Demographic shifts and a burgeoning economy will unleash a huge wave of consumer spending in urban
Diana Farrell, Ulrich A. Gersch, and Elizabeth Stephenson
2006 Special Edition: Serving the new Chinese consumer
The lure of
However, fixating on the urban-affluent consumer could mean that companies fail to capitalize on the dramatic changes that lie ahead as
Although producers of luxury goods may continue to cater only to the wealthiest households, other companies—especially manufacturers of mass consumer goods—can win the bigger prize by broadening their focus to include the emerging middle class. Because tomorrow's middle-class consumers are today's urban workers (dispersed across many cities and still relatively poor), serving them will naturally require a company to change its strategy significantly. Early movers, such as Coca-Cola and P&G, have already begun creating models to target this segment profitably.
Recognizing tomorrow's middle class
The rising economy in
Rapid economic growth will continue to transform the impoverished but largely egalitarian society of
As this economic tide rises, we anticipate two phases of steep growth in the middle class, with waves of consumers in distinct income brackets emerging and receding at specific points (Exhibit 2). The first wave, in 2010, will be the lower middle class, defined as households with annual incomes of 25,001 to 40,000 renminbi. A decade later the upper middle class, with annual household incomes of 40,001 to 100,000 renminbi, will follow. These numbers may seem low compared with consumer incomes in the world's richest countries—current exchange rates and relative prices tend to underplay
By around 2011 the lower middle class will number some 290 million people, representing the largest segment in urban
Two features of
Second, the urban middle class will dwarf the current urban-affluent segment in both size and total spending power. From 2010 onward we will see some distinct subsegments among the affluent—including the mass- and global-affluent categories—but they will still total only 40 million households by 2025, accounting for just 11 percent of all urban dwellers. Their total consumption will equal 5.7 trillion renminbi11—just 41 percent of middle-class consumption.
While total spending by the middle class will exceed that of urban-affluent consumers, the latter will remain a critical market for some companies. These upper-tier households already account for 25 percent of Chinese household savings and will continue to control the bulk of the nation's accumulated wealth—60 percent by 2025. Their importance to banks and other financial-services firms will therefore increase. As in other countries that have underdeveloped consumer credit markets, Chinese households with sizable savings are the most likely to buy relatively expensive items, such as automobiles and durable goods.
Nevertheless, the biggest opportunity for companies selling mass-consumer goods and services will be the newly empowered middle class. To serve these households successfully, companies will need to understand how the saving and spending patterns of consumers change as their incomes increase.
Hitting a moving target
Although the middle class will not reach its full spending potential for nearly 20 years, its household saving and consumption patterns have already begun to take shape. Today
A McKinsey survey indicates that the top two reasons for high saving rates in
As incomes rise, spending patterns change. Families tend to buy more discretionary and small luxury items, and the share of the household budget that goes toward food, clothing, and other necessities shrinks. In
While basics may decline as a share of consumption, in absolute terms they will continue to grow as the overall economy expands. We expect, for example, that urban spending on food16 will grow by 6.7 percent annually during the next two decades, holding its place as the largest consumption category in urban areas and making
Housing and health care will be two of the fastest-growing categories. In many emerging economies consumers spend proportionately less on housing as their incomes increase. Since private ownership of
As incomes rise, Chinese consumers will also devote a larger proportion of their household budgets to educational expenses (such as tuition, tutors, and textbooks)—more than their counterparts in developed countries. This spending will be driven by the strong link between education and higher salaries, as well as by the growing number of options for both higher and vocational education.
Serving tomorrow's middle class today
Even companies that understand and anticipate changes in consumer saving and spending patterns may struggle to serve
Despite such obstacles, some companies have already begun targeting urban working households. As incomes rise, new entrants will find more profitable opportunities to accompany these consumers up the growth curve. By serving them today, businesses will gain the exposure and experience necessary to stay relevant as the incomes—and tastes—of urban consumers evolve.
Given the challenges of such a rapidly changing market, some companies have already had to think creatively about lowering product costs, reconfiguring business systems, and shifting to local sourcing strategies. The German retailer Metro, for example, keeps costs down by sourcing 95 percent of the products for its Metro China shops from domestic suppliers. Even a successful formula for current market conditions can soon become obsolete, however. Companies that target current urban working consumers—say, by reducing prices and repositioning products for lower-end segments—may find that these customers will abandon the brands as soon as their pocketbooks allow. To avoid this trap, several companies have adopted multitiered branding strategies, enabling them to follow their customers up the income ladder. P&G, for example, offers more affordable Olay products in supermarkets and hypermarkets and high-end lines such as Olay Regenerist in department stores.
About the research
The McKinsey Global Institute used an econometric approach to project income growth across different segments of
For variables such as GDP growth and inflation, we formulated a base case scenario resting on a mutually consistent set of consensus estimates. We assumed average growth of 6.5 percent in per capita GDP from 2005 to 2025 (a midrange forecast), with higher annual growth initially but slowing after 2015. We also assumed an absence of major exogenous shocks to the economy. Certain events—for example, a dramatic shift in exchange rates, an avian flu epidemic, or the disruption of the government's market-friendly policies—could make our GDP assumptions overly optimistic. Conversely, other factors (such as increased labor productivity, a more efficient capital allocation, or land reform) could make them too conservative. An analysis of the scenario for Chinese urban disposable income in 2025 therefore indicates a wide potential range of 16.9 trillion to 39.4 trillion renminbi.
About the Authors
Diana Farrell is director of the McKinsey Global Institute, Ulrich Gersch is a consultant in McKinsey's
The authors would like to acknowledge the contributions of their colleagues on the McKinsey Global Institute China demand team—Jonathan Ablett, Eric Beinhocker, Ezra Greenberg, Grace Hu, Yuan Luo, Jani Moliis, and Vivien Singer, and of Geoff Greene, an external adviser to MGI—as well as Kevin Lane and Ian St-Maurice.