Like other big holiday seasons in China, January's Lunar New Year was a slow time for news. But perhaps not as slow as French firm Carrefour might have liked. As New Year revelers headed to their local stores to stock up for the festive season, many couldn't help but notice that the prices they were paying at Carrefour's check-out counters were higher than expected. All of a sudden, the world's second-largest retail chain (after Wal-Mart) — and one of China's top five — found itself in the headlines in the country's newspapers for all the wrong reasons, and not just because of a national pricing scandal embroiling some of its stores. Public wrangling with one of its biggest suppliers also provided plenty of news fodder. And while news coverage of Carrefour is now dying down, it isn't in the clear just yet as it settles record fines with government regulators and wades through sticky contract negotiations with key suppliers.
For better or for worse, Carrefour is in good company. Other foreign retailers in China have also stumbled recently. In January, Home Depot, a U.S.-based retailer and the biggest home improvement chain in the world, confirmed that it shuttered its remaining store in Beijing — its fifth closure in two years — leaving just seven of the stores it acquired from local chain Home Way in 2006. And earlier this month, U.S. toy-maker Mattel closed its loss-making flagship Shanghai Barbie venture, only two years after cutting the ribbon on the six-story, multimillion-dollar store. Meanwhile, U.S. electronics giant Best Buy is beginning a new China strategy after its surprise announcement a few weeks ago that all nine of its stores in China will cease operating, leaving hundreds of staff and many customers high and dry.
Like these multinationals, Carrefour has a lot riding on its China business. In the midst of a group turnaround plan launched in 2009 and after two profit warnings in 2010, Carrefour's head office in Paris has a new multipronged global strategy, involving not only store closures in Russia, asset sales in Thailand and a spin off of its discount chain Dia, but also ramping up in China, among other emerging markets. Though accounting for around 5 billion euro (US$7 billion) of the group's 90 billion euro annual revenue, China is one of Carrefour's largest markets outside Western Europe, and the retailer continues to expand nationwide, with its 177th hypermarket in the country having opened on December 31 in the city of Shenyang.
Rest assured, competition is stiff. According to the China Chain Store Business Association, Bailian is among the country's state-owned heavyweights that dominates the retail sector, but RT-Mart, a Taiwan-based company that is majority owned by French retailer Groupe Auchan, and Wal-Mart are among the foreign players holding their own. With its grubby, crowded and chaotic shop floors, Carrefour, meanwhile, is fighting it out at the low end of the market, where margins are razor thin and pricing pressures are intense.
Big Guy vs. Little Guy
At the heart of recent tensions is the generally tempestuous relationship between retailers and suppliers in China. Part of the problem is a market imbalance, according to a spokesperson at the Commerce Ministry, who says the country has too many suppliers and too few major retailers, giving the latter tremendous leverage over even the largest supplier. That's not to say retailers have it easy. To hit ever tougher performance expectations laid down by corporate headquarters, large local and foreign retailers stand accused of squeezing, even bullying, suppliers — pitting one supplier against another in bidding wars, dragging out payment terms and cutting deals that have steadily been increasing the amount of fees and commissions they charge to stock particular goods.
It's by no means a new phenomenon, but it is intensifying. Some 20 years ago, suppliers in China typically paid retailers a "commission" or "rebate" of 4% on the sales of their goods, according to management consultants McKinsey; today, they're paying between 10% and 15%. But according to a manager at a long-time Carrefour supplier, the French firm is charging more than 20%, forcing smaller companies into a corner. “Only big manufacturers … are tough enough to stop supplying Carrefour when it asks for higher rebates," says the manager. "Small suppliers like us … just have to do as we're told if it asks us to pay more rebates.”
And it doesn't stop there. Suppliers face a host of other fees, sometimes in the form of under-the-table kickbacks. Yao Wenhua, a representative of the Beijing Suppliers Association, says that unlike commissions or rebates, some of these fees are levied by individual stores so they don't appear in contracts in order to stay off head office's radar. It's also common for manufacturers to pay retailers promotional fees for showcasing a particular product on store shelves. All told, says another supplier, fees can reach as much as 30% of sales, which adds up to a hefty price to pay for keeping a big customer happy.
It was over commissions that a disagreement erupted in December between Carrefour and Taiwan’s Tinghsin Group, the company behind greater China's biggest instant noodle brand called Master Kong. At an impasse, it’s reported Master Kong refused to supply some of its products to Carrefour for several weeks and the supply was resumed after late February.
At a different time in Carrefour's history, the disagreement probably would have been noticed by just a few company managers. After all, as experts note, losing a big supplier isn't a show-stopper per se since there are plenty of competitors willing to fill the void. What's more, says Ma Rui Guang, president of Yi Ma Management Consultants in Shenzhen, such tussles are a regular occurrence when contracts are up for renegotiation and both sides want to gain leverage. “This kind of conflict between retailers and suppliers is always there,” he says. But this hasn't been Carrefour's only run-in played out in public. Aside from Master Kong, it has locked horns with other well-known Chinese companies, such as heavyweight state-owned food supplier COFCO and Jiusan Oil & Fat Company, suggesting more than a subtle shift in retail relationships.
“Supermarket retailers make money from manufacturers by charging them store entry fees, display fees, promotion fees and annual rebates based on sales volume. In other words, China’s retailers traditionally do not, and cannot, make money from price mark-ups,” says Li Fei, professor of management at Tsinghua University’s School of Economics and Management and director of the China Retail Research Center in Beijing.
But as suppliers put their collective foot down with the likes of Carrefour, should China's retail sector brace itself for more pricing scandals like the one discovered over the New Year holiday?
Perhaps, but retailers have long resorted to bait-and-switch tactics like those that various Carrefour — and Wal-Mart — outlets stand accused of deploying, which woo shoppers to their stores with promotions but then charge more for a product than advertised, says Z. John Zhang, professor of marketing at Wharton. “Although no retailer should do it, Carrefour and Wal-Mart are certainly not the only retailers using the deceptive practice and they are not necessarily the worst offenders,” he contends.
What's immediately striking about the New Years cases are the fines slapped on the perpetrators: On January 26, the National Development and Reform Commission fined both retailers RMB 500,000 (US$76,000) for each offending store, a total of 19 stores between the two companies. At a total of RMB 9.5 million, it's the largest-ever fine levied in China for such a transgression.
Both retailers have issued public apologies and promised customers generous refunds. Newspaper reports say Carrefour has also vowed to step up the monitoring of individual stores by setting up what is expected to be the first of many "price centers" at a store in Guangzhou City, which will oversee prices and possibly serve as a model for other stores. Carrefour is also said to be introducing price management as part of individual performance metrics.
But some retail experts wonder whether the pricing scandal is part of a larger governance and management issue bedeviling multinationals like Carrefour — how much leeway should they give to local managers in vast and fast-changing markets like China. It's an issue that Eric Legros, Carrefour China's president, has been grappling with since arriving in the country in 2006. In contrast to the 10 years before his arrival, Legros has been curtailing the autonomy of regional and individual stores, even if it means a noticeable hit to top-line growth, not to mention a number of resignations.
“Before, a Carrefour manager had the authority to promote and price products in his store, which is essential to making a store more competitive than its rivals,” notes a former Carrefour manager in Eastern China who resigned last year. But as Legros most likely knows, giving individuals such broad authority has also meant giving them an open opportunity to demand kickbacks and other "fees" to double or even triple their take-home pay.
It's been a tricky balancing act. “Carrefour’s many fights with suppliers and scandals over price issues are a result of heated competition [aiming to] satisfy highly price-sensitive Chinese consumers. But Carrefour went about it in an unhealthy way,” says Li of Tsinghua University. “In this competitive industry, all retailers would like to offer low prices, and at the same time transfer costs to suppliers, which are the reasons for Carrefour’s recent crisis. However, every retailer has the responsibility to provide high-quality products and honest prices.”
The China Challenge
Figuring out how to woo China's price-sensitive consumers has flummoxed other foreign retailing newcomers. A case in point: Best Buy, the US$49.7 billion (in fiscal 2010 revenue), Minnesota-based electronics retailer, whose entry into China has been arguably among the most cautious of the recent arrivals. Five years after introducing its brand in China, it had only opened nine stores before announcing recently that it is closing them, although it's not giving up on China: Best Buy says up to 50 new stores under its Five Star Electronics subsidiary will be opened between now and next year.
But the retreat of its flagship Best Buy stores left retail experts wondering whether there is more to what company press statements call "a change of strategy" than meets the eye. “Best Buy went into the Chinese market with basically the same model it used in the U.S., and that probably didn’t make sense,” says Barbara E. Kahn, a Wharton marketing professor and director of the school's Jay H. Baker Retailing Center. “First, while the brand name means something in the U.S., it is unknown in China. Second, the competition in the electronics business in China is different from that in the U.S. In China, the market for selling electronics is fragmented, and there are many smaller mom-and-pop stores.”
Wharton's Zhang agrees that China's competitive landscape has a lot to do with why foreign retailers like Best Buy struggle. "'Store density' is much higher in China than in the U.S., which is why the Best Buy model is harder to [make work]," he says. "In China, there can be as many as three stores offering the same products located one right next to the other, fighting to attract customers."
Beyond that, experts say Best Buy generally misread China's consumers with its formula of charging shoppers higher prices in return for providing well-staffed, customer-friendly stores and first-rate after-sales service. In the brutally price-conscious Chinese market, the tactic didn't work, as many customers browsed the shelves at Best Buy, then made their purchases at cheaper retailers.
Best Buy has also been at a disadvantage operationally. For example, it used its own capital to buy products from suppliers, in contrast to local competitors Gome and Suning, which charge "rental fees" from suppliers and receive a percentage of sales. Best Buy also hired its own shop floor staff, while Gome and Suning keep overhead costs down by having suppliers provide some of their staffing.
Best Buy’s model "does not match current consumer demand,” says Li. “Electronics consumers in China are not willing to pay for service and a pleasant shopping environment." He cites research from the China Retail Research Center, which found that the most important factor influencing a consumer’s purchase in an electronics store in China is price; service ranks second.
Carrefour, Best Buy and other multinational chains face another hurdle in China: public relations. In the case of Carrefour's woes, Li of Tsinghua University says, "Carrefour in China has traditionally only focused on maintaining good relationships with the government and industry associations, but it doesn't know how to build up effective communication with media, academics and consumers." That was evident during the Beijing Olympic Games back in 2008, when consumers began a nationwide boycott of its stores after pro-Tibet protests during the Olympic torch relay in France and reports of Carrefour executives donating funds to the Dalai Lama. No stranger to controversy, then as now, Carrefour's PR efforts have been part of the problem, rather than the solution, experts say. When news of the current crisis broke, says Li, "the company even refused to give interviews, didn't issue public communications like press releases and has been very slow in reacting to the recent crisis." All told, he adds, "this could very likely ruin the golden opportunities of its future development in China."