The Rise of China’s Lower Tier Cities

September 05, 2019

Chinese consumers are upgrading their purchases as they move up the consumption value chain. Engel coefficient, which measure the proportion of income spent on basic necessities, is used by the UN (United Nations) as a proxy to measure a country’s level of affluence (with a decline indicating an increase in affluence). China’s score improved from 29.3% to 28.4% in 2018 as consumers continue to benefit from higher disposable income, as reported by the National Bureau of Statistics. During the same period, the percentage of services-oriented consumption as part of total domestic consumption increased from 39% in 2013 to more than 44% in 2018. Chinese consumers are spending more and trading-up for a better quality, more expensive products.

The above is substantiated by the fact that overall domestic expenditure on luxury products – including experimental luxury goods, fine wines and spirits, sport cars, and jewelries – has seen accelerated growth of 13% from 2016 to 2018, compared to 7% from 2014 to 2016.

Current economic trends and demographic data indicate that China’s lower-tier cities will be the new drives of consumption and economy growth as middle-class benefits from an increase in disposable incomes and broader access to products and services. Lower-tier cities also benefit from relatively lower housing costs, effectively unleashing consumption potential on more discretionary items.

We are witnessing how rapidly aggregate spending in lower-tier cities drives overall consumption in China: rate of consumption growth in tier 3 or 4 cities is outpacing those in tier 1 cities. In the past, a lot of media coverage have linked China’s growth to tier 1 cities (Beijing, Shanghai, Guangzhou, and Shenzhen). In doing so, they have lost sight of the massive potential contained in China’s lower-tier cities. By 2030 it is expected 3X growth in household consumption originating from tier 3 cities and below, of which the net gain alone will surpass today’s consumption market.

From a structural perspective, expenditures in tier 3 cities are more robust and diverse since consumers have a higher proportion of disposable income to spend. According to a 2018 study conducted by Morgan Stanley, housing spend is recognized as the top expenditure in tier 1 and 2 cities. While in tier 3 and tier 4 cities, housing spending is only ranked #4 with daily necessities, education, and discretionary consumption (travel, dining, healthcare, etc.) ranked in the top 3. Overall, it is estimated that consumption in lower-tier cities will triple to $US 6.9 trillion by 2030, while consumers in smaller cities are catching up with tier 1 and tier 2 markets in valuing quality over price.

In a recent report from AliResearch Institute, of the 200K new products launched on Tmall last year, 44% of the sales came from Tmall users residing in lower-tier cities. Research also shows that consumers living in third and lower-tier cities exhibited high levels of activity across major online platforms, including Tmall and JD during 2019 Chinese New Year. 

In fact, Alibaba’s platform boasted an increase of 100 million new annual active users in 2018, of which 70% resided in less developed cities. To further capture demand from these geographies, Alibaba launched this year’s 6-18 mid-year shopping festival to specifically help brands and merchants on Taobao and Tmall tap into smaller cities and rural areas with 1.5 million products and heavyweight promotional offers. Meanwhile, Luxury Pavilion, Tmall’s dedicate channel for luxury and premium brands, saw over half of its total sales generated from third-tier cities and below.

According to PWC’s Global consumer insight study, Chinese consumers from tier 3 cities demonstrate a higher “willingness to pay” when compared with those in tier 2 cities across different categories. This major shift in consumption toward higher ticket items such as health and wellness products and travel means that people in less developed cities are increasingly seeking an upgrade in the quality of life and experience, which for brands, represents a lucrative “blue ocean” segment to get into.