Western Price-Gouging in China -- October 01, 2020

  

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.

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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