Jacques Penhirin, Alvin Miu
December 23, 2002

Hypermarkets are poised to emerge as the winning retail format in China's fast-growing retail sector. The formula, now familiar elsewhere - big stores that offer a wide assortment of food and other merchandise - is a hit with China's shoppers, and generates better margins than other large retail models such as supermarkets and department stores. But domestic and multinational retailers intending to open big stores of their own in this market should take note: hypermarkets in China are very different from hypermarkets elsewhere in the world.

China's retail market is growing at 7 per cent a year, much faster than the sector in most emerging economies. With US$405 billion (HK$3.2 trillion) in retail sales last year, the Chinese retail market was 56 per cent larger than most other major Asian markets combined, excluding Japan, and could grow to US$713 billion by 2010. Hypermarkets are the fastest-growing segment in this fast-growing sector.

While still comprising less than 2 per cent of all retail sales in China, sales through hypermarkets have been growing at 64 per cent per year, versus 7 per cent growth for department store sales and 2 per cent for supermarkets. Sales through hypermarkets are forecast to grow by 25-30 per cent every year through 2010.

Like their counterparts in the West, China's hypermarkets draw customers with low prices. On average, goods tend to be 10-15 per cent cheaper than in supermarkets and department stores. Some players, such as Chinese hypermarket operator Nonggongshang, offer up to 20 per cent lower prices than supermarkets.

Hypermarkets can afford to charge lower prices thanks to their vastly higher volume: sales per square metre in Shanghai's hypermarkets are generally three times higher than in supermarkets. Larger volumes also enable them to negotiate better prices with suppliers, savings they pass on to their customers. Larger sales volumes and lower purchasing costs add up to better store economics. Some foreign hypermarkets operating in China earn margins of up to 3 per cent versus the 1 per cent typical of most locally managed supermarkets.

So what's so different about hypermarkets in China? In the US and Europe, hypermarkets tend to be located in suburban areas. In China, where few people own cars, hypermarkets are more common in densely populated cities. This helps the stores to maximise traffic and establish a local base of repeat customers.

With space at a premium, hypermarket operators in China have to tweak the model. They have been forced to build multi-level stores versus the typical single-level store found in the West. Customers in the West tend to load up on goods once a week and therefore spend more per visit, while Chinese customers visit the local hypermarket more frequently, spending less per visit.

So smaller shopping carts are used in China. And limited parking space leads to such creative services as the shuttle buses offered by Wal-Mart to customers in Shenzhen.

In China, traditional wet markets and supermarkets remain the predominant source of fresh groceries, and homemakers make daily trips to buy their fruits, vegetables and meats. Hypermarkets, however, increasingly compete head-to-head with these formats: about two-thirds of the goods they offer are either fresh or packaged food.

Hypermarkets in China resemble giant grocery stores laid out over several floors like multi-level department stores, with non-food items added as part of the product mix. With their much larger customer traffic, they turn food over more quickly, enabling hypermarket operators to keep their shelves stocked with fresh produce and meats.

Finding products for a hypermarket can pose a particularly daunting challenge in China, where it is often difficult to trace products back to the original producers. The hygiene standards of farmers vary widely, and regulations regarding pesticide use are either very limited in scope or loosely enforced. Thus, stocking fresh and hygienic food products is a constant challenge for both foreign and local hypermarket operators.

Finding the right location is another key challenge: competition in "Tier 1" cities such as Shanghai and Guangzhou is heating up rapidly. Enormous opportunity remains, however, in "Tier 2" cities such as Tianjin, Nanjing, Chengdu and Dalian. According to our estimates, the 33 cities in this category can accommodate 550-800 additional new hypermarkets by 2010.

While there are several strategic and operational challenges that need to be tackled, these do not seem to be holding back either multinational or local hypermarket operators. Carrefour, a pioneer in the market, has opened 31 stores since 1995 and has announced plans to open another 10 stores per year.

Until other formats respond to the challenge, hypermarkets will continue to take their share of this enormous market.

Jacques Penhirin is a partner in McKinsey & Company's Hong Kong office and co-leader of its retail practice. Alvin Miu is a consultant in McKinsey & Company's Hong Kong office.

This article was originally published in the South China Morning Post.