sra asia middle-class 2013

8/13/2019 SRA Asia Middle-class 2013

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THE RISE OF ASIAS MIDDLE-CLASSThe worlds new growth driver

SILK ROADA S S O C I A T E S

Hong Kong | Bangkok | Melbourne


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SILK ROAD ASSOCIATES | 2MAY 2013

Travel around the region and it doesnt take long to find signs of Asias ris-

ing middle-classrestaurants in Hong Kong are fully-booked, theme parks in

Malaysia are full, and the roads in Guangzhou are jammed, all as a result of theregions growing numbers of middle-class households who are finding new ways

to spend their money.

The fact that Asias middle-class is rising at the same time that the middle-

class in Europe and the U.S. is fallingas a result of stagnant job creation and real

income growthis good fortune for the global economy. And while the absolute

size of the worlds middle-class is not necessarily increasing, its centre of gravity

is certainly shifting east.

To be sure, Asias purchasing power is still lower than it is in Europe and

the U.S. for all but the wealthiest households. But the regions vast populations

help to make up for that; after all, Asia has seven out of the worlds top 20 mostpopulated countries. (The broader Silk Road region has an even higher 11 of the

worlds top 20).

Its no surprise then that we see a growing number of mid-sized foreign com-

panies from Europe and the U.S., among other countries, looking to tap into Asias

consumer demand. Thats a major change from 10 years ago when only the

worlds biggest multinationals had the appetite and resources to establish opera-

tions in Asia.

China and India offer the biggest markets: their populations of 1.4 billion and

1.2 billion, respectively, account for 36% of the worlds total and their share of

global demand will only rise ahead.

Introduction

The rise of Asias middle-classCompanies looking to benefit from Asias booming economic growth are increasingly

focused on the regions middle-class. But the rapid change in consumer demand creates both

opportunities and challenges. For foreign firms, identifying the right countries and consumer

segments is critical.


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Asias Middle Class

China is especially attractive as the spread of growth from the countrys

coastal cities to the inland regions is creating a vast new consumer market. Still,

whether foreign firms can tap into that market is less certain. Moreover, for all theattention paid to sales of Louis Vuitton bags or Audi sedans, it is sales of services,

such as health and education, that will surprise.

The rest of Asia also deser ves at tention: Thailand, for instance, has a popula-

tion of 68 million, ranking it alongside most of Europes larger countries, includ-

ing France (65 million) and the United Kingdom (62 million). Indonesia and the

Philippines are even larger and many of their citizens enjoy a purchasing power

not dissimilar to those of China.

Indeed, this is the challenge for foreign companies wanting to sell to Asias

consumersthe regions consumer demand is worth the same $-value as de-

mand in the U.S., but it is spread across more than 14 countries and evolvingrapidly. For a foreign company that means making difficult trade-offs between

countries and consumer segments.

It is also possible to destroy a middle-class, not just create one. The Asian

financial cr isis in 1997, for instance, pushed many middle-class famil ies towards,

or even below, the poverty line. Today, a sudden burst of food or energy inflation,

as witnessed in 2008, could similarly reverse many of the recent gains, meaning

companies must be prepared for volatility.

This special report is due to the combined efforts of our Hong Kong and

Bangkok offices. We have surveyed consumers in Bangkok, toured malls

in Hanoi, as well as visited private clinics in Beijing and private schools is

Pakistan; we have also scoured the local media for key anecdotes that the

English language press of ten misses. To learn more about the authors of this

report and Silk Road Associates see the final pages.


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Asias Middle Class

Introduction 2

Critical issues 6

Who is Asias middle-class? 7

Market Study: Identify the middle-class 10

Case Study: Indonesias auto-sector 12

Asias middle-class giant 14

Graph: Mapping Chinas middle-class households 17

Case Study: High-end retail in Asia 18

Case Study: Luxury goods consumption 20

Services are the future 22

Case study: Chinas health sector 24

Case study: Pakistans education sector 26

Does consumer credit matter? 28

The regions rising tourism 30

Case study: Budget airlines 32

How to destroy a middle-class 34

The Authors 36

About Silk Road Associates 37


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Asias Middle Class

Emerging Asias private consumption matches that of the U.S., but split across 14+ countries

Figure 2: Emerging Asias private consumption, on a purchasing power parity basis, matches that of the U.S.. However,

demand is spread across more than 14 countries, each ring-fenced by dif ferent cultures, investment regimes, and regula-

tory authori ties . Moreover, despite of China, India, and Korea account ing for a large share of total demand, other markets

are also emerging rapidly. It is critical companies consider carefully which countries and markets segments they will target

before executing.

Private consumption, $ billion, purchasing power parity basis

The rise of the Asian consumer is a compelling story

Figure 1: At a time when Europes economy is in crisis, the sheer size of Asias population makes the region a naturally at-

tract ive option for companies looking for alternative markets.

Size of circles represents relative size of populations

China $3,953bn

India $2,218bn

Korea $823bn

Indonesia $614bn

Taiwan $525bn

Pakistan $411bn

Thailand $328bn

Philippines $288bn

Hong Kong $229bn

Malaysia $220bn

Ten Largest Consumers

$10,729bn $10,276bn

United States Emerging Asia


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Are you ready to sell to Asias middle class?

Companies considering selling to Asias middle-class face a daunting range of op-portunities. The region is enjoying a boom in consumer demand, but consumersand competitors are also evolving rapidly. In order to benefit, mid-sized compa-nies must ask hard questions before allocating precious resources. Even multina-tionals face an increasingly complex set of trade-offs.

Silk Road Associates has identified a number of critical issues that companiesshould consider. Those able to answer in the affirmative to all the questions be-low are ready to sell to Asias middle-class.

MarketHave we identified our key markets and decided on either asingle-country or multi-country strategy?

Have we chosen to focus on wealthier gateway-cities and/orthe growth markets in second-tier cities?

Customers

Can we tailor our products to suit the changing level ofconsumer appetite and education?

Do we understand how to win customer loyalty when

competing with cheaper but inferior quality products?

Competitors

Do we understand how our cost structure differs to our localcompetitors and what makes us competitive?

Have we developed our own relationships that can help uscompete with well-connected local firms?

Business structure

Do we understand the advantages of replicating our existingbusiness structure or adapting to local conditions?

Have we decided whether to operate wholly-owned or tocollaborate with a local partner?

Have we identified the right staff to run our local operationsand are incentivizing them correctly?

Do we have the processes in place to evaluate and monitor ourlocal operations and partners?

Market institutions

Have we identified how to exploit differences in market

institutions in our target market?

Risk management

Have we identified the potential government, business, andsecurity risks in our target market?


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Estimating the size of Asias middle-class

We recently visited the Chinese coastal city of Qingdao, famous for its beer

and picturesque Laoshan Scenic Park. The beer is cheap, but the park is not, with

a tour of all the various sites costing around $70, or more than the cost of a ticket

to a Six Flags amusement park in the U.S. Nevertheless , on the day we visited, the

Laoshan Scenic Park was packed with local tourists.

A short walk in Jakarta meanwhile reveals signs of a booming local economy.

There are a growing number of upmarket malls in the city. Budget hotel chains

are expanding rapidly to cater to the growing ranks of travelling sales agents

marketing their companys goods, especially those everyday items, from biscuits

to beer, for which demand is booming.

The Chinese tourists in Qingdao are visibly wealthier than the Indonesian

households in Jakarta. But both groups have money to spend, making them a

target for companies . That makes it more usual to measure the middle-class in

terms of specif ic segments, or income thresholds, with a par ticular focus on the

lower-, middle-, and upper middle-classes.

Our estimates are based on academic models. But we find these tend to

use surprisingly low thresholds, and our own preference is to use slightly higher

benchmarks for annual per capita income$5,000, $7,500 and $10,000as

measured in US dollars and adjusted for purchasing power parity (PPP).

The results vary hugely depending on the threshold used. If we use the lower

threshold of $5,000 per capita then Emerging Asia has a middle-class some501 million strong, or not dissimilar to the size of the U.S. and Europe combined,

Who is Asias middle-class?

Identifying multiple consumer segmentsThere is no single definition of the middle-class. Ins tead, the middle-class is composed of

multiple segments, each with a different level of income and purchasing power. The upper

middle-class might attract media at tention, but sales among the lower middle-class are strong.


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Asias Middle Class

clustered in some 150 million households. On this basis, China accounts for the

largest share at around 70% and the rest is evenly split between ASEAN and

South Asia.

But raise the threshold to $7,500 per person and the size of Emerging Asias

middle-class drops to 286 million people in some 86 million households with

the shares relatively unchanged. Raise the threshold again to $10,000 per per-

son and the middle-class shrinks to just 123 million clustered in just 35 million

households (albeit the estimates of the upper middle-class are less precise owing

to their smaller numbers and of ten grey sources of income.)

These results should also be used as an indicative, rather than as a precise,

measure of the middle-class. Estimates vary between countries for a number of

reasons, including: simple data quality issues; challenges in distinguishing be-

tween income from salaries and family-owned business; and the reliabilit y ofpurchasing power parity measures.

But the most important conclusion remains the sameChina accounts for

the largest share of the regions middle-class regardless of the threshold applied

and even af ter including India.

Its no wonder then that the worlds multinationals are so focused on China,

especially the countrys interior provinces where half of Chinas population is

found. Still, the inter ior provinces are not always easy places to sell to, and are de-

scribed by some regional CEOs as high-cost, low-yield, and highly-fragmented

(see our separate report on MNCs in China), and we would also caution against

becoming overly focused on just a single country.

How big is Asias middle-class?

Figure 3: Asias middle-class is large in numbers, albeit still small as a share of the regions total population. At all benchmarks,

Chinas middle-class is far larger than that of the rest of the region combined, including India.

Million people and Asias middle-class as a share of regions total population by income bracket

Source: World Bank, IMF, SRA: Note all f igures are based on purchasing power parit y.

Size by region (millions) Share of region (percent)

US$10,000 and above

US$7,500 and above

US$5,000 and above 16

8

4

412

204

69

81

43

16

78

39

39

China ASEAN South Asia

There are no strict

definitions of who is,

or isnt, middle-class


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Asias Middle Class

Indeed, few companies have ambitions to target the entire Chinese market.

Moreover, there are 274 cities across Emerging Asia with a population greater

than 750,000. All have a sizeable and growing middle-class that can materiallyboost sales revenue and, when compared to China, many also have lower barri-

ers to entry for foreign firms and higher margins.

Moreover, the equally important lesson is the relative size versus purchasing

power of the lower-, middle- and upper middle-class, each of fering different sales

opportunities.

Consider how the global cosmetics firm LOreal sells low-cost sachets of

high-end beauty products in India and so taps into the aspirations of the coun-

try s lower middle-class, or how the global consumer goods company Unilever

sells sachets of Pepsodent toothpaste, Brooke Bond Red Label tea and bars of

Lifebuoy soap for a few rupees.

Then there are the global luxury goods brands selling handbags, watches,

and shoes in China to the core middle-class. Indeed, 19 foreign luxury brands

have opened an astonishing 899 stores in China, of which only 295 are located

in the major cities of Beijing, Shanghai, Shenzhen, and Guangzhouthe rest are

in smaller second- and third-tier cities.

Consider also the regions low-cost airlinesAir Asia, Tiger Airways, and

Cebu Air, to name just three of over 40 airlinesthat are benefiting from a grow-

ing number of core to upper middle-class families travelling abroad, such as Chi-

nese scuba-diving in Malaysia or Indians enjoying Balis traditional Hindu culture.

And there are the regions private healthcare providers, such as Singapores

ParkwayHealth or Koreas Samsung Health, which are expanding rapidly by deliv-

ering world-class day clinic and surgical services to upper middle-class families

in hospitals that often appear no different than 5-star hotels, and into countries

with already high quality public health services.


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There is no consistent measure to define who is, and isnt, middle-

class. For governments, matching expecations with economic reality

can be crucial for political stability. If the large majority of a country

feels middle-class, but dont enjoy the economic benefits, they may

grow disatisfied. But for foreign companies, does it matter whetherhouseholds believe they are in fact middle-class? Does it change the

way they aspire to own automobiles or take holidays?

Do I feel middle-class?

In China and India it is common to hear talk of the laobaixingand the

common man. The two terms have been popularly used for decades to

describe the millions of people who are not yet part of the upper-class,

typically working in factories, off ices, and government departments . For

years, they described the average man and woman.

But much has changed in the past decade. The rise of the middle-

class has created a new economic and political force, squeezed between

the working class and the wealthy.

But who are the middle-class? It is a slippery term that differs mark-

edly by country. The chart on the following page illustrates this point. It

shows the share of respondents across a number of key Asian countries

who consider themselves to be middle-class as against the more ob-

jective measure of GDP per capita (in nominal US dollars) for the same

countries.

The results are star tling: India and Vietnam have a similar per capitaGDP at around $1,400, yet over 51% of Indians consider themselves to be

middle-class compared to just 14% of Vietnamese. China and Thailand

likewise have a per capita GDP of around $5,000, but 65% of Thais see

themselves as middle-class compared to only 48% of Chinese.

Households might claim to be middle-class for cultural, social or his-

torical reasons, yet they are more rightly considered working class on the

basis of their purchasing power, such as in Indonesia. By contrast, other

households might claim to be working class even if they own a car or

house, and yet are genuinely middle-class, such as in China.

MARKET STUDY

Surveying consumers on their perceptions of whois middle-class

There is little relationship

between perceptions

and GDP per capita when

determining who is middle-

class


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Asias Middle Class


Such slippery definitions can create headaches for

authorities. The Chinese Academy for Social Sciences, for

instance, recently discovered the risks after publishing areport on Chinas middle-class: critics attacked the report

for sett ing an excessively low income benchmark , arguing

that i t included many families who didnt feel middle-class

based on their spending power.

There are more objective measures. Car-ownership, for

instance, is a popular measure given that many households

will buy a car as soon as they can afford it and auto sales

certainly take of f at around the $4,000 level (see the Case

Studyon page 11). Still, in Asias dense ci ties, car-ownership

isnt always an option and public transport is cheap.

The realit y is that the middle-class is made up of mul -

tiple layers, each with dif ferent tastes. The most successful

companies naturally distinguish between each layer as par t

of their commercial strategies.

Moreover, there may be an arguement that the aspira-

tion to be middle-class is greatest in those countries, such

as China, where the large majority of the population of the

country view themselves as working class. Buying Louis

Vuitton handbags, for instance, is a demonstrative way ofchanging your status.

It would certainly help explain why public demonstra-

tions of wealth play such an important role in the rise of

Chinas middle-class relative to other countries. And it might

be that other countries such as India and Vietnam, where

perceptions of middle-class status are similarly low, will fol-

low in a similar track. If so, thats good news for the worlds

branded goods companies.

For those looking to change theirstatus, public demonstrations of wealth

are important

14

48

51

65

74

81

Vietnam

China

India

Thailand

Korea

Indonesia

Are you middle-class?

Figure 4: What is your class? The answer of ten depends less on economics and more on culture and societ y. When asked whether

they def ined themselves as middle-c lass, respondents had surprisingly dif ferent answers.

Percent share of individuals defining themselves as middle-class and GDP per capita in $ (2011)

Source: Values Survey Databank

$3,512

$22,424

$5,395

$1,514

$5,417

$1,374

A similar number of Indonesians and Koreansbelieve they are middle-class. Yet Korea has aGDP per capita seven times higher.


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The rapid growth of Indonesias consumer demand over the past five

years has produced record sales growth for many consumer product

multinationals. To be fair, households that are not yet middle-class

account for the biggest gains, as they consume more everyday goods.

However, the growth in the countrys auto-sales also tells a powerfulstory about the rise of a true middle-class that has money to spend on

durable goods.

Rising car sales (and traffic jams)

Indonesias auto sales have surged in the past two years, in an almost

identical repeat of events in China between 2009-10. When combined

with a lack of investment in infrastructure, the result is worsening traffic

problems, with one of our colleagues recently stuck in a five-hour traffic

jam in Jakarta. But s tronger sales are also an indication that Indonesias

middle-class has reached a cri tical tipping point.

Car sales are an important benchmark for the middle-class. On a per

capita GDP basis, car sales start to accelerate rapidly at around $4,000.

The char t below shows how China, Korea and Thailand have all crossed

this threshold with the result that their auto sales subsequently surged.

For Indonesia, the countrys GDP per capita, PPP-basis, also crossed the

$4,000 threshold in 2009, implying a rapid increase in middle-class de-

mand, especially for autos.

It is no surprise then that Indonesian auto sales increased by 17% in

2011, to reach 900,000. Estimates for 2012 are also frothy and on track

to rise an even larger 23% to 1,100,000 units. That already makes Indo-

nesia a larger car market than Australia and Spain, and on a trajec tory to

pass Italy and the United Kingdom around 2015.

Ironically, the Indonesian authorities have been so concerned about

the industr ys growth that they have tried to apply the brakes. Minimum

down payments on cars have been increased from 20% to 25-30% of

the sales price (around 65% of car purchases are still financed by con-

sumers); the Governor of Jakarta has even directly asked car firms to re-

duce sales growth by limiting supply (not even China has attempted such

direct intervention!)

MARKET STUDY

Indonesias auto sector and the countrys growingconsumer class

Indonesias auto sales are

booming as GDP per capita

crosses the critical $4,000threshold


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Asias Middle Class


Even so, nothing appears able to dampen the momen-

tum of car sales, especially as many showrooms are now

using sharia lending rather than traditional credit channelsto supply consumers.

But surging auto sales are only a small part of what is

a major consumer boom in Indonesia. Sales of fast mov-

ing consumer goods, such as biscuits and beer, are also

surging, and while these products are consumed mainly

by households that are not yet middle-class, the strength of

sales has raised hopes that Indonesia is on the verge of an

even bigger consumer boom.

Car sales are just one indication ofIndonesias rising spending on other

goods and services

Moreover, the fact that Indonesia has 15 cities with

populations greater than 750,000 is further reason to add

the countr y to a regional commercial s trategy, rather than

focusing on China alone. Indeed, Jakartas GDP was worth

$120 billion in 2011, the figure having doubled in five years,

making it larger than the national GDP of Vie tnam and only

a little smaller than that of New Zealand.

Multinationals are responding: Ace Hardware, a U.S.

home appliance retailer, is investing $20 million to expand

its retail outlet network; LOreal is shortly due to open itslargest factory in the world; Procter & Gamble is similarly

planning a factory in West Java to produce infant products;

IKEA will open its first store in 2014; and IBIS is rapidly ex-

panding its hotel network.

Foreign companies looking to enter the Asia region for

the first time have often adopted a China-only strategy

given the size and wealth of the country s middle-class. But

ignoring Indonesia is increasingly difficult to justify as GDP

per capita crosses the $4,000 threshold and the countrys

consumers, both middle-class and those aspiring to be

middle-class, go shopping.

Mapping Indonesias growing consumers

Figure 4: Indonesia has a large number of heavily populated cities, albeit the numbers fall when measuring only households earn-

ing more than $10,000 (PPP-basis) per year. Consumer goods MNCs are zeroing in on these cities.

Number of Indonesian cities with households earning more than $10,000, PPP-adjusted, per year

Source: Statistics Indonesia, SRA

More than 100,000

50,000 to 100,000

30,000 to 50,0000


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The lobby of the St. Regis Hotel, on the 75th floor of the KK100 skyscraper

in the southern Chinese city of Shenzhen, has a remarkable view of the entire

cityits possible to see the bustling shopping district of Luohu to the east, thenew financial district of Futian to the south, and even as far as the industrial parks

in the citys outlying districts.

It is these industrial parks that turned Shenzhen into one of Chinas wealthi-

est cities over the past three decades with a population of around eight million

and an annual GDP of $180 billion. To put that into perspective, Shenzhen has a

similar sized economy to Peru, Kazakhstan or Algeria, and its all visible from the

75th floor of the KK100.

There is no doubt China is the worlds most populated countr y. But the speed

of wealth accumulation in cities such as Shenzhen is equally remarkable with

GDP per capita, on a PPP-basis, having doubled since 2005 to reach $8,387 in2011. Compare that to India, with a similarly large population, but where GDP per

capita is s till just $3,663.

The results are also evident in the size of Chinas urban middle-class . Using

official data, we can calculate the spread of the urban middle-class across 10

different income brackets. The results show a surprisingly robust middle, with

over 41 million households (equivalent to 127 million people) earning between

$15,000 and $20,000, on a PPP-basis. (Note that the $-figure is per household,

rather than per person.)

Its no surprise then that foreign companies are making significant efforts to

try to understand Chinas middle-class and its spending habits . So far sales of

Asias middle-class giant

Tapping into Chinas fast growing middle-classChinas middle-class is larger than the rest of the regions middle-classes combined. It is also

has a strong core middle-class. Nevertheless, there are challenges, especially in the interior

provinces where local companies are well-established, making joint-ventures increasingly

popular.


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Asias Middle Class

watches, handbags and cars have captured the worlds imagination, and rightly

so given that China is accounting for a rapidly rising share of global sales (see

page 16).

Yet there are other equally important phenomena that explain Chinas rising

middle-class, and the opportunities and challenges for foreign firms wanting to

sell to the country.

For a start, Chinese households tend to spend more on services, relative to

goods, as they grow wealthier, much like Western households; after all, there are

only so many Louis Vuitton handbags or Cartier watches the typical individual

can possess. By contrast , there is a vast range of services on offer, such as private

school tuition, gym memberships, or overseas holidays.

The data show that households earning $15,000 per year (PPP-basis) spend

around 16% of their total consumption on transport and communication ser-

vices, whereas a household earning $5,000 spends just 9%. The same wealthier

households also spend a higher 13% on education and recreation as against

10% for lower-income households.

Next, wealthier Chinese households account for a large share of overall con-

sumer spending, again much like wealthier Western households. However, the

fact the Chinas wealthiest 25% of households account for a huge 50% of urban

consumption is often overlooked in socialist China. (Indeed, the wealthiest 50%

account for 75% of spending.)

Chinas urban middle-class has a solid middle

Figure 5: Chinas core urban middle-class is surprisingly large, according to official data, with

18% of households earning between $15,000 and $20,000. Moreover, these figures might be

even higher if taking into account undeclared earnings.

Million households arranged by five income brackets ($, annual income, PPP-adjusted)

Source: CEIC; SRA calculations

$25,000

$20,000

$15,000

$10,000

$5,000

China

5 million households

>

sra asia middle-class 2013

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