Western companies are learning a harsh lesson that the Chinese middle classes will not simply view commoditised global brands as premium ones just because they are western.
Consumer staples brands are losing market share to local competitors warns David Coombs, Rathbone IM’s head of multi-asset investments, speaking to Global Investment Megatrends.
Indeed, the market may have rerated many companies making the wrong assumptions about the economic shifts to China and the growth of the Asian middle classes.
Marmite – no thanks
Coombs says that the received wisdom was that as the middle classes expanded in Asia, especially in China, they would simply want Western brands to buy our “Dove Soaps and Marmites”.
“There was a view that our kind of commodisised, everyday goods would be seen as luxury goods in the China.”
“A lot of the staples companies, the P&Gs, the Unilevers, the Reckitts were all getting rerated. They had been viewed as boring bond proxies for years. All of a sudden, they could be growth companies because Coleman’s mustard will be hot in Shanghai.”
Coombs began to seriously question that view following a meeting with one of the brands expected to storm the Chinese market – Colgate.
“Eighteen months ago, I was in New York meeting with with Colgate. They were discussing how they were having real problems on their premium brands in China. They were being beaten by local brands.
“The reason was the premium brands were selling jasmine tea and green tea flavoured toothpaste. They weren’t selling peppermint or even charcoal or whatever nonsense they sell in the States.
“They were packaging them in boxes that looked more like a herbal medicine. The toothpaste box had greenery on it. It was branded differently. Marketed differently. It tasted different. It was priced premium, not cheaply and was eating into Colgate’s premium market. Colgate were not losing out to Sensodyne or Macleans.”
It was a big game changer for him.
The result was that Coombs sold out of Colgate and almost all the other consumer staples brands. The exception was Unilever, athough he constantly reviews that position as well.
“We felt that entire view of the nature of the long-term mega trend was possibly built on a false premise.”
It certainly doesn’t mean ignoring China but it does mean looking more precisely at companies where China is an important market.
How Estée Lauder gets China right
So, for example, Coombs owns Estée Lauder but the key is that it is in a prestige market, not competing in a commoditised or even simply premium one.
“They’re very savvy about the way that they take new brands into China. The head of their China business is Chinese, who is empowered to set sales and marketing strategy in China, rather than just implementing a Western strategy which is what Colgate was doing.”
“If you went into a store in a third-tier city in China, Colgate would still be red, you’d recognise it from Boots. That was a really enlightening moment, all thanks to toothpaste.”
He says there is a read across to Chinese companies more generally as well.
Chinese entrepreneurs don’t just want to sell cheap stuff
“We’re being a little bit patronising and condescending thinking that Chinese entrepreneurs can be happy just selling cheap stuff, exporting stuff for our Christmas crackers and selling cheap electronics. No, they want a bite of the high margin premium stuff.”
He says that he expects to see more Chinese companies using their talent and capital to break into global markets in a similar way to Korean and Japanese firms in the past although probably more rapidly.
Coombs says while there are companies in or related to the state sector that are capable of destroying capital, very many Chinese businesses and business leaders have the same entrepreneurial spirt and talk the same business language as their equivalents in the US.
He says that of course the trade war remains a significant issue including the implications for supply lines. You also have to be careful of the sector because of the nature of state and commercial relations – for some parts of the economy – pest control for example.
However, more broadly, the economic shift is indisputable.
Indices out of whack
Indeed, he says the global and EM indices seem completely out kilter with their low single digit exposure to China.
“It is a complete mismatch between how the indices tell us we should invest globally compared to the size the Chinese economy.”
This is also a factor when he speaks to CEOs of global firms in the US and to a lesser extent Europe.
“If you talk to CEOs in the States and ask which are the two most important consumer markets to you, in most cases, they say first it’s the home US market, China is second and Europe is a poor third. When it comes to allocating capital to grow their businesses, Europe is third in line.”
He says that in several ways China is similar to the US based on ease of route to market with one economy, one legal system.
Europe, despite the single market is a more complex marketplace, legally and culturally.
He says: “We look at US companies, or even European companies, to see who sees China’s a very important market. We have a look at the culture, we have a look at the management structures. The companies that seem to do less well are those where the Chinese businesses seem to be more of a branch executing global strategy, rather than a subsidiary executing a localised strategy with the product base of the company. It’s the latter that tends to be more nimble.”
He says finally that big brands can be losing out as much as 5% sales loss a year. It is very similar to Western markets with niche premier brands springing up.
“It’s USA 2 in terms of how the consumer is changing, the fickleness of the consumer, and the lack of loyalty. Think back to when consumers who were loyal to Heinz or Kellogg’s forever. Now consumers are looking at some local cornflake, made by the farmer down the road. It’s the same thing happening in China. So we’ve got to reset our thoughts on how we’re valuing those big beasts. They’re probably overly optimistic.”