15 July 2016

The MME Opportunity and Economic Outlook

Despite the forecast for lower GDP growth, the Chinese Communist Party’s goals initially outlined for the 13th Five Year Plan seek to bolster infrastructure, improve operational costs and open consumer access for mid-market enterprises (MME).

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China’s Five Year Plans (FYP) are macro social and economic roadmaps created by the Central Committee of the Communist Party of China. Decisions to encourage development of e-commerce, logistics, services and transition out of an investment-dominated economy were all aims of the 12th FYP. Companies operating in China use the FYPs as guides to where government aims to spur development and encourage business activity.

China’s 13th Five Year Plan (FYP) announced in late October 2015 comprises key development themes for the upcoming 13th FYP that are guiding principles for pinpointing opportunity for international companies:

  • Innovative: including Internet Plus, a government initiative that aims to integrate mobile Internet, cloud computing, big data and the Internet of Things with modern manufacturing
  • Coordinated: tackling geographic economic imbalances through initiatives that integrate cities and preferential zones in to integrated economic regions
  • Green: supporting the development of green technology, environment protection and sustainable economic growth
  • Open: further economic opening up, including internationalization of the RMB, further loosening of capital accounts and capital flows, outbound investment and M&As
  • Shared by All: promoting further urbanization and migration, from farm areas to cities, and aim to double both urban and rural incomes between 2010 and 2020

The policy shift towards quality of development (rather than speed of development), began with the 12th FYP and is likely to continue through the 13th. This focus on increasing consumption as proportion of GDP and bolstering the services sector, while seeking to open up less developed markets in China means that MMEs can employ more regionally-focused business strategies. MME may be able to leverage pockets of faster growth where investment and overhead costs may be lower and consumers are seeing faster income growth.

Coordinated regional development

The central government is continuing its massive urbanization and inland development measures, particularly in Western and Central China, where the aim is to level regional income disparity and increase economic diversity. These policies have led to stronger growth in inland cities like Chongqing municipality and Guizhou province in Southwest China, which saw GDP grow by 11% and 10.8% in the first 3 quarters of 2015, compared to global metropolises Shanghai and Beijing’s respective 6.8% and 6.7% growth over the same period1.

“Economic growth in China today is more disparate. With some parts of the country growing at 11% and others at 3%, this is telling us the consumer strategy around the country is different,” says Jose Rasco, Head of Investment Strategy, HSBC Private Bank Americas.

The 13th FYP’s focus on “Coordinated” regional development will create more economic integration across neighboring cities and regions, like the Jing-Jin-Ji zone around Beijing-Tianjin and Hebei. Growing such regional hubs will lead to better developed transportation and logistics systems, and as a result, MMEs once tied to or focused on China’s well-developed coastal areas will find more cost incentives to base operations in the interior. An additional option stemming from these policies is to operate near (rather than in) expensive locations for proximity to markets, infrastructure and economic ecosystems; for example, in Hebei province near Beijing, or in Jiaxing city near Shanghai.

Points of access

The key policy term "Open" is illustrated with continued rollouts of experimental Free Trade Zones (FTZs), with the Shanghai Free Trade Zone the first to be established in 2013. The FTZs offers companies lower barriers of entry to Chinese consumers through faster company registration procedures, and access to supporting ecosystems within the FTZs. In 2015, the introduction of three (3) new zones in Tianjin, Guangdong and Fujian has increased points of access to the Chinese market, as well as more convenient access to the flourishing e-commerce market in China for MMEs that do not have massive budgets for investment in brick and mortar presence.

"In general, FTZs have a positive impact on e-commerce in China. There are lower barriers to entry, and MMEs can work with other companies registered in the zone. Under existing laws, limitations on foreign e-commerce operators to establish online stores in China are strict, however, certain foreign e-commerce operators without a physical presence in the country may directly set up online stores, depending on the goods they sell, which marks a step in the right direction for such a booming industry," says Stephen O’Regan, an Associate in the International Business Advisory of Dezan Shira and Associates in Guangzhou.

In addition to accessing China at specific geographical points based on their respective specialties (eg, the Guangzhou FTZ is popular for shipping and with e-commerce companies), MME strategies post- entry may also look at targeting suitable pockets of growth within the country for their sectors.

For example, certain cities have larger pools of labor with more specialized skill sets. Dalian is a second tier city along China’s northeast coast that has attracted many outsourcing companies, with a focus on Japanese and South Korean companies as clients. "This has since led to a large pool of Japanese and Korean-speaking workers in Dalian, benefiting MMEs with business operations in East Asia," says Wandy Chan, Head of East China at TMF Group. In addition, the presence of many expatriates from Japan and South Korean have increased demand for products from those markets, a niche demand MMEs can fulfill through e-commerce.  

Accessing the consumers with rising disposable income

For MMEs selling in to China, one way to find larger consumer bases is to  look for regions of faster income growth. China’s National Bureau of Statistics reported growth in disposable incomes of rural residents in the first three (3) quarters of 2015 which surpassed that of urban ones, at 8.1% versus 6.8%, beating the national average growth of 7.7% as well2. In addition, consumption has grown to 60% of GDP in the first half of 2015, with stronger spending domestically and overseas3. With faster income growth stemming from lower tier cities, MMEs could look to skip increasingly saturated and competitive consumer spaces like Shanghai and Beijing, and directly enter the market in emerging consumer bases. With more streamlined focus, MMEs can allocate China market budgets more efficiently.

Technology is the answer to reaching these customer segments with rising incomes. "Making use of technology is very important in the China market, as domestic e-commerce is huge. The consumers in China are very adaptable to new technology and willing to try new things, like making bank transactions and payments on mobile phones and scanning QR codes for deals," says Wandy Chan.

To illustrate the scale of e-commerce’s reach, China’s e-commerce retail sales were expected to increase by 42.1% in 2015 to USD 672.01 billion, with the market expected to reach USD 1.57 trillion by 2018.  4/5 For MMEs that do not have the MNC-scale budgets of investing in distribution and owned-store space, reaching the emerging Chinese consumer is a matter of these low-cost leveraging fast-expanding channels to maintain profitability. 

Balancing costs of establishment

National-level policies to broaden the economic mix and grow the service industry also create benefits for international services firms of all categories. The tax reform of the service industries to a VAT tax system has benefited sectors such as professional services, real estate, telecommunications, transportation and logistics. "These measures, which will likely continue through 2016, will help MMEs to transfer tax costs to end users, as well as lift the burden for service providers," says Wandy Chan.

Just as lowering tax costs help in raising profitability, social policy measures may in the future mitigate employee costs in China. When it comes to mitigating HR costs, minimum wage raise targets in the 12th FYP appear to heavily increase staff costs that are already relatively high in Asia. However, central policies to build a national social security system and unified insurance program are likely to decrease overall employee costs: "In China, if wages are RMB 10,000 then- as an example- an employer may be paying RMB 5,000 for each employee’s social insurance. But if the government pays an increasing proportion of this social insurance the corporate sector’s burden will be lightened, equal to a tax cut to employers," says Xiaoping Ma, Macro Economist at HSBC China.

In addition, as the Chinese government continues to promote urbanization of rural areas and migration in to cities, movement of workers from rural areas to third, fourth, fifth and lower tier cities will likely create opportunities to find pools of labor at lower base salaries. For instance, minimum wage in Chongqing was RMB 1,250 in July 2015 - far lower than Shanghai’s RMB 2,020. For MMEs, changes in staff costs impact bottom lines more than those of MNCs. Zoning in on regions with lower employment costs but growing labor pools will mitigate high costs of investment capital.

"Inland areas may take longer to reach, but lower labor costs keep our clients in China, where infrastructure is more developed than competing countries, and where the market is larger as well," says Jose Rasco.

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