americans and Europeans increasingly turn to alternatives such as Wal-Mart (WMT), Carrefour, Best Buy (BBY), and Amazon (AMZN), in China "there is still plenty of potential for department stores" says Yuan Fei, chief financial officer of Intime, a Beijing-based chain with 20 outlets that aims to triple in size by 2016.

That kind of growth is attracting investors. PCD raised $377 million in a Hong Kong initial public offering in December, and the stock is up 50%. Other chains are doing even better: Intime's shares have increased 320% since March, Parkson Retail Group's have more than doubled, and New World Department Store's have tripled.

Department stores in China have big competitive advantages over their Western counterparts. E-commerce has yet to take off in the mainland, and brokerage CLSA expects China's retail market to expand by 24% this year. Department stores, unlike many retailers in China, have a reputation for eschewing counterfeit goods. "People think department stores are safer," says Shaun Rein, managing director of China Market Research Group. The retailers also benefit from the growing interest in the designer names they carry. "With the emergence of the middle class, people are going for better brands," says Yuval Atsmon, an associate principal for McKinsey in Shanghai.

To reach those consumers, department stores have narrowed their scope. The most successful have stopped trying to match the prices of discounters like Wal-Mart and Chinese electronics chains such as Gome and Suning. Instead, they devote most of their space to high-margin goods such as cosmetics, clothes, and shoes. Those items now account for 70% of sales at the top department stores, Boston Consulting Group (BCG) estimates. In contrast to U.S. custom, large Chinese retailers sign deals directly with brand owners, charging them rent and letting them manage their sales in the store.

That's not to say that department stores face a trouble-free future. Foreign fast-fashion chains such as Zara and H&M are targeting China, appealing to the same young and affluent shoppers who are the department stores' core customers. And China has more than 1,000 department-store operators, a legacy of the days when practically every mainland city had its own state-owned store. "Consolidation is inevitable," says Alfred Cheng, CEO of Parkson, one of the biggest chains, with 45 stores in 29 cities. Today, the top five department store operators together have just 8% of the market, vs. 70% in the U.S., BCG estimates. That will soon change, Cheng predicts: "There will be only 10 to 15 groups remaining 10 years down the road."

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