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Innovation and Individualism Driving Change in China

As Alibaba’s IPO garners international headlines and a new class of luxury labels break into the Chinese market, China is as ever, a conundrum of change. Shaun Rein, managing director of China Market Research, a strategic market intelligence firm, has tracked China’s ascent, which he outlines in his upcoming book, “The End of Copycat China: the Rise of Creativity, Innovation and Individualism in Asia,” available in October.

Sourcing Journal spoke to Rein about China’s position as a global producer, its consumers’ newfound appreciation for unique designers, and how innovation will change the world’s perception of the country and its manufacturing capabilities.

SJ: What is the key change in consumer trends in China? What brought this change on?

SR: For years Chinese consumers wanted to buy the flashiest luxury brands with easily recognizable logos such as Louis Vuitton (LV) and Gucci. Chinese became the second largest buyers of luxury goods in the world and luxury houses needed to change their supply chains to sell to the Chinese consumer. Over the past year luxury sales have been dropping with formerly popular brands like LV falling out of favor. In part, the slowdown has been due to the crackdown on corruption by President Xi, but a large part is due to the maturation of the Chinese consumers.

They no longer want bling and the same brands. They are willing to try new brands which explains the popularity of Michael Kors, Tory Burch and another new premium to luxury brands entering the market. Brands need to understand that there are great opportunities to carve out new niches. Also important is that consumers are looking for experiences, which is why tourism and cinema-going is soaring. Last year, 113 million Chinese travelled abroad, up from 50 million in 2010.

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SJ: What innovations have shifted China from its copycat ways to a more creative locale?

SR: Over the past 30 years, China was so far behind technologically from America and western Europe that it did not make sense for Chinese companies to focus on innovation and R&D. It was much easier to rely on technology transfer, and there was too much low hanging fruit. I might add, this is exactly what America did in the late 19th century when it transferred technology from Europe, or as Japan and South Korea did at the start of their economic growth. But over the past few years, as I pointed out in my previous book “End of Cheap China,” margins have been squeezed in China due to soaring rents and wages.

As a result, Chinese firms have had to focus on innovation and moving up the value chain in order to survive. The search for profits, and a maturing industrial base, have forced innovation.

SJ: What should manufacturers be watching out for in terms of China’s progress as a producer?

SR: Despite China’s high costs, the country won’t lose its overall manufacturing dominance anytime soon. It has far superior infrastructure in place. Other markets like Indonesia, Cambodia, Sri Lanka will gain in light industry but those nations do not have a large enough trained labor pool and infrastructure in place. What will happen in China is that manufacturers will have to automate more, train employees better and focus on higher value added products. In “The End of Copycat China” I have a case study in production line innovation that Italian mannequin manufacturer Almax has done in China. They built a state of the art factory in Shanghai by innovating in the production facility, making it zero waste and automating much of the process. They are now able to get product to clients faster than ever before and the have seen huge market share gains.

SJ: How can brands and manufacturers compete with the Asian giant?

SR: What worked in China three years ago might now work anymore and certainly won’t work three years from now. It is important that brands and manufacturers really understand the drivers changing the economic landscape—the consumer and political driven ones—and re-address how they approach China. Before the market was relatively small and there was little competition so it was easy to forgive small mistakes but now the stakes are too high. China is the largest market in the world for Porsche, Qualcomm, and KFC so profits are to be made but savvy, well-capitalized domestic Chinese brands are rising.

SJ: How are rising costs in China affecting the market? And how is China dealing with these increases?

SR: The government has set urbanization of 3rd-5th tier cities high on the priority list. This is causing rents to go up, so it is very difficult for retailers and expensive to get good locations. Rents are higher in suburbs in China than in most other urban cities in America, so the hypermarket model for instance just does not work here as in America. Moreover, pollution problems are so bad right now that many consumers tell us they do not want to shop outside. The result is consumers prefer to shop online, and retailers are finding it is cheaper and more profitable to push e-commerce.

SJ: What has Alibaba in particular done to position itself as the e-commerce leader that it is?

SR: Alibaba has become the giant in the country for e-commerce—they have so much eyeball traffic that retailers want to sell there and because so many retailers are there consumers keep shopping there. We expect e-commerce to grow 35 percent a year for the next three years with Alibaba benefitting the most. That said, Alibaba is facing a serious threat from mobile shopping. Another Chinese internet giant, Tencent, dominates mobile so Alibaba has been on an acquisition spree in the past six months scooping up mobile players.

SJ: What’s next for China?

SR: China’s growth will undoubtedly slow over the next few years. The 10 percent growth rates of before are gone, and frankly, that is good because there was too much overcapacity in some sectors, rising non-performing loans and too much pollution. President Xi is now focused, rightly, on more sustainable growth. The real exciting opportunities will come not in tier one, famous cities like Shanghai and Beijing, but in the central and western part of the countries like Sichuan. Those are the regions that the government is pushing urbanization and where costs are still attractive enough for companies to relocate to.

The world also better get used to innovative global Chinese brands. Companies like Tencent (specifically with their WeChat tool) or handset maker Xiaomi are becoming global brands in southeast Asia. Sooner than people realize they will make great inroads into the U.S. and Europe.