Tuesday, March 3, 2009

Consumer Credit: The Key to Domestic Growth

Economic Stimulus[1]

China is committed to a policy of domestic economic growth to offset a declining rate of export growth. Export accounts for one-third of Chinese output. Decreasing exports due to global slowdown (recession + protectionism) will result in factory down scaling, shutdowns and skyrocketing unemployment. This will affect all of China’s export regions.

There are two Western ways to stimulate domestic economic growth: 1) Increase consumer demand for goods by increasing employment through infrastructure investment and reduced interest rates for private investment to meet increased demand (Keynesian economics) ; 2) using incentives for people to produce goods and services, such as adjusting income tax and capital gains tax (Supply side economics.). Both approaches aim to increase the amount of money consumers will spend on goods, but takes different paths. Keynesianism increases government spending to increase demand and employment; supply side economics increases private spending and investment to increase demand and employment.

The problem with these models in China is that there is no assurance that increased employment and money in the pocket will be spent to boost the domestic economy. China has a savings culture (over 40% of earnings) while the U.S. has a spending culture (zero savings). This difference is reflected in the size of the retail sector in both countries. China’s retail sector accounts for only 30% of GDP; while U.S. retail accounts for 70% of GDP. In the U.S. people will spend all of the money in their pocket and move on to their credit cards. In China, people will spend only a small portion of new money. They will save the rest. Hence, western models in China would result in much less economic stimulus than in the U.S.

A further fact must be considered to understand the impact of Western models on consumption. The average Western consumer leverages every new dollar in the pocket with consumer credit. Hence, economic stimulus is compounded. China, on the other hand, is still a cash economy, so there is no leverage on added earnings. In fact the opposite is true. An extra dollar in China results in only $.60 cents of spending. Hence it is far most costly in China than in the U.S. to gain an equal amount of demand for a given amount of stimulus.

Some argue that the key to Chinese domestic growth is to convert savings into spending. But this is an intractable cultural problem. How do you change a 3,000 year habit? And how do you win the political battle with National banks and their state-owned industrial borrowers that want to retain savings deposits? It is more reasonable to leverage the 60% of earnings that are spent on consumption by instituting widespread consumer credit.

Expanding Consumer Credit

Government expansion of consumer credit requires a marketing strategy. All marketing strategies consist of nine steps.

1. Vision. Den Xiaoping said, “It is glorious to be rich.” This early vision of China’s export market economy did in fact build wealth at the top through direct foreign investment to a new class of owners who invested that money in factories and capital equipment for an export economy. They paid taxes and fees, which in turn built public infrastructure.

The new policy of domestic growth requires another vision, “It is glorious to consume.” This mantra affirms the pivotal role of the middle class in supporting Chinese domestic growth. They have the resources for consumer credit. They will not spend enough cash to grow the domestic economy. But they will spend credit and work hard to revolve and extend their credit lines. Many other countries have gone through this process. The Chinese government will regulate consumer credit expansion.

2. Objectives. Credit card use is very new in China. There are 100 million credit cards in circulation. Most credit cards are used for business expenses, not personal or household consumption. Credit lines are also very limited. A typical card will carry a credit limit of RMB 20,000. This is hardly enough to make a make a down payment on a car. It is reported that 85% of car sales are cash transactions.

The government has to set a reasonable objective for the projected size of the consumer credit card market. That size has to be a percentage of retail sales and a percentage of GDP. The benchmarks of different countries are all over the place. In the U.S. consumer credit is $2.6 trillion, or 20% of GDP. The U.S. retail sector is 70% of a $13 trillion GDP, or $9.1 trillion. Nearly 1/3 of current retail is supported by current consumer credit. The U.K. is closely approaching the same ratio of consumer credit to GDP as the U.S.; but Germany, Norway and Sweden are at around 10%, while Hungary, Switzerland and the Czech Republic have a 3% ratio of consumer credit to GDP. Mexico has a low percentage of the credit cards to population – only 34%. China has a much lower percentage. So what is a viable benchmark?

The most reasonable benchmark appears to be Germany. Like China, Germany has a high savings rate and an export ratio of 40% to GDP. So it is not unreasonable to project a 10% ratio of consumer credit to GDP as a long term objective in China. The official exchange rate GDP of China is $3.2 trillion. Using the German benchmark of 10%, consumer credit should be at $320,000,000. China’s current ratio is less than 1%of GDP. Hence, China has a long way to go and requires a policy regime to grow consumer credit to a reasonable level to meet objectives of domestic growth. China needs a 5-year plan for consumer credit growth to reach the lower standard of the Czech Republic at 3%. A second 5-year plan could boost it to the German level of 10%.

3. Target Customer Segments. The only way to achieve rapid growth of consumer credit from a very low starting point is to market cards to segments of the population that already have them and use them to some degree for personal consumption. That means more cards and extended credit lines to current users and their demographic and psychographic cohorts. A qualified cohort profile can be extracted from current data. It would include all people similar to the people who already have and use credit cards. In all likelihood, 80% of that cohort either do not yet have credit cards or do not yet use their credit cards for personal consumption.

There are two segments that fall into this target market. The first group is the population under 24 – “the little emperors” of a one child policy. They are at the universities in major cities and have enough cash from their parents to pay credit card bills. They are spending their parent’s savings, so they have taken the first step to be true consumers. Consumer credit will leverage their family cash support for minimum payments and enable this segment to buy several-fold the amount of goods they are buying for cash. Their credit lines are limited because they are not employed, or fully employed. But they are a numerous class and can generate a high volume of credit based retail sales.

The second segment is the professional and young entrepreneurial class 25-50 in age. They need to show success and status and are paying cash for these the emblems of achievement. But they psychologically need to buy more than their cash permits. They are employed and have a rosy future. They can support a substantial credit line. The proper targeting strategy for fast domestic growth through consumer credit is to penetrate the cohorts that have cards and use them. There is no need to try to convert endemic savers into spenders.

4. Value proposition. The value of consumer credit to target segments is that credit cards multiply the goods you need to impress those with whom you are connected and those with whom you wish to be connected. This is an economic value proposition. Consumer credit is an investment in your advancement. As the Chinese economy matures, the value proposition will shift to Western modes of emotional rather than economic purchase, like impulse purchase, cult, or identity purchase, experience consumption, shopping sprees and other non-economic motives. But China is not there yet, and hopefully will not reach the excesses of the West. The economic value of status is enough to greatly expand the domestic economy.

5. Brand strategy. The government and card issuers need a brand strategy to manifest the value proposition with powerful messages, symbols and design. This requires the best way to tell the story of personal success through consumption; consumer happiness through brand identity; portraying leaders and celebrities as consumer role models; improved design to enhance the shopping experience; and the social value of credit use to the country.

6. Products. There are many credit card products. Typically in the West there are many levels of branded card offerings that relate appropriately to different demographic and life style classes. Silver, gold and platinum cards denote wealth classes. Affinity cards that are issued by banks, associations and companies reflect life style hobbies to which cardholders are very loyal. Sport teams issue cards, along with airlines, social cause groups, and so on.

7. Promotion. Cards are typically promoted through direct marketing by mail, online advertising and application or direct enrollment at events of card issuers. Credit card issuers spend a lot of money on print, TV and online marketing. The government will have to play an active role in promoting credit cards by its communications and information agencies.

8. Pricing. Annual fees, interest rates and rewards are key elements in the competition between credit card issuers. China has to be careful to regulate these matters and avoid the usurious interest rates prevalent in the West.

9. Distribution. The backward supply chain of credit card distribution is complex. Applicants have to be evaluated for credit qualification. Credit has to be financed by a chain of financial institutions and service organization. Risk has to be widely distributed. The forward supply chain is also complex. Distribution companies like American Express, Visa, Master Card, and Union Pay need information systems to organize and implement issuance, transactions, payments from buyers, payment to sellers, as well as receipts from and payments to financing sources and regulatory agencies.

Benefits of Consumer Credit

Chinese policy and Chinese enterprise have great aspirations for innovation and branding. But it is very important to understand how these aspirations relate to consumer credit. Innovation creates a useful or desirable value-added object. Branding adds a rational and emotion appeal to the innovation. But consumer credit makes it possible for people to buy these products.

So long as Chinese consumption remains on a cash basis, very few people can afford to pay cash for discretionary goods. They save their cash to purchase a home, a car and educate their children. They lay out a lot of cash for these fundamental purchases and take out banks loans for the balance. There is little cash left for goods that can support status and advancement, like gifts, stylish and fashionable apparel, entertainment, home furnishings, consumer electronics, and other appurtenances of personal success and achievement. They need to purchase expensive goods to display their status. Innovation and branding tempt purchase, but consumer credit enables purchase and accelerates domestic economic growth.

[1] This article was published in February, 2009 in the 21st Century Business Herald.

40 comments:

  1. Dr. Kotler,

    How might home equity play a role in expanding consumer credit? Would Chinese be more willing to take out these larger secured loans (to buy a car, for example) or use credit cards for "status" and other smaller consumption?

    Also, the early history of card usage in America has a 37 year span from the introduction of the Western Union card in 1921 to the true revolving credit of BankAmericard in 1958. This time not only allowed for businesses to make the needed infrastructure investment, but also for consumers to grow comfortable with using the cards.

    One thing that sped up this comfortability was the fragmented banking system in the US during early introduction. ATMs from the consumer's home bank were not prevelant everywhere, as they are now. China has gone in the opposite way: adopting large banks (Agri BOC, China Construction Bank, etc.) and a systemized network of ATMs to allow people to withdraw cash whenever they need it, even if they travel to different cities or provinces.

    I think that credit card companies will be more successful in implementing a rewards system than the standard credit card. Chinese consumers are both proud of their frugality and like to show off. A rewards system might accomodate both of these desires. Perhaps, as was the case in the United States, it can start with gasoline purchase?


    Sincerely,

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    Student of Economics,
    Georgia Institute of Technology

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