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Hidden dragon

Published:  23 July, 2008

At a recent lunch at the Grand Hyatt Shanghai, six Chinese businessmen ordered five bottles of wine. Malcolm Zacanaro,
the executive assistant manager for food and beverage at the hotel, initially thought nothing of it until he saw the bill, which came to more than RMB 120,000 (US$15,000) for the wines alone. Zacanaro says, The Chinese market is extremely price-sensitive. At the top end, hosts want to impress, so they order the most expensive bottles. And at the bottom end, people are less knowledgeable, so they order by price.'

All across Shanghai, every new building seems to be competing to be the most futuristic, most modern or tallest building not just in China but in the whole world - quite ambitious for a country that still has only a US$1,000 per capita income (urban coastal cities are about US$1,500 a year). But the buzz and electricity is palpable in China's two main cities, Beijing, as it prepares for the 2008 Olympics, which is suddenly around the corner, and Shanghai, as it revs up for the 2010 World Expo.

Prestigious brands have taken up prime real estate in gleaming new glass and steel towers all along Nanjing Xilu and the French Concession in Shanghai, and at Wangfujing Dajie and the China World shopping mall in Beijing. Substantial wine lists have appeared in swanky and stylish new restaurants along the Bund waterfront and Xintiandi in Shanghai.

It's hard not to be drawn in and hypnotised by the buzz in Shanghai and Beijing's optimistic rhetoric about the rising dragon's future in the world economy. Around 150 million to 200 million people are now able to buy mid-priced consumer goods. China State Information Service predicts 200 million middle-income consumers by the end of 2005. Goldman Sachs Asia predicts China's economy will grow by 9.2% this year, compared to only 3.8% in the US and 1.4% in the EU.

For every successful realisation of the China dream', though, hundreds have discovered that the dragon is an elusive shadow - and, at best, it is a slumbering dragon still chained to a Communist master. This is as true in the wine and spirits industry as in any other industry in China. Many of the key wine-importing companies, such as Montrose and ASC (the two largest bottled-wine importers), have been suffering from bouts of financial difficulties since their establishment in the 1990s. Both companies were compelled to sell shares to raise capital to fund their growth.

On the production side, large beverage giants have pulled out of China over the past five years - Pernod Ricard at Dragon Seal, Rmy Cointreau at Imperial Court and Allied Domecq from Huadong winery. But some have remained, and others are taking the place of those that have left: Dynasty continues the relationship that it has had with Rmy since 1980, and Bordeaux's Castel group has had a joint-venture winery with Changyu since 2001. Meanwhile, Illva Saronno's 33% bid for Changyu is still pending government approval.

Almost everyone in China is reporting huge growth, but realising profits is another story. Even the monolithic LVMH, working through its subsidiary Riche Monde in Asia, has been struggling on and off since 1998, despite the sparkling-wine sector growing in value by 69% since 1997. As one industry insider asked, What does it say about a market when one of the largest international companies must resort to dumping in order to realise growth?' Indeed, Mercier and Veuve Clicquot are very competitively priced in Carrefour and other outlets, despite high hidden costs in China and numerous tax layers.

The numbers

Looking at numbers alone, China's alcoholic drinks market looks impressive. Alcoholic drinks as a category within fast-moving consumer goods is the second highest in value - worth around US$35 billion in 2004, just behind fresh and dry vegetables (according to 2004's Wine in China' report by Access Asia, an independent research company based in Shanghai). This sector has been growing at an average annual rate of 11% and value is projected to increase to US$54bn by 2008. In 2004, beer had 51% value of the alcoholic drinks market, spirits at 48% and wine at 1%. In terms of volume, beer has grown to over 85%, spirits have shrunk to 13% and wine remains at 1%.

China, with the largest wine-consumption increase in the world over the past 10 years, can certainly dazzle even the most critical economist with its double-digit growth figures. Most investment houses, including UBS, calculate the wine market in 2005 to be worth nearly US$1bn. According to the World Wine Industry Association, the projected growth rate for wine sales is about 5% for the world, 16% for Asia and 35% for China. The lowering of duties for wine in 2004 to just 14% and the recent lowering of duties for spirits this year both appear to be a boon for imports.

But the starting base is small: imported bottled wine is a mere 1% of the market and at best close to 2%. Actually volumes are tiny, at 7 million to 7.5 million litres - far less than Hong Kong's 10 million litres, with a population of only 6 million people! Ethan Perk, sales and marketing director at Montrose, one of the largest wine importers, says, Everyone is asking me, Why are you not selling a million bottles of my wine?' The reality, he says, is that even two of the most popular wine brands in China - Mouton Cadet (distributed through Torres) and Mondavi's Woodbridge (through Montrose) - sell only 10,000 cases a year.

Domestic giants

Much of the growth in wine can be attributed to the domestic companies that have invested substantial funds for advertising and promotion over the past eight years. The number of wineries is estimated to be about 400, with 100 active wineries and only 10 wineries capable of processing more than 10,000 tons. The

top five wine companies, controlled mainly by local governments, have close to 75-80% of the total wine market. This is not so different from other developed wine markets, but due to an inordinate amount of red tape and the hidden costs of doing business in China, most of the major beverage analysts and market-research firms believe domestic companies will continue to dominate.

Growth in wine consumption has been steadily increasing, and UBS analyst Joe Zhang believes the wine market will continue to grow steadily at 10% per annum. Domestic wineries are all expanding to keep up with demand. Fu Mingzhi, deputy general manager and director of Changyu winery, says, We expect substantial growth in China's wine industry, with 20% increase in production, reaching about 500,000 tons for the entire country over the next few years. On the consumption side, we project a 15-16% increase during the same time period.'

Changyu winery alone produced more wine in 2004 than all the wines imported into China. In 2004, Changyu vinified 60,000 tons of grape juice, while total imports, including bulk wine and bottled wine, came to just 50,000 tons, or 48 million litres (official estimates are about 43 million litres). Tonnage figures in China are nearly always for grape juice and not uncrushed grapes as in the EU, the US or Australia. Fu calculates 1 ton (Chinese reference) to be about 1,300 bottles or 975 litres.

Gao Xiaode, executive director and general manager of Dynasty, says they will double their production capacity to 60,000 tons by 2008. Great Wall, one of the top five wineries in China, plans to increase production by 30% per year over the next few years.

The largest companies set the pace, not just for local competition but also for imports. Great Wall set the scene for vintage awareness by hyping up a vintage - 1992 - seven to eight years later. The ultimate flattery was quickly to follow: the vintage marketing' concept was copied by all the other wineries. Despite the fact that the wine still possessed youthful traits without any signs of browning at the rim 10 years later, the vintage was highly sought after. Vintages have become an important marketing point in the past five to six years for domestic wines, and Don St Pierre Jr, managing partner of major importer ASC Fine Wines, says this has helped bring awareness to vintage differences for imported wine.

According to industry insiders, Chinese wine can contain as much as 50-80% imported bulk wine. To confuse matters (and consumers) even more, until recently, wine labelled grape wine' could contain additives including fruit-juice concoctions. Labelling has become more stringent in the past few years and new rules are expected soon; however, enforcement may take several years longer.

Bong Ha, national sales and marketing manager for Torres, a growing China-

based importing company formed by the eponymous Spanish winery, used to work as the marketing manager for Dragon Seal, one of the largest domestic wineries. He notes, There is no enforcement or strict rules regarding grape origin for now, but this should be changing soon.' He adds that it is possible for a product labelled Chinese wine' to be made using only 1% local grapes. Bong says that, due to rising demand, even smaller wineries are now importing bulk wine for blending. However, none of the large domestic wineries will publicly admit to using any bulk wine in their blends.

Struggling imports

Imports, which amount to 43 million litres, make up only about 10% of China's total wine sales. Of these imports, 36 million litres is Chilean bulk red, arriving on China's shores in huge containers; the remaining 7 million litres is bottled wine. Imported wines (on average, about RMB 55, US$7) compete with the growing segment of premium wine (US$7 or more) in the major cities. Lower-end wines RMB 20-40 (US$2.50-5), which make up the majority share of all wines sold, are the territory of domestic wineries.

Imported spirits, compared to domestic production, is even smaller, representing a fraction of 1% in total spirits value and volume. However, with the spirits market growing at an annual average of more than 11%, there is room for growth for

both domestic and imported products.

The lowering of tariffs (reduced from 47% to 10% early this year) on imported spirits may help boost sales, but competition is fierce among tens of thousands of established spirits producers.

Multiple realities

Trying to come to grips with a cultural, social and business reality as complex as that in China is like peeling the layers of

an onion and finding there is no core, only additional layers. A major cultural hurdle is the linguistic nuances of wine and spirit terms that do not accurately translate into Chinese. For example, wine is roughly translated as grape alcohol' (putao jiu), while spirits is white alcohol' (bai jiu). However, in normal everyday Chinese, putao jiu is hardly used for wine; rather

hong jiu is used, which translates into red wine'. Thus grape wine and red wine are synomymous for many Chinese. For white wine, the translation is the same as spirits, bai jiu, although occasionally some will specify and state putao bai jiu (grape white wine'). According to Ana Ng, sales manager of Watson's Wine Cellar in Guangzhou, many people do not understand that white wine is also made from grapes. Some believe it is either a spirit or a wine made from fruits other than grapes. Wineries are translated into grape factories' or grape-processing companies'.

The social reality of alcohol in traditional Chinese culture is that it is usually not an accompaniment to food but rather a social-occasion beverage. In the instances that alcohol is consumed with food, it is usually in a ganbei, or bottoms-up', style, with the goal of everyone becoming inebriated. However, the high social and health cost of spirits intake encouraged the then premier Li Peng to decree in 1996 that all state banquets use wine instead of spirits. The timing could not have been better: studies regarding the health benefits of red wine were well documented, and switching to grape wine prevented precious grain from being converted to alcohol.

Judy Leissner, CEO of Grace winery, a boutique premium winery in Shanxi province, says, Most Chinese consume wine during business dinners - for example, at a restaurant. "Bottoms-up" is a way to show hospitality. Most people associate drinking with work; hence, they don't enjoy it. They tend to mix all the different alcoholic beverages together during a meal. The typical sequence is usually beer, then rice wine, followed by wine, then back to beer.' In bars or KTVs (karaoke clubs), beer, spirits, soft drinks and wine are often all brought together on a tray and can be mixed like a cocktail according to the customers' wishes. Leissner says, Most wine is consumed at restaurants rather than at home; Chinese don't entertain at home because most of their apartments are too small.'

The business reality is incredibly complex, mainly due to lack of transparency from the government; this filters down to the state, provincial and corporate levels. Corporate reports issued by the top three wineries in China - Changyu, Great Wall and Dynasty - all claim to be the largest in China. Even industry analysts are confused, and most reports will add a disclaimer saying, Data presented here may differ among various sources due to differing definitions or lack of same standards' (Macquarie Research). According to Paul French, publishing and marketing director of Access Asia, the government's customs and import figures are fairly reliable as long as they are cross-referenced and back-checked (even older figures can be revised).

The emerging middle class

Wine consumption is minuscule at only 0.2-0.3 litres per capita, though in urban cities the amount is closer to 0.75 litres, or a bottle per head per year. UBS says that in 2004 China's wine sales grew 17% to reach a total value of RMB 7.5bn (almost US$1bn). Industry analysts such as Zhang at UBS believe that, at the premium end, wine is winning over spirits, while at the bottom end, wine is making little headway against beer. Beer is cheaper than bottled water,' says Bong Ha. On the streets in Beijing, you can buy a bottle of beer for just RMB 1.50 [cost is RMB 2.50, but RMB 1 is returned

on every bottle], compared with RMB 2 for a bottle of water.'

According to two independent market-research companies - China Infobank and Access Asia - the majority of wine consumption is outside the home by young professionals aged 25-35, which, by happy coincidence, constitutes the majority of China's adult population. National statistics released in 2004 state that 20- to 29-year-olds make up the largest portion of the adult population, followed by 30- to 39-year-olds.

Though everyone agrees that most wine consumption is on-trade, the scene is changing rapidly as China opens up its retail and distribution market to foreign investors. Carrefour, the most established foreign supermarket chain in China, now has 61 hypermarkets, eight supermarkets and 201 hard-discount stores. Wal-Mart, a more recent player, is playing catch-up, with 40 Super Centers, three SAM'S Clubs and two Neighborhood Markets. Carrefour's Gubei branch in Shanghai has a substantial wine selection, including a fine-wine section.

Paul French of Access Asia says a huge portion of off-trade wine purchases are for gifts. The range in prices for wine and the prestigious image that wine enjoys, together with the positive health aspects, all make wine a perfect gift in China. French, who has lived in China for more than 15 years, says, Sometimes I will receive a box of wine [premium wines are nearly always packaged in gift boxes], and I can tell it

has been passed around a few times! Wine is a perfect gift for someone else.'

At Watson's Wine Cellar in Guangzhou, Ana Ng says the majority of their revenue arises from the two major holidays -

Chinese New Year and the mid-autumn festival - when gift giving is at its highest. Ethan Perk at Montrose in Beijing concurs, adding, Packaging is very important in the off-trade market.' Gift boxes come in colourful red and gold or in wooden boxes for the super high end.

According to Jiang Tao, vice manager of marketing at Great Wall winery, Most of our consumers are successful, white-collar professional males making about RMB 3,000 (US$400) per month in urban cities like Beijing.' Perk agrees: We believe there are about 110 million Chinese who can afford wine. They are 25 to 45 years old, usually male and they dine out two to three times a week. These are successful men buying their first car and who already have, or will soon have, their first apartment.' Don St Pierre Jr, managing partner at ASC agrees. Wine is seen as an important modern lifestyle component,' he says. Most consumers are currently men, but women will be key consumers in the near future.'