• Multinationals are losing market share in China to domestic rivals as the quality and marketing of home-made goods become more sophisticated, according to our latest brand survey.
  • This trend is particularly notable in third-tier cities. Multinationals face a greater challenge in these crucial markets than they did when first expanding into first-tier urban centres such as Beijing and Shanghai.
  • We expect domestic brands to continue to erode the market share of multinationals. However, premium goods will maintain their cachet — our survey data show Chinese brands have had little success so far in categories such as cosmetics.

Multinational companies are continuing to lose market share to domestic companies across several categories, FTCR consumer brand data show. Our latest quarterly survey reflects the strides made by domestic companies in manufacturing for and marketing to a domestic audience. This trend is particularly notable in China’s third-tier and smaller cities, a market of nearly 500m consumers.

Starting with Coca-Cola in 1979, many foreign companies entering the Chinese market have thrived in the country’s biggest cities (see chart). They were helped by rising incomes and the fact that domestic competition was so weak. Amid signs of saturation in the country’s most developed urban centres, foreign firms are now expanding into the giant market that is lower tier Chinese cities. China has 147 cities of more than 1m residents.

The challenge presented by domestic brands means multinationals will face a tougher time expanding into smaller cities than they enjoyed during their initial expansion into China’s biggest urban centres.

Smartphones

The greatest gains for homegrown names are seen in the smartphone sector. Our data, based on a quarterly survey of 2,000 households nationwide, show that the combined popularity of domestic brands passed that of multinationals in the third quarter last year and has continued to build.

In third-tier cities, the proportion of respondents who chose domestic phone brands rose to 62.2 per cent in our second-quarter survey, up from 46.7 per cent in the first quarter of 2016, when our quarterly survey began. This compares with 50.6 per cent among first-tier-city residents and 56.7 per cent for second-tier cities.

Local brands have flooded the market with models that can compete on hardware but at price points well below Apple’s iPhone and Samsung’s flagship Galaxy phones. In the premium segment Huawei has been eroding the dominance of Apple, thanks in part to handsets catering to the domestic market.

Aggressive marketing has also boosted the popularity of domestic companies such as Oppo and Vivo. Of the total spent on advertising in traditional media by China’s 20 top smartphone brands in the first half of this year, domestic brands accounted for 82.3 per cent, up from 62.1 per cent during the same period last year, according to CTR Market Research, a joint venture between China International Television Corporation and Kantar Group. Between them, Oppo and Vivo now sponsor seven of the 10 most popular Chinese television variety shows.

Cars

In the auto sector, domestic carmakers accounted for 11.8 per cent of advertising spend on traditional media during the first half, up from just 4.2 per cent during the same time last year, according to CTR. Although joint-venture manufacturers still dominate China’s auto sector overall, the proportion of respondents who chose domestic brands continued to increase in third-tier cities, rising 2 percentage points from the first quarter of 2016 to the second quarter of 2017, to a record high of 19.3 per cent. Although this suggests incremental improvement, the trend is unmistakable. The growth in popularity among first-tier-city residents was even more pronounced between the start of 2016 and the second quarter of 2017, but from a lower base.

Domestic marques have been more successful in meeting demand among smaller city respondents for SUVs priced under Rmb150,000 ($23,000). Sales of these models accounted for 63 per cent of total SUV sales last year, up from 44 per cent in 2012. Eight of the top 10 bestselling SUV models in China in the first half were built by domestic brands versus just one among the top 10 sedans.

Retail

The popularity of domestic brands has also steadily increased across the retail landscape. The proportion of respondents who said they use domestic convenience stores increased to 72.4 per cent in the second quarter of 2017 from 70.1 per cent 18 months previously, while for homegrown supermarkets the share increased 2.9 percentage points to 30.1 per cent. The Chinese retail landscape is littered with the failed forays of foreign retailers, from B&Q and Best Buy to, most recently, Marks and Spencer. Ministry of Commerce data covering the top 100 large-scale retail enterprises found the foreign share of total retail sales fell to 9 per cent last year from 23.2 per cent in 2010.

In third-tier and smaller cities, local names that have gained in popularity include Yonghui, which was cited by 7.8 per cent of consumers in our most recent survey versus 4.5 per cent at the start of last year. The Fujian-based firm has built a reputation for stocking a wider range of fresh produce and perishable goods than its rivals and also benefits from more decentralised operations than stores such as Walmart and Carrefour. Despite foreign retail’s well-documented disasters in China, Walmart remained the second most popular supermarket brand overall in our second-quarter survey, behind RT Mart, which is owned by Sun Art Retail of Taiwan.

Cosmetics

In cosmetics, domestic brands have had less success. Overall, their popularity among respondents rose just 0.7 percentage points to 8.3 per cent in the 18 months through the second quarter. Domestic brands accounted for just 14.7 per cent of ad spend in the first half of 2017, largely unchanged from 14 per cent the previous year, while that of foreign brands increased to 71.3 per cent from 68.3 per cent. Notable gainers in third-tier cities over the past 18 months have been Origins, owned by Estée Lauder, and Biotherm, which is part of the L’Oréal group of brands.

However, we expect these companies to face a greater challenge in these markets. As well as less developed logistics operations in the provinces, we have already seen how operating further from the centre of power leaves firms more open to local protectionism. Yet their biggest challenge may come from a crop of domestic names that are proving more able to compete on their home turf.

FT Confidential Research is an independent research service from the Financial Times, providing in-depth analysis of and statistical insight into China and Southeast Asia. Our team of researchers in these key markets combine findings from our proprietary surveys with on-the-ground research to provide predictive analysis for investors.