I frequently ask business people why they are interested in doing business in China. The most common response I hear involves the promise of 1.3 billion Chinese consumers with rapidly rising disposable incomes. While this may be factually accurate, in my experience I’ve found that it’s safer for businesses to think of China as having many demographic subsets, rather than thinking of it as one country with a homogenous population.
Cutting up the dragon
It can be quite dangerous to think of China as one large market of 1.3 billion consumers. When someone does that, the math becomes so enticing it’s almost impossible to not justify some sort of expansion in China. The common argument goes something like “If I just get 0.1% of the Chinese population to purchase one of these widgets at $5 each, I’ll be filthy rich. And these things are worth far more than $5 each so there’s no doubt in my mind that they’ll want to buy these.” If only it were that simple.
There are a number of different ways you should segment the Chinese market before doing this kind of math. Let me make it clear, though, that I don’t recommend a top-down approach to market sizing; but, if you’re just trying to run some back-of-the-bar-napkin numbers or are interested in calculating the Total Accessible Market (TAM), then here are a few ways you can segment the Chinese market at a high level.
First-tier versus Second-tier cities
In the US we certainly have large and small cities, and there’s a difference between the availability of goods in these different tiers of cities. However, the differences between the two are fairly small and anyone with a mailing address can log on to Amazon, or any national retailer’s website, and order nearly anything they want. Also, even people in the very small towns can take a trip to the nearest Walmart to get their fill of mass-produced goods. While it is true that anyone in a second or third-tier city in China can get onto Taobao to order something from the “big city”, in my experience it’s not nearly as simple in China as it is in the US.
In addition to obvious differences in the availability of goods and the population density, I have also found that most people in second-tier cities in China, much like their counterparts in second-tier cities in the rest of the world, have a far less “worldly” view than those in first-tier cities. People living in Beijing and Shanghai see international brands launched at the same time as they are launched in London and New York, often see movies as soon as they are launched internationally (though there are restrictions in this area since the release of foreign movies is controlled by the Chinese government), and, even if they aren’t able to travel internationally themselves, they often have access to people who frequently travel abroad. This leads to a dispersion of international trends within first-tier cities that only slowly makes its way into the second and third-tier cities, if it ever manages to find its way there at all. Obviously, there are many “worldly” individuals in second and third-tier cities. However, people in first tier cities are generally much more “international” or “worldly” than their counterparts in second and third-tier cities, often making them a better target for foreign products and services.
Urban versus Rural
Another basic, but important way that any business considering entering China should segment the Chinese market is between the urban and rural population. While the US boasts an urbanization rate of 82%, China’s was only at 47% in 2010 according to the CIA’s The World Factbook. While the census figures in China might not be completely accurate, it is clear that there is a much lower urbanization rate in China than in most developed countries. What that really means is that the 1.3 billion that people think of as the starting point for their Total Accessible Market (TAM) calculation should really be thought of as 650 million people at the very most. Unless you have a product that would appeal to both urban and rural consumers, it’s hard to imagine that you would ever start with a higher number than that.
Beijing, Shanghai, and Guangzhou versus New York, Los Angeles, and Chicago
For most foreign companies entering China, their initial target market will be consumers in the major Chinese cities: Beijing, Shanghai, and Guangzhou. According to GeoHive, Beijing has roughly 20 million residents, Shanghai has roughly 23 million residents, and Guangzhou has roughly 13 million residents, for a total of 56 million residents. When comparing this to agglomerations in the US we find that the greater New York area (including Northern New Jersey and Long Island) has approximately 19 million residents, the greater Los Angeles area (including Los Angeles, Long Beach, and Santa Ana) has approximately 13 million residents, and the great Chicago area (including Chicago, Naperville, and Joliet) has approximately 10 million residents, for a total of 42 million residents. While the difference between these cities is still substantial, it’s not of the same order of magnitude as the population difference between China and the US as a whole, and may make some people reconsider the benefits derived from China having a very large population.
Don’t run away just yet
My objective in writing this is not to scare away businesses that are interested in entering China. There are certainly plenty of opportunities for businesses that add value in China, and for those with a long-term perspective they can build a strong foundation in China and can experience solid growth over many years, and maybe even many decades. Many companies are also using China as a base of operations for the rest of Asia, and are therefore seeing rapid growth in the region as a whole.
However, if you’re considering entering China, or trying to expand your existing operations, don’t think of it as one market. Think of it as a collection of different markets based on the context of your business. For example, if you’re creating a service that appeals to urban residents and are planning to start your operations in first tier cities, then use the population of those cities as a starting point and then start narrowing your Total Accessible Market down from there. But don’t think that you always have to enter China through first-tier cities. There is abundant growth in many second-tier cities and those can serve as an excellent entry-point for companies offering value to residents in those locations.
Whatever your entry or growth strategy is, don’t be comforted by the thought that there is a huge population waiting to embrace your product or service, because not only is that population segmented in a way that the majority of it is not likely to have access to what you’re offering, but it’s also a very diverse population that requires a nuanced strategy and houses aggressive and nimble competitors.
 One could fairly point out that the comparisons I am making here might not be entirely accurate since I am comparing city populations in China to agglomerations in the US. However, in the cases of Beijing and Shanghai, the city boundaries are quite large and encompass most, if not all, of the densely populated areas around those cities. One could also argue that there are a large number of migrant workers in Beijing, Shanghai, and Guangzhou who are not accounted for in the census numbers. However, since this discussion is about market-sizing based on the number of consumers in a given region, I think the comparison is still valid since those migrant workers have very low disposable income and are therefore not realistic target customers for most foreign companies operating in China.
UPDATE: Based on a comment from my close friend Thomas Twardowski, who has over a decade of experience working in China, it’s worth clarifying that there are far more nuances to segmenting the Chinese market than what is mentioned in this single post. I’m planning to delve into this much more in future posts, so stay tuned. And if there are specific areas you would like to know about, or if you would like to add the ways you have cut up the dragon in your experience, please leave a comment below.