Casey Hall
SHANGHAI (Reuters) – An aggressive market takeover by low-cost Chinese retailers has delivered windfall profits for some firms but has also fueled a brutal price war, exacerbating deflationary fears in the world’s second-largest economy.
From coffee to cars to clothing, Chinese discount retailers are slashing prices on virtually everything, chasing consumers whose confidence has been shaken by a housing crisis, high unemployment and a bleak economic outlook.
While the decline in retail sales has boosted revenues for companies such as the discount e-commerce platform. Pinduoduo (NASDAQ:) against larger competitors such as Alibaba (NYSE:), economists fear their success is entrenching a Japanese-style deflationary mindset among consumers that will be hard to shake.
Because retailers compete primarily on price, they force their suppliers to cut costs harshly, squeezing profit margins. This in turn leads to lower wage growth or greater reliance on low-wage part-time work, which harms household demand.
“If this situation continues, China may find itself in what we call a vicious circle: lower value-added consumption, deflation, low profit margins leading to low wages, which further pushes consumers to reduce their consumption levels,” He said -Ling Shi, Professor of Economics at Monash University in Melbourne.
In the latest earnings season, low-cost companies’ earnings beat market expectations and outpaced their peers.
Revenue at PDD Holdings, which owns Pinduoduo, rose 131%, while China’s leading food delivery app Meituan posted 25% growth. Discount retailer Miniso and Lukin Coffee (OTC:) reported growth of 26% and 42%, respectively.
PDD, Meituan, Miniso and Luckin Coffee did not immediately respond to requests for comment.
Chinese consumer price data for May, to be released on Wednesday, is expected to show a slight rise in inflation to 0.4% from 0.3% in April.
However, analysts expect the headline numbers to be mostly supported by rising utility prices, masking more critical deflationary pressures.
RACE TO THE BOTTOM
In an environment where consumer confidence is at its lowest, price is critical.
Automakers in China have been locked in a price war for nearly two years due to sluggish domestic demand. Over the past two months, some auto dealers and auto loan companies have launched loan programs with no down payment and even zero interest rates.
Starbucks (NASDAQ:), whose revenue in China fell 8% in the first quarter due to what CEO Laxman Narasimhan called “fierce competition among value players,” has increased its use of discount coupons in recent months to bring prices closer to Luckin Coffee . .
Food delivery giant Meituan CEO Wang Xing said last week that the company had expanded coupon offerings and opened more delivery-only kitchens with lower overhead costs than dine-in restaurants. The new hotel booking app business is pursuing what Wang called a “low-star” strategy aimed at budget-conscious domestic travelers.
Alibaba’s domestic e-commerce unit Taobao, Tmall Group and JD (NASDAQ:.com), which have seen single-digit revenue growth, said on earnings calls that price competitiveness will be key to future growth.
Both companies have introduced longer sales periods for China’s mid-year shopping festival known as “618”, with lowest price guarantees on millions of items. In response, Pinduoduo launched an “automated price tracking system” to allow merchants to track and beat competitors.
An internal memo to employees sent by JD.com founder Richard Liu in which he described his firm as “bloated” led to speculation that the company would respond to increased competition with job cuts, the opposite of what China needs to restore domestic demand.
In the long term, price wars could wipe out weaker players in various industries, allowing rivals to then raise prices and give their supply chains some breathing room, said Albert Hu, an economics professor at China Europe International Business School in Shanghai.
But he warned they could only do so if growth in other industries created enough jobs and income growth to offset any exits from markets caused by price wars on consumer goods.
“Deflation is a serious problem and Japan has been struggling with it for more than three decades,” Hu said. “The critical factor is wage growth.”