Sell a clearly different product
Marketers should start by researching the consumers' needs—segmenting them into "premium needs," on the one hand, and generic benefits, on the other—and then establish a clear differentiation between premium products and value-priced variants. Johnson & Johnson, for example, was the first multinational in China to introduce midpriced sanitary-protection products. It identified leakage protection as the core generic benefit and made this the product's focus, restricting claims of comfort and superior absorption to its premium range. Similarly, value-priced variants of Procter & Gamble's Crest toothpaste focus on generic benefits such as cavity protection, leaving claims of teeth-whitening properties to higher-priced versions.
To ensure that the premium and value segments are differentiated clearly and to prevent premium customers from trading down, companies must make it possible for consumers to identify tangible variations in the taste, smell, packaging, or performance of products. Colgate-Palmolive uses relatively inexpensive flavorings for the cheaper varieties of its Colgate toothpaste and alters the packaging, for example. Procter & Gamble uses a cotton covering (less absorbent than the synthetic paper used in its core premium offerings) for the midpriced products in its Whisper sanitary-napkin category. In turn, a premium product may have to be differentiated further through promotions targeted only at people who might be likely to purchase it or through a packaging upgrade accompanied by a fractional price increase.
Differentiate at the point of sale
To discourage cannibalization, it is vital to manage distribution channels. Channel differentiation can occur on many levels: between geographic locations, between different retail channels (traditional mom-and-pop stores versus modern department stores or convenience store chains, for example), and even between different shelves in a single store. In stores where Johnson & Johnson offers both premium and midpriced variants of its feminine-protection product Carefree, for instance, it sees to it that they are positioned on different shelves. The result is a rate of cannibalization half that of the company's nearest competitor.
Piggyback on existing advertising campaigns
One of the most compelling benefits of brand stretching is the chance to reap huge savings in the cost of advertising and promotions
One of the most compelling benefits of brand stretching is the possibility of reaping enormous savings in the cost of advertising and promotions by leveraging awareness of an established brand to introduce new products. Our experience shows that launching product variants aimed at the middle market could cut advertising costs to no more than half of the 10 to 15 percent of sales a new brand would typically require. The degree to which a new product can benefit depends, however, on the strength of the existing premium brand. Where it enjoys relatively high awareness and a robust advertising share of voice, the costs involved in launching new, lower-priced products by piggybacking them on it can be substantially lower than usual. But launching new products on the back of a weak brand might not generate the sales volume necessary to cover their fixed costs.
Brand stretching can work in ChinaCareful management helps companies to stretch brands vertically and to minimize cannibalization. Eight years after the Chinese launch of Procter & Gamble's Crest toothpaste, it had established itself as the premium brand in China. By 2000, it had a commanding 50 to 60 percent share of the high-end segment. But 70 percent of the total market was in the middle and low-end segments, and competition from Procter & Gamble's biggest competitor, Colgate-Palmolive, was heating up. Colgate had successfully launched several varieties in the middle segment, capturing 10 percent of it by 2000. In response, Crest launched "power SKUs" (a term Procter & Gamble uses to describe high-volume value offerings), with a price 30 percent lower than that of its premium products and on par with Colgate's middle-market toothpaste. To reduce costs, Crest developed a different product formula, exploited the advertising materials of premium products, and relied heavily on distributors to get the product out cost-effectively to a wider range of channels where middle-tier customers shop, such as traditional supermarkets, mom-and-pop stores, and kiosks. The power SKUs helped Crest more than double its total volume share of the middle market, from 5 percent in 2000 to almost 12 percent in 2002. Of that larger volume, 3.5 percentage points were accounted for by the new middle-market products. Crest apparently achieved this with little or no cannibalization of its premium products, since these too increased their market share, to 8 percent, from 5. | ||
Brand stretching won't necessarily work for every brand or product category, nor will it be suitable for all companies. When it is done properly, though, its rewards can be substantial (see sidebar, "Brand stretching can work in China").
Bringing down costs
Targeting the middle- and lower-income consumer segments calls for products that are 30 to 50 percent less expensive than premium ones. But unless costs can be brought down proportionately, gross profit margins will quickly turn south. Foreign companies in China can ill afford to increase their costs to launch a new brand aimed at the middle or lower tiers of the market; in fact, they will need to cut their costs substantially to turn a profit. All told, local companies enjoy a cost advantage of as much as 30 percent against their foreign competitors. What should a foreign company do to bring its costs in line with those of the locals?
Less automation is one method
Manufacturing costs account for much of the difference between the way foreign and local companies operate. Capital depreciation costs rank among the biggest factors. Multinationals serving premium markets in China abide by standards of equipment quality and efficiency similar to those at their plants in developed markets. They therefore invest far more money in capital equipment than do Chinese companies. For a multinational that makes, say, sanitary napkins, the cost of a single assembly line can run as high as $15 million, against a Chinese company's $500,000 or so.
Foreign manufacturers that really want to cut their costs to local levels should consider building less automated production lines
Foreign manufacturers might think that their equipment gives them a worthwhile edge in productivity. Not so. Even adjusting for their efficiency gains, the Chinese company still comes out ahead. Although the line speed (and thus the production capacity) of an assembly line using advanced technology could be three times higher than that of a Chinese assembly line, the enormous gap in the cost of equipment means that the foreign company's capital depreciation expenses end up being six to seven times higher. A less advanced production line might require 20 people to operate, rather than 10 for the high-speed line, but low labor costs more than make up for this efficiency gap. Average wages for line workers in Chinese factories are 500 to 600 renminbi a month; even the most highly skilled workers receive no more than 2,000 renminbi. So the potential savings in capital costs from using less advanced equipment far outweigh any incremental labor cost.
Faster machines also reduce flexibility. When a company wants to change the product made on an advanced assembly line, two hours might be needed to change the equipment on it, partly because of the number and complexity of the parts and partly because it will be necessary to clear many semifinished goods on the line at the time of stoppage. Some of them could end up being scrapped if they are at a sensitive point of production. By contrast, a Chinese company, with its slower assembly lines and higher ratio of labor, might not have to stop work at all, so it can manufacture a wider variety of products on a given line, with little wastage. We estimate that the material scrap rate of multinational companies could run as high as ten times that of local ones. In the case of a multinational sanitary-napkin producer, the scrap rate runs at about 3 percent, against an average of 0.3 percent for Chinese manufacturers.
The quickest way to replace high-end capital equipment with a more labor-intensive model would be to outsource the production of new, less expensive products to low-cost local manufacturers, as Procter & Gamble and Johnson & Johnson have done in the past. Finding an appropriate local manufacturer and managing the quality of its output without assuming direct control over its manufacturing operations can be problematic, however. If foreign manufacturers are serious about reducing their costs to local levels, they should consider building their own less automated production lines.
This approach, though not yet widely adopted, isn't entirely new. For several years after Procter & Gamble launched Safeguard soap in China, the company held down costs by relying heavily on manual labor to pack soap into paper cartons. (Today, with 30 to 40 percent of the soap market, P&G has shifted toward a more automated system because it can amortize capital costs across a much larger production volume.) Colgate-Palmolive uses the labor-intensive manufacturing facilities it acquired from a local toothbrush maker, Shantou Sanxiao Industry, to supply a large chunk of the worldwide demand for its toothbrushes.
Designing products to cost targets
Materials are another huge expense for consumer goods makers. Procter & Gamble is among the handful of foreign companies that have reached sufficient scale and purchasing power in China to reap savings of 20 to 30 percent in this area. The rest can't count on negotiating favorable purchasing terms with suppliers.
Such companies can, however, reduce the cost of the materials they use by keeping specific cost targets in mind when they design products. It might be necessary, for example, to use cheaper ingredients or to remove certain ingredients from a product formulation. For many foreign companies, this strategy will involve a significant shift from the one they pursue with premium products: importing designs and formulas directly from developed markets.
Market research may be required to help companies develop product designs and formulations that satisfy their cost targets as well as consumer preferences. Procter & Gamble operates a Beijing research institute that designs products with both sets of requirements in mind.
Reconfiguring the supply chain
Foreign companies in China usually have higher logistics and supply chain costs than their Chinese counterparts do. Many of the foreigners rely on long-haul trucking, an expensive option in China considering its underdeveloped roads and high intraprovincial customs fees. What's more, a recent government crackdown on the common practice of overloading trucks by 50 to 100 percent of their capacity means that costs will increase, since trucking companies will have to invest in more vehicles and drivers to move a given quantity of goods. Shipping by ocean or river can halve the cost of transportation. This explains why Chinese companies tend to congregate near rivers and coastal areas.
Locating factories in coastal regions or close to the Yangtze River, which flows through several big inland cities, therefore makes considerable sense. In deciding between these two possibilities, companies should consider labor costs: average wages in an inland city such as Wuhan are up to 60 percent lower than wages in Guangzhou, which is near the coast. If a factory must be located close to a port facility in a coastal area, a city such as Ningbo can offer labor costs that are half those of Shanghai. Unilever recently moved the manufacture of its household and personal-care goods from Shanghai to a new facility in Anhui province, where labor costs are lower. The many other foreign companies with factories in Shanghai should contemplate following this example.
Targeting customer segments in the middle and lower price levels might depress gross-margin ratios, but it could also enable foreign consumer goods companies to scale up their business in China more rapidly and to increase their total revenues and profits dramatically. Companies that go down this road must not only give careful thought to the design and marketing of their products but also cut their manufacturing costs to levels approaching those of the local competition. Above all, the corporate headquarters of foreign companies with operations in China should challenge them to seek out the enormous growth opportunities that lie ahead and give them the support they need to do so.
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