Western Price-Gouging in China
By LARRY ROMANOFF – October 01, 2020
One of the major trends affecting society
during the 1970's and 1980's was the reversal of position of (largest)
manufacturers, (middle-sized) wholesalers and (smallest) retailers. Market
power and influence corresponded with size. The manufacturer of a product
appointed a few wholesalers to handle its lines, and obedience to price and
marketing practice was obtained by the knowledge that lucrative contracts could
be terminated, in which case a corporate life could be measurably shortened.
This was even more true in the relationship with retailers, who often had
marketing and promotion practices dictated to them, as well as firm pricing
policies which could not be ignored. Those relationships may not have been the
best for all concerned, but the markets were stable, distribution was
efficient, and behavior was mostly responsible even if not always totally
ethical. But with some retailers becoming extremely large, the balance of power
shifted 180 degrees to the point where today some retail groups have almost
absolute control of markets.
Price-gouging and price-fixing are a standard
feature of Western capitalism, with virtually all foreign companies
participating in these practices. Most governments focus their attention on
price-fixing conspiracies because some laws exist to prevent the practice.
Price-gouging by individual firms often escapes the regulatory net, although
this should not be the case because the principle of using market position to
overcharge is essentially the same. In one recent case in China, six LCD
manufacturers, Samsung and LG from South Korea and four firms from Taiwan, were
levied fines and other costs of nearly 800 million RMB for having engaged in a
massive conspiracy to set prices at an extremely high level. The evidence was
that these firms held a total of 56 meetings in South Korea to reach agreement
on LCD pricing, adding huge costs to Chinese manufacturers of computers, mobile
phones and similar devices since the LCD panels alone account for about 80% of
the total cost. In addition to the heavy fines, these firms were required to
refund nearly 200 million RMB to their customers. These same firms were also
investigated and heavily fined by US and European authorities for the same
violations. The fine in the US was $1.2 billion, nearly $900 million in Europe,
and another $200 million in South Korea.
International
luxury brands have long set much higher prices for their products in China than
in many other countries. In fact, luxury goods in
China are not only priced high, but rarely or never discounted, these practices
being so consistent and widespread, they are almost certainly the result of the
same kind of collusion that was proven in the auto and baby milk markets. By
contrast, it is common to see discounted luxury goods in Europe where major
luxury brands such as LV and Gucci often offer discounts of 30% to 50% on many
items during holidays and festivals. Executives of these foreign brands are
always quick to blame the price differences on China's luxury goods taxes, but
these are not large compared to the huge price differences, and many of these
goods are actually produced in China so import taxes are not a factor in any
case. Chinese luxury goods prices that are
often two and three times those in North America or Europe, derive almost
entirely from a marketing strategy that assumes Chinese are infatuated with
foreign goods and have more money than experience. Neither of those
assumptions is true any longer, as evidenced by the dramatic plunges in the
sales of these goods in China. Once the Chinese discovered the vast price
differential, they either abandoned the purchases or did their buying in
Europe. This part of the honeymoon is over.
Here is a live example: At an Italian men's
clothing shop, Ermenegildo Zegna, in the Jing'An District of Shanghai, was a
suit priced at 30,000 RMB, about $6,000 at the time. It was a reasonably nice
men's wool suit, more or less well-tailored but nothing special, and in North America
or Italy it would have carried a price of perhaps $1,000 or $1,200, certainly
no more. Here are the economics of that suit: for 6,000 RMB I can buy a return
plane ticket to Italy, for another 6,000 I can stay there for a week's holiday,
and for another 6,000 I could buy that same suit. And return to Shanghai with
nearly half of that 30,000 RMB still in my pocket. And that is why the sales of
so-called luxury goods in China are failing.
US-based Levi Strauss, the makers of Levi's
brand blue jeans, are one of the worst firms in China in terms of pricing
practices. A pair of ordinary Levi's blue jeans that sell in the US, Canada and
Europe for about $40, are priced at 800 or 900 RMB in China, about four times
as much, yet these products are made in China and should cost less. Even worse,
I have heard persistent rumors that
items passing the firm's quality control tests are reserved for sale in the
West while those failing are reserved for sale in China. The basic foreign
clothing brands like Levi's, Puma, Nike, Adidas, Gucci, are all far more
expensive than in the West, even though these items are almost all manufactured
in China and should cost less.
Wines are worse than clothing. A $200 wine costs $1,000 in China. A bottle
of champagne that costs $80 or $100 in the US or Europe, is 2,800 RMB in
Shanghai, almost five times the price. The five so-called 'first-growth'
French wines from Bordeaux that cost $200 everywhere else, are $2,000 in China.
A second problem is that of the European wines imported into China, and
certainly the French wines, almost all
are from the bottom 20% or so in terms of quality, most from vineyards that
even experienced wine drinkers have never heard of. Importers of European
wines are not bringing the best into China, but the worst, most of which are
not worth drinking but nevertheless carry prices of much finer wines.
California wines are worse. Aside from the clear fact that European wines,
especially those from France, are superior to anything produced in the US, the
California wines brought into China are cheapest and lowest-quality but
carrying prices five or more times their value. Almost all are overpriced
rubbish. As I discuss elsewhere with olives and pistachios, California has a
climate where many plants will grow, but few grow well enough to be marketable,
meaning that perhaps the majority of California products are substandard, being
grown far outside their natural habitat.
Foods are not better in any respect. In 2011,
Yum! Brands had 19,000 KFC and other
outlets in the US and only 3,700 in China, yet the company derived about 60% of
its revenue and more than 50% of its profits from China, compared to 32% from
the US. From these numbers, it is patently obvious that Yum! products are
grossly overpriced in China, so it's hardly a surprise sales are finally
dropping. Häagen-Dazs, owned by Nestle, is a particular irritation, being so
stupidly priced I cannot understand anyone buying that product, the company not
only charging Chinese consumers three times the Western price but being
repeatedly accused of short-weighting the packages. Nestle's Nescafe isn't much
better. Similarly, nobody in the West would pay $5 or $6 for a coffee, $8 for a
pound of butter or $15 for a pound of bacon. The same is true for all American
and many foreign food products, the excessive prices unrelated to either
importing costs or duties, many products costing seven or eight times the price
in their home country. "Western" style restaurants like Hooters, Element Fresh, Wagas, Malones,
and so many others, are similar, with prices far higher than would be charged
in the West. Papa John's must have
set some kind of record for pricing pizza in Shanghai at about three times what
it might charge in the West. In 2013, China issued fines of nearly 700 million
yuan to six baby formula companies for
conspiring to set minimum resale prices for distributors and punished
distributors who sold their products at lower prices by suspending supplies or
ending contracts. Their practices caused milk powder prices in China to rise to
as much as three times the foreign prices, restricted competition in the
market and illegally sucked billions of dollars from Chinese consumers.
Foreign automobiles are the same. In 2013 the
WSJ published an article titled "Luxury-Goods Firms' Little China
Secret", which began with the statement "The dirty little secret among luxury-goods companies is that they
have been persistently overcharging their best customers in China."
The article discussed auto prices, which I deal with below, but noting that
many luxury car models are 50% to 75%
higher in China than in the US or Europe, even when those same autos are
manufactured in China. The automakers attempt to defuse the issue by
claiming Chinese cars have more features, but those additional accessories are
a minor or trivial cost and account for little of the difference. The excessive cost in China is simple
price-gouging and price-fixing, evidenced by the criminal investigations and
huge fines levied against many of the foreign automakers.
It seems everybody wants to get into the act
of heavily overcharging consumers in China, and usually for substandard
products. Samsonite, which to many
people is basic McLuggage, have high hopes for China, having reclassified their
ordinary low-cost products as luxury goods at three or four times the price.
Like Starbucks, Nescafe, KFC and Pizza
Hut, Samsonite are trying to rebrand themselves as a luxury-goods company
to Chinese who are unfamiliar with their products. But the only real difference
between Samsonite and McDonalds is the spelling of the name. The Thermos brand of vacuum bottles is the
same; a very low-cost basic product in the US but ten times the price in China.
Retail
giants like Wal-Mart, and others like 7-11 who dominate a niche, have proven to
be poor value to society and far more greedy than their predecessors.
One manifestation of this lies in the slotting and stocking fees now
universally charged by these huge retailers. In other words, if you want your
products in my store, you will pay heavily for the privilege. The large
retailers have considerable power, with these fees having become a major profit
source to the extent that most of these retail firms now make more profit from
these fees and commissions than from the actual merchandising of the products
themselves. These fees are not small. One California nut producer complained of
having to pay US$50,000 each month to keep his products on retail grocery
shelves. These fees and charges began in the US, in the most fertile land for
corporate greed and plundering, and with a supportive government loathe to
interfere in the workings of a "free market". From there, the practice
spread worldwide to the detriment of consumers everywhere. These fees
constitute a form of extortion and caused widespread public disputes in China
after Wal-Mart and Carrefour levied
increases that suppliers considered outrageous. It is by no means unusual to
see even high-profile international brands suddenly disappear from the shelves
in both Wal-Mart and Carrefour, from companies refusing to pay.
A slotting fee is a one-time payment by a
manufacturer or vendor to a retailer in order to obtain shelf space in the
retailer's store. In effect, the retailer is demanding a bribe from you, if you
want him to carry your product. For a new product, the initial slotting fee
might be 150,000 RMB ($25,000) per item, per store in a regional cluster of
stores, but may be as high as 1.5 million RMB ($250,000) in high-demand markets
like Shanghai. Slotting fees are bitterly hated by producers, and can be a
major cost factor in the market introduction of any new product, since this
"down payment" must be made before a product will appear on the store
shelves. Stocking fees are monthly payments by a supplier to retailers to
guarantee shelf space in the store. In effect, a supplier or manufacturer is
paying a monthly rent to the retailer, at a fixed amount per square meter of
shelf space. These fees are widespread in North America, in convenience stores
like 7-11, grocery chains, retail chains like Wal-Mart, bookstores, pharmacies,
and more. And with all the foreign firms here, they are certainly no stranger
to China. If the US experience is any guide, firms in China are paying as much
as 1 million RMB per year for each square meter of retail space, a huge cost
that is passed on to the consumer. It's extortion, but if you won't pay, you
will have no sales outlet. Suppliers must pay for every cm. of space, including
aisles, shelf end caps, cooler footprints, everything. These fees are payable
either in cash or in wholesale price discounts, or by surrendering dozens of
cases of free products. This topic is politically very sensitive, and secret.
According to one report, "When a US Senate Committee held a hearing on
these fees, producers refused to testify unless they wore hoods and used a
voice scrambler to conceal their identities, such was their fear of retaliation
from retailers."
In addition to slotting and stocking fees,
powerful retailers like Wal-Mart or Carrefour will often charge promotional
fees, entry fees, shared advertising fees, "sponsorship" fees,
"anniversary celebration" fees, holiday celebration fees, and
anything else they can imagine and get away with. Wal-Mart in 2010 had more
than 20 categories of such fees, while Carrefour had 30. The greed became so
great that at some of these firms individual store managers and buyers were
levying their own 'fees' which oddly appeared on no invoices anywhere. It was
so bad that one supplier in China had more than 30 million in sales to one of
these foreign big-box firms, but less than 300,000 in profit because of all the
fees charged. In the wide range of extortionate practices invented by large
retailers to bleed their suppliers, a new scheme has recently appeared, that of
demanding cash payments to be placed on, or to remain on, an approved list of
suppliers. Large retailers have a thousand or more suppliers, so requesting
what is euphemistically called an "investment payment" of even a few
thousand dollars each, can easily produce an annual windfall of a hundred
million dollars or more. The very large firms like Wal-Mart, Safeway or
Carrefour can reap hundreds of millions each year since suppliers cannot often
afford to sacrifice such a large customer.
I have written of some of the practices of
killing major domestic brands in a foreign market, but in a country like China
there are still hundreds of thousands of smaller domestic brands which
collectively still represent significant competition. These slotting and stocking fees are one tactic widely used by American
firms to kill off these smaller brands. They are a competitive strategy to
deliberately evict domestic brands from local retail distribution channels, a
quite effective way to kill local brands and eliminate competition. The fact is
that the large multinationals control the retail space and don't want any
competitors in it. There is so much money involved they will do whatever is
necessary to maintain control of the space. Companies like Pepsi and P&G
welcome, and would even overpay, high stocking fees to eliminate their
less-well-financed domestic competition. In effect, they are paying retail outlets
to drop domestic Chinese brands. If you
want to kill all domestic products and force consumers to your foreign brands,
these shelf "rentals" are less expensive than media advertising and
far more effective, since this way you simply eliminate most other consumer
choices. Since consumers cannot find local brands on the shelves, they are
usually forced to purchase the foreign brands and, since the domestic brands
have been forced out of the shelf space, they will slowly wither and die in the
small towns. Consider the Bee &
Flower brand, makers of one of the finest shampoos and hand soaps ever
produced, superior in most respects to almost all of the so-called
"premium" foreign brands. But the Brand's shampoo normally sells
for only 8-10 yuan while the bars of hand soap are priced at 3-4 yuan. If the
stocking fees are raised too high, product retail prices might have to be
increased by 50% to 100% to cover the increased fees, and such an increase
would kill a brand by pushing it so far outside its normal price point. The
alternative is to withdraw the brand from these retail outlets, which of course
will also kill the brand since consumers can no longer find it.
Ten years ago in Shanghai I could find dozens
of domestic brands of some kinds of snacks, like potato chips, but today in
every supermarket large and small, it seems that 90% or more of the total shelf
space is filled with the Lay's brand (Pepsi). Similarly, I could once find
dozens of brands of domestic Chinese chocolate bars but today it seems that 90%
and even 100% of that shelf space contains only Snickers bars and Dove
chocolates, both products of US-based Mars. The same process is occurring with
tasteless and overpriced California pistachios and almonds, and during recent
years all chewing gum everywhere appears to be the Wrigley's brand - also owned
by Mars. As another example, I would find dozens of Chinese brands of household
cleaners, but today all those brands have disappeared to be replaced by
inferior products from US-based S. C. Johnson at four times the price.
Some of these stocking contracts are merely a
rental payment for a stipulated amount of shelf space, and perhaps location.
But many, perhaps more, contain an agreement to stock only a particular
company's products. One more way to ensure the disappearance of local brands.
If you pay attention to the business news, you will sometimes read articles
about a retailer reducing the number of available brands in many different
product lines, often described as a "streamlining" effort or a move to
"greater efficiency". But most often, that's not really what
happened. Instead, some suppliers have formed a pact with the retailer to
promote their products, often exclusively, having offered high enough payments
to justify the retailer dumping the competing brands. Whenever you see what
appears to be an excess of any one brand or any product in a shop, and an
absence of others, you can suspect this is happening. Well-financed companies
like Nestle, P&G, and Coca-Cola can afford to pay high fees to gain control
of 80% of a retailer's available space, with all other competitors sharing the
little that remains. This practice exists in China on a far wider scale than
realised, and certainly applies not only to food and beverage producers like
Pepsi, Nestle and Danone, but to all foreign FMCG companies like P&G and
Unilever. And on a retail basis, it certainly applies to foreign companies like
Wal-Mart and Carrefour, 7-11, Family Mart and many more. And now that Wal-Mart
has taken control of Yihaodian, we'll watch to see how this plays out, and if
brands begin to disappear. Certainly, Wal-Mart knows how to play this game
better than most people. These exclusive contracts are also frequently the
cause of sudden and large price increases. Often, an exclusive contract with
(for example) Lay's, could see all competing brands disappear, and Lay's prices
double.
A series of disputes between suppliers and
retailers attracted high-level attention in China in 2012, after Carrefour and
Wal-Mart reportedly raised slotting allowances and other fees that outraged
many product suppliers - certainly most domestic ones. China's government is
now deciding how best to regulate retail businesses and is drafting new rules
to minimize disputes and complaints over these fees. But the practice is extortionate and a violation, and should be banned
outright. This kind of US-brand predatory capitalism is damaging to
everyone except the handful of beneficial stockholders of firms like Pepsi,
P&G, J&J, Mars and Wal-Mart, and of course serves to increase the
income disparity we all want to avoid. The process pushes all consumer prices
increasingly higher, while forcing all low-cost, mostly domestic, products out
of the retail market. Many economists have estimated that supermarket retail prices are at least 30% higher than would otherwise
be the case without this predatory practice. If permitted to run free, it
will destroy all competition, leaving consumers with only a few over-priced and
low-quality choices of American products. These excessive payments not only
increase consumer retail prices, but squeeze the profits of the suppliers since
costs cannot be recovered through higher wholesale prices, and are driving many
manufacturers out of the supermarkets and chain stores. We already see it in cities like Shanghai where, for personal care
products, we have only the grossly-overpriced multiple brands of companies like
P&G, Unilever and J&J, with most domestic brands no longer available.
Carrefour
in particular are noted for their greed and lack of discretion in such matters,
to say nothing of a lack of class. The firm exited the
Korean market altogether after a huge criminal case where they were severely
fined for their fee collections. In 2009 and 2010, the company also exited
Russia, Japan and Portugal. In Belgium, Carrefour sold half their stores,
closed the other half, and exited that country as well. And in 2010 China
experienced a bit of an uproar in its retail markets precisely due to these
fees, resulting in many domestic brands being forced to withdraw their products
from Carrefour because of an increase in 'commissions' of up to 15%.
This retail model is a serious hindrance to
creativity and innovation because it discourages businesses, especially small
ones, from even attempting to create new products, since the up-front placement
costs would simply be too high. And if a new product is created by a smaller or
weaker competitor, the "expand and destroy" Managers at P&G,
Pepsi or Mars, can use these stocking
fees as a tool to prevent new competition from ever entering the market. The
small company or the less-well-financed domestic company simply cannot afford
to pay the millions or tens of millions of RMB that would be necessary to bump
a P&G that is intent on defending its retail shelf space. Often, the only
choice available to a small local competitor, almost regardless of the
excellence of the new product, is to sell it to one of these predatory
multinationals. The price won't be high, but it's all you get. During this
brutal campaign, these same firms will cry increasingly louder for "a
level playing field" and for even more access to China's markets, all
based on the jingoistic US corporate hypocrisy that "increased
competition" is best for the market. But
in fact the last thing any of these companies want is competition. Their entire
souls are possessed with a determination to destroy that which they so
fervently profess to venerate.
*
Larry Romanoff is a retired management consultant and businessman. He has held senior executive positions in international consulting firms, and owned an international import-export business. He has been a visiting professor at Shanghai's Fudan University, presenting case studies in international affairs to senior EMBA classes. Mr. Romanoff lives in Shanghai and is currently writing a series of ten books generally related to China and the West. He can be contacted at: 2186604556@qq.com
Larry Romanoff is one of the contributing authors to Cynthia McKinney's new COVID-19 anthology ''When China Sneezes''.
Copyright © Larry Romanoff, Moon of Shanghai, 2020
