Is there a gap for foreign retailers in China's convenience store sector?

Shanghai, the most Western of China’s cities, leads the country in the most Western of retail formats - the convenience store. By the middle of last decade, 5,650 CVS had opened in the city - a third of the nation’s total - giving it a density of one per 4,400 residents. The dominant franchises were CVS start-ups owned by major food conglomerates - Quik, (Lianhua) Kedi and Alldays (Nonggongshang). Foreign challengers arrived late, but tout grand plans. 7-Eleven, for example, opened its first store in the city last year, and intends to have 300 within five years.

Industry observers say it won’t be easy. “Shanghai is saturated with convenience stores, rent is high and the locals have the best locations,” explains Euromonitor research analyst Alex Liu. “7-Eleven would need at least a hundred stores to build up a supply chain that would allow profitability.”

Two hundred stores might be a more realistic minimum. Quik, Alldays and Kedi have more than a thousand stores each nationwide, and are barely profitable, adds Liu.

For CVS franchises, logistics is the weak link, and lack of infrastructure will stall the emergence of national chains for at least a decade.

“They are beginning to understand that they can’t be successful everywhere at this early stage,” says Robert Gregory, research director at Planet Retail. He cites as an example Lianhua’s sale of 110 Quik stores in Guangdong to Dairy Farm in 2007, the operator of that province’s much stronger 7-Eleven franchise.

The regional approach is evident from 7-Eleven’s use of three licensees - Dairy Farm in Guangdong (1992), Beijing Shoulian in Beijing (2004) and most recently Taiwan’s Uni-President Chain Store in Shanghai.

Last year, 7-Eleven had 667 stores, double that of the next foreign chain, Lawson, with 330. Family Mart had 305, with Circle K on 74, according to Planet Retail.

That gave foreign franchises 1376 of China's 9008 CVS stores. The top local CVS brands in terms of outlet number were Quik (1,980), Alldays (1,450), Kedi (1,190), Liqun (820) and Buddies (580).

Naturally, entrenched locals command prime locations in tier one cities, and the way to get a foothold - for local and foreign franchises - is to purchase the stores of weaker competitors.

Another option is to pioneer the hinterlands. A truism in the CVS world is that convenience stores emerge when per capita income reaches US$3000 a year. In China, per capita income rose from $2,340 in 2000 to $5,370 in 2007, according the World Bank. Today, rural farmers subsist on $750 while residents of Shanghai, Beijing and Guangzhou enjoy about $10,000. Tier two and tier three cities are currently in the CVS industry's $3000 annual income sweet spot.

“I once walked 20 minutes in Wuhan without finding a convenience store,” said Darryl Andrew, CEO, Synovate China. “Tier two and tier three cities offer great potential. Foreign franchises like 7-Eleven and Circle K are rare, while none of the local CVS are the flagship for the channel. All they do is ‘build a store’ and that’s a long way from building a brand.”

Yet what is certain is that China’s current store count for CVS is only the beginning. Planet Retail predicts 13,142 stores by 2014.

Modern retail is in its infancy, and competitors are coming from other formats. Faced with a severe shortage of sufficiently large sites, hypermarkets are launching minimarkets. Tesco kicked off the trend with TescoExpress in Shanghai, and has since been followed by WalMart with Hui Xuan stores in Guangdong. Meanwhile, China National Petroleum Corporation created a forecourt store, uSmile, for its gas stations.

Until recently, foreign CVS franchises were guests in China. To remedy this, China passed its first comprehensive franchising law in 2004, a condition for its membership in the World Trade Organisation. But foreign retailers should still expect the unexpected. Last year, for example, foreign owned CVS were prohibited from selling tobacco products, which account for nearly a fifth of per-store sales.

Analyst comment

Chris Morley, China managing director, The Nielsen Company:
“2009 was an interesting year for China’s convenience stores. Store count grew 20 per cent, yet sales volume growth declined - from a vibrant 22 or 23 per cent in mid-2008 to negative single digits in the first half, before eventually improving in the second half. For the year, sales volume growth was a lacklustre four per cent.

Other modern retail formats fared better. For hypermarkets, a 10 per cent growth in store count was matched by 10 per cent growth in sales volume. Supermarkets did even better. Store count grew 26 per cent, while sales increased 18 percent.

One problem that convenience stores have but hypermarkets and supermarkets don’t is price. In most markets, CVS charge a premium for convenience but Chinese customers expect CVS to be at price parity with supermarkets or even hypermarkets. This is a challenge for all CVS, but especially for those that have not yet achieved scale.

Getting product to the shelf at a competitive price is difficult if a distribution network serves only a small chain of stores. Having a huge volume taken on promotions in these stores creates distribution challenges and inefficiencies.

To achieve scale, the deep-pocketed CVS franchises will boost store counts by buying out the smaller chains. Even so, these acquisitions will take time to assume a national scale . Each might add a half per cent market share to the buyer, and it will be years before a single player can claim 10 per cent share nationally, meaning China will continue to be a unique modern trade environment for some time to come.”

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This article was originally published in the 6 May 2010 issue of Media.