Understanding the Chinese consumer

Laurent Philippe, the head of Procter & Gamble in China, explores how to beat the competition in the country’s huge and complex market.

China's market for consumer goods is growing quickly, stimulated by a strong economy that is putting more disposable income into the people's pockets. Competition to serve consumer needs is intense; multinational companies are battling one another and also taking on increasingly sophisticated Chinese players. One of the bigger issues facing multinational consumer goods companies in China is their ability to serve the mass market cost-effectively—an important advantage of the local competitors.

Procter & Gamble, one of the world's leading consumer goods companies, is facing this challenge head-on. P&G is the most successful foreign marketer in China as measured by market share, with leadership positions in four of the seven product categories in which the company competes. Last year, China generated almost $1.8 billion in sales for P&G, or about 3 percent of its total revenues. While growth has slowed in major markets such as the United States, sales have risen much more briskly in China. In 2003 it was P&G's sixth-largest market, up from tenth just three years earlier.

Leadership hasn't come easily. Procter & Gamble entered the Chinese market through a joint venture in 1988. For many years, the company focused its marketing effort on premium-priced products—its traditional path—in China's relatively wealthy coastal areas. But growth and profitability pressures have pushed P&G into what Laurent Philippe, its president for Greater China, describes as the midtier consumer segment. This strategy puts the company in direct competition with regional and national Chinese enterprises that often have lower costs and a better knowledge of the territory. As a sign of confidence in this market, P&G recently spent $1.8 billion to buy the remaining 20 percent stake in its joint venture with Hutchison Whampoa China.

Laurent Philippe is no stranger to emerging markets. After a P&G marketing career in Western Europe, he took positions as general manager in North Africa and Eastern Europe before being named head of the Greater China region, which includes Hong Kong and Taiwan, in 2001. Of P&G's history in China, he says, "It has been a rich learning journey, and the journey is only starting." He described the steps the company has taken to address the nonpremium market and its associated cost challenge in an interview with Jacques Penhirin, a principal in McKinsey's Greater China office.

How does China fit into Procter & Gamble's global strategy?

Laurent Philippe: When our chief executive officer, A. G. Lafley, took charge of the company, in spring 2000, he made developing markets a strategic priority for P&G. China is a focus market on two grounds: it is a developing market, and it is big. Kerry Clark, our head of global market operations, then defined key strategic priorities and factors for success in developing markets, such as affordability, lower costs, building a broader portfolio, and improved go-to-market capabilities. These critical strategic interventions at the top of the company are enabling people at my level—the presidents of the developing regions—to be successful.

There's a strong sense of collaboration at the top of the company. The presidents of the developing regions meet and talk regularly with the heads of the global business units. We identify important trends, such as emerging consumer and customer needs and common challenges across markets, and we work together to develop effective solutions. This transnational network is crucial.

What are the biggest challenges of working in China?

Laurent Philippe: Our aspiration is market share leadership in all P&G core categories in China, and this is a challenge because of the diversity and scale of the country. The diversity is in the consumers—affluent versus modest—as well as in geography—east versus west China—and in the trade channels—global retailers; modern Chinese retailers; traditional trade, such as mom-and-pop groceries; and kiosks.

Consumers in Shanghai, Beijing, and Guangzhou are looking for experiences and products that are very similar to what we find now in Hong Kong and most other developed markets. That is one extreme. Conversely, the more westward you go in China, the more consumers seek basic functional benefits and a simpler personal-cleansing regimen. For example, consumers of laundry products who work in offices in top cities use washing machines and have more garments in their repertoire. Their needs and desires are different from those of small-town manual workers washing smaller collections of clothes, less frequently, in basins.

Then there is the enormous scale of the market. Each subsegment is large in its own right. If you take only the population in China's top four cities, you are dealing with 30 million people. A company like ours cannot neglect any of these segments or subgroups. We have the ability to win in every one. In product categories, we compete in laundry, hair care, baby care, feminine care, personal-cleansing products such as body washes and soap bars, skin care, and dentifrice. Of these seven core categories, we are leaders in four and a strong number two in three.

Some skeptics say that few companies are making money in China today and that the market is a long-term play. Is P&G profitable in China?

Laurent Philippe: Our profitability in China today is comparable to the company average. With developing markets—and China, in particular—becoming an increasingly important part of the company's total operations, our shareholders would not accept a dilution of its financial performance. It is a financial imperative to continue delivering superior returns to our shareholders.

Some companies may take the attitude that China is a growth market where they need to build a position for tomorrow, thinking that eventually they could raise profitability to target levels. This is not what we are trying to accomplish in China. We have set adequate, definable profit objectives for ourselves and believe that from both a strategic and an organizational focus this is the best way to take on the cost challenge involved in serving the midtier consumer segment in China. Tough profit objectives force you to get your cost structure competitive.

P&G has historically been very good at addressing the wealthier segment of the market. Recently, however, you have put a lot of effort in China into tapping different consumer segments, including the midtier one that you just mentioned. Could you tell us more about this?

Laurent Philippe: Because we aspire to leadership, we need to compete in more than the premium segment. We need to compete at least in the middle segment as well. In volume terms, you can segment our categories into three price tiers: the top tier is 15 percent of the volume in units, the middle tier is 30 percent, and the bottom tier is 55 percent. The split in value, or revenue, is a little bit different: it is 30 percent in premium, 40 percent in the midpriced segment, and only 30 percent in the low-end segment.

This segmentation, by the way, is not mechanical; it is consumer driven. In other words, for each category in which we do business we ask consumers to tell us where—in their perception—price tiers start and stop. The answer varies considerably by category.

In any given category, a 15 percent value-share position may primarily reflect a price premium versus the category average. This may be overstating the long-term strength of your brand because you may only have a 5 percent share of volume, which is probably not a sustainable position. It means your cost structure is inefficient and your prices are too high, leaving too much room for lower-cost producers to undercut your pricing. So I think volume share is more important, except in a couple of categories like skin-care cosmetics, where value share is what matters. I think volume share is the most difficult challenge because it forces a company to accept the cost challenge that goes with it. But if a company meets the challenge of cost and delivers scale in purchasing, manufacturing, and marketing, then the prize is very, very big.

Do you think that you need to stretch your brand to reach the diverse segments in the market?

Laurent Philippe: Sometimes yes, sometimes no. To succeed with one brand across multiple tiers, one has to understand the consumer needs in each subsegment and to focus the product offering, pricing, and consumer communications to meet the specific needs of each subsegment. We are finding that the offering cannot be the same. We are not offering a cheaper Crest toothpaste; it is a different Crest. It has a different flavor and uses a different paste. The scientific justification of the cavity-prevention benefit is different. The secret is to have, for each segment, a position that is tangibly different so you do not cannibalize your higher-priced products.

We do not want people to trade down. We do not want people to say, "Well, I cannot afford that; this one is good enough." Individual consumers shop in every segment. The female consumer will buy cosmetics in a certain segment and buy laundry detergent in another, but it is the same woman. If you offer her a cheaper version of the same brand across different channels, she will be very confused. We do not want to drive this confusion. At the end of the day, you need to be careful, but we believe that big brands can address different consumer segments and needs as long as the overall benefit promise is broad enough.

How do you make your global brands appeal to the Chinese consumer?

Laurent Philippe: We do not see our brands in China as global; we see them as Chinese brands, and that is something we are proud of. Our global brands are known in China by their Chinese names. "Pampers" means "helping baby's comfort." "Whisper" means "protection, comfort, and a very precious item." "Ariel" is about the bright and clear wave of cleaning, the power of cleaning. The Chinese names trigger meaningful visuals or associations with benefits. Of course, these brands happen to benefit from the breadth of our company expertise and know-how in the areas of branding and technology. But we are trying to build Chinese brands for the Chinese consumer. I think Chinese consumers see our brands, such as Ariel and Tide, as Chinese brands from a global company with a great reputation.

In the middle-market segment, do you compete with local players?

Laurent Philippe: All our global competitors are in China. Like us, they have recognized, obviously, the tremendous strategic importance of China. We also have many local Chinese manufacturers that are demonstrating a tremendous ability to deliver good products at a fraction of the costs of some international companies. This has an impact on price conditions, making the Chinese market very, very competitive. There are categories, like laundry, where the key competitor is Diao Pai, a Chinese brand. The Chinese players are also learning things like marketing very quickly. We all tend to underestimate the speed and capability with which they will emulate the current practices of the global companies. I think this competition is good for the Chinese consumer. It is also good for P&G because it is driving us to bring our game to another level.

What are some of the things you must do differently?

Laurent Philippe: There are categories, like prestige skin care, where our Chinese consumers aspire to own the best global technology and products. The SK-II and Olay products that we are selling in China are the products we sell in Japan and the United States, so they are international. But in some categories the cost challenge is so tough—the cost differential between what I would call global, or Western, technologies and what Chinese consumers need or can afford is so wide—that you cannot just take a global technology and make it cheaper by simply removing or replacing certain ingredients. The cost gap is too big. So we are now using our research-and-development capabilities to create different value offerings superior to those of the local competitors but at an equal or even lower manufacturing cost. These products are designed from the outset to meet certain cost, and therefore pricing, targets. Laundry detergent is certainly one category where we need to meet the local cost challenge and to develop unique Chinese solutions as a result.

What do you do differently in China to design products suited to Chinese consumers while at the same time leveraging the strength of your global R&D?

Laurent Philippe: In the area of product development, P&G has always had marvelous scientists and technologies—a wealth of research capabilities. But there has been a significant paradigm shift in the mind-set of some of our research people. They continue to feel strongly rewarded for delivering novel technologies at the top of the value and price pyramid. However, they also find considerable satisfaction in designing from scratch, from a white sheet of paper, unique technologies for a developing market or technologies developed from the outset against specific cost and pricing targets.

We are now getting the power of the company's R&D capabilities to address not only the top of the pyramid but also the core of the market: the mainstream market. It all starts with a superior understanding of the Chinese consumer. We have a research-and-development center in Beijing, where some of China's leading universities are based. The Beijing Technical Center can leverage P&G's global R&D resources to focus on those categories where local solutions are appropriate. For instance, the work done on Tide and Crest was led by the Beijing Technical Center.

What is different about those products?

Laurent Philippe: We aspire to develop products that not only meet the unique needs of the Chinese consumer but also, among other things, can be formulated using local flavors, colors, and textures. Some ingredients, for instance, build on some aspect of Chinese wisdom, such as the belief that salt is good at whitening your teeth or that tea is good at controlling bad breath. We have jasmine tea-flavored Crest, for example. These are the kinds of local insights that you can capture.

Can you apply some of what you learn through your R&D in China to other markets?

Laurent Philippe: Indeed we can. First of all, it is no accident that we chose to locate our technical center beside Tsinghua University, so we have access to the best scientific talent of China. We conduct two streams of R&D activities in China. One stream focuses mainly on technology inventions with global reapplications. And the other stream focuses primarily on local innovation for China. There is a forum for the cross-fertilization of ideas across our P&G network of knowledge experts, although other locations need to do their own local customization work.

What is your view of television as an advertising vehicle in China, both at the national and the local level?

Laurent Philippe: Television is a very important medium, more so than in some developed markets, and will remain the primary medium of choice for brands aspiring to leadership. Other tools, like print and radio, continue to grow but remain well behind TV in penetration, especially outside the top cities. For brands having a national presence, the national TV channels—CCTV—are a major vehicle for national reach. We also see great innovation from city channels. For example, the Shanghai Media Group and Beijing TV are very effective in their regions.

What special challenges have you encountered as P&G built its organization of more than 4,000 people in China?

Laurent Philippe: Developing a strong local organization is a strategic imperative, but I do not see this challenge as any different from those we face in any other young P&G organization. The dynamics are the same; the process is the same. The development of such an organization starts with high-quality expatriates dedicated to transmitting company knowledge and wisdom from generation to generation. Of course, this initial investment in expatriates has already been scaled down as local managers take over more and more management responsibilities.

Building an organization is also about superior recruiting, retention, and competitive compensation packages. Chinese people—especially the younger ones—do aspire to succeed. In addition to seeking material success, they see their personal development as critical; thus, working for a company like P&G is very important. Being successful in China as a company is a great recruiting, retention, and motivation tool. I have noticed how much our young Chinese employees want to work for a winner. This is terribly important for them.

'We are already a net exporter of management talent, meaning that we have more Chinese abroad than we have foreigners in China'

We also see an opportunity for making China play a bigger role in terms of management talent. It could be a base for reexporting knowledge, management, or eventually products outside China. In fact, we are already a net exporter of management talent, meaning that we have more Chinese abroad than we have foreigners in China. Of course, they are not at the same level of leadership, but this is a good sign that we are committed to building the Chinese leaders of tomorrow. We are also committed to diversity. Diversity in China has three dimensions: gender, the expatriate-local balance, and the balance among the People's Republic of China, Taiwan, and Hong Kong. We try to have a geographic representation of Chinese talent that is consistent with our business needs and the needs of the region.

What advice might you give multinationals contemplating joint ventures with local Chinese companies?

Laurent Philippe: The point I would make here is to assess whether multinationals need local partners; that is, what are the capabilities multi-nationals are looking to complement? If they decide that they do need local partners, they should take the time to assess whether they and their partners have consistent, not opposing, objectives. For example, many local enterprises may have the objective of maintaining state employment, while multinationals would be interested in major productivity improvements immediately. People need to do extensive due diligence and to understand whether the objectives of the two sides will conflict.

How have you dealt with the counterfeiting of your products in China? Have you seen any improvement in this area?

Laurent Philippe: The senior Chinese leadership in the central government is committed to addressing this problem. I believe that as a result of their commitment, the problem, while still serious, is gradually improving.

There are other macroeconomic factors driving progress in this area: the emergence of modern retail trade, such as supermarkets, in secondary cities and in the biggest towns, for instance. Since pricing is pretty aggressive and homogeneous across trade channels, consumers have a real incentive now to shop in the modern trade channel because they get the genuine product at a price equal to that of the inferior product purchased from traditional trade channels. Remember, in our categories, people do not know that they are buying counterfeits until they use the counterfeits at home and have a poor experience. This indeed reflects poorly on the superior brand image we are building. The strength of our leadership brands on a broad geographic basis and the sales coverage that comes with this are other factors helping us in the counterfeiting challenge.

Of course, the problem remains; it has not been completely eradicated. But we are seeing early signs of improvement. Of concern, however, is the fact that we have noticed, in the past 18 months or so, the emergence of an export counterfeit business out of China.

Is P&G winning in China today?

Laurent Philippe: We are winning. But the Chinese market is so tough and so competitive that no one can ever assume that a leading position is unassailable. We have to keep working at it every day. This is a long learning journey.

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