The flotation of China's largest hypermarket operator Sun Art Retail Group has highlighted the recent rapid growth in the sector and the potential that retailers believe the channel will continue to have. International chains have made their presence known in the country's main cities. Now, second- and third-tier cities are driving growth and becoming increasingly attractive targets for further expansion but, as Wang Fangqing reports, competition is fierce.

That China offers the international branded food sector huge opportunities has long been a cornerstone of corporate strategies but new regional markets are developing, with smaller, provincial cities becoming richer.

The benefits that China's widening urbanisation can have on the country's largest businesses have been highlighted by the listing of Sun Art Retail Group, the country's number one hypermarket operator, in Hong Kong this week.

Investor interest in Sun Art was high, with the retailer's IPO raised HK$8.2bn (US$1.05bn) and shares in the company surged almost 50% on first-day trading to HK$10.58 a share, up on the initial price of HK$7.20.

A joint venture between French retailer Auchan and Taipei-based Ruentex Group, Sun Art runs 197 hypermarkets across mainland China under two names – Auchan and RT-Mart, earning CNY56bn (US$8.69bn) in 2010, up 23.7% from 2009, according to a Sun Art spokesman.

China's regions are helping to fuel rapid growth in the country's hypermarket channel. Data from Euromonitor says the sector is growing at over 15% a year and analysts predict that sales from hypermarkets are expected to reach CNY911.3bn in sales by 2015.

Sun Art declined to comment further ahead of its shares trading in Hong Kong but an indication of the retailer's belief in the continued potential of the hypermarket format in China came in its IPO prospectus when it said it had secured 121 locations for further stores and 51 hypermarkets were "under development".

The retailer is market leader, accounting for 12% of sales through hypermarkets in China, according to Euromonitor. However, a clutch of rivals are not far behind. Wal-Mart Stores has a market share of 11.2%, local retailer China Resources Enterprise holds 9.1% of the market and Carrefour is fourth, with a market share of 8.1%.

Speaking to just-food, Ed Chan, the CEO of Wal-Mart's business in China, says growth in the hypermarket channel is being generated by the fast pace of urbanisation outside major cities such as Beijing and Shanghai. Lower-tier cities, and even small towns, offer ripe markets for cost-conscious retailers such as Wal-Mart, which already has 345 stores across China.

"Our stores can be seen in over 120 cities in China, and 80% of them are in tier-two to tier-four cities. Emerging cities and markets will be our focus in the future," Chan explains, adding that consumption in these cities is burgeoning.

And it is not just the big international players that benefit: local privately-owned food retailers are also prospering.

Better Life Commercial Chain Share Co., a private retailer based in Xiangtan city, Hunan province, is a good example. Founded in 1995, the group operates supermarkets and hypermarkets under the Chinese name Bu Bu Gao in Hunan province and the neighbouring Jiangxi province.

As the first listed privately-owned retailer in China, Better-Life now owns 104 stores. A new store in Yueyang city, Hunan, is due to open this December.

Yu Shuhua, director of the research centre at the Beijing-based China Commerce Institute (CCI), claims local retailers have the advantage and argues that state-owned and multinational retailers find it hard to compete.

"They know the local consumers best – what kind of food they love, how much they are willing to spend, and even the way to display the products. Also, in terms of logistics, they are familiar with the local suppliers and distributors, which saves them a lot of energy and time on outsourcing," she says. And Chinese food consumers are often loyal to established retailers, so it makes sense to get in first. Newcomers could struggle later, she warns. "Local people are already so used to the local stores."

Yu also argues that hypermarkets may not suit every region. Different-sized stores, she says, are essential in China and this has fragmented regional markets.

"The hypermarket represents a western lifestyle, so it is not for everywhere," Yu says. "In the vast rural areas and small towns, where people are used to going to local grocery stores, small to mid-sized community-orientated stores are preferred."

It seems the big chains are aware of this. Yu highlighted Wal-Mart's Discount Compact Hyper, a mid-sized, simply designed chain of stores launched last December. Targeting low-income consumers who are still concerned about quality, the US retailer expects the store to tap the emerging next generation of branded food consumers in the newly growing provincial cities.

Meanwhile, competition is heating up, with retailers struggling to distinguish themselves to get more customers.

However, Yu argues that, after more than a surging decade of development in China, stores are increasingly offering similar services in big cities and this trend will probably continue nationwide. "Ultimately, it is the price and quality that can attract more customers," she said.

This could play to the strengths of Wal-Mart, which has long been known for its firm control of costs through global sourcing and its advanced supply chain management. More importantly, it has also developed a comprehensive supply chain within China, building a partnership with more than 20,000 Chinese suppliers, who contribute over 95% of the products sold in the retailer's stores. It is also buying more vegetables and fruits directly from local farmers but Wal-Mart says this is not only driven by cost but also quality.

At present, the CCI's Yu says that, in general, foreign retailers have been better at cutting cost than their Chinese counterparts. "For example, Chinese suppliers like to work with foreign retailers because they pay on time, and it gives foreign retailers the upper hand when it comes to negotiating prices,” she said.

However, there is set to be a lot of growth up for grabs. No retailer has yet to dominate the sector and competition will be fierce. Sun Art, backed with the proceeds from its IPO, hopes it can steal a march on its rivals.