China's consumer army has yet to leap forward

While a small elite buys Burberry, most of the country's one billion people follow the age-old maxim that to prosper you have to save
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As names of villages go, 414 is, admittedly, a little on the unusual side. Situated near the sprawling port of Tianjin, about 150km east of Beijing, the 1,200-strong farming community adopted its numerical name in 1961 to honour the day Chairman Mao visited: 14 April 1961.

Fast forward to 2006, and 414 illustrates how much has changed in China. Progressive, Western-friendly leaders have taken Mao's place. Where 414 was once remote, a busy four-lane motorway stretches along one side of the village. And the sprawl of Tianjin is now such that 414 is considered part of the city, testament to the extraordinary economic growth that has gripped China.

Yet it also represents how little has changed. Most citizens are still poor farmers, who rent the state-owned land on which they work from a central committee. The village is made up of rows of traditional courtyard houses, and there are only a handful of basic stores. Cages of dried corn are stacked outside; chickens are being killed and plucked in a small slaughterhouse that is open to the street; stray dogs bark at the few passers-by, and transport along the narrow, roughly paved alleys is on foot or bike, despite the bitter December weather.

A group of men sit inside one shop playing mah-jong; in winter, there is little to do other than sit out the cold months.

This month is the fifth anniversary of China's entry to the World Trade Organisation, and although Communism remains, capitalism has replaced the five-year plans of old, making China the fastest-growing major economy in the world.

Standard & Poor's, the credit ratings agency, which ranks China as "A" with a stable outlook, believes annual GDP is likely to remain at more than 8 per cent and points out in a recent note that: "China has made full use of its strong economic growth to enhance its budgetary revenue and reduce contingent liabilities."

The government deficit is around 1 per cent of GDP, less than that of India or Japan. But even without the hard figures, the growth is evident: cranes dot the skyline of Beijing, while construction workers in yellow hats squat on street corners, taking a food break before getting back to work.

Ownership restrictions and corruption remain, but that has not stopped Western business flooding in. Overseas companies are keen to tap this burgeoning economic growth and, in the consumer sector in particular, to gain access to China's one-billion-strong population. Private consumption as a percentage of GDP hit 38 per cent last year, while disposable income is rising at 13 per cent a year and retail sales by 14 per cent.

Burberry, Tiffany & Co, Porsche, Ferrari, Wal-Mart, Anheuser-Busch (the US brewing giant that owns Budweiser), SABMiller, HSBC, Royal Bank of Scotland, MTV, Kingfisher's B&Q, InterContinental Hotels and Ikea are all there, to name but a few.

But one billion people, in a country as disparate as China, does not equate to one billion consumers. Beijing and Shanghai, with a combined population of around 24 million, may be boom towns rife with Western retailers and malls, but little has changed away from major urban centres. According to Credit Suisse, China is home to a quarter of the world's population, yet represents only 4 per cent of global household consumption. The average national wage is just 16,000 yuan (£1,038).

"The fruits of China's strong economic growth have been very unevenly distributed," says Kim Eng Tan, S&P's associate director for sovereign and international public finance ratings. "A very small proportion of the population has become very rich while the majority have seen income growth far lower than the headline nominal GDP growth."

So while a middle class is emerging, it is both small and hard to quantify. "Someone used family cars to measure the size of the middle class, and concluded that there are around 30 million people," says Minggao Shen, vice-president of Asia Pacific economic and market analysis at the investment bank Citigroup. "But no quantitative studies have been done to understand their spending power."

This means that, away from the high-end brands such as Burberry, consumer companies do not have the luxury of targeting just the middle class. Instead they must accept that doing business in China is about high volumes and look to build enough scale to make it work.

The FTSE 100 brewer SABMiller entered the market in 1994 and has a 49 per cent stake in China Resources Snow Breweries (CR Snow). This company runs 44 breweries - with more being built - and makes one of the country's most popular beers, called Snow. SAB has a strong reputation in emerging markets. Yet as Wayne Hall, SAB's financeial director for China, concedes, business is not easy.

"It's a low-margin, high-volume business. Only those with any scale make money. The average man on the street is moving up, and they do have much more disposable income to spend. But if you look at the demographics, it's not a good story, mainly because of the one-child policy. The population is ageing and our target marketing of between 20 and 40 [-year-olds] is reducing."

At the upper end of the market, CR Snow beers sell for up to 15 yuan, if not more. Yet, at the same time, the group sells 600ml bottles of beer for just 1 yuan to farmers during the peak summer months.

"A Chinese middle class is developing," says S&P's Mr Tan. "However, with about two-thirds of the population in rural areas, it makes up a relatively small proportion of the country. While the growth in their spending power is evident when you visit cities, the impact is much less significant when you consider the Chinese economy as a whole.

"My view is that private consumption is unlikely to play a larger role to bring about more balanced economic growth as long as much of the rural population continues to receive so little of the gains of economic growth."

So the real issue is how and when China as a whole will start spending, especially as an increase in wages alone will not kick-start the process. Citigroup's Dr Shen believes that the lack of consumption can, in part, be attributed to the need of the Chinese to save for the future - unlike credit-embracing Westerners. (There is a Chinese saying, qin jian chi jia, which translates as "only diligence and savings can prosper a family".) Dr Shen argues that most think it will take up to 15 years to ensure they have all they need: to take care of their parents, their children, to buy a home. Only then will they feel free to start spending.

"China needs a good capital market," he adds. "We have a bond market but it is dominated by government bonds, and the yield is 3 or 5 per cent. It's also illegal for people to lend to each other. So really the only way to benefit is to put money in the bank. If you ask the majority of people what would they prefer, one million in cash or one acre of land, most would choose the land.

"To promote consumption, it's not only important to increase wages, it's important to provide better investment vehicles, and it will take a while for that to occur."

This gap in the market is one of the reasons why so many Western banks, such as HSBC, Citigroup and Bank of America, have bought footholds in Chinese rivals.

Royal Bank of Scotland, for instance, last year led a consortium to take a 10 per cent shareholding in Bank of China, the second-largest of the country's four banks. RBS paid around £900m, and the value is already going up as BoC's profits grow.

Commentators are optimistic that the authorities are well aware of the problems still facing the economy. As S&P says in its note on China: "The commitment of China's policymakers to economic reform has not wavered. Notwithstanding the country's considerable challenges, the government is still likely to execute reforms gradually, steadily and predictably."

It is perhaps not surprising, then, that big financial players are resident in China. The blue-chip venture capitalist 3i, for example, has offices in Beijing, Shanghai and Hong Kong and is looking to invest up to $200m (£102m) in individual deals. Top of its preferred sector list is consumer and retail, followed by food and beverages.

Likewise, SAB's Mr Hall is buoyant. "People do spend," he argues. "They are embracing Western habits. There's also still a huge opportunity in third- and fourth-tier cities - it's something that we're looking at."

This is particularly relevant as people continue to move from the countryside to ever-expanding urban areas. According to Citigroup, there are currently around 150 million migrant workers, and this figure is forecast to double by 2020.

Mr Hall, meanwhile, also expects his industry to consolidate as the market matures, making competition more effective and allowing CR Snow to up its prices. And while it may still be selling 1 yuan bottles of beer, SAB is considering introducing Miller, a premium international beer. Snow is forecast to become SAB's biggest brand by next year, and last month China Resources Enterprises - SAB's joint venture partner in CR Snow - announced a rise in earnings at its beverage business of 19 per cent in the first nine months of 2006, to HK$226m (£15m), with sales volumes up 32 per cent. China now represents 80 per cent of SAB's Asia and African business.

China has, and never will be, a simple market. Quite aside from the vagaries in the depth and breadth of economic development, culturally it is very different to most markets, even the emerging ones, that Western companies operate in. Brewers, for example, have discovered that the Chinese love beer, but that there is no social drinking culture. Other than a handful of bars in Shanghai and Beijing, frequented by tourists and the young and trendy urban Chinese, the norm is to drink at home or at restaurants, though most only eat out when they have something to celebrate.

Yet companies adapt, and in time so will China to its new status on the world stage. It is just not something that will happen overnight. Back in 414, and 600ml bottles of Snow sell for 1.5 yuan. That is an increase on 1.2 yuan last year, and the group intends to up the price to 1.8 yuan next year - an important rise but still a retail price of just 12p.

China and its people are getting richer, and Western companies are there to take advantage. But it's going to take a while for the citizens of 414, and all the other millions of people in villages and towns across China to realise the changes taking place - or have the means to partake.

A POWERHOUSE IN THE MAKING: Eight per cent and rising: the facts behind the boom

China is the fastest-growing major economy in the world ...

Population: 1.3 billion

Capital city: Beijing. China has 661 cities, 166 of which have populations of more than one million

Currency: the yuan, also known as the renminbi (or "people's money")

Average national wage: around 16,000 yuan (£1,038) per annum

Foreign currency reserves: in excess of $1 trillion

GDP: Chinese GDP grew at 9.8 per cent in 2005 and is expected to stay well above 8 per cent in the coming years

Retail sales: total sales reached $840bn last year - growing at a rate of 13 per cent annually

Recent key developments: state-controlled Nanjing acquires UK car group Rover; Lenovo buys IBM's PC business; Bank of China debuts on Hong Kong stock market; China National Offshore Oil Corporation tries to buy rival Chevron but is blocked is by US authorities; Google enters Chinese market