The impact of the downturn is playing out differently in lower-tier cities (tiers 4 to 5) than in higher ones (tiers 1 to 3). Until recently, coveted middle-class and affluent consumers (MACs) in smaller cities were relatively immune to the economic crisis owing, among other reasons, to their lower cost of living. Their optimism made them the most attractive consumer segment in the country, as detailed in Big Prizes in Small Places (BCG report, November 2010).
Now, the tide has begun to turn. The decline in optimism in large cities is bottoming out. Consumers in smaller cities, however, are finally feeling the effects of the domestic slowdown—in fact, its impact is more noticeable in lower-tier cities—and the mood has altered. After having expressed ultra-high levels of intended spending and plans to trade up, the optimistic sentiment of small-city MACs has dropped by double digits this year. This change is driven by a number of distinctive small-city features:
More Entrepreneurs and SMEs. Entrepreneurs and small and medium enterprises (SMEs) benefited from China’s earlier investment-led economy, which included significant fixed-asset-investment (FAI) growth. In the past, FAI was growing 10 percent faster in smaller cities than in big ones and was the key driver for local economic development. In recent years, FAI growth has declined steeply nationwide because of structural changes in China’s economy. That decline took longer to reach lower-tier cities, but the drop was much more sudden and drastic. Since there are more entrepreneurs and SMEs in smaller cities, this has had an especially strong impact on the economic outlook there and, in tandem, the confidence of these cities’ MACs.
More Civil Servants. China’s smaller cities have a much larger percentage of MACs who work in the public sector—41 percent, compared with 27 percent in big cities. This makes them more sensitive to policy changes. In particular, many have been hit hard by government anticorruption campaigns in the wake of the leadership transition last spring. Since corruption in China often involves wining and dining government officials, the sternly enforced campaign had an immediate negative impact on bulk purchases at hotels, restaurants, and entertainment venues as well as on individual consumption. Some of our survey respondents said they have seen event, banquet, and hotel bookings drop by as much as one-half or two-thirds. And one city-government worker we surveyed said that the reduction in vouchers and gift cards he has received is equivalent to one-third of his salary.
Shorter Wealth History and Weaker Financial Muscle. Although their income levels are similar to those of their peers in bigger cities, small-city MACs tend to have weaker cash reserves and fewer assets because they became wealthy much more recently. (They have been a part of the MAC segment for an average 3.7 years, whereas their big-city counterparts have been there for 5.4 years.) Small-city MACs said that their cash reserves can only sustain them for ten months, half the time as for big-city MACs. This makes them less secure and more frugal. Just 57 percent of small-city MACs said they feel financially secure—a 13-percentage-point drop from last year, and 14 points fewer than their big-city equivalents.
A Heavier Family Burden and a More Traditional Mindset. The prudence of small-city MACs stems from a more traditional mindset, which means they not only put more emphasis on saving for family-related purposes but also tend to have larger families—a result of having several generations of family living together and, sometimes, of laxer enforcement of or legal exceptions to the one-child policy. (Saving for families is important to big-city MACs, too, but they are also saving with an eye to future big-ticket purchases such as property and cars.) In addition, the cost of supporting children’s education is higher, relative to income, in small cities. This is especially true when small-city children are drawn to larger cities for school or work and have to contend with a higher cost of living. Hence, 47 percent of MACs in small cities cite their children’s education and development as a key motivation for saving, as opposed to 25 percent in big cities. Small-city MACs also have more elders at home, and they face less-robust health-care resources and elder-care facilities. In small cities, 34 percent of MACs said the need to support elders is a key reason for saving, versus 23 percent in big cities.
Nonetheless, small-city MACs remain the best drivers of future population and consumption growth in China. At present, their numbers and their spending are smaller than big-city MACs, but by 2020, they will make up 27 percent of the urban population (compared with 22 percent for big-city MACs) and a solid 40 percent of urban consumption (versus 37 percent). Though consumer sentiment among them is down this year, the dip is temporary. In keeping with the pattern already playing out in big cities, sentiment will bounce back once the economy has stabilized.
Moreover, the current spate of pessimism comes primarily from middle-aged and older consumers. Younger generations (ages 18 to 34) have not felt any impact from the downturn at all and consequently are highly optimistic about the future. Their intention to spend has actually strengthened, and they comprise the most attractive segment of all the MACs in cities of any size. (See Exhibit 2.)
Companies wishing to tap into the rising opportunities that exist in lower-tier cities should expand their regional footprints, develop a customized go-to-market strategy for small-city MACs, and think about which value propositions will work more effectively for this market. They should, of course, keep in mind that the message will vary for different categories with different target-consumer profiles. For example, younger MACs are still upbeat, while mature ones are more reserved.
The overall decline in consumer sentiment does not represent the last days of an optimistic China. The future will be more volatile, and we should expect ups and downs in sentiment as the country undergoes a structural transition from investment-led to consumption-led growth. However, a slight increase in short-term pessimism should not be interpreted as headwinds for the long term. Consumerism is still on the rise, and spending is highly regarded as positive and beneficial to society. Though consumers may be choosing to spend less, they have become more sophisticated shoppers, optimizing their spending with a growing focus on quality. And the MAC population continues to grow and evolve, particularly in lower-tier cities, where China’s future consumption-growth lies.
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