For many foreign food and beverage companies in China their failure to make a profit and, indeed, to incur significant losses, is down to one phenomenon – the Chinese wholesale system.
While it is true that the ongoing economic reforms and market liberalisations have reduced the power of wholesalers (as well as some spirited undermining by the likes of French retail giant Carrefour) they remain crucial to any FMCG distribution strategy.
Wholesalers in China are a legacy of the socialist command economy put in place after the 1949 revolution and modelled largely on the system in the USSR. The state held the monopoly on distribution and massive wholesale corporations were created controlling logistics across China’s vast expanses. Most of the wholesale corporations were integrally part of city, provincial or local administrations.
As the command economy was rolled back under Deng Xiaoping it became apparent to the people who ran the wholesale corporations that they were extremely powerful in the economy – they retained their links with the authorities but were partially freed to start making a profit. They profited well, effectively controlling a region’s food supply – they were able to dictate terms and enforce their edict on manufacturers, suppliers and retailers. If they didn’t carry your product or decided they didn’t like you or you didn’t accept their often preposterous terms and conditions then your product stayed out of their area – national penetration was denied you. This led to instances of corruption and bribery.
At first foreign companies played the game – and it cost them – not just in long banquets and damaged livers but also in cold hard cash. The rush into China in the 1980s and 1990s meant that wholesalers could play brands off against each other and push up prices – what one writer called a game of ‘one sided poker’. Companies handed over goods on credit – credit that was never paid by the wholesalers. All this came on top of the poor state of the infrastructure that led to massive waste, breakage and spoilage. Legal remedies to recover goods or cash were few and far between – legal decisions winnable but rarely enforceable. All it did was annoy the wholesaler. The result has been literally millions and millions of dollars written off by foreign companies in lost goods and money.
Things are changing in the wholesale sector though much of that traditional distribution framework remains in place, albeit in an eroded state. WTO membership promises major liberalisation to China’s distribution sector, though liberalisation in the logistics sector will take longer. With immediate effect from China’s accession to the WTO in December 2001, foreign firms have been able to invest directly in distribution and supply chain management. This may finally start to change the odds in the game of one sided poker.