Primark Expansion Into China

Imperial College Business School MSc Management International Business

Primark China - Expansion Plan

Executive Summary

Primark is currently the UK’s second biggest clothing retailer. Established in 1969 in Ireland, the company has grown enormously in size and strength since its conception.

Since the late 1990s, the company has greatly

expanded and now has 193 stores across Europe. Primark offers a great variety of products including men’s, women’s and children’ s wear as well as home products. Primark’s business model to sell good quality products at a low price has proven highly successful in Europe. In this report, we are proposing a $1billion dollar investment to expand Primark’s retail operations into the Chinese market.

This expansion plan

involves establishing retail stores in key locations across China, building distribution centres, introducing online retail platforms and expanding Primark’s already existing production capabilities.

Expansion strategy for China

Overview We propose to establish Primark’s presence in the Chinese market through both physical (‘brick and mortar’) expansion and online retailing offering Chinese young consumers high-quality products at value-for-money prices.

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Target group The prime target market that has been identified is the middle and low-income class under 35 interested in fashion trends at bargain prices. According to a McKinsey survey on China's urban young adults (a segment of about 15 million people), half perceive foreign brands to be of higher quality than local brands. Similarly, 36 percent of China's young adults say they like to try out foreign products and brands on a regular basis. They also shop for apparel more frequently people in other age groups spending larger sums on clothing and are likely to spend even more as their incomes rise [1].

Mode of entry As labour costs are relatively low in China, Primark will set up ‘Green Field’ operations rather than establishing a presence through M&A. According to the Ministry of Commerce, the most common ways of entry for foreign enterprises into China are Equity Joint Ventures (EJVs), Contractual Joint Ventures (CJVs) and the establishment of Wholly Foreign Owned Enterprises (WFOEs). We suggest that Primark chooses the WFOE as its mode of entry. The advantages are as follows: Firstly, independence and freedom in developing and implementing strategies autonomously without having to consult with a Chinese partner. Secondly, the ability to formally carry out business rather than just function as a representative office and being able to issue invoices to their customers in RMB and receive revenues in RMB. Thirdly, there will be no requirement for import-/ export licence fees; and, finally, the company retains full control over the human resources development, as well as greater efficiency in operations and management.

Strategy in-depth

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Production and design Primark already owns manufacturing sites in China. In order to meet the increased demand, the proposed expansion into the Chinese market, production capacities would need to be greatly expanded. We propose to extend the current production contracts to already established manufacturers in China and, thereby, reducing the risk and expense of building factories from scratch. Producing products in China will greatly reduce distribution costs meaning the company could retain its low price level-strategy. In order to keep up with global fashion trends, customer satisfaction surveys should be held on a regular basis in order to ensure the products and their designs meet the needs and wants of consumers. On average, it currently takes six weeks from the design table until a product is in the shops.[2] We would seek to reduce the product release-time down to three weeks for the Chinese market; given that manufacturers would be in closer range to the distribution centres than before, this would immensely improve Primark’s competitiveness.

Additionally, product sizes

would need to be adapted to ensure they meet the requirements of Chinese consumers.

Supply and distribution Primark makes its profit primarily by selling its products at low prices but in high volumes. In order to achieve a high stock turnover in China, the supply and distribution of goods needs to be secure, fast and efficient. We propose to set up two large distribution centres in China which will be used to stock, process, and supply goods to the retail stores.

Retail store establishment Naturally, the location of the Primark retail stores will be of great importance in 4

creating brand awareness and addressing the appropriate target market. We propose to set up Primark flagship stores on high streets and shopping malls which are frequented by young workers and students in first-tier cities like Shanghai, Beijing and Guangzhou. In addition, we suggest opening a further flagship store in Hong Kong.

In a second stage, we plan to expand the

physical stores of Primark to second-tier cities with high household living expenditure per capital like Zhejiang, Jiangsu, Fujian, Guangdong, and Tianjin. In order to reduce costs while opening a large number of stores in the shortest amount of time, we propose leasing buildings and floor space rather than buying them. Retail stores will all have an open, bright and spacious atmosphere making the stores look welcoming and structured.

The

appearance, look and feel of Primark stores and the overall customer experience will be a key element to succeeding in China.

(Source: State Statistical Bureau)

Human Resources 5

Primark will employ people from local communities to work in its stores and distribution centres in China. This will both reduce employment costs and ensure employees have a good connection with consumers. Training staff with the help of training consultants, who are fluent in Mandarin and have a significant amount of retail experience in Europe, will be major priority for Primark.

Marketing At the initial stage of entry to the Chinese market, we plan to invest in local marketing efforts, even though this is contrary to Primark’s UK strategy. Unlike foreign retailers like Zara or H&M which were widely known before entering the Chinese market, the brand awareness for Primark is relatively low. Adverts should be placed in local fashion magazines, billboards and ‘Metro’ newspaper to create and then raise brand awareness.

Further

emphasis will be put on the shops’ window displays.

Metro Express Metro express is distributed freely everyday in tube stations and is popular among young white-collar workers.

Ruili Fashion Ruili is a fashion magazine with a high circulation and is targeted at young people under 35, which corresponds with Primark’s projected target market.

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Online store We propose to introduce online retailing in the first phase of the expansion as an additional retail channel. The first online shop should be launched through Taobao Mall, a highly successful ecommerce platform, and then later be expanded to create an own Primark online shop. The rationale behind this approach will be explained in greater detail below.

Growing garment e-commerce In 2008, the number of Internet users in China has surpassed the US reaching 253 million.

The total amount of consumption through Internet

shopping in China was expected to rise to US$ 85.6 billion by the end of 2008 which is an increase of 47.3% from 2007.

Figure 1: Number of Internet users in China from 2000-05 (Source: iResearch CNNIC, 2006)

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Figure 2: Total amount of consumption through Internet shopping in 2005-08 (Source: DCCI, 2008)

From the above figures, we can see that fashion e-commerce is a fast growing market with room for future investments. With the increasing number of people in china choosing to shop online, the market holds a huge potential for companies like Primark.

Taobao China For the first half of 2009, Tabao’s transaction volume is reported to be RMB 80.9 billion (US $11.8 billion) which is 97% increase from last year. [3] Many well-known Chinese domestic brands, but also foreign brands like Dell, Lenovo, Procter & Gamble and Uniqlo sell their products through online shopping platforms like Taobao Mall. In July 2009, the official Lenovo online store was earned more than RMB 10 million, in one month only.[4] Tabao Mall is mainly used by young middle class consumers, 39% of which are between 16-25 and 40% of them are between 26-35.[5]

This

suggests that a huge share of the users of Tabao Mall are in Primark’s main target group. To launch an online store through Taobao greatly reduces the initial costs and risks in contrast to setting up an own online store. We believe that online retailing in this form will benefit the company in two ways: On the one hand, it will help the company to reach customers in all 8

parts of the country without setting up costly stores. On the other hand, it will serve as a database for Primark helping to understand customer behaviour and preferences of its new Chinese customers.

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Strategy timeline This report assumes a five-year time line for the outlined expansion plan. The table below shows a breakdown of goals to be implemented within this timeframe. Time Period Short term

Strategic Goals •

Expand manufacturing capacity

•

Build distribution centres

Year 2

•

Establish flagship stores

Year 3

•

Establish retail stores in Beijing, Shanghai & Hong Kong

•

Cooperate with Taobao to build first online

Year 1

shop Long term

Year 4

•

Establish retail stores in other selected cities

Year 5

•

Implement and launch own online store

Rationale behind the expansion into China

With a population of over 1.3 billion, China is both a production and consumption powerhouse as well as a low-cost manufacturing centre for foreign and domestic firms.

Fastest growing economy China has a nominal GDP of US$ 4.4 trillion (2008) and has had the fastestgrowing major economy over the past 30 years with an average annual GDP growth rate above 10%. According to research centre of the State Council of China, an average 7.9% GDP growth can be expected between 2001 and 2010.[6] Making it an ideal destination for many multinational companies. 10

Growing middle class According to McKinsey China’s middle class (defined as those with annual income of at least US$5,000) has now reached 80–150 million and is still growing rapidly, creating an enormous market for consumer goods of all types within a fairly short time-span in the process. China's retail market is worth RMB8921 billion (US$1302 billion) in 2007 and growing at 16.8% annually.[7]

Apparel industry in China China accounts for 37.8% of the entire Asia-Pacific apparel retail industry’s value. The Chinese apparel retail industry grew by 5% in 2008 reaching a value of $84.9 billion. In 2013, the Chinese apparel retail industry is forecast to have a value of $106.2 billion, an increase of 25% since 2008.[8]

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Five Forces of apparel industry Bargaining power of suppliers

Bargaining power of buyers

New entrants Substitutes

Competitive rivalry

The current suppliers (wholesalers and manufacturers) are quite fragmented which weakens the bargaining power of supplier. Low Almost all the buyers are individual consumers and the fragments consumers as style is an abstract concept that defines individuals, to an extent, an extension of personality and therefore highly individualized, which significantly weakens buyer power. Low Entry to the apparel retail industry does not require large capital outlay; setting up an independent apparel retail store is within the means of many individuals. High Substitutes for apparel retail include buying direct from manufacturers; with increasing online purchasing. Other substitutes include home-made and custom-made (couture) clothing. Overall Moderate The competition in the current apparel market is becoming fierce among both domestic retailers and foreign retailers. Selected key competitors Domestic brands: The top two competitors are

Metersbonwe Group is China's leading casual wear apparel company. The company operates around 1,800 stores across China and has over 5,000 employees. It targets 18-25 year old male and female consumers.

Natural and simple is provides a full range of value-for-money for the prices and outstanding market share.

the motto of Baleno. The brand casual wear with the emphasis on mass market. Offering competitive quality, Baleno holds a significant

Foreign brands:

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Year of entry No of stores in China

Zara 2006

H&M 2007

Uniqlo 2002

35

15

46

(until October

(until Sep

(until October

2009[9])

2009 [10])

2009[11])

From the Five Forces analysis, the apparel industry is an attractive industry to invest in with low bargaining powers for both suppliers and buyers. However, as a new player in the market, attention must be paid especially to differentiation from competitors.

Low distribution costs By manufacturing products for the Chinese market in the country, Primark’s reduced distribution costs will make it possible to extend low prices to consumers, boosting its competitiveness in the market.

Manufacturing Expertise As Primark is already producing some of its products in china, it benefits from an existing infrastructure and expertise. Other foreign retailers like Zara who have mainly produced in Europe previously, do not have this advantage.

RISK ANALYSIS (PESTEL)

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Political factors The Chinese retail and distribution sectors have been the last ones to be deregulated.

Modern retail trade did not emerge from under the central

planning system until the middle of the 1990s.

Foreign access to the

domestic markets was only granted gradually and many areas domestic retailers still dominate; many of them with government support.[12] Subsidised competition, corruption and protectionism hamper foreign retail investors in all fields and regulation in certain aspects conflicting and confusing.[13] Despite increasing liberalisation, the government retains considerable control in areas directly affecting the retail sector: Advertising rates, for example, are still state-controlled which makes it more costly to reach customers than in many Western countries, while the rewards remain lower since the average disposable income in China still remains lower in comparison. The index value for GDP per head in power purchasing parity (PPP) in China is 11.8 (US=100), while for the UK it is 77.1.[14][15]

Economic factors Despite the political and structural restraints foreign investors are faced with in China’s retail sector, the general environment for investment is positive and optimistic against a background of substantial growth over the past years in all retail formats and sectors. The Chinese GDP has grown 13.7% between 2002 and 2007 and 35 of the world’s Top 50 retailers are now represented in China. [16][17] Yet, in spite of a steady and steep economic growth rate, there are some signs for caution; foreign investors need to bear in mind in order to be able to understand the dynamics in the Chinese market.

Growth is evident, but

where does it come from? In the retail sector, growth mainly seems to stem from new stores with a consumer price inflation of 5.9% (UK: 4%) and private consumption making up only for 35% of the GDP. The average in other Asian 15

countries lies between 50-60%.

The government has now realised this

situation could need some encouragement and has begun to devise some incentives to boost private household consumption. [18] The Chinese retail market is vast and complex and, therefore, bears a multitude of opportunities for investors, but also risks. Its only recent deregulation and the aforementioned aspects are very likely to be the reasons why, despite ongoing growth, only 2.6% of total retail sales came from foreign invested retail operations in 2006 and why exports from the US and Europe have remained flat in the past year.[19] In the fashion retail market, the inflow of foreign capital into Mainland China is a rather recent phenomenon, but, nevertheless, a growing one. National domestic chains have only started to emerge in the last couple of years, while, at the same time other foreign fashion retailers have begun creating a national footprint. Esprit was among the first and now has over 280 concessions throughout China. Giordano, Bossini and Baleno have successfully expanded from Hong Kong into Mainland China clearly benefitting from existing joint ventures and some level of brand awareness. [20] The Japanese chain Uniqlo, after a patchy start in 2002, is now reporting steady revenue growth. European chain Zara opened their first Shanghai flagship store in Shanghai in 2004, while H&M now owns thirteen shops since first opening their doors to Chinese customers in 2007. All of the above are planning on opening further outlets in the near future. Foreign retailers like the above, tend to produce locally. Their goods are generally perceived to be of high quality and pricey in comparison.[21]

Socio-cultural factors Continuing urbanisation and the liberalisation of the markets have led to the emergence of an urban middle class of increasingly sophisticated consumers demanding higher quality, variety and innovation from their retailers.

The

number of households with an annual income of over US$5,000 has now 16

reached 150 million. Growth has been uneven among different geographic regions as well as rural and urban areas. Eastern coastal regions demonstrate better overall economic performance with average household incomes rising and above the national average. In addition, the past couple of years have seen a significant rise in households’ disposable incomes. Chinese consumers tend to have more of a taste for variety and many firms have found it profitable to extend their ranges according to local tastes.[22] [23] The expansion of the retail market has led to a shift in focus on the customer experience and the retail environment: High-end shopping malls are being built in first and second tier cities across the country as a response to the fierce competition for good retail space which has driven to unrealistic heights given the rate of new developments being created; this is particularly true for cities like Shanghai and Beijing. The opening of the market has given Chinese customers a profile and retailers are responding to it. As the broad demand for established brands like Apple and Levi Strauss (which are sold in China at higher prices than anywhere else) reflects, the acceptance of Western goods is universal.[24]

Technological factors China is one of the largest manufacturing countries in the world. Successful foreign firms, in general, tend to have invested a lot of time and resources into building a functioning distribution network and raising awareness for their products. While it is a lesser concern in cities like Shanghai and Beijing, distribution to second and third tier cities remains largely inefficient and unpredictable. Implementing control and efficiency in these factors requires a lot of resources from any investor. As Primark is already producing some of its collections, it benefits from an existing infrastructure and expertise. Other foreign retailers like Zara who have mainly produced in Europe previously, do not have this 17

advantage.[25]

Environmental factors China’s environmental performance is notorious.

As one world’s biggest

emitters of water pollutants and CO2, The Economist has ranked it among the world’s worst performing countries in terms of its environmental health, biodiversity, air and water pollution among other factors.[25] China has a comprehensive set of ever increasing environmental regulations for firms in place. The problem is enforcement, though. As awareness of environmental issues is on the rise, government agencies are increasingly wary of firms and their contribution to the problem. Based on Japanese and European models, China is introducing the notion of sustainability or the ‘Circular Economy’ which is based on a set of laws requiring companies to “build or upgrade a production line to replace hazardous raw materials with non-hazardous ones in its products and adopt production processes and equipment with high resource utilization rates and little pollutant generation. Where economically and technically feasible, facilities must recover and use their own production wastes and waste heat or transfer these wastes to other facilities or persons with the ability to use them”.[26]

Legal factors Since 2002, most regulations in retail sector have been lifted. It is now possible to establish wholly owned enterprises rather than just joint ventures, which has resulted in growing confidence among foreign retailers. Local entities are now controlled by local Mofcom (Ministry of Commerce) bureaus, rather than from one centralised ministry. Local officials tend to extend favours to companies on their patch granting preferential access to land or credit and easing bureaucratic constraints.[27]

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Why invest in Primark?

Primark’s growth The value retail industry has seen a huge rise in the UK retail market over the past 5 years with Primark at the helm of this rise. [28]

Primark’s sales

performance has been exceptionally good with revenues rising from £1,933 billion in 2008 to £2,314 billion in 2009.[29] This is an excellent achievement especially when the current recession’s adverse effect on other retail chains is taken into account. Primark’s financial growth shows that its trading philosophy of selling quality products at low prices is immune to economic instability, appeals to spending conscious consumers and will serve as a great advantage when expanding into the Chinese market.

Fig1: Number of Primark stores trading [30] Fig 2: Primark’s financial growth from 2005 -2009 [31]

Flexible investment options We believe that there is a good investment opportunity for expanding into 19

China. Assessing the risks, we consider China to be a friendly place for European retailers, something that is also evident from the performance of other European retailers in China. In addition, our plan to become the first European retailer to launch Internet sales in China’s fast growing e-commerce sector, makes Primark’s investments prospects even better. For this expansion strategy, we require an initial investment of one billion US Dollars. For this investment, we are searching for an investor from the Middle East. We offer the opportunity for an investor to finance this project, using flexible investment models that will meet the requirements of Islamic Finance and Sharia Law if the investor so requires. A corporate vehicle will be used, Primark China Ltd, where the investor will become a preferential shareholder and not a creditor. This will follow the basic Islamic Finance model, based on profit sharing and not the receivership of interest rates. Preferential shares in the company will carry a fixed dividend rate, over and above the current market interest rate. The initial capital of one billion US Dollars will be used for contracting out more manufacturers, setting up an efficient distribution network and leasing and equipping the first stores. All assets will be assets of the company, creating security for the investment. As already mentioned above, our plan is a five-year plan, in which first five years, money will be re-invested, within the company up-until all of our strategic targets are met. Thus we expect a return on investment over and above the interest rate after the initial five-year period. In order to reflect this in the return for our investor, an option will be granted to him, to turn his preferential shares into ordinary shares, after five years, in order for him to be able to gain from actual dividends and capital gains profits. Alternatively, if the investor wishes not to exercise the option, the preferential shares will carry a maturity date within ten years, at which point the investor will be able to reclaim his original investment or renegotiate the terms of his investment.

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In summary, we consider this to be a great investment opportunity for a Middle Eastern investor due to the flexible terms offered. The investor will be able to secure an initial payback over the market interest rate, while eventually he will have the opportunity to gain from the overall operations and growth of Primark in China.

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References [1] China: Small Budgets, Small Wardrobes. The McKinsey Quarterly, 2007, P70. [2] Gelb, Mallary (Dec 2, 2005) Primark – King of no-frills fashion [Online] Available at http://news.bbc.co.uk/1/hi/business/4466986.stm [Accessed on Nov 30, 2009] [3] [4] [5] Business Wire (2009) Taobao sees significant new trends in Chinese online consumption [Online] Available at http://www.allbusiness.com/company-activitiesmanagment/operations-supply/12703131-1.html [Accessed on Nov 20,2009] [6] http://en.wikipedia.org/wiki/People's_Republic_of_China [7] Ho, Filfreo. Importing, Exporting and Investing in China. Asian Supply Chain. March 2007. [8]

Datamonitor

(2008)

Apparel

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in

China

[Online]

Available

at

www.datamonitor.com [Accessed on Nov 25, 2009] [9] Available at http://www.zara.com [10] Available at http://www.hm.com/cn/hm/hm/china__worldofhm_countrycode_cn.nhtml [11]. Available at http://www.uniqlo.com [12] [16] [20] [18] [22] [24] [25] PWC (2006) Investing in China’s Retail Industry. [Online] Available from: http://www.pwc.de/fileserver/EmbeddedItem/PwC%20TL%20China %20Retail%20Apr%202006.pdf? docId=e502f94f9294a46&componentName=pubDownload_hd [Accessed on October 25, 2009] [13] [14] [21] [23] The Economist (Oct 15, 2009) Impenetrable: Selling foreign goods

in China [Online] Available at: http://www.economist.com/displayStory.cfm? story_id=14660438 [Accessed on October 25, 2009] [17] The Economist (ed.) (2009) Pocket World in Figures – 2010 Edition. London, Profile Books, 132-133 [18] The Economist (June 25, 2009) Shopaholics wanted: Consumer spending in China [Online] Available at Http://www.economist.com/businessfinance/displaystory.cfm? story_id=E1_TPJDDTNV [Accessed on December 1, 2009]

[19]

McKinsey

(2008)

Preparing

for

China’s

Growth

[Online]

Available

at:

http://www.mckinsey.com/mgi/publications/china_urban_summary_of_findings.asp [Accessed on December 10, 2009]

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[26] McElwee, Charles II (2008) Who’s cleaning up this mess? Rising environmental awareness is affecting business in China. China Business Review [Online] Available from:

http://www.chinabusinessreview.com/public/0801/mcelwee.html

[Accessed

on

December 5, 2009] [28] Associated British Foods Annual Report 2009, page 44 [29] Associated British Foods - Annual Report 2009, page 43 [30] Primark Stores Ltd. (2009) Primark’s History [Online] http://www.primark.co.uk/page.aspx?pointerid=eb44df4565934edca627dac6ec12145a

[31] Associated British Foods Annual Reports from 2005 – 2009

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Appendix 1. Map of China

2. Progress of Retail Deregulation in China

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3 .Procedure of WOFE Registration Procedures Foreign companies are not allowed to directly submit the application documents to the relevant authority. They must retain a PRC entity that is authorized or permitted by relevant authorities to act as a sponsor. The sponsor will submit all the documents to the examination and approval authority on behalf of the foreign enterprise. Procedures to set up a Wholly Owned Foreign Enterprise in Shanghai are as following: Step1: Company name checking and registration (about 5 working days) Step2: Approval Certificate (about 15 working days) Step3: Business License (about 7 working days) Step4: Organization Code License (about 1 working day) Step5: Tax registration(about 7 working days) Step6: Open an RMB bank account (about 3 working days) Step7: Register Foreign Currency Certificate (about 1 working day) Step8: Capital verification (about 7 working days)

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