Smaller cities offer bigger scope

There is a dramatic shift in geographic distribution of consumer spending amid rapid urbanization

Over the next decade, China's continuing growth will bring an additional 270 million consumers into the MAC (Middle-income and Affluent Consumers) segment. That is roughly the same number of MACs as there are in the United States today - or the combined populations of Germany, France, the UK and Italy. Furthermore, the income distribution of urban residents will shift significantly over this period. By 2020, there will be nearly 800 urban locations (cities and the urban portions of counties) with real disposable income per capita greater than Shanghai's today.

A dramatic shift in the geographic distribution of consumer spending power is also under way. Large groups of consumers residing in smaller cities will rise into the MAC segment for the first time. Today, only 18 percent of consumers in China's smaller cities qualify as MACs, but that number will grow to 45 percent within a decade. By 2020, the MAC population in China will nearly triple, from about 150 million to more than 400 million, and two thirds will live in small cities.

?

This critical rebalancing of China's economy will open up new consumer markets that extend far beyond the swath of coastal provinces where most MACs currently live. To serve this consumer segment, companies will need to expand their footprint rapidly. Today, in order to reach 80 percent of China's MAC population, a company must be in 340 urban locations - but to have the same coverage in 10 years, it will need to be in nearly 550 locations. And many companies are currently falling short of 80 percent of their targeted segment, so their need to expand is particularly urgent. Any position ceded now to competitors in this strategic market will be very hard to recover.

Different strokes

To date, the penetration of consumer product companies into small-city markets is still low compared with their presence in big cities. Small-city markets are much less consolidated, with local brands outnumbering the sophisticated brands available in the larger cities. This introduces a huge growth opportunity for multinational companies, but it will be crucial for them to understand the differences among small-city MACs in attitudes and spending behavior. The greatest mistake a company can make in entering China's small cities is to assume that MACs there are similar to MACs in big cities - and that all small-city MACs are the same. Regional differences in tastes, spending habits and brand preferences can be quite significant. There are also differences in trade structure and distribution channels across regions.

Less stressful lives

Although the infrastructure in China's lower-tier cities is catching up with big-city levels, daily existence in small cities remains, for the most part, slower paced and more relaxed. Consider the lives of He Bing, who lives in Shanghai, and Xue Wei, who lives in Anshan, a tier-3 city in Northeast China. Both are young bachelors who plan to run their own businesses. They work at white-collar jobs and earn about 7,500 yuan (862 euros) a month. Yet He Bing describes his life as busy, stressful and full of social obligations. He works longer hours and takes less time for lunch than Xue Wei, and spends most of his evenings either working overtime in the office or out with business partners at restaurants, bars, or nightclubs. Xue Wei, on the other hand, has a stable 9 am to 6 pm workday, enjoys leisurely two-hour lunches, and spends most of his evenings after work with his girlfriend at home, where they play badminton, watch TV or surf the Internet. He characterizes his life as relaxed and centered around family.

Lower cost of living

Because the costs of education, transportation, housing and food are much lower in small cities, MACs there have relatively more discretionary income. In fact, some small-city MACs are able to save as much as one-third to one-half of their monthly income. In addition, government policies such as subsidy programs that stimulate demand for household appliances and automobiles have focused on the smaller cities and rural areas, which have eased cost-of-living pressures.

Interestingly, it is not unusual for an MAC family living in a small city such as Xuzhou, a tier-3 city in Jiangsu province, to be able to afford a moderately priced apartment, whereas it would be a considerable stretch for an equivalent family in Shanghai. Not only would a similar apartment cost nearly three times more in Shanghai, the big-city family would likely have less money in savings for a down payment.

Greater purchasing power

Average incomes of MACs in the big cities will continue to be much higher than those of MACs in small cities. Therefore, big-city MACs remain an important market - especially in categories with sophisticated products and advanced technologies. However, small-city MACs offer a powerful growth opportunity. Having moved up into the MAC segment, they are able to afford more expensive brands (especially in packaged goods and clothing) and potentially have greater purchasing power. For instance, when we interviewed middle-class consumers (that is, consumers with annual household incomes of at least 60,000 yuan (6,900 euros) in Anshan and Xuzhou (both tier-3 cities) and Shanghai, we found that middle-class consumers in the smaller cities spend the same or even more on apparel and shoes, personal-care products and cosmetics relative to middle-class consumers in Shanghai, who are squeezed by higher living costs.

Focus on health

Compared with big-city MACs, small city MACs are more willing to trade up in general, especially for discretionary items such as home decoration and appliances, apparel and skincare products. For everyone, however, health is a top reason for spending more. About half of our respondents said that they would trade up for healthier products.

This is most likely because product safety and quality are less certain in emerging markets than in developed countries. For example, within the food and beverage category, the most popular products for trading up are dairy products, fresh food, juices and teas. Indeed, the intention to trade up for juices and teas has increased dramatically in 2010.

More practical

In our survey, small-city MACs indicated that they enjoy the feeling of spending, although they are most interested in basic functionality rather than extraneous features. Specifically, many more small-city MACs than big-city MACs make purchases on the basis of "meaningful technical differences" or because they perceive an item to be healthier than competing products.

For example, both big-city and small-city MACs are interested in casual sportswear, but for different reasons. In top-tier cities, consumers are particularly interested in fashionable brands that convey an energetic and youthful attitude. In small cities, by contrast, consumers are more practical about sportswear, which they see as comfortable, easy to match and durable.

Trust in brands

We found that MACs in smaller cities tend to place greater trust in well-known brands than big-city MACs, and they cite brand prominence as among their top motivations for trading up. However, their trust doesn't necessarily carry over to international brands. When purchasing infant formula, for example, small-city MACs regard international brands much less highly than big-city MACs. In tier-4 and smaller cities, only half of the MACs in our survey preferred international brands, compared with nearly three quarters in tier-1 and tier-2 cities. This is partly because of small-city MACs' focus on basic functionality as opposed to the premium benefits that they associate with international brands. But it is also true that international brands aren't yet well positioned to gain the trust of small-city MACs.

Quick deciders

Small-city MACs spend much less time than their big-city peers in researching product features before deciding to purchase. When purchasing home appliances, for example, more than 60 percent of MACs from tier-4 and smaller cities said that they generally make up their mind to purchase within a week, whereas only 40 percent of MACs in tier-1 cities make a purchase decision that quickly. One reason that small-city MACs make relatively quick purchase decisions is that they have limited access to information and consider only a few basic factors.

Different outreach channels

The manner in which MACs search for information on products varies with the size of city. When we asked MACs what sources were most trustworthy for information on consumer electronics, home appliances and baby products, word of mouth proved to be highly influential across all city tiers - three quarters of respondents cited it as one of the three most trusted information sources. However, in-store sales promoters have more influence in smaller cities and small city MACs are somewhat more likely than big-city MACs to trust television commercials. Interestingly, only about 20 percent of both small- and big-city MACs said that they trusted information from online channels. This is obviously an area for further development.

The authors are from Boston Consulting Group.