Required Report - public distribution

**Date:** 3/9/2006

**GAIN Report Number:** CH6804

CH6804

**China, Peoples Republic of**

**Retail Food Sector**

**All China Retail Annual Report**

**2006**

**Approved by:**

![](media/image1.wmf)Ross Kreamer

U.S. Consulate

**Prepared by:**

Ralph Bean/ATO Guangzhou/ATO Beijing

**Report Highlights:**

The retail food industry continues to grow and modernize as
hypermarkets, supermarkets and convenience stores displace wet markets
and other traditional outlets. Distribution systems have not kept pace
however, and penetration of imported foods into the retail market
remains relatively low.

Includes PSD Changes: No

Includes Trade Matrix: No

Unscheduled Report

Shanghai \[CH2\]

\[CH\]

Table of Contents

[**I. Market Summary 3**](#i.-market-summary)

[I.A. Overview of the Retail Food Market in China
3](#i.a.-overview-of-the-retail-food-market-in-china)

[Retail Distribution Development 5](#retail-distribution-development)

[I.B. Sectoral Overview 6](#i.b.-sectoral-overview)

[I.C. Advantages and Challenges for U.S. Products In the Retail Food
Market
9](#i.c.-advantages-and-challenges-for-u.s.-products-in-the-retail-food-market)

[Table 2. U.S. Products in China's Retail Market
9](#table-3.-u.s.-products-in-chinas-retail-market)

[II. Road Map for Market Entry 9](#ii.-road-map-for-market-entry)

[II.A. General Guidelines 9](#ii.a.-basics-of-market-entry)

[II.B. Market Structure 12](#ii.b.-market-structure)

[Distribution By Market Type 12](#distribution-by-market-type)

[Figure 3. Imported Goods Distribution Chain: Major Port
12](#figure-3.-imported-goods-distribution-chain-major-port)

[Figure 4. Imported Goods Distribution Chain: Emerging City via Major
Port
13](#figure-4.-imported-goods-distribution-chain-emerging-city-via-major-port)

[Industry Profiles 14](#industry-profiles)

[Company Profiles 14](#__RefHeading___Toc130186258)

[Table 3. Top Food Retailers 14](#table-4.-top-food-retailers)

[Entry Strategy: Hypermarkets and Supermarkets
14](#entry-strategy-hypermarkets-and-supermarkets)

[Entry Strategy: Boutique Stores 15](#entry-strategy-boutique-stores)

[Entry Strategy: Convenience Stores
16](#entry-strategy-convenience-stores)

[II.C. Regional Market Profiles 17](#ii.c.-regional-market-profiles)

[Shanghai Region 17](#shanghai-region)

[Table 5. Top Players in Shanghai Retail, 2004
18](#table-5.-top-players-in-shanghai-retail-2004)

[Hypermarkets 18](#hypermarkets)

[Table 6. Structure of Shanghai's Food Retail Sector, 2005
19](#table-6.-structure-of-shanghais-food-retail-sector-2005)

[Supermarkets 19](#supermarkets)

[Convenience Stores 21](#convenience-stores)

[Boutique Stores 22](#boutique-stores)

[Beyond Shanghai 22](#beyond-shanghai)

[Beijing Region 23](#beijing-region)

[Table 7. Major Hypermarkets/Supermarkets in Beijing
25](#table-7.-major-hypermarketssupermarkets-in-beijing)

[Beyond Beijing 26](#beyond-beijing)

[Guangzhou Region 27](#guangzhou-region)

[Consumer Trends 28](#consumer-trends)

[Supermarket retailers 28](#supermarket-retailers)

[Profiles of select retail outlets
29](#profiles-of-select-retail-outlets)

[Convenience stores 30](#convenience-stores-1)

[III. Competition 30](#iii.-competition)

[IV. Best Product Prospects 32](#iv.-best-product-prospects)

[IV.A Products Present in the Market Which Have Good Sales Potential
32](#iv.a-products-present-in-the-market-which-have-good-sales-potential)

[IV.B Products Not Present in Signficant Quantities, Which Have Good
Sales Potential
32](#iv.b-products-not-present-in-signficant-quantities-which-have-good-sales-potential)

[V. Post Contact and Additional Resources
33](#v.-post-contact-and-additional-resources)

# I. Market Summary 

## I.A. Overview of the Retail Food Market in China

Total retail sales in reached \$674 billion in 2004, growing by 17.6%
over the previous year. Expansion slowed slightly in the first half of
2005, with retail sales gaining by 13.2% over the same period in 2004.
[Retail Forward]{.underline} now ranks China as the world's 7^th^
largest retail market, likely to move to 5^th^ within the next five
years. Although modern formats and chain retailers are spreading rapidly
across the country, small-scale retail continues to dominate: in 2004
sales by chain stores accounted for slightly over 8% of the total. This
number is deceptive in that market penetration of chain retail tends to
be very high in the cities and very low in rural areas. Food sales
constitute a large proportion of retail sales, with food accounting for
over 1/3 of average Chinese urban household expenditures.

Food retailing in China's urban areas is undergoing a rapid
modernization, although the pace varies widely by geographic location.
Major urban centers in Guangzhou and Shanghai lead the way, with Beijing
following close behind. Most major cities now host multiple hypermarkets
and one or more international retailers. With markets in Beijing,
Shanghai and Guangzhou approaching saturation, many chains are expanding
to second and even third tier cities. Development in retail distribution
has not kept pace, and over 90% of the products for sale, even in
international retailers, are locally sourced. Outside of the cities of
Shanghai, Beijing and Guangzhou, penetration of imported foods is
extremely low, typically constituting less than 1% of SKUs (this issue
is discussed in detail below).

International retailers such as Carrefour, Wal-Mart and Metro have set
the pace for retail development, and domestic and international
competitors have entered these markets in large numbers, bringing the
level of development close to international standards. Ferocious
competition in these cities is leading the major retailers to push out
into increasingly remote markets. China is an immense country however,
and despite rapid growth and massive investment, all international
retailers combined still account for only 3-4% of total grocery sales
and 2.6% of all retail sales. At the same time, however, in a retail
landscape populated by small shops these international chains stand out:
within the ranks of China's top 100 chain stores, they accounted for 23
percent of total sales in 2004 (as compared to only 16 percent the
preceding year).

Domestic retailers are developing quickly. State-owned giants Lianhua
and Hualian, both based in Shanghai, remain by far the largest food
retailers in China. At last count, Lianhua operated 3,377 stores, mostly
small supermarkets, across China, with plans to open another 600 stores
in 2006 and a final goal of 8,000 by 2008. Although Lianhua and Hualian
were merged two years ago to form Bailian, both chains continue to
operate as separate entities. Much of their expansion has been fueled by
acquisition of smaller chains. While this has extended their reach, it
is also creating management problems. Lianhua is establishing stores in
Europe, with the intention of sourcing and selling in both markets.
Another state-owned giant, Shanghai Nonggongshang, has begun to expand
into cities throughout East China.

Privately-owned domestic chains are growing even more quickly. Key
players include Wu-Mart in Beijing, Jiadeli in Shanghai and Suguo in
Jiangsu province. Relatively small size and narrower geographic focus
makes these chains quicker and more responsive to market conditions. All
are expanding: Wu-Mart recently acquired rival MerryMart; Jiadeli is
rumored to be in talks with a U.S. fund manager to raise funds for a
nationwide expansion; and Suguo received a boost when CRE Vanguard, a
major player in South China, raised its stake to 80%. CRE is also
rumored to have hired away a number of managers from international
retailers as they beef up their management capabilities. All of the
major domestic retailers are hedging their bets by fielding a variety of
different store formats. Lianhua, Hualian and Nonggongshang have
developed special, branded hypermarket companies to compete with
international hypermarkets. All three also own convenience store chains.

The pace of development among international retailers is extraordinary.
Major new players have already entered the market, starting with Tesco's
purchase of a 50% stake in HyMall, which overnight gave it 32 stores in
China. Hong Kong's Sincere also announced plans to enter Shanghai's
crowded convenience store sector, and SPAR has received permission to
establish a wholly-owned foreign enterprise in China, having already
established a joint venture with the Jiejieqiang chain in Shandong.
Their voluntary chain model is likely to appeal to smaller chains
looking for a competitive advantage. SPAR plans to open 15 stores in
Shandong over the next three years. Another voluntary chain, IGA, has
signed an agreement with Sanjiang Shopping Club in Ningbo, Zhejiang
province. The most recent rumor involves the sale of Taiwan-based
Trust-Mart, which, with 90 stores, could create a powerful new
competitor overnight, depending on the buyer.

Many international retailers who have been present in the market for a
number of years are also gearing up for expansion. The most notable is
Lotus, which has quickly but quietly built up to over 78 Supercenter
stores (as of February, 2006), with a target of 100 by the end of 2006.
Lotus' efforts are focused on East China, with 20 stores in Shanghai
alone. Its parent company, CP Group of Thailand, has diversified
investments in agricultural processing across the country, which it may
be able to leverage in the future. Ito Yokado has announced plans to
double the number of high-end stores it is operating in Beijing to 10
(Ito also has two stores in Chengdu).

Liberalization of China's foreign ownership regulations has added to the
ferment. Prior to 2004, all international retailers were required to
enter into joint ventures with local companies. As a result, most
international retailers were left with joint ventures with partners they
may not have wanted. Carrefour Shanghai, for example, is a joint venture
with it's biggest local competitor: Lianhua. In the wake of the reform,
international retailers have either increased their stake or bought out
their partners altogether. In the past year, Lotus has bought out money
losing stores in Beijing and Tianjin, Carrefour has bought out partners
in Changsha and Kunming, and Metro has increased it's stake from 60% to
90%. Wal-Mart, however, has announced that it does not intend to follow
this trend, regarding the joint ventures as important to its relations
with the local community.

Increased competition is forcing retailers, both domestic and
international, to adapt. The strategies they are pursuing vary widely.
Some (Carrefour, Wal-Mart and Metro) are resolving geographic imbalances
by opening new stores in areas where they lack a presence. In Fall,
2005, Wal-Mart opened it's first store in Shanghai, while in the same
year Carrefour opened it's first stores in Fujian (Fuzhou and Xiamen),
and Metro opened it's first store in Guangzhou. Another strategy,
followed successfully by Taiwanese retailers Trust-Mart and RT-Mart is
to invest in less well-known but fast-developing cities, avoiding the
most competitive markets. (Trust-Mart and RT-Mart have also cashed in on
their strong knowledge of Chinese culture and products to attract
customers in cities less familiar with foreign trends). Wal-Mart appears
to be following a similar strategy. While it has no stores in Guangzhou,
it has 10 in neighboring Shenzhen, and a list of locations that includes
Guiyang and Taiyuan, the capitals of the mountainous inland provinces of
Guizhou and Shanxi, as well as a very successful venture in Nanchang
(Jiangxi province).

The opposite strategy, focusing on a narrower geographic market, has
proved successful for other chains, particularly domestic retailers such
as Wu-Mart, Suguo and Chengdu's Hongqi. This approach allows retailers
to build greater volume and build stronger distribution chains, and is
particularly favored by supermarket and convenience store chains. Lotus
and E-Mart appear to be following this strategy as well, focusing most
of their effort on Shanghai and the neighboring cities. Metro has
focused on a niche of a different sort, having tailored its
cash-and-carry membership model to become a supplier to China's hordes
of small family-owned restaurants and cafeterias. Ito Yokado appears to
be following both a geographic and demographic niche market strategy by
targeting high-end consumer in Beijing.

### Retail Distribution Development 

Retail distribution channels have not grown to match the number and
quality of retail outlets. With some notable exceptions, distribution is
handled on a store-by-store or city-by-city basis, with stores receiving
most imports through a local distributor, often even when alternatives
exist. Because of their relative size, stores are able to negotiate
highly favorable terms that include free return of unsold products, high
listing fees for new products, and credit terms, effectively passing all
market risk onto the distributor. This gives store managers a powerful
incentive to favor the local distributor over alternatives that offer
less generous terms. In at least one case, an international retailer's
effort to establish single-desk distribution of imports failed when
their own stores refused to work with the selected distributor. A second
reason for reliance on local distributors is the tendency of
international retailers to expand rapidly nationwide rather than
focusing on a single city or region, creating large numbers of isolated
stores that lack the volume to support a dedicated distribution network.
A final reason has to do with the role of relationships in Chinese
business: local distributors can provide a store with a network of
business and government contacts that are useful in resolving problems
with minimal fuss.

Because of the high level of risk they are expected to absorb,
distributors tend to be extremely conservative about new products,
particularly imports. As a result, penetration of imported foods into
the retail sector is low. Even in relatively affluent cities,
international retailers typically carry less than 1% imported SKUs.
Notable exceptions include stores in Shanghai, Beijing, Guangzhou and
nearby boomtowns, which are home to both large expatriate communities
and to a large number of Chinese with overseas experience. Further
inland, distribution problems are further complicated by China's heavily
fragmented logistics systems, which make it difficult to transport
products directly from the coast to deep inland cities. One survey in
Chengdu found that temperature sensitive items, such as imported poultry
and meat, changed ownership as many as five times before reaching the
final user.

Fragmentation among suppliers of locally sourced products, particularly
of vegetables and meat, helps to perpetuate the dominant role of the
local distributor. One regional chain, Suguo, made repeated attempts to
source produce directly from producers or wholesale markets. The sheer
volume of transactions required to meet their demand was overwhelming,
however, forcing them to give up the effort. Eventually Suguo came to
rely on distributors not just for sourcing, but for most aspects of
marketing---essentially granting the distributor space in the store to
market their products. This is changing slowly, as farmers' professional
associations become more common, giving producers the ability to supply
larger quantities from a single source and at a more consistent level of
quality.

Exceptions to these conditions also exist. Some retailers (e.g. Metro)
have centralized distribution for many imported products, and a few
large distributors have negotiated more favorable terms with retail
chains at the national level, in some cases waiving listing fees. As
chains grow larger and handle increasing volumes, and as Chinese and
foreign suppliers become more organized, the role of the local
distributor in handling imports is likely to decline in the long run.
Nonetheless, for now, distribution remains the key obstacle to sales of
imported processed food in China's retail sector.

## I.B. Sectoral Overview

**Supermarkets** -- This is the oldest modern retail format, and remains
the most common in urban China. The sector is dominated by state-owned
domestic retailers, the largest being the Shanghai-based companies
Lianhua and Hualian. A number of strong, privately owned and regionally
focused competitors have appeared in recent years, however, exemplified
by Beijing's Wu-Mart. Although the supermarket format is losing market
share to hypermarkets and convenience stores, the actual number of
stores continues to grow. The durability of the supermarket model is
rooted in the demographics and buying habits of Chinese shoppers. Small
apartment sizes, small refrigerators, relatively low rates of car
ownership makes long trips inconvenient, and limits the amount of food
that can be kept at home. At the same time, Chinese consumers are
extremely sensitive to the freshness and quality of the food that they
buy. As a result, most Chinese prefer to make smaller shopping trips on
a daily basis, rather than going on weekly or monthly shopping
expeditions to a distant superstore.

The key weakness of China's supermarkets lies in the poor selection and
quality of produce, an item in high demand with daily shoppers. This
mismatch between supply and demand has not gone unnoticed, and it is
common in many Chinese cities to see impromptu wet markets form outside
of some supermarkets to take advantage. Several supermarket chains are
expanding their line of fresh produce in an effort to capture this
business, but face steep obstacles in sourcing the quantity and quality
of produce they need. They are receiving support in this effort from
local officials, who tend to regard wet markets as unsightly and unsafe,
not to mention a source of untaxed commerce. The movement of
supermarkets into fresh produce may prove a boon to fruit exporters, as
fruit is one of the few imports that have been able to penetrate into
the local wholesale markets that supply these stores.

Supermarkets have the poorest penetration of imported products of all
the modern retail formats, even in major cities. The only U.S. imports
routinely found in these stores are frozen corn and mixed vegetables,
frozen potatoes, and occasionally fresh oranges, apples and wine. This
is the result of both customer base and distribution systems. Chinese
supermarkets cater primarily to middle-market daily shoppers, who are
extremely price sensitive. By contrast, hypermarkets and convenience
stores are less price sensitive, with hypermarkets appealing more to
upscale shoppers (particularly those who own cars), while convenience
stores make an open tradeoff between time and money. The other obstacle
to imports lies in the weak distribution systems for supermarkets, who
tend to rely on small-scale local distributors or local wholesale
markets, or to buy directly from local manufacturers.

**Hypermarkets** -- Hypermarkets have seen the fastest growth of any
sector. International retailers are far stronger in this format than in
any other. Useful statistics are difficult to come by, as chains tend to
lump different retail formats together. This being said, Carrefour
appears to be the dominant player, although Lianhua and Hualian also
have a large number of hypermarkets. Carrefour added 14 stores in 2005
to reach an estimated total of 70, and plans to add 20 more in 2006.
Many of the new stores are located in markets where Carrefour previously
lacked a presence. Among international retailers, Wal-Mart is a distant
second at 47 stores, but has ambitious plans for expansion. As noted
before, Wal-Mart has generally avoided markets that are already
well-developed in favor of less well-known markets. Wal-Mart just this
year opened its first store in Shanghai, and has yet to establish a
presence in Guangzhou, though it has a huge (10 stores) presence in
neighboring Shenzhen. ![](media/image3.jpeg){width="3.2875in"
height="2.191666666666667in"}

Metro Cash & Carry has expanded more slowly. The German-based retailer
currently has 29 stores, but plans to double this number in the next
three to five years. Metro's niche-market strategy of selling directly
to restaurants and food service, however, makes it more of a player in
the HRI sector than in retail, and some international retailers do not
regard Metro China as a competitor. Thailand's Lotus, by contrast, has
expanded at an extraordinary pace in the past year, estimated at a total
of 49 supercenter stores, concentrated primarily in or near Shanghai.
This places them ahead of Tesco, which entered the market by buying a
50% share of Taiwan-based Hymall, with 32 (39 as of early 2006)
locations in 2005 and plans to open 15 more. Ito Yokado has staked out a
position as a high-end retailer, with five stores in Beijing and two in
Chengdu, and plans to add five more in Beijing. The long list of other
hypermarket companies operating in China also includes Auchan (France),
RT-Mart (Taiwan), Trust-Mart (Taiwan), Parkson's (Malaysia),
CRC/Vanguard and E-Mart (Korea).

In addition to the major chains, hypermarkets often face competition
(especially in Northeast and Central China) from local deparment store
operators with one or two locations. These have evolved in the direction
of hypermarkets, adding large food stores, while many hypermarkets have
taken on some attributes of department stores. Hypermarkets in China
tend to be somewhat smaller than their western counterparts, and very
few (excepting Metro) follow the big-box format faithfully. In large
cities, they are typically multi-story operations. Most act as small
shopping malls, setting aside a large amount of space for independent
boutiques and eateries, a habit that tends to reinforce the perception
of hypermarkets as places for occasional shopping expeditions rather
than daily shopping. For the hypermarket proper, the food sales area
typically accounts for a good half of total area. Management within the
stores tends to be quite good, but distribution has not kept pace.

**Convenience Stores** -- This has been one of the most dynamic sectors
for development, yet is still the one with the farthest distance to go.
The industry remains overwhelmingly concentrated in Shanghai, which
hosts nearly half the convenience stores in the country, and Guangdong
Province. The industry continues to be dominated by domestic state-owned
retailers, with the largest being Quik (owned by Lianhua), Kedi (owned
by Nonggongshang's Bright Dairy subsidiary) and Alldays (directly owned
by Nonggongshang).

These giants are being challenged on two fronts. International
convenience retailers are expanding more aggressively. 7-Eleven has
broken out of Guangdong, and now has a small number of stores in
Beijing. Japan's Family Mart (connected to Ito Yokado) and Hong Kong's
Sincere have also entered the market. Other international convenience
chains in China include C-Store (Taiwan) and Lawson's (a JV between
Lawson's Japan and Hualian). The other challenge comes from local
chains. In cities where major chains are not well established, local
companies are filling the void. Chengdu's Hongqi, Jiangsu's Suguo and
Beijing's Wu-Mart providing examples. Faced with growing competition in
their home markets, retailers are expanding into new territory or
seeking niche markets. Quik and Kedi in Shanghai, and 7-Eleven in
Guangzhou, are both expanding into nearby satellite cities, taking
advantage of their high incomes, close proximity and lack of local
competitors. Other chains, like Lawson's, are seeking niche markets,
targeting office workers in commercial districts.

Chinese convenience stores tend to be somewhat smaller than their
western counterparts, but all have refrigerator cases and microwave
ovens, and most offer a selection of hot food, typically meatballs or
fishballs and tofu on skewers. The vast majority are pedestrian stores,
with no allowance made for parking, although several chains have entered
cooperative agreements to open gas station stores. Since gas sales are
controlled by a small number of petroleum companies, these stores are
actually co-located with gas stations, rather than being gas-and-go
convenience stores, as in the U.S. Convenience stores also offer a
variety of services, including bill payment, IP cards and even inflating
bicycle tires, all as a means of generating foot traffic.

**Traditional markets** -- These continue to be a presence throughout
China, although they are no longer the dominant factor in the larger
cities. Traditional markets fall into three general categories: wet
markets, variety stores (xiaomaibus), and fruit stands. Wet markets
specialize mainly in fresh vegetables, meat, poultry (sold live), eggs,
tofu and to a lesser extent, fruit and staple foods. Sanitary standards
are extremely low, particularly for meat. Officials generally regard wet
markets as an eyesore, as well as a source of both food safety problems
and unregulated (i.e., untaxed) commerce. The SARS epidemic, followed
shortly by avian influenza outbreaks, provided more impetus to efforts
to reform or close these markets. Nonetheless, they persist. The main
reason for this is a lack of alternatives for buying fresh vegetables
and, to a lesser extent, meat. The selection and quality of vegetables
in most supermarkets is poor, and hypermarkets are too far for daily
shopping trips. Until competitive alternatives are widely available, wet
markets will persist.

The other traditional formats are small variety stores (xiaomaibus) and
fruit stands. The typical xiaomaibu is much smaller than even a
convenience store, family owned, and stocks an eclectic mix of products.
Although they face a serious challenge from convenience stores, the
xiaomaibu persists even in Shanghai. While convenience chains follow
standard formats and target key sites (train and bus stations, schools,
hospitals, etc.), xiaomaibus are infinitely adaptable. Small size and
independent ownership allows these shops to adapt to individual sites
such as apartment complexes, and adapt their product selection even to
match individual consumers. Like convenience stores, xiaomaibus also
offer a range of services, such as bill payment and IP card sales.

Fruit stands fill another gap left by the convenience stores, which
rarely carry more than one or two types of fruit. Sales are boosted by
the tradition of giving gifts when visiting friends, and most fruit
stands will wrap fruit baskets to order. Fruit stands frequently carry
imported fruit, usually for inclusion in fruit baskets. However, they
are generally regarded as poor venues for imported products, as they are
generally price driven and poorly regulated. Counterfeiting is
widespread in these markets, and where a brand name adds value, it is
certain to be copied. As a result, there is little room for marketing
and promotion of imported products. While both xiaomaibus and fruit
stands will likely continue to decline in numbers relative to
convenience stores, China's high urban population densities are likely
to support their continued existence for many years.

##  

## I.C. Advantages and Challenges for U.S. Products In the Retail Food Market

+----------------------------------+-----------------------------------+
| ##### Table 3. U.S. P            |                                   |
| roducts in China's Retail Market |                                   |
+----------------------------------+-----------------------------------+
| Advantages                       | Challenges                        |
+----------------------------------+-----------------------------------+
| U.S. products are generally      | U.S. products are routinely       |
| regarded as high in quality.     | counterfeited.                    |
+----------------------------------+-----------------------------------+
| Urban Chinese consumers spend    | Overall incomes remain relatively |
| 38% of their income on food.     | low, with imports selling mainly  |
|                                  | to higher income groups.          |
+----------------------------------+-----------------------------------+
| Consumers are interested in new  | Consumers are very price          |
| tastes.                          | sensitive, and often unwilling to |
|                                  | risk spending money on unfamiliar |
|                                  | products without trying them      |
|                                  | first.                            |
+----------------------------------+-----------------------------------+
| Many U.S. brands are widely      | Many U.S. companies have          |
| recognized and respected in      | established plants in China,      |
| China's major urban markets.     | manufacturing their products in   |
|                                  | China with Chinese ingredients.   |
+----------------------------------+-----------------------------------+
| Incomes are growing rapidly in   | Distribution and logistics remain |
| second and third tier cities,    | underdeveloped outside of the     |
| creating a whole new range of    | largest urban centers, making     |
| opportunities.                   | distribution of imported products |
|                                  | to interior cities difficult.     |
+----------------------------------+-----------------------------------+
| Western foods are more widely    | Lack of knowledge about U.S.      |
| available than ever, and growing | products and how to prepare them  |
| in popularity with consumers.    | properly makes consumers hesitant |
|                                  | to buy.                           |
+----------------------------------+-----------------------------------+
| China's entry into the WTO       | Labeling regulations and sanitary |
| reduced tariffs on a wide range  | restrictions limit access to the  |
| of imported products.            | market. Enforcement of            |
|                                  | regulations is haphazard,         |
|                                  | creating confusion for exporters. |
+----------------------------------+-----------------------------------+
| The number of qualified          | Many U.S. exporters continue to   |
| distributors for imported food   | rely on gray market channels,     |
| on the mainland is growing,      | reducing their level of contact   |
| along with the volume of direct  | with end users and understanding  |
| exports.                         | of the market.                    |
+----------------------------------+-----------------------------------+
| Rapid growth in retail chains    | Purchasing by most                |
| has created the potential for    | foreign-invested chains remains   |
| bulk sales, with consequent      | decentralized, preventing them    |
| improvement in pricing and       | from sourcing in bulk. Close      |
| handling.                        | relationships between store       |
|                                  | managers and local distributors   |
|                                  | help to reinforce this tendency.  |
+----------------------------------+-----------------------------------+

# II. Road Map for Market Entry

## II.A. Basics of Market Entry

### General Guidelines

China is not a single amorphous market, but a jigsaw puzzle of small,
overlapping markets separated by geography, culture, cuisine,
demographics and dialects. As such, there is no single formula for
success in China. The best approach to marketing a product will vary
depending on the product and the specific market (geographic
[and]{.underline} demographic) being targeted. Nonetheless, there are
some basic guidelines that can be applied to most cases.

**1) Understand the importance of relationships.** China's legal system
is developing, but remains inconsistent. Enforceability of contracts
varies widely, but is generally weak. Business in China instead relies
heavily on personal contacts and influence (referred to as 'guanxi').
For companies with a serious interest in China, no investment will be
more important to their success than the network of relationships that
they establish in China. For more pointers on the role of guanxi in
Chinese business culture, please see report CH4835, Chinese Business
Etiquette.

**2) Find a local partner and/or distributor.** For smaller companies
without the resources to directly market their products in China, a good
distributor is critical to success. Distributors provide the network of
relationships with buyers, regulators and others, that is needed to do
business in China. Unfortunately, these tend to be in short supply. ATOs
keep lists of well-known distributors. Keep in mind that contract
arrangements with retailers tend to place most of the market risk for
new products onto the distributor, so they may require some convincing
before they will take on an unfamiliar product. Specialized distributors
also exist for certain product categories, most notably wine, seafood
and fruit. Be careful in selecting a partner and in establishing an
incentive structure: partnerships gone sour are the most common cause of
business failure in China. Paying close attention to payment terms can
be an important aspect of this (confirmed letters of credit are
standard).

**3) Know the rules.** Chinese regulations are often vaguely worded,
arbitrarily enforced and opaque. Your distributor can (and should)
handle this for you. However, weak enforcement has made short-cutting a
common practice, and exporters that rely entirely on Chinese partners
for this are often unaware that their products do not conform to the
rules until a problem arises. To defend against the unexpected,
exporters should try to be reasonably familiar the actual regulations.
Product registration, labeling and product expiry dates are the top
concerns in this area. To enter the retail market, food products must
receive a hygiene certificate from the local government where the
product will be sold. Food products must also be labeled in accordance
to Chinese government standards, with the labels pre-approved by the
government. Functional or health foods must obtain a health-food
certificate, and claims of health benefits on packaging or in
advertising are strictly regulated. Foods containing GMO ingredients may
be subject to additional labeling requirements, as are organics. Please
see the FAS FAIRS reports for China on the FAS website for details
(www.FAS.USDA.gov; attache reports) or the website for China's
Administration for Quality Standards, Inspection and Quarantine (AQSIQ)
at www.AQSIQ.gov.cn.

**4) Get to know the market**. As noted above, China is a surprisingly
diverse place. Tastes, customs, culture, business practices and
government regulations vary from place to place. Experience in other
markets will not necessarily help in China, and some aspects of the
market need to be witnessed to be fully understood. The best strategy is
to target a specific place and get to know it well. The scope of your
effort will determine whether you select a single city or a whole
region. Travel to China is highly recommended to evaluate partnerships,
build guanxi (see above), and identify new opportunities and potential
obstacles. (Partners are frequently hesitant to mention problems in
formal communications, but will be more forthcoming over informal events
like dinners). FAS market briefs offer a good source of information on
the market, and are available for free on the FAS website noted above.

**5) Find your market niche and focus on it.** China is a very, very big
place. The mass market may be huge, but it is driven entirely by price
and dominated by lowest-cost local producers. Better returns are to be
had from targeting a specific niche. The country has a nearly infinite
number of niche markets, some of them quite large. Examples include the
high-end gift market, where margins are high but packaging is crucial
(wine, ginseng); the expatriate market (famous brands from home like
Betty Crocker and Post); or health-conscious young parents (prunes,
almonds, fresh fruit).

**6) Invest (wisely) in consumer research.** To outsiders, Chinese
tastes can seem fickle. Tastes poorly received in the U.S. may prove
successful in China, while products targeted to one market niche may end
up finding their greatest success in a completely different one. To
avoid unpleasant surprises and find new opportunities, exporters with a
long-term interest in China are advised to research the market and test
new products directly. Be careful how you invest research money,
however. The quality of research by international market research firms
is often not much better than that of much less expensive local
companies. ATO-sponsored activities offer good opportunities to field
test new products or packaging.

**7) Adapt your products.** Exporters should be prepared to adapt their
products to the demands of their Chinese consumers. This includes
flavors, packaging, prices and labeling. Small changes to flavors or
packaging, based on market research, may make the product more viable in
China. For example, Chinese consumers are often unwilling to buy
unfamiliar products if they can't actually see them, so including a
transparent window in the box or offering free samples can help sales.
Products that are marketed as gifts, such as wine, should place extra
emphasis on the packaging, as this is considered an important part of
any gift. Many exporters seeking to break into the gift market have
special packages manufactured in China, which can also help to address
labeling issues.

**8) Be flexible.** Things don't always work as expected in China. This
can be a good thing, provided you can take advantage of opportunities
when they arise. Exporters who enter the market with preconceived
notions of how to market their products often miss out. ATO activities
routinely turn up unexpected opportunities: for premium boneless pork in
Chengdu; for d'anjou pears and cherries in Shanghai; for Mexican food in
Wuhan. By the same token, a product may find its best niche in an
unexpected place. Washington State apples have done quite well in China
despite tough competition from local products, because superior
appearance and consistent quality made them the top choice for gift
baskets.

**9) Pursue gradual but sustainable growth.** A common pitfall is the
temptation to pursue explosive growth, focusing on geographic
penetration rather than sustainability. This may produce impressive
short-term results, but exporters with limited means may find themselves
overextended very quickly. If the exporter is unable to meet the
expectations of their customers, they may turn to other sources (such as
local copycats or counterfeiters) or demand may collapse. Alternatively,
the exporter may find themselves overly reliant on local agents that
they do not know well, and who have little interest in the long-term
success of the product. The go-slow approach gives exporters time to
learn the markets, accumulate customer feedback, and build their
distribution channels.

**10) Invest in market promotion.** Once in the market, an exporter's
product will be competing with tens, if not hundreds, of similar
products. Domestically made products will often have advantages on
price, familiarity and local brand recognition, while imports can be
aided by aggressive promotional campaigns. Lacking the massive marketing
budgets of multinationals like Nestle or Kraft, most exporters must
design and implement their marketing campaigns carefully. Attending only
quality, focused trade shows for your particular market segment is a
good way to start. In-store promotions are also a cost-effective way to
support your product and build relationships with distributors and
retailers. Above-the-line media advertising should be carefully planned,
as TV and radio time is expensive and has limited reach. Exporters are
strongly advised to explore joint marketing opportunities with ATOs or
with a State and Regional Trade Group (such as NASDA, WUSATA, MIATCO or
SUSTA). These events tend to be cost effective and draw more attention
than standalone promotions.

### Entry Strategy: Hypermarkets and Supermarkets 

[Hypermarkets:]{.underline} The hypermarket sector represents the best
high-volume option for U.S. food exporters. International retailers
generally have a higher level of familiarity with imported brands and
products, and recognize the value of bringing new products to market and
promoting them. Hypermarkets frequently source high-volume merchandise
directly from manufacturers, but rarely do so with imports. Even in the
largest and most sophisticated markets, they tend to source from local
distributors.

The first task is to get to know your retailer. Policies vary widely
among different chains: some charge listing fees, while others do not.
Some require two months' credit, while others pay up front. Although
these problems are usually handled by the distributor, they will affect
your sales. Another reason to get to know your retailer is that
hypermarkets in China tend to develop groups of favored distributors.
They dislike working with unfamiliar companies unless they can offer a
large number of SKUs, strong marketing support or some other sweetner.
Distributors for their part, tend to be very conservative in introducing
new products, due to the high level of market risk (see section I.A.).
As a result, exporters with a limited product range need to work both
ends of the problem at the same time, identifying a retailer that is
interested in the product, and identifying a distributor that either has
an existing relationship or is willing to work with the retailer.

The alternative is to identify a distributor that is willing to
aggressively market the product directly to retailers, and count on them
to find markets for your product. This requires that the distributor be
fully convinced of the marketability of the product, given their high
level of risk. Distributors generally fall into one of two categories.
The largest distributors tend to have longstanding relationships with
the major retail chains, and can source in larger volumes and place
products in a larger number of stores. However, they also tend to carry
a large number of SKUs, and cannot dedicate resources to marketing any
one particular item. Specialty distributors tend to be focused on one
area or product type. Although they sometimes lack the volume and
connections of larger distributors, they tend to be more aggressive in
marketing products and better at identifying and selling into specific
niches. The quality of these smaller distributors varies widely,
however, and exporters need to be extremely careful in selecting a
partner.

Products that are already in the market but being sold mainly through
gray channels or sub-distributors tend to be the most attractive to
distributors. A handful of retailers also act as distributors. Although
they tend to provide less marketing support, they can be an effective
means of getting product to retailers that have already expressed an
interest, but cannot handle the import formalities themselves.

[Supermarkets:]{.underline} Imported food is relatively rare in Chinese
supermarkets. Products that do well in this sector tend to be commodity
products already widely available, such as fresh fruit, frozen
vegetables and nuts. Supermarkets rarely if ever import directly, or
even buy directly from an importer, tending instead to rely on wholesale
markets and local manufacturers or distributors. Stores with a
significant expatriate community nearby are likely to carry imported
breakfast cereals and a perfunctory selection of imported sauces
(especially pasta sauce) and seasonings. The best possibilities are in
the smaller, privately held chains, which are more likely to see the
value of high-margin imports and tend to have better integrated
distribution systems. Such chains may carry products as varied as wine,
exotic fruit (avocados, in one case) or confectionery, but only in low
volumes. Even so, price will remain a consideration. State-owned
supermarket chains generally have less integrated management and
distribution. Opportunities exist, but only on a fitful basis with a
small number of stores, and only for products already present in the
market. For either state-owned or private supermarkets, direct contact
with company officers is the best means of introducing a new product.

### Entry Strategy: Boutique Stores

This category includes expatriate-focused gourmet stores and specialty
stores for organic foods, wine, cheese and similar high-end products.
These stores have proliferated in recent years, particularly in Beijing
and Shanghai. Although volumes tend to be quite small, price pressure is
not as high as in the hypermarkets. In addition, managers tend to be
more aware of famous brands and actively search for niche products not
otherwise available in the market. Many high-end and specialty products
first enter the Chinese market through these types of outlets before
moving on to larger venues. A handful of these companies also include
import/distribution operations, and can assist exporters with issues
such as labeling and product registration. Otherwise, exporters will
need to identify a good distributor. In the case of high-end and
specialty products, HRI-focused distributors (who are familiar with the
products but may lack experience with labeling issues) may be as helpful
as larger retail-oriented distributors (who often lack experience
marketing high-end products), particularly in emerging city markets.
Because of the small scale and highly varied nature of this market
segment, interested exporters should contact the relevant ATO for a list
of potential venues.

### 

### Entry Strategy: Convenience Stores

Convenience stores represent the greatest untapped potential. The sector
is very new, and most chains have cutting-edge management systems and
integrated distribution. The industry also tends to be highly
concentrated geographically, giving chains larger bulk sourcing
capabilities. Competition is also driving a rapid move toward
specialization, in turn creating new niche opportunities. Import
penetration, however, tends to be relatively low, despite a high level
of interest on the part of several chains. Being largely domestic
companies, management at convenience store chains tends to be less
familiar with imported products than their counterparts in the
hypermarket sector. A second difficulty faced by imports is packaging:
convenience stores typically require smaller package sizes, being
focused mainly on single-serving products. Exporters are advised to open
discussions directly with chain officials to identify products with
potential, and ensure that packaging meets their needs. Then the
exporter will need to identify a local distributor that can handle the
import paperwork and labeling issues. One alternative to this is to work
with an importer/repacker, who can import in bulk, then package the
products in China with Chinese labels and packaging appropriate to the
convenience market. This strategy has proven extremely successful for
U.S. prunes. Competition also tends to make convenience stores somewhat
conservative about pricing, though ATO/Shanghai's experience indicates
that chain managers are more price sensitive than their customers.

## II.B. Market Structure

### 

### Distribution By Market Type

Distribution varies widely throughout China based on geography, product
type and retail sector. As a general rule, the three cities of Shanghai,
Guangzhou and Beijing have the best infrastructure and the largest
number of experienced distributors. Increasingly, those systems are
being extended to the large webs of satellite cities surrounding
Guangzhou and Shanghai. Ports in these cities offer a growing array of
services, including bonded storage (with temperature controlled
facilities, if needed) and online inventory tracking. Some have
duty-free industrial zones where products can be repackaged or further
processed, with duty paid only on the original import value, and only
after products leave the zone.

##### Figure 3. Imported Goods Distribution Chain: Major Port

Other major cities along the eastern seaboard, beyond the reach of the
'big three,' generally have good logistics infrastructure, but most
still rely on one of the 'big three' as an entry point for imports. The
number of distributors handling imported products in these cities is
usually limited. These tend to be good markets for commodity products
such as meat, poultry, fruit and seafood, as well as sauces, condiments
and wine.

Deeper inland, there are a number of large cities with good market
potential. Logistics can be dicey, but improvements in the national
highway system have made trucking direct from Shanghai or Guangzhou far
easier than it was just four years ago. As a result, high value and
sensitive products shipped by truck directly from the importer to a
local distributor do surprisingly well, while lower value and
shelf-stable products that ship on local roads through conventional
distribution chains face more difficulties. Distribution in these cities
is generally underdeveloped. Many cities have only a single distributor
for imports, particularly high-value or temperature sensitive products.
Products going through conventional distribution channels typically
change hands numerous times before reaching their destination.
Distribution channels for HRI tend to be better developed, and may be
the best place to start for exporters seeking to develop new markets.

##### Figure 4. Imported Goods Distribution Chain: Emerging City via Major Port

Distribution also varies widely by product type. Channels for
shelf-stable grocery products tend to be the most heavily fragmented and
the most dependent on the good graces of local distributors. This is
partly because market risk is perceived to be higher: although shelf
stable, the number of SKUs tends to be high and turnover low compared to
other product categories. Hence the risk that a product will not sell
(and the distributor will have to accept a return) is higher. Meat,
poultry and seafood also face fragmented distribution, but the combined
demand from HRI and retail venues is sufficient to warrant special
arrangement for these high-value products. Fresh fruit appears to have
the best distribution, working through a patchwork of wholesale markets
and specialized distributors that works better than it should. Imported
frozen corn and mixed vegetables are almost universally available,
reinforcing the notion that the problem is less one of logistics than of
distribution. Wine deserves special mention, due to the presence of a
community of specialized distributors, some of whom act as exporter,
importer and distributor all in one, taking product direct to retailers.

###  

### Industry Profiles

Statistics on China's food retail industry have serious shortcomings,
for a variety of reasons. Mergers, buyouts and cross-investment,
combined with the effects of China's previous requirement for foreign
companies to work through joint ventures, has created a hopelessly
tangled web of ownership. It is difficult to be certain whether revenues
do or do not include income from joint ventures or subsidiary chains.
Store numbers are less opaque, but still present problems. Many
retailers operate a range of different store formats, and it is not
always clear whether a number includes only hypermarkets, supermarkets,
or convenience stores, or some combination of the three. Lastly, the
retail sector is expanding at such a rapid pace that store numbers can
change on a weekly basis. Keeping these difficulties in mind, the
following table provides a rough outline of the current state of the
retail industry.

+-----------+--------+----------+-----+-----+-----------+-----------+
| #####     |        |          |     |     |           |           |
| Table 4.  |        |          |     |     |           |           |
| Top Food  |        |          |     |     |           |           |
| Retailers |        |          |     |     |           |           |
+-----------+--------+----------+-----+-----+-----------+-----------+
| Company   | Own    | 2004     | Sto | Sto | Business  | Location  |
|           | ership | Revenue  | res | res |           |           |
|           |        |          |     |     | Line      |           |
|           |        | (million | 2   | 200 |           |           |
|           |        | RMB)     | 004 | 5\* |           |           |
+-----------+--------+----------+-----+-----+-----------+-----------+
| Lianhua   | China  | 30       | 3,  | 3,  | Super     | N         |
|           | SOE    | ,681\*\* | 123 | 377 | /Hypermkt | ationwide |
|           |        |          |     |     |           |           |
|           |        |          |     |     | Co        |           |
|           |        |          |     |     | nvenience |           |
+-----------+--------+----------+-----+-----+-----------+-----------+
| Hualian   | China  | 21       | 1,  | NA  | Super     | N         |
|           | SOE    | ,518\*\* | 693 |     | /Hypermkt | ationwide |
|           |        |          |     |     |           |           |
|           |        |          |     |     | Co        |           |
|           |        |          |     |     | nvenience |           |
+-----------+--------+----------+-----+-----+-----------+-----------+
| Carrefour | France | 16,241   | 62  | 72  | Hy        | N         |
| China     | JV     |          |     |     | permarket | ationwide |
+-----------+--------+----------+-----+-----+-----------+-----------+
| Beijing   | China  | 16,000   | 70  | NA  | Hy        | North     |
| Hualian   | SOE    |          |     |     | permarket | China     |
+-----------+--------+----------+-----+-----+-----------+-----------+
| Suguo     | China  | 13,880   | 1,  | NA  | Superm    | Jiangsu   |
|           | JV     |          | 345 |     | kt/Conven | /Shandong |
+-----------+--------+----------+-----+-----+-----------+-----------+
| Nong      | China  | 13,703   | 1,  | NA  | Super     | East      |
| gongshang | SOE    |          | 232 |     | /Hypermkt | China     |
|           |        |          |     |     |           |           |
|           |        |          |     |     | Co        |           |
|           |        |          |     |     | nvenience |           |
+-----------+--------+----------+-----+-----+-----------+-----------+
| Beijing   | China  | 13,277   | 608 | NA  | Superm    | Beij      |
| Wumei     | Pvt    |          |     |     | kt/Conven | ing/Hebei |
+-----------+--------+----------+-----+-----+-----------+-----------+
| Trust     | Taiwan | 12,000   | 88  | 90  | Hy        | N         |
| Mart      | JV     |          |     |     | permarket | ationwide |
+-----------+--------+----------+-----+-----+-----------+-----------+
| Huarun    | JV     | 11,014   | 476 | NA  | D         |           |
| Wanjia    |        |          |     |     | epartment |           |
+-----------+--------+----------+-----+-----+-----------+-----------+
| RT-Mart   | Taiwan | 9,500    | 40  | NA  | Hy        | N         |
|           | JV     |          |     |     | permarket | ationwide |
+-----------+--------+----------+-----+-----+-----------+-----------+
| Xinyijia  | China  | 8,500    | 58  | NA  | D         |           |
|           | Pvt    |          |     |     | epartment |           |
+-----------+--------+----------+-----+-----+-----------+-----------+
| Wal-Mart  | US JV  | 7,635    | 43  | 47  | Hy        | N         |
|           |        |          |     |     | permarket | ationwide |
+-----------+--------+----------+-----+-----+-----------+-----------+
| Parkson   | HK JV  | 7,400    | 30  | NA  | D         | N         |
|           |        |          |     |     | epartment | ationwide |
+-----------+--------+----------+-----+-----+-----------+-----------+
| Lotus     | Thail. | 7,394    | 41  | 49  | Hy        | N         |
|           | JV     |          |     |     | permarket | ationwide |
+-----------+--------+----------+-----+-----+-----------+-----------+
| Hym       | UK/    | 7,000    | 31  | 39  | Hy        | N         |
| all/Tesco | Taiwan |          |     |     | permarket | ationwide |
|           |        |          |     |     |           |           |
|           | JV     |          |     |     |           |           |
+-----------+--------+----------+-----+-----+-----------+-----------+
| Metro     | Germ.  | 6,459    | 23  | 29  | Hy        | N         |
|           | JV     |          |     |     | permarket | ationwide |
+-----------+--------+----------+-----+-----+-----------+-----------+
| Source:   |        |          |     |     |           |           |
| China     |        |          |     |     |           |           |
| Chain     |        |          |     |     |           |           |
| Store     |        |          |     |     |           |           |
| Franchise |        |          |     |     |           |           |
| Ass       |        |          |     |     |           |           |
| ociation, |        |          |     |     |           |           |
| except \* |        |          |     |     |           |           |
| obtained  |        |          |     |     |           |           |
| through   |        |          |     |     |           |           |
| direct    |        |          |     |     |           |           |
| contact   |        |          |     |     |           |           |
| with      |        |          |     |     |           |           |
| chains,   |        |          |     |     |           |           |
| and \*\*  |        |          |     |     |           |           |
| from      |        |          |     |     |           |           |
| Shanghai  |        |          |     |     |           |           |
| St        |        |          |     |     |           |           |
| atistical |        |          |     |     |           |           |
| Yearbook, |        |          |     |     |           |           |
| 2005.     |        |          |     |     |           |           |
+-----------+--------+----------+-----+-----+-----------+-----------+

## II.C. Regional Market Profiles

As noted many times before, China is a diverse place, and fragmented
distribution and logistics systems help to reinforce existing divisions.
To assist exporters in dealing with these divisions, FAS maintains four
offices in China, with Agricultural Trade Offices in Beijing, Shanghai
and Guangzhou, and an overall Agricultural Affairs Office in Beijing.
Individual market profiles for each region are offered in the following
sections.

### Shanghai Region 

The city of Shanghai is a massive market unto itself, with a population
estimated at 20 million, and incomes among the highest anywhere in
China. As costs in the city have risen, the economy has begun to shift
away from manufacturing and into financial and management services.
Manufacturers seeking to escape high costs in the city while taking
advantage of the infrastructure and massive consumer base have created
an economic boom in the surrounding region. The city is located at the
center of a web of economic development that includes the provinces of
Zhejiang and Jiangsu, and is collectively referred to as the Yangtze
River Delta (YRD). This region accounts for nearly 1/3 of China's GDP.
Massive infrastructure investment has led to major improvements in
logistics and drawn the region closer together. The opening of the
Yangshan deepwater port facility last fall is expected to make Shanghai
the world's largest container port within the next few years. Shanghai's
large expatriate community (estimated at 350,000) is dominated by
Taiwanese, who bring with them a familiarity with foreign brands and a
taste for U.S. and Japanese foods.

Shanghai's retail sector is well developed, and home to a large number
of supermarkets, hypermarkets and an extremely strong convenience store
sector. Supermarkets remain the dominant, and oldest, modern retail
format, with relatively weak management and infrastructure. Supermarkets
are losing ground to hypermarkets and convenience stores. This loss in
market share, however, is counted in growth not captured: new stores
continue to open. The supermarket format is quite durable owing in part
to Shanghai's high population density (the highest in China and one of
the highest in all of Asia), which makes it possible to have a small
supermarket within walking distance of virtually any place in the city.

+------------------------+--------------+--------------+--------------+
| ##### T                |              |              |              |
| able 5. Top Players in |              |              |              |
|  Shanghai Retail, 2004 |              |              |              |
+------------------------+--------------+--------------+--------------+
| Company                | Total        | Outlets in   | Sales Volume |
|                        | Outlets      | Shanghai     |              |
|                        |              |              | (\$million)  |
+------------------------+--------------+--------------+--------------+
| Lianhua                | 3,290        | 1,796        | 3,835        |
+------------------------+--------------+--------------+--------------+
| Hualian                | 1,693        | 583          | 2,690        |
+------------------------+--------------+--------------+--------------+
| (Carrefour China)      | \*70         | \*7          | \*2,030      |
+------------------------+--------------+--------------+--------------+
| Nonggongshang          | 1,224        | 1,164        | 1,713        |
+------------------------+--------------+--------------+--------------+
| RT-Mart                | 25           | 5            | 1,736        |
+------------------------+--------------+--------------+--------------+
| Metro                  | 23           | 4            | 796          |
+------------------------+--------------+--------------+--------------+
| Hualian GSM            | 25           | 16           | 520          |
+------------------------+--------------+--------------+--------------+
| Lotus                  | 12           | 10           | 570          |
|                        |              |              |              |
|                        | \*41         |              | \*924        |
+------------------------+--------------+--------------+--------------+
| Jieqiang Tobacco,      | 312          | 193          | 227          |
| Sugar & Wine           |              |              |              |
+------------------------+--------------+--------------+--------------+
| Jiadeli                | 117          | 105          | 208          |
+------------------------+--------------+--------------+--------------+
| Auchan                 | 3            | 3            | 162          |
+------------------------+--------------+--------------+--------------+
| Changfa Dept. Stores   | 1            | 1            | 50           |
+------------------------+--------------+--------------+--------------+
| E-Mart                 | 2            | 2            | 48           |
+------------------------+--------------+--------------+--------------+
| Watson                 | 17           | 17           | 50           |
+------------------------+--------------+--------------+--------------+
| Jiajiale               | 39           | 39           | 38           |
+------------------------+--------------+--------------+--------------+
| Source: Shanghai       |              |              |              |
| Statistical Yearbook,  |              |              |              |
| 2005, except for \*    |              |              |              |
| derived from CCSFA     |              |              |              |
| figures. Note that     |              |              |              |
| CCSFA and Shanghai     |              |              |              |
| Yearbook numbers for   |              |              |              |
| Lotus differ sharply.  |              |              |              |
+------------------------+--------------+--------------+--------------+

#### Hypermarkets

Hypermarkets constitute the single best retail venue for imported
products. International chains such as Carrefour and Wal-Mart are both
familiar with the products, and count large numbers of expatriates in
their customer base. Most are experienced in promoting new products, and
flagship stores like Carrefour's Gubei store or Lotus' Superbrand Mall
store have it down to a science. Despite this, imports rarely constitute
more than 5% of total SKUs in even the high profile stores. As elsewhere
in China, the most decisive component in hypermarket food promotion is
free sampling. Shanghai consumers are cautious rather than impulsive
buyers, and will rarely spend money on a product they have not had a
chance to try. Hypermarket promotions also come with many strings
attached: most charge listing fees and demand that promoters be provided
at the distributor's expense (some even charge fees to have the
promoters on their premises). Other conditions include accepting returns
of unsold products at the end of the promotion. (These issues are
discussed in detail in Section I.A.).

The hypermarket industry in Shanghai has expanded quickly, reaching an
estimated total of 121 stores by the end of 2005. The sector is
dominated by international retailers, with over 67 outlets in Shanghai
accounting for 76% of the sector's combined 21.4 billion RMB in sales.
Hypermarkets are eating into market share for supermarkets as growing
ownership of cars and larger refrigerators make bulk shopping trips more
practical. Management of these stores is generally modern, and SOE
hypermarkets such as Lianhua's Century stores are bringing in foreign
experts to upgrade their management to compete with the international
retailers.

While Carrefour continues to dominate at the high end, with 7
hypermarkets in Shanghai alone, Lotus has quietly expanded and now
actually has 20 stores in Shanghai, although turnover for these stores
is lower than for Carrefour stores. Wal-Mart finally established a
presence in the city by opening its flagship Nanpu store in late 2005.
Two more Wal-Marts are planned for 2006. Tesco's purchase of 50% of
Taiwan-owned HyMall has given it a foothold in Shanghai, but experience
with Hymall indicates that Tesco may need some time to integrate its
management with HyMall's. Korea's E-Mart, which currently operates three
stores in Shanghai, also plans to ramp up its efforts, having recently
opened a store in Tianjin and with another scheduled to open in Shanghai
in 2006. E-Mart's final target is 33 stores in the region, ten of them
in Shanghai. A total of 14 retailers have hypermarkets in Shanghai,
including Auchan, RT-Mart, Trust-Mart and Hyodo. Most have announced
plans for further expansion.

Under pressure from competition, hypermarkets are seeking ways to
differentiate themselves. Wal-Mart has announced a cooperative effort
with a Chinese pharmacy company to provide pharmacies in their stores,
and Carrefour is in talks to do the same. Lotus' flagship store in the
Superbrand Mall last year became the city's first 24-hour hypermarket.
Although Carrefour's flagship Gubei store quickly extended its hours,
few others have been willing to follow suit. Most hypermarkets in
Shanghai now stock a wide range of ready-to-eat products such as
rotissiere chicken, and have in-house bakeries. House brands are also
becoming popular as retailers seek to cash in on their reputations.
Carrefour leads the way through heavy house branding in its Dia discount
stores. Chinese hypermarkets are following suit, led by Century Lianhua.

+-----------------+----------------+----------------+-----------------+
| ###             |                |                |                 |
| ## Table 6. Str |                |                |                 |
| ucture of Shang |                |                |                 |
| hai's Food Reta |                |                |                 |
| il Sector, 2005 |                |                |                 |
+-----------------+----------------+----------------+-----------------+
| Sector          | Total Sales    | International  | International   |
|                 | (million RMB)  | Retailer Sales |                 |
|                 |                |                | As % of Sales   |
+-----------------+----------------+----------------+-----------------+
| Supermarket     | \*67,900       | 630            | 1               |
+-----------------+----------------+----------------+-----------------+
| Hypermarket     | 21,400         | 16,300         | 76              |
+-----------------+----------------+----------------+-----------------+
| Convenience     | 9,300          | 630            | 7               |
+-----------------+----------------+----------------+-----------------+
| Source:         |                |                |                 |
| Shanghai Daily  |                |                |                 |
+-----------------+----------------+----------------+-----------------+

Metro relies on its niche-market strategy of targeting small and medium
sized restaurants, effectively positioning itself as an HRI wholesaler
and distancing itself from competitors. To this end, Metro has added a
training kitchen to its facilities in Shanghai. ATO has worked with
Metro on a number of occasions, arranging for USDA cooperators to
provide training in the purchase, handling and use of U.S. food
ingredients, while Metro provides facilities, and recruits from their
customer base of restaurants. Parkson's, with a presence across China,
offers relatively small spaces for food sales in their department
stores, but focuses on very high-end products, including imports.

#### Supermarkets

Supermarkets have the lowest penetration of imported products of all the
modern retail venues in Shanghai. U.S. food products in these venues are
typically limited to frozen corn and mixed vegetables, frozen potato
products and occasionally fruit (apples or oranges). Other items tend to
appear on a haphazard basis: past checks have turned up breakfast
cereals, low-end wines and California avocados. The sparse selection of
imports is rooted in the customer base of these stores, which focus on
working class shoppers, who are notoriously price sensitive and less
inclined to try new products than the more well-heeled customers that
frequent hypermarkets and convenience stores. Distribution is also a
problem, as stores tend to source from local distributors, directly from
manufacturers, or from local wholesale markets.

The supermarket sector in Shanghai is dominated by domestic companies.
The only foreign-invested supermarkets in Shanghai are Tops and
Watson's, which combined only registered 630 million RMB in sales in
2004, out of a sector total of 67.9 billion RMB. State-owned companies
are dominant, with Shanghai serving as headquarters to three of China's
top ten food retailers: Lianhua, Hualian and Nonggongshang, all
state-owned. Although Lianhua and Hualian were nominally merged two
years ago to form the behemoth Bailian, they continue to operate as
distinct (and competitive) chains. Bailian appears to be more focused on
rationalizing its diverse portfolio, and developing its shopping mall
management component. Both Lianhua and Hualian have expanded
aggressively through acquisitions of other chains, leaving both
companies with a challenge incorporating them into already weak SOE
management structures. Inspired by foreign-invested companies (Dia
carries 1,000 SKUs of house brands), the Chinese chains are paying
greater attention to branding, and most now carry a substantial number
of house brands.

Despite the dominance of SOE retailers, Shanghai has several smaller,
privately owned chains. The largest of these, Jiadeli, operates some 130
stores in the Shanghai area, and is actually larger than Nonggongshang
in the supermarket sector. All are seeking ways to survive in an
increasingly competitive landscape. Industry sources claim that a U.S.
fund manager plans to buy a 32% stake in Jiadeli, injecting a large
amount of cash to take the brand nationwide. Another local chain,
Jieqiang, is cooperating with China Life Insurance to sell travel
insurance policies through their stores. Lianhua and Alldays convenience
stores are also working with China Life on this project. Most
supermarkets have imitated the convenience chains by offering a wide
range of additional services such as bill payment, at a nominal fee.

Shanghai's supermarkets are small and focus on daily necessities, but
are weak on fresh produce. It is not uncommon to find vegetable sellers
with blankets covered with vegetables for sale outside of supermarkets,
and fruit stands tend to locate close to supermarkets. This started to
change after the SARS and avian influenza scares. City officials
throughout China tend to regard informal and wet markets as unsanitary
eyesores. In Shanghai, after years of unsuccessfuly trying to shut down
informal markets, they are now attacking the other end of the problem by
encouraging supermarket chains to create 'fresh' supermarkets, expanding
the floor space dedicated to fresh products from less than 1/3 to over
1/2. Shanghainese place an extremely high value on clean, well-lighted
venues, and it is highly likely that the presence of a reasonable
alternative to wet markets will do more to hasten their decline than
efforts to force them to close. To date, only Nonggongshang has made a
public commitment to this strategy, converting over 100 (current numbers
are not available) of their stores. Supermarkets throughout the region
(including Suguo) appear to be moving in this direction, but are being
slowed by problems in sourcing large quantities of quality product.

Aggressive competition from Carrefour's Dia discount stores may push
more supermarkets to carry fresh products. Dia carries many of the same
staple goods as supermarkets at deep discounts, but does not carry fresh
products. The threat from Dia should not be understated. Although
Carrefour has opened only 150 of these stores in Shanghai to date, they
plan to reach 300 in 2006 and open new stores at a rate of 20 per month
after that. Dia stores are small, carrying a limited range of products,
mostly house brands. Anecdotal information indicates that the Dia stores
are competing quite well. Nonggongshang has also established a chain of
discount stores called 'One Price' or '5 Reminbi,'offering most products
for less than \$1. They planned to open a total of 160 free-standing
discount stores by the end of 2005.

All three major SOE supermarket chains (Lianhua, Hualian and
Nonggongshang) have hedged their bets. Lianhua owns the Quik convenience
store chain and is the partner in Carrefour's Shanghai joint venture.
Hualian is the JV partner with Japan's Lawson's in their chain of
convenience stores in Shanghai. Nonggongshang owns the Allday's chain of
convenience stores, as well as the area's largest dairy company, Bright,
which owns yet another major convenience store chain, Kedi. All three
have also opened branded hypermarkets in and beyond Shanghai, and
Lianhua is putting a particularly strong effort into its Century Lianhua
hypermarkets. Although Nonggongshang's market share has slipped, it is
attempting to expand its reach to match Lianhua and Hualian, opening NGS
hypermarkets in distant cities like Nanchang, with mixed results.

#### Convenience Stores

Convenience stores are rapidly becoming a more favorable environment for
imported foods, as stores seek ways of distinguishing themselves, while
the higher prices for higher-quality imports provide a better per sale
return. Again, Lawson's is leading the way in this field, having worked
with ATO/Shanghai and U.S. product distributors to launch a U.S. food
festival in selected stores, promoting Sun Maid Raisins, Planter's Nuts
and macadamia nuts from Hawaii, among other things. The results made
clear that products need to be adapted to the convenience store format,
most particularly in terms of reducing package sizes. One of the most
successful suppliers of U.S. product to the sector imports U.S. prunes
and re-packs them into single-serving packets that are sold to
schoolkids at 1 RMB (about 12 cents) apeice. U.S. frozen potato
products, cooked and sold ready-to-eat, have also been successful in
this format.

Shanghai's convenience store industry is by far the most developed in
the country, with the city playing home to an estimated 4,500
convenience stores---nearly half of the national total. One source
estimates the number at 1 store per 3,800 residents (not including
immigrant workers), comparable to saturation levels in Japan and the
U.S. Despite this, the sector continues to grow. Shanghai's convenience
sector is overwhelmingly dominated by subsidiaries of the giant SOE
supermarket chains: Quick (Lianhua), Alldays (Nonggongshang), Kedi
(Nonggongshang via its Bright Dairy subsidiary) and Lawsons (a JV
between Hualian and Lawsons Japan). However, new investment is coming
from international convenience chains. Japan's Family Mart entered the
city two years ago, and now has in the range of 120 stores in Shanghai,
with plans for 350 by the end of 2006. Hong Kong's Sincere has announced
plans to enter the market with 300 stores by the end of 2006. Aside from
Family Mart and the Lawson's JV, Taiwan's C-Store franchise is the only
international convenience retailer currently with stores in Shanghai.
Stores compete aggressively for good locations, and it is not uncommon
to see three different convenience stores within 100 feet of each other
in prime areas.

Management in convenience store chains is probably the best of any
retail sector. All stores have refrigerator and freezer sections,
microwave ovens, and most have a selection of hot snacks (mostly
meatball or tofu on skewers). More to the point, most chains have
integrated distribution systems, including fully automated, real-time
inventory and ordering. The main exception is for fresh products (mostly
dairy and prepared meals) which are often distributed directly by the
manufacturer. Store layouts are highly standardized, although some
chains have developed more complex systems that customize product
selection to the peculiar location based on past sales patterns.

Ferocious competition has spurred efforts to innovate and to target
niche markets. Quik and Kedi have both entered into deals with gas
station operators to open markets in their stations. Lawson's pioneered
efforts to target white collar employees and service staff in shopping
districts with high-quality Japanese style lunch boxes. Kedi is now
following this lead with a 'Korean Taste' campaign, providing all three
daily meals in Korean styles and a selection of other Korean food under
a house-brand label. Family Mart expects to benefit from superior
management and technology (they may be surprised by the local
competition). As noted earlier, nearly all convenience stores offer a
range of services to draw foot traffic, with Alldays ushering the latest
innovation by providing China Life travel insurance policies at their
stores. 21 Century went a different direction, merging with the Maya
music chain to create food and music stores.

#### Boutique Stores

Boutique and specialty food stores in Shanghai have multiplied, becoming
a force unto themselves. Expatriate grocery stores continue to expand.
The most venerable, City Supermarket, continues to be one of the best
single venues for imported food in Shanghai, and now does significant
business as a distributor of imports to other stores. Chiro Group's
(Singapore) Pines The Market stores are providing City Supermarket with
competition, carrying a high-end selection of gourmet products. Another
trend is in specialty wine retailing: several specialty wine outlets
have opened (not to be confused with the traditional state-owned hard
liquor and tobacco stores). The most notable is Cheese and Fizz, which
features a wide range of wines and imported cheeses. Yet another trend
is in organics. While City Supermarket markets its own brand of locally
grown organic vegetables, California's O-Store last year opened its
first all-organic food store in Shanghai, with ambitious plans as both a
retailer and distributor of imported organics. O-Store imports mainly
from Germany, Japan and the U.S.

#### Beyond Shanghai

The immediate area surrounding Shanghai (the Yangtze River Delta, or
YRD) is a beehive of industrial and commercial activity. In the key
cities, retail development is already well advanced. Suzhou and Hangzhou
are home to Carrefour and other hypermarkets (including Auchan, Lotus,
RT-Mart, Tesco/Hymall and Trust-Mart) and Quik, Kedi and C-Store
convenience stores. Hypermarkets throughout the region source imports
through Shanghai, taking advantage of the region's outstanding logistics
and Shanghai's large community of experienced food importers. The
supermarket sector in these cities is typically dominated by either
Lianhua, Hualian or Nongongshang, but with a preponderance of
independents (with the notable exception of Nanjing's Suguo)

During a recent FAS/China nationwide retail distribution exercise with
Carrefour, stores in **Suzhou** and especially **Hangzhou** performed
far beyond expectations, with sales of U.S. food products at the
Hangzhou store matching or exceeding levels in larger and better-known
cities. Hangzhou is becoming a major market in its own right, and was
selected by Forbes Magazine in 2005 as the best place to do business in
China. Development is now moving on to a third tier of cities.
Particularly notable are **Wuxi** (Forbes' #2 choice), which has become
a major distribution center for seafood and meat products in the YRD
area; **Ningbo**, which has average incomes on par with Shanghai but a
less well-developed retail sector; and **Nanjing**, the capital of
Jiangsu province.

Many of these cities are home to relatively strong independent chains,
particularly those further from Shanghai. Voluntary chain IGD has
entered into talks with Ningbo's Sanjiang Shopping Club. Interestingly,
Sanjiang is linked through a voluntary association to Shandong's
Jiajiayue, which is working with voluntary chain SPAR. Local officials
in China tend to protect local businesses aggressively, a fact that
could work to the advantage of voluntary chains, particularly in the
community of wealthier cities with distinct identities that lay at the
edges of the YRD, such as Wenzhou, Nanjing and Ningbo.

Farther inland, the picture becomes less clear. Retail development has
progressed at different paces and with widely differing results. Most
large cities host at least one international hypermarket, typically with
several local imitators and independent supermarket chains. The
following section touches briefly on the key markets and offering some
perspective as to the degree of variation.

**Kunming**, in Yunnan province, developed at an astounding pace,
ultimately attracting 10 international hypermarkets, including Wal-Mart,
Carrefour, PriceSmart and Metro, in the space of a few years. This pace
exceeded local demand, however, and many of the stores have languished
with a few closing. **Chengdu**, by contrast, developed more slowly, and
is now home to more than 6 international hypermarkets, all of which
appear to be doing well. One international retailer referred to Chengdu
as the only city in West China where they routinely turned a profit.
Incomes are generally lower than in coastal cities, but the residents of
Chengdu appear to have a very high propensity to spend, particularly on
food. ATO/Shanghai's efforts with both Ito Yokado and Carrefour stores
in this city were immensely successful. Nearby **Chongqing** is less
well developed. Although it has strong potential for the future, the
best opportunities appear to be in the HRI sector.

**Wuhan**, in Hubei province offers a mid-range prospect. It has a
reasonably well-developed retail sector, with Metro, Carrefour and
Wal-Mart all represented. Past efforts with Metro found a surprisingly
strong market for Mexican-style foods, while Carrefour's Wuhan store was
one of the strongest markets for fruit during last September's
distribution exercise with that chain. Wal-Mart's remarkable success in
**Nanchang**, the capital of Jiangxi province, provides a good case
study for retail in China. Nanchang was not generally regarded as a
retail market in the same class as Kunming or Chengdu. However, close
cooperation with local officials netted Wal-Mart a prime location, just
as the city launched a major redevelopment effort, making for a major
success. The success of this venture is all the more striking given the
relatively weak performance of Nonggongshang's NGS hypermarket,
established several years earlier in the same city, and demonstrates the
value of local market knowledge.

### Beijing Region

Beijing's retail scene has the most room for future expansion of China's
'big three' cities, a byproduct of its relatively slow development.
Beijing experienced consumer goods retail sales growth of 14.4% in 2004
compared to 2003, with a 22.7% increase in retail food sales compared to
2003. Unlike Guangzhou or Shanghai, Beijing is not at the center of a
wider economic development web, with Tianjin the only nearby urban area
worthy of mention. However, the broader region is home to some of
China's most dynamic coastal cities, including Dalian and Qingdao, and
the major Northeast China cities of Shenyang and Harbin. Shandong
Province in particular is becoming a major industrial and commercial
center.

In Beijing proper, the most rapid development is taking place in the
fast expanding suburbs, where skyrocketing auto ownership now adds about
1,500 new car registrations daily. Beijing's retail sales totaled \$35.8
billion in 2005. Many **hypermarkets** are locating in the borderline
areas between city and suburb in hopes of attracting customers from
both. The sudden surge in car ownership means that for the first time
parking lots have become a major requirement. By the end of 2004, there
were some 3,760 retail outlets including large supermarkets,
hypermarkets, convenience stores and warehouse clubs or a 22.8% increase
over 2003. Beijing's unique status as the national capital has allowed
it to attract an extremely large and varied expatriate community that
supports a large number of boutique and specialty grocery stores that
carry imported products. Jenny Lou's operates half a dozen stores around
Embassy compounds and expatriate communities. The store has a thriving
business having found its own niche-market charming expatriates with
good service and familiar foods from home. In addition to expatriates,
these stores target growing numbers of up-market Chinese consumers who
have lived or studied abroad. The presence of the expatriate community
is also felt in department stores, often including high-end food
sections as part of their operations.

Acquisition and consolidation in retail industry appears to be a
continuing trend in recent years. Tesco has invested \$260 million in
China to acquire a 50 percent stake in Hymall, a Chinese chain operating
31 hypermarkets nation-wide. This expansion will enable Tesco,
third-largest retailer in the world and the largest in the United
Kingdom, to challenge Wal-Mart and Carrefour in China\'s increasingly
competitive marketplace. Tesco will open a 20,000 square meter shopping
mall in Beijing near the 4^th^ Ring Road in early 2007. At the beginning
of 2006, Wu-mart, 10^th^ largest chain store operator in China and the
largest retail chain operator in Beijing took control of competitor
Merry-Mart, the fourth largest retailer in Beijing. The acquisition
signaled increasing competitiveness in the domestic retail business now
rife with expansion and consolidation. This consolidation should result
in greater procurement bargaining and purchasing power for Wu-mart.
Wu-mart claims to be the fastest growing consumer goods seller in
Beijing and self-predicts it will become the major wholesale channel in
Beijing as well.

Overseas retail giants continue to be aggressive in this market. French
retail giant Carrefour, the largest foreign player in China, plans to
open 20 stores across China this year after establishing 14 in 2005. As
of February 2006, Carrefour operates 71 stores nationwide with 24 in
North China. Yet, Chinese regulators routinely favor domestic firms at
the expense of foreign operators, and some State Operated Enterprises
still receive 'soft loans' from state-run banks in order to finance
local retail expansion.

##### Table 7. Major Hypermarkets/Supermarkets in Beijing

+-------------+--------+--------------+-----------------+------------+
| *           | *      | **2004 Total | **% of Sales    | **No. \#   |
| *Retailer** | *Owner | Sales        | Increase over   | outlets**  |
|             | ship** | (Million     | 2003**          |            |
|             |        | USD)**       |                 | **(Dec.    |
|             |        |              |                 | 2003)**    |
+-------------+--------+--------------+-----------------+------------+
| Beijing     | China  | 2000         | 25              | 70(n       |
| Hualian     |        |              |                 | ationwide) |
| Group       |        | (nationwide) |                 |            |
+-------------+--------+--------------+-----------------+------------+
| Beijing     | China  | 1660         | 61              | 608        |
| Wu-mart     |        |              |                 |            |
+-------------+--------+--------------+-----------------+------------+
| Beijing     | China  | 655          | 3               | 140        |
| Jingkelong  |        |              |                 |            |
+-------------+--------+--------------+-----------------+------------+
| Beijing     | China  | 267          | 13              | 43         |
| Chaoshifa   |        |              |                 |            |
+-------------+--------+--------------+-----------------+------------+
| Beijing     | China  | 245.4        |                 | 56         |
| Shoulian    |        |              |                 |            |
+-------------+--------+--------------+-----------------+------------+
| Beijing     | China  | 76           | 8               | 18         |
| Shuntianfu  |        |              |                 |            |
+-------------+--------+--------------+-----------------+------------+
| Carrefour   | France | 2,030        | 21              | 70         |
|             | JV     | (nationwide) |                 | (n         |
|             |        |              |                 | ationwide) |
+-------------+--------+--------------+-----------------+------------+
| Wal-mart    | US     | 954.4        | 30              | 43         |
|             |        | (nationwide) |                 | (n         |
|             |        |              |                 | ationwide) |
+-------------+--------+--------------+-----------------+------------+

Source: CCFA / ATO Beijing

Despite the strength of its expatriate community, percentage of imported
foods in Beijing hypermarkets rarely reaches above 3-4% of sales. Stores
routinely adjust quantities of imported food in a particular store based
on neighborhood incomes, expatriates, etc. Warehouse stores generally
target higher-income consumers or those who own cars, and generally
stock more and higher-value imports. Sam's Club stores in Beijing sell
three times as much imported food as Wal-Mart Super Centers, but the
ratio of imported products is still only 3-4% of sales. Beijing
retailers hold US products in high regard for their quality although
European, Korean and other suppliers are increasingly popular. Shelf
surveys reveal special sections devoted to imported beer, fruit, wine,
etc. Dairy cases are expanding often displaying imported cheese.
Substantial displays of imported breakfast cereals, biscuits and
beverages are also becoming common. Although most stores boast extremely
large frozen food sections, these are stocked mainly with frozen
dumplings, excepting imported frozen mixed vegetables, corn and peas.

Hypermarkets in the Beijing area generally expected to make higher
profits on imported foods, because the market risk is higher. They also
expect promotional assistance for new-to-market items, including
in-store demonstrations, sampling, and negotiated fees for promotional
efforts. Some retailers, like Carrefour, charge slotting fees whose cost
can reach as high as RMB 10,000 (\$1,200) per slot, per store. Other
retailers like Wal-Mart and Auchan appear to put most of their effort
into keeping prices as low as possible.

Modern **convenience stores** are just beginning to make an appearance
in Beijing and other northern cities with many operated by the same
state-owned chains dominating Shanghai, and other parts of China. These
stores are characterized as clean, well managed, heavily automated, with
real-time inventory systems. In many places they are rapidly replacing
the traditional xiaomaibu stands that sell snacks and drinks, but stock
few imported products. Initial reports indicate convenience store chains
are re-thinking their Beijing strategy where the consumer culture is
driven by the automobile. In addition, 24-hour service is less of an
advantage in the cold North than in the warmer South where most of
China's convenience chains are currently based.

In the race to develop Beijing and North China, state-owned behemoth
Lianhua has moved quickly into the lead with its Quik chain. On the
other hand, 7-Eleven, with a strong foothold in South China, began
opening Beijing outlets in April 2004. However, the stores have never
made money. Rapid growth in car ownership has created great interest in
gas marts that may be a more important source of growth for the retail
sector in the future here. However, overall, the convenience sector has
been relatively slow to develop. Beijing's government has made a
concerted effort to limit growth in this sector, fearing both over
development as in Shanghai, and the displacement of traditional
family-owned stores. The generally unfavorable regulatory climate may
also be a factor, as permits and licenses can be difficult to obtain in
Beijing even at the best of times.

### Beyond Beijing

Beyond Beijing, retail growth has been impressive. While hypermarkets in
Beijing have begun catering to car owners, this has not been the case in
other northern cities, where shoppers most often walk, ride bikes or use
public transportation. As a result, the volumes that can be purchased on
a single shopping trip are limited. Shoppers at warehouse stores are
more likely to drive cars or small trucks, or to arrange for delivery.
One variant on the hypermarket in China are department stores with large
food sections. Most are older stores, but Malaysian-invested Parkson's
is trying to develop a niche in imported food. Stores often measure more
than 30,000 square meters. Although the food departments are generally
about the size of a domestic supermarket, they stock higher quality
products and a higher percentage of imports. This particular format is
still important in parts of North China and in inland provinces,
although the expansion of modern retailers has placed their long-term
viability in doubt.

The current development trends show that existing transport and
infrastructure bottlenecks will be significantly relieved, and some
northern cities that have been difficult to access previously are
becoming much more attractive locations for domestic and foreign
investors. As industries in these cities begin to develop, there will be
major demands for more and better retail. On the other hand, small
northern retailers are going bankrupt in unprecedented numbers, battered
by the winds of intense competition brought by increased foreign
involvement in the sector. Small retailers start looking at some
practical choices such as joining voluntary chains. The biggest
voluntary retail chain in Europe SPAR entered the Chinese market after
signing a deal with Shandong retailer Jiajiayue supermarket in November
2004. The agreement will result in the opening of 15 new SPAR
supermarkets in Shandong Province over the next three years.

Shandong, a coastal province to the south of Beijing, is home to a
number of growing industrial cities and rising incomes. Climate and soil
conditions are ideal for a variety of food and agricultural products
such as poultry, beef, fruit, peanuts and aquatic products. Companies
from nearby Japan and Korea have invested heavily in the development of
the province's modern infrastructure, including cold chain and container
port facilities. While no single city has per-capita incomes approaching
those of Beijing, the cities of Qingdao, Yantai, Weihai and Jinan are
among the most prosperous in China, and have developed a significant
middle class. In 2005, retail sales of the top ten Qingdao retailers
experienced a 39.8% growth compared to the previous year. In addition,
Shandong's long history of trade has made the local culture more open to
imported products than most other parts of China. In March 2005, ATO
Beijing partnered with Qingdao Jusco for an American Food In-store
Promotion soon after Jusco's completion of 30,000-sqaure meter store
space expansion. Nearly 350 U.S. food and beverage items including U.S.
pork, Alaska Seafood, Washington Apples, Sunkist citrus and canned salsa
were featured during the 2-week promotion period. To Jusco and ATO
Beijing's surprise, shoppers for featured U.S. food products turned out
not to be expatriates but local consumers.

Another standout market is the port city of Dalian, one of the fastest
growing cities in China and gateway to the large yet relatively untapped
Northeast China market. Similar in many ways to Qingdao, Dalian is a
trade-oriented city with heavy investment from Japan and Korea. Dalian
has excellent infrastructure and high disposable incomes compared to
other cities. During the last few years Dalian's food retail sector has
undergone a radical transformation given the rapid rise of supermarkets
and hypermarkets. These retail formats have extensive dry and frozen
goods, fresh and frozen meat and seafood, fruit, vegetables, prepared
food, and food service sections. Many of these outlets are located in
mall settings or a shopping destination for the whole family with
restaurants, theatres, fashion boutiques, sporting goods stores, and
other specialty shops. Relative to domestic supermarkets, imported foods
have a significant presence in foreign operated supermarkets and
hypermarkets even if imports account for no more than 3-4% of total
store sales. However, local retailers should not be ignored either as
Dalian's very own 'national' retail food chain Dashang recorded the
second highest sales for all of China in 2003, well ahead of Carrefour
(4th) and Wal-Mart (10th), not to mention a 42.2% increase over 2002
sales. Most retailers state the main reason they do not stock more
imports is the high price. While Dalian residents consider U.S. food to
be equal or superior to most other imports, high prices are the largest
constraint.

Harbin, the capital of Heilongjiang province in the far Northeast, is
the largest provincial capital in China, and has become a hotspot for
retail development. A few short years ago this city of 10 million had no
large supermarkets. Besides Carrefour and Metro, Wal-Mart has set up
shop in the town, choosing Harbin as the location for its first store in
the northeast. Local supermarkets, convenience stores and other format
of retails outlets have a rather complicated web of ownership and yet
are quite consolidated. Newly built residential communities have high
expectations as consumers seek higher quality, consistency, sanitation
and convenience. At end of 2005, Dashang, with 120 stores in 26 cities
in the Northeast and North China, announced its merger with Harbin's No.
1 Department Store, one of largest department stores in the country. The
new venture will preserve the name Harbin No.1 Department Store and
create on its original site, a golden area at Daoli District Harbin, a
refurbished store and a New-Mart Plaza in front of the store. The merger
bodes well for Group's expansion into the Northeast retail market.

In other parts of North and Northeast China, retail development has
lagged due to a legacy of large and unproductive state-owned
enterprises. These holdovers from the Mao-era's command economy still
dominate much of production and employment in this part of the country,
and have acted as a drag on both development and reform. Despite this,
modern retailing has come to every major city in the region, and
development is likely to continue for the foreseeable future, creating a
wealth of opportunities.

### Guangzhou Region 

South China's food sector is quickly transforming into a modern retail
system as supermarkets and hypermarkets continue to pop up across the
region. While these types of outlets are already well-established in
Shenzhen and Guangzhou, many retailers are penetrating into nearby
secondary cities. Food retailers are also increasingly locating within
state of the art shopping malls like CR Vanguard's Mix-City in Shenzhen.
With a total surface area of over 180,000 square meters, this store
attracts younger generations by combining various activities with
grocery shopping, such as high-end clothing shops, restaurants, movie
theaters and ice-skating rinks. Convenience store chains continue to
expand as well, with 7-11 dominating the market in South China.

Cold chain logistics have always been a major concern for retailers in
South China. However, new expressways and distribution centers in the
Pearl River Delta are facilitating the introduction of new, imported
food products throughout the region. A network of local importers and
distributors is expanding in the region, while Hong Kong transshipments
of many products still plays an important role in the local food trade.

South China's 280 million residents enjoy higher-than average incomes
thanks to the region's rapid economic development. Guangdong province is
located in the southern most part of China and now is a home for major
modern hypermarkets and supermarkets. With its close relationship with
Hong Kong and Macau, Guangdong has benefited from the Closer Economic
Partnership Arrangement (CEPA) where goods can enter Guangdong more
easily than in the past. Every year, nearly 50 percent of all food
products imported into Hong Kong are transshipped to mainland China,
primarily through Guandong.

#### Consumer Trends

Consumers in South China continue to seek safe and nutritious foods for
themselves and their families. Market demand also shows the trend
towards healthy diets based on functional foods. While Chinese cuisine
still dominates restaurant menus and home-cooked meals, Western-style
foods are becoming increasingly popular as China\'s integration into the
world economy accelerates. Once a small novelty market, Western food has
developed into an emerging industry and an essential part of Chinese
food culture. Chinese children are all too familiar with McDonalds,
Pizza Hut, and KFC. They are developing appetites for ice cream and
cheese on their pizzas.

One of mainland China's earliest consumers of Western-style foods, South
China's growing middle-class has the purchasing power to afford imported
foods. This group also has a strong preference for these products in
part due to their reputation for high quality, but also for health and
food safety reasons. Within this affluent market segment, the
consumption trend is towards "green" and "organic" foods. The most
popular imports include baby foods/infant formula, chocolates, dried
fruit and nuts, fresh fruit and vegetables, potato chips, popcorn and
canned foods such as soup.

Although Chinese consumers are extremely price sensitive, Washington
Apples, Sunkist oranges and California table grapes are commonly found
on supermarket shelves in South China. Durian and lychees from Thailand,
butter from New Zealand and cheeses from France and Australia are also
typical imported products. California wines are available, but wines
from Australia, South Africa, Chile and France also have a strong
presence in this market.

Many other fresh and packaged foods from the U.S. are now available as
well, but consumers still lack knowledge of U.S. products and how to
prepare and serve them. This makes consumers more reluctant to buy.
ATO/Guangzhou is encouraging both US exporters and Chinese importers to
make every effort to register their products and to provide proper
labels in Chinese.

#### Supermarket retailers

In South China, hypermarkets, supermarkets have gradually gained a
larger piece of the market and are quickly replacing traditional "wet"
markets. Competition among these retailers has turned South China into
an Olympic battlefield for retail business, with each key player trying
to expand and gain more market share in the region.

Expansion plans in South China are in the works for both global giants
like Wal-Mart, Carrefour, Metro, Jusco and HK based or domestic players
such as Park'n Shop and CR Vanguard. Growth in the cities of Guangzhou
and Shenzhen may slow somewhat as these markets become saturated.
Supermarkets continue to be the most common retail format, but
hypermarkets are gaining in popularity and are now present in most
medium and large sized cities. The fastest development is likely to take
place in two areas: satellite cities near Shenzhen and Guangzhou, such
as Dongguang, Zhuhai, Zhongshan and Foshan, and the large second and
third-tier cities further inland. To facilitate this growth, retailers
Wal-Mart, Carrefour and Jusco are currently establishing large
purchasing centers in Shenzhen, bringing their American, French and
Japanese product standards and sales concepts to South China.

Regional supermarkets and hypermarkets purchase products from local
importers, wholesalers and distributors, who face difficulties in
obtaining and/or transporting imports to the mainland. For example, some
lack sufficient information on where to source imported food and
beverage products. However, many companies directly and indirectly
purchase foreign products that have been transshipped to the mainland
via Hong Kong. This allows importers and distributors to avoid paying
VAT and customs duties, and exposes the market to some products
currently banned from the mainland. The "gray channel" trade makes it
difficult for US exporters and most western-style supermarkets that
insist on using proper invoices and health certificates to be
competitive with contraband products. The ATOs in China are encouraging
US companies to do their homework and to develop direct trade
relationships with buyers in the mainland to avoid the gray channel and
to look at the long-term potential of the China market.

Domestic competition is also on the rise. The key domestic players in
Shenzhen: CR Vanguard, A.Best and ShuiBao, have proposed to open more
stores in Guangdong Province in order to increase their market share.
However, they still lag far behind their foreign counterparts in terms
of management experience and capital strength. There is also a movement
in South China to upgrade traditional wet markets, since these will
continue for the near future to be the main food source for lower income
consumers with limited purchasing power and access to transportation.
Many of these markets are being cleaned up and moved into structures
with roofs and proper cold storage and food handling facilities.

#### Profiles of select retail outlets

**Wal-Mart** Up to now, Wal-Mart has opened 56 stores in mainland China,
26 in South China alone. Wal-Mart continues to aggressively open new
stores with the goal of penetrating into mainland second-tier and
third-tier cities. In November, Wal-Mart's Jinjiang Supercenter was
opened in Fujian. This milestone marked the first Wal-Mart store set in
a Chinese second-tier city with approval from the Chinese Ministry of
Commerce. By the end of 2006, South China could have as many as 43
Wal-Mart stores. The company, headquartered in Shenzhen, will celebrate
its 10th year anniversary in China this summer. To date, three Sam's
Clubs have been opened, including one in Shenzhen, one in Beijing, and
another in Fuzhou. The Shenzhen store is reported to be one of the most
profitable Sam's Club stores in the world.

**Carrefour** In 2005, Carrefour claimed a whopping 25 percent sales
increase in China while the global sales rose a mere 6.1 percent.
Carrefour already has 72 stores in China, with 13 in South China.

In January of this year, the French-based giant announced plans to open
20 new stores in 2006, including an additional two stores in Guangzhou,
three more in Shenzhen and one in Hainan.

**Metro** This German chain, which is the third largest retailing group
in the world, opened its first cash-and-carry hypermarket in Guangzhou
in January 2006. This is Metro's 29th store in mainland China and its
third in Guangdong Province. It is estimated another two new stores
would be soon launched in Guangzhou and Shenzhen

**Trust-Mart** With over 100 stores in mainland China and 28 in South
China, Trust-Mart is one of the biggest retailers in the country.
Trust-Mart recently announced they may sell a 25 percent share of their
presence in the China market. The Taiwanese company has 19 stores in
Guangzhou and four in Shenzhen, as well as others in the second-tier
cities of Donguang and Zhanjiang. Some people in the trade speculate
that Wal-Mart might be interested to take over some of the Trust-Mart
properties. Especially since Wal-Mart doesn't have a single store in
Guangzhou.

#### Convenience stores

When it comes to convenience stores, 7-Eleven is a leader in the South
China market. At the same time, many domestic retailers are struggling
to turn a profit. Quik (Lianhua ) owns 100 outlets in Guangzhou. Over
the next three years, Quik expects to expand this number to 300.
Meanwhile, Hong-Kong based OK now owns 36 outlets. OK announced also to
open more within three years to reach 500 outlets. Taiwan-based XiShiLi
has over 50 convenience stores in the Guangzhou area.

The Taipei-based President Chain, which controls 7-Elevens in South
China, is the world\'s third-largest 7-Eleven franchise. This group is
trying to broaden its revenue base into China as growth in Taiwan slows.
In 2004, it set up a joint venture in Shenzhen and expects to open 100
stores in that area in five years. Total 7-Eleven outlets in Guangdong
Province are expected to reach 400 in 2006.

One factor contributing to 7-Eleven's success is the chain's ability to
differentiate individual stores based on location. Managers tailor
product selections to fit the neighborhood. For example, they might
place fresh fruit and more imported products in a store near a five-star
hotel, while a store in a middle-class residential neighborhood might
have more local products.

7-Eleven and OK have also added fast food counters to boost profits over
the low-margin common commodities sold in convenience stores. These
retailers are earning profit margins as high as 30 percent on these
products, compared to the 10 to 15 percent margin earned on regular
packaged products.

It is anticipated that, on March 1, 2006, the government will enact a
new policy allowing the provincial government to approve the
establishment of convenience stores with less than 300 square meters of
retail space. The new policy would also shorten the approval period to
one or two months and is an attempt to encourage the establishment of
new convenience stores as residential communities are growing and there
is more rural to urban movement.

# III. Competition

The most serious competition for U.S. food exporters comes from local
and joint venture food producers and processors. The quality of fruit
and vegetables in particular has increased rapidly, and many local
traders now contend that the best of China's fruit is similar in quality
to imports. The general lack of coherent marketing systems continues to
plague China's industry, however, making it difficult to source
significant quantities of products with consistent quality. While
oranges similar in quality to U.S. navel oranges are available, the
transaction costs of dealing with large numbers of small farmers, then
sorting and packing raises the final market price to levels similar to
imports. The formation of farmers' voluntary organizations such as the
Zhejiang Pear Association has the potential to reduce these problems,
but such organizations are still relatively new.

Competition is equally intense for processed foods, although differences
in taste mean that the primary competition comes from third country
competitors or joint venture manufacturers. Shelves may appear to be
stocked with famous foreign brands such as Pringles and M&Ms, but close
inspection reveals that most of these products are manufactured locally
or in Southeast Asia. This allows manufacturers to cash in on brand
identification, take advantage of low labor costs in China, and adapt
their products to Chinese tastes and labeling regulations, all at the
same time. Years of food adulteration scandals have made Chinese
consumers cynical, however, and most will attribute a higher level of
accord to products that are genuinely imported.

The general trend to date has been for local manufacturers to push
imports out of the price-driven mass market and into niche markets where
quality and novelty are more important than price. This has already
happened to varying degrees with pet food (Mars' locally manufactured
Pedrigree and Whiskas labels dominate the middle market), wine (Chinese
labels dominate at the low end), apples (Washington State apples sell
extremely well in gift markets) and confectionery. Growing local
competition has emerged for table grapes, and domestic sweet cherries,
lemons and almonds appear to be improving in both volume and quality,
albeit from a very low base. Certain products, particularly
western-style prepared foods, face little or no competition from local
manufacturers, constituting a niche unto themselves. Improvements in
quality and increased efforts at brand development are allowing Chinese
companies to compete more effectively for some niche markets, but local
manufacturers face the same distribution problems as imported products,
as well as a high level of skepticism among consumers.

![](media/image6.wmf){width="4.4374015748031495in"
height="2.6251968503937007in"}

Third country competition comes in two distinct areas: commodity-type
products such as frozen meat, poultry, seafood and fresh fruit, and
western-style niche products such as canned and prepared foods and
ethnic cuisines and ingredients. Competition in the fresh and frozen
meat, fruit and vegetables arena, as well as dairy, comes primarily from
Pacific rim neighbors, including Thailand, New Zealand, Australia,
Canada and Chile, as well as South Africa and Brazil. Competition for
western-style prepared foods is much more global, with competitors
playing to their strengths in individual products such as olive oil,
wine, pasta sauces. The following list gives an idea of the range of
countries and products competing in China.

The U.S. remains the largest single exporter of consumer-oriented food
to China, with a 21% share of China's total imports in 2004, and is the
only exporter with a presence in most categories. According to U.N.
data, market share dropped in 2004 owing mainly to reduced shipments of
poultry and beef (other sources show a smaller decline). This is
projected to ![](media/image7.wmf){width="4.5208661417322835in"
height="2.6251968503937007in"}recover in 2005 due to the restoration of
poultry trade and increased shipments of pork, as well as a sharp
increase in shipments of fresh fruit. China is attracting a growing
level of interest from other countries, however, and has signed or is
negotiating bilateral trade pacts with most of its neighbors. Following
is a brief outline of key products and competitors.

**Top Products and Competitors**

\- Oranges U.S., New Zealand, South Africa

\- Grapes Chile, U.S.

\- Apples U.S., Chile, N. Zealand

\- Cherries U.S., New Zealand

\- Lemons and Limes U.S., New Zealand

\- Red Meat (f/c/f) U.S., Canada, Denmark, New Zealand, Australia

\- Breakfast Cereal United Kingdom, U.S., Korea

\- Cheese New Zealand, Australia, EU, U.S.

\- Frozen Proc. Potatoes U.S., Canada, New Zealand

\- Frozen Corn U.S.

\- Dairy (not incl. cheese) New Zealand, Australia, France, U.S.

\- Poultry U.S., Brazil

\- Tree Nuts Russia, Korea (chestnuts), Iran (pistachios),

> U.S. (almonds, pistachios, walnuts, hazelnuts), Mongolia

\- Premium Chocolate Switzerland, Belgium, Italy, France

\- Premium Ice Cream France

\- Seafood Russia, North Korea, U.S., Canada, Norway, Japan

\- Wine Chile, France, Australia, U.S., Italy

\- Ginseng Canada, U.S., Korea

# IV. Best Product Prospects

## IV.A Products Present in the Market Which Have Good Sales Potential

\- Nuts and dried fruit (prunes, raisins)

\- Seafood

\- Poultry meat

\- Red meat

\- Frozen vegetables (esp. sweet corn)

\- Infant formula

\- Baby food

\- Dairy products (esp. ice cream)

\- Frozen potato products

\- Fresh fruit (oranges, apples)

\- Premium ice cream

## IV.B Products Not Present in Signficant Quantities, Which Have Good Sales Potential

\- Fresh fruit (cherries, pears)

\- Processed/dried fruit (blueberries, cranberries)

\- Mexican food

\- Ready-to-cook and ready-to-eat foods

\- Organic foods (niche market)

\- Functional foods

# V. Post Contact and Additional Resources

FAS has four offices in China:

**Agricultural Affairs Office, Beijing**

5-2 Qijiayuan Diplomatic Compound

Jianguomenwai, Beijing, 100600

Phone: (8610) 6532-1953

Fax: (8610) 6532-2962

E-mail: agbeijing@usda.gov

**Agricultural Trade Office, Beijing**

Kerry Center, Beijing

24^th^. Floor, Suite #2425

Phone: (8610) 8529-6418

Fax: (8610) 8529-66922

E-mail: atobeijing@usda.gov

**Agricultural Trade Office, Guangzhou**

China Hotel Office Tower, 14/F

Guangzhou 510015, China

Phone: (8620) 8667-7553

Fax: (8620) 8666-0703

E-mail: atoguangzhou@usda.gov

**Agricultural Trade Office, Shanghai**

Shanghai Center, Suite 331

1376 Nanjing West Road

Shanghai 20040, China

Phone: (8621) 6279-8622

Fax: (8621) 6279-8336

E-mail: atoshanghai@usda.go