Heralded as a welcome bonanza in connection with last summer’s Olympic Games in Beijing, the Chinese sporting goods market is heading for an angry clash between international brands and their retail partners, after weak sell-throughs in the second half of last year. Sitting on large inventories and facing a slowdown in sales growth, some of the largest Chinese retailers have sharply cut their orders for the second half of this year.
The depth of the issues came to light in a series of interviews conducted by Sporting Goods Intelligence Europe with leading Chinese retailers around the Ispo China trade fair held in Beijing earlier this month. They pointed to a likely decline in the growth of the Chinese sports market this year and deepening frictions in the relationship between international brands and their retail partners in China.
The problems are linked with the specific business model applied by the international sports brands in China, which built up their sales in the last decade by teaming up with retail partners to open thousands of mono-brand stores – leaving little space for any multi-brand sports retailing in China. In the early years, international brands could impose tough buying conditions on inexperienced Chinese retailers: In a seemingly absurd distortion, purchasing prices imposed on Chinese retailers were often higher than in Europe. This enabled the brands to achieve eye-popping profits in China, reaching gross margins of about 55 percent – and more.
The retailers themselves fared well for several years, as sales expanded massively and they enjoyed low costs. Labor and corporate regulations were still lax, enabling retailers to do away with social benefits for employees, and to reduce their tax burden. Furthermore, rental costs remained relatively low and marketing costs were not an issue, since they were carried by the suppliers. For many years, Chinese retailers therefore enjoyed healthy net profit margins of 5 to 10 percent.
However, the situation changed drastically in the second half of last year, after some leading international brands encouraged their retail partners to buy hugely inflated volumes of products – with heightened expectations ahead of the Beijing Olympics. The expected levels of sell-through failed to materialize, and the problem was worsened from November as the global economic crisis began to affect Chinese consumption.
At the same time, Chinese retailers were hit by tougher labor regulations, which inflated their costs. Margins reported by some of the largest Chinese retailers last year shrunk below 5 percent, making it all the more difficult for them to deal with their massive stock of unsold products. Retail prices of leading sports brands in China are at roughly the same level as in Europe, with average discounts of 15 percent – but the piling inventories have prompted retailers to strongly increase their discounts in the last months, thereby further reducing their margins. Our store visits showed abundant discounts of around 40 percent, and one mall even had Adidas products at a discount of 70 percent.
Lingering resentment about the conditions imposed by suppliers were brought to the surface as a result of this mishap, with some retailers feeling that an unjustified volume of products and the ensuing problems had been dumped on them – based on unrealistic expectations by the suppliers of branded products.
Furthermore, the inventory issue has caused cash flow problems for quite a few smaller retailers. It highlighted the fact that the cost of inventories is offloaded by international brands to their Chinese retail partners. In the existing pattern, Chinese retailers order four times per year, but they have almost no opportunity to re-order.
Retailers indicated that the two international market leaders, Adidas and Nike, responded very differently to the situation and pleas of order cancellations in the second half of last year. The unanimous verdict was that Nike proved relatively conciliatory, while Adidas remained inflexible and badly antagonized some of its retail partners. Evidence gathered through retailers and other sources is that these issues may be widening the gap between Nike and other international market players. Our interviews indicated that Chinese orders of Adidas products had been slashed by up to 50 percent for the second half. The company declined to comment ahead of the publication of its annual results next week.
The level of discontent is unprecedented in the Chinese market, and many retailers feel that the time has come to tip the balance of their relationship with suppliers. Along with the market circumstances, the growing concentration of the business is playing strongly in favor of some big retailers: two of them, Belle International and the YY group, are thought to make up more than 50 percent of the sales of Adidas and Nike in China. Another four mid-sized retailers account for about 20 percent of their sales.
Apart from the purchasing prices, Chinese retailers are battling for more flexible deliveries. Suppliers partly make up for their lack of re-ordering services in China by staggering their deliveries of pre-ordered products, to make sure that there are always fresh products in store. However, retailers want to avoid the problems experienced in the second half of 2008 by reducing their share of pre-orders and increasing re-orders. Furthermore, retailers are clamoring for more assistance from suppliers to support their growth, in terms of data processing and logistics.
Nike has apparently heeded the call, since it announced earlier this month that it would invest $99 million to build a distribution center in Jiangsu, with a surface of 120,000 square meters. The construction is to start in the next months and the distribution center should be operational in the third quarter of 2010. Willem Haitink, general manager of Nike China, stated that this could reduce delivery times by up to 15 percent.
While Chinese retailers are putting forward heightened demands, anxiety about the reduced growth of the Chinese economy has also motivated them to take their own measures to rationalize their business: They admit that the current problems could be partly blamed on wild expansion that was not properly managed.
As China enjoyed annual economic growth rates of more than 10 percent for the last few years, Chinese sports retailers watched their sales flourish by opening one or more stores per day – with little regard for the sell-through and profitability of individual stores. It only takes a short stroll down the main street of Wuhan, a town of about 9 million people in the Hubei province, to grasp the problem: It is literally lined with mono-brand sports stores.
With the economic slowdown starting to bite, sports retailers have begun to tackle such absurdities. The latest forecast by the International Monetary Fund places projected growth for the Chinese economy at about 6.7 percent, below the government target of 8 percent. China’s exports have reached their lowest level in a decade, and 26 migrant workers, out of an estimated total of 130 million, have become jobless. This has provided factories with increased bargaining power and led to a reversal in the recent trend for higher Chinese factory wages. The drop in employment, reduced wages and anxiety about the situation are hardly stimulating consumer spending.
Officials of Belle International, the leading retail partner for international sports brands in China, indicate that the sell-through of some of these brands has further declined since the beginning of this year – with an actual fall in value compared with the same period last year. This has been partly offset by stronger sales of cheaper Chinese brands, led by Li-Ning, Anta and Erke.
As the Chinese market leader for women’s fashion footwear, Belle launched its sports department in 2002. By the end of last year it had more than 3,000 mono-brand sports stores, including about 1,000 Nike stores and 800 Adidas outlets – and only a very small minority of franchises. Belle’s sports stores never reached the same margins as its shoe stores, but Belle happily watched the sports department expand. Sales growth was applauded as the company prepared its launch on the Hong Kong stock market in May 2007, which raised $1.1 billion. Belle International reported sales of about RMB 11.7 billion (€1.338.2 m-$1,710.2m) in 2007, and sports stores made up about 48 percent of the turnover.
In the last few weeks, Yu Mingfang, general manager of Belle’s sports department, has been negotiating more balanced terms with suppliers. But at the same time, he has decided to reduce the pace of Belle’s sports store openings, and to close down unprofitable stores. He predicts that the Chinese sports market could end the year with a flat number of sports stores – which would have been unthinkable two years ago.
The focus for Belle’s own sports department has strongly shifted from store openings to improvements in sales per store and profit margins. Among many other measures, Belle will strive to reduce the number of employees per store – even though labor costs make up only an estimated 5 percent of retail costs in China.
YY Sports, the sports wholesale and retail arm of the Yue Yuen group, is moving in the same direction. Along with much larger revenues from sports shoe manufacturing, the group reported retail sales of about $849 million for the financial year ended last Sept. 30. Separately, it has a wholesale arm holding licenses for Hush Puppies and Wolverine, while another Chinese license with Converse was turned into a distribution deal in January.
Just launched in 2001, the YY group’s sports retail business now boasts several thousand mono-brand stores around the country, for brands from Nike to Adidas, Converse, Kappa and Li-Ning. Furthermore, it has 137 stores under the YY Sports banner, which could be described as small department stores featuring shop-in-shops by brands from The North Face to Kappa, Dolomite, Speedo and Crocs.
YY’s sports division reported a sales increase of about 50 percent for 2008, driven by store openings. On a comparable basis, store sales increased by about 15 percent for the year. However, Lu Ning, who heads up the northern Chinese half of the company, indicates that it will reduce the pace of its store openings and that its comparable sales will be roughly flat in 2009.
YY Sports’ retail arm is also zooming in on profitability. The company already has sophisticated sales monitoring systems, enabling it to analyze sales on a daily basis, but it wants to sharply improve its merchandising, logistics and purchasing policies. Another priority for YY Sports is to cut its costs by reducing its workforce by about 10 percent per store. The cuts should not entail any redundancies in the company’s retail staff, but some of the departing staff will not be replaced.
The same concerns and priorities are echoed by mid-sized retailers such as Cheng Yiliang, the owner and managing director of Donggan 96 in Beijing. This company has about 300 mono-brand sports stores, of which 110 are run by Donggan 96 and the others are franchised. Cheng Yiliang is the brother of Cheng Yihong, the founder and manager of Dongxiang, a listed company that has the rights for Kappa in China, Macau and Japan, and a stake in Donggan 96.
The retailer did well for most of last year. It reported a sales increase of about 70 percent for the year, including a comparable sales rise of 20 percent, in spite of the economic worries that began to affect sales in November. For this year, however, the outlook has changed: While Donggan 96 had planned to open another 50 stores in the first half of this year, the schedule has been drastically revised, and the same goes for original growth forecasts of about 50 percent for the full year.
Once the current problems have been settled, there is no question that the potential for growth of the Chinese market remains huge, since international brands have barely started to tap the smaller cities and rural areas. Belle is thought to be particularly well-equipped to handle such expansion in the coming years, due to the infrastructure it has built up for its shoe business.
However, the current issues might encourage international brands to rethink their distribution strategies in China. For the last few years this could be best described as mono-brand saturation: The brands became almost addicted to store openings, as their salespeople pocketed handsome commissions and executives could report massive profits. But the issues raised in recent months have clearly shown the limits of this approach.
