In early 2023, China's economic environment showed unexpected trends, and many began to worry that China's economy would become fully Japanized. Behind this topic are two Japanese economists, Richard Koo and Kenichi Ohmae, who studied Japan's economy: they proposed that Japan experienced a balance sheet recession in the 1990s and, due to economic changes, fully entered an M-shaped society.

The author was recently invited by Merrill Lynch to share insights on whether China will fully enter a Japanized economy. This article is a compilation of that sharing for the readers.

What Can China Learn from the M-Shaped Society?

Let's first review what Kenichi Ohmae's M-shaped society entails:

With Japan's economic recession in the early 1990s, Japan's middle-class society collapsed comprehensively—national income polarized, with 80% of the population falling into the middle-low class.

  • Office workers saw the value of their land and houses plummet, and those middle-aged workers burdened with high-leverage loans fell into a debt spiral. (This also occurs in China; some middle-class individuals have become insolvent due to falling property prices.)
  • Office workers, fearing layoffs, accepted salary cuts and extended working hours, feeling the hardships of life. (In China, a large number of platform workers have emerged.)
  • Through hourly wages, increased contract workers, and layoffs, companies' performance did recover, but the compensation workers deserved decreased.
  • Reasons for Japan entering an M-shaped society: First, the increase in the elderly population who view goods as non-essential (changes in population distribution); second, the shift from existing production methods to just-in-time production (inventory becomes non-essential, changes on the corporate side); third, consumer psychology that, due to anxiety about the future, values money over material possessions (changes on the individual side). In other words, it's not a situation premised on economics, but the interaction of these three aspects occurring in today's society.
  • After the collapse of a society where the middle class constituted the majority of the working population, the distribution of income classes moves toward the lower and upper extremes, forming an 'M-shaped society' with peaks at both ends and a trough in the middle. This trend became particularly pronounced in the United States after the 'Reagan Revolution,' and Japan followed suit 20 years later.

Ohmae also mentioned the changes in the U.S. retail industry under the M-shaped society:

Among the top 10 U.S. retail companies by sales in 1971, 8 were mass merchandisers and supermarkets, with only one department store making the list. By 2003, Walmart, which started as a discount retail supermarket, ranked first, and only Sears remained as a mass merchandiser, which was acquired by Kmart in 2004.

Why such a big change? Simply put, mass merchandisers targeting the middle class declined, while discount retail stores targeting the middle-low class rose. The rise and fall of the U.S. retail industry can be seen as an inevitable trend after society transitions into an M-shape.

The same situation occurred in Japan.

Meanwhile, Ohmae, in his M-shaped society, also addressed the polarization of consumption and the increase in luxury goods consumption, offering his own views:

There are many reasons for the rise in new luxury goods consumption. First, discount retail stores save ordinary households some expenses, allowing the middle-low class to have extra money to buy slightly more expensive items. For example, they usually shop at 100-yen stores but have a particular obsession with luxury interior furnishings; they wear mass-brand clothes but want a designer bag; they usually eat cheap supermarket products but are particular about miso and soy sauce. In other words, a consumer can have two completely different consumption behaviors simultaneously. Additionally, single women or housewives in the workplace use a fixed budget to 'reward themselves' or enjoy 'occasional luxury.' Even women with middle-low incomes often spend large sums on designer bags.

Ohmae segmented Japan's consumer groups and named each segment. Using selective consumption and expenditure as the vertical axis and income and assets as the horizontal axis, he illustrated the distribution of each segment.

China's market has also undergone fundamental changes, and this change is not an isolated case

Since China joined the WTO and integrated into the global economic chain, China's economy entered the fast lane, starting 20 years of rapid growth.

Consumers have always had strong desires to improve their lives due to national economic growth, increased personal income, and willingness to consume. They are also willing to take on high leverage to buy cars and houses to improve living conditions, and even invest surplus funds in real estate.

The government, due to economic growth and strong consumption willingness, also enjoyed good land finance revenue, leading to large-scale infrastructure investment, and modern cities rose from the ground.

However, all these were achieved through a stable external environment, certain investment directions, and a sound economic cycle.

But since 2018, with Trump taking office, some external environments began to change. The international political environment became unstable: the U.S. fully blocked China's high-tech fields, the Russia-Ukraine war, the Middle East war, and U.S. interest rate hikes all made the world economy highly unstable.

Meanwhile, China's economy also faced many pressures:

  1. China has entered a deeply aging society. In 2023, the number of births fell below 10 million for the first time since the founding of the country, the marriage rate dropped significantly, and the divorce rate rose sharply.

  2. The total population reached a turning point of decline in 2022. Consumer goods are premised on population base; when population stops growing, total consumption decreases.

  3. The U.S. is relentlessly suppressing China's high-tech manufacturing, attempting to decouple China from the world economy, and investing large subsidies to bring manufacturing back to the U.S.

  4. Real estate, one of China's three economic pillars, entered a downward cycle. Middle-class individuals with high-leverage loans to buy houses became over-indebted, and overnight, they were back to square one.

  5. The three years of the pandemic emptied the government's coffers, and land finance became less effective as real estate entered a downward cycle.

  6. The three years of the pandemic also made ordinary people see some things clearly, and consumption gradually became conservative; they dared not consume or invest.

China's economic environment is extremely complex. The country is hovering around the middle-income trap, people's assets are shrinking, income expectations are pessimistic, and consumption is very cautious.

What we have taken for granted over the past 30 years has changed today. In the spring of 2023, at the China FMCG Conference, the author proposed a viewpoint: enterprises, society, and individuals are like a huge coupling gear, containing a large number of constants and variables. In the past, enterprises only needed to focus on the small gear of variables, but today they must pay attention to changes in constants.

Changes in constants are the biggest changes.

This change is very similar to Japan at the end of the last century and the United States in the early 1980s. The changes in the retail industry are essentially a basic microcosm of changes in social and economic constants.

Although China will face the same problems as Japan, China's economy will not truly become fully Japanized

After discussing the similarities, let's talk about the differences.

First, let's present the conclusion from my personal perspective: China's economy will not truly become fully Japanized.

From four aspects:

1. Differences between the Chinese and Japanese markets:

Large population: China is a country with a huge population of 1.4 billion, possessing the world's largest middle-class group and the most industrial workers. Although China faces deep aging, this problem is a huge market opportunity in China. At the same time, China also has the largest group with consumption upgrade needs.

Deep economic hinterland: China has vast territory. Whether it's the economic environment of the north-south, east-west, high- and low-tier markets, or consumption attributes, there is both unity and difference. Economic development is extremely uneven. Just the issue of industrial relocation is significantly different from small countries like Japan and South Korea that lack economic depth.

Broad industry coverage: Not only does China have deep economic hinterland, but it is also the only country in the world with a complete industrial chain. The industrial support is complete, the division of labor is detailed, and more importantly, due to huge production capacity, there are significant advantages in production costs and supporting facilities.

Many players: China has the world's largest educated population with bachelor's degrees or above, and countless entrepreneurs and research institutions are competing with all the top players worldwide. Whether it's new energy, chips, automobiles, or large aircraft manufacturing, as long as there is huge profit potential, China is competing comprehensively with industries worldwide.

We can use some simple, framework-like conclusions to view the Chinese market:

  • Manufacturing remains the ballast stone of China's economy. As long as China remains the world's largest manufacturing country and the basic national policy of building the country on industry remains unchanged, it will be difficult for China to hollow out, financialize, or service-ize. Although wealth polarization may occur, based on the communist goal of common prosperity, it is unlikely that large-scale polarization will appear.
  • High-tech industries such as chips, new energy, new energy vehicles, and large aircraft absorb a large number of high-tech talents, creating China's largest high-income group. This indicates that the new middle class brought by future technological leadership will have strong consumption and purchasing power.
  • Behind global geopolitical instability, China's political environment is extremely stable, which also provides the most basic guarantee for economic development.
  • The strong, self-improving Chinese culture with a desire to change destiny is a spiritual core that few people notice. In any stage of Chinese history, no matter how war-torn the country was, as long as there were 20-30 years of recuperation, China's economy would quickly recover to a state of prosperity.

China has gradually begun to enter a fully mature, developed consumer market

  1. In the 40 years of rapid development in China, there is cognitive inertia in our generation's lives and concepts. Most ordinary people have not experienced economic cycles and believe that China's economy will continue to develop and we will get better and better. Their income expectations are optimistic, and they are willing to consume. So we see many families taking on high leverage to buy houses and cars to improve their lives.

But economic development cannot always move forward; any country's economy has cycles. China has already created a miracle of rapid development among world economies. Even without the pandemic, China would gradually shift from high-speed growth to slow growth.

It was the three years of the pandemic that changed many consumers' consumption concepts, making them realize that their future income expectations would face many uncertainties.

For example, people who experienced the great famine in the 1960s have a notable characteristic: they are particularly frugal and love to hoard goods. The behavioral psychology behind this can be understood as 'hunger memory.' An old Chinese saying accurately describes this behavioral psychology: 'Once bitten by a snake, one fears a rope for ten years.'

So the pandemic affected the consumption concepts of all 1.4 billion Chinese people. The slow economic growth changed Chinese consumers' future consumption expectations. When these two factors combine, consumers begin to reduce debt ratios, increase savings, and become conservative in consumption—an inevitable result.

  1. When consumption upgrades meet slow economic growth, consumption differentiation is inevitable.

For example, Japanese women today are particularly frugal at home, shopping at Uniqlo and Don Quijote for low-priced goods; but when they go to work, they wear designer clothes, carry luxury bags, and apply expensive cosmetics.

The logic behind this is that consumers choose goods and services with different value logic based on different needs and scenarios, considering the functional, social, and emotional value of products and services.

  1. Socialized supply chain infrastructure is increasingly complete, consumption purchases are increasingly convenient, information is increasingly transparent, and for premium products, consumers have enough information and choice to decide which channel can buy similar goods at lower prices.

  2. Food safety bottom lines are rising, and consumers' perception of white-label products is no longer that they are fake or low-quality. Consumption concepts have begun to change significantly, with white-label products seen as synonymous with good quality, affordable prices, and as substitutes for big brands.

  3. The chain, scale, and branding of retail will also promote the emergence of product white-labeling. Note that it's only product white-labeling; in essence, it still relies on the retail channel's brand as a trust endorsement to build transactions.

  4. From e-commerce to community group buying to livestream e-commerce, the logic behind all is to provide consumers with better quality and lower-priced goods. By aggregating traffic and reversely forcing the supply chain, they demand lower prices from the supply chain while ensuring quality, forcing the supply chain to reduce costs through centralized procurement, large-scale production, and reducing supply links.

  5. The low prices of new retail are increasingly impacting traditional retail. The retail industry is severely involuted, forcing offline traditional retail to undergo major reforms, also promoting the accelerated arrival of discounting.

  6. It's not just discount stores that sell discounted goods; it's the comprehensive discounting of the retail market. Don't treat hard discount as a channel, because hard discount will be a model that all retail will need to optimize in the future. It is directly linked to consumers' decision-making logic. No consumer will pay for inefficient supply chain costs for products that only have functional value. Channel brand stores will launch a large number of private-label, affordable, high-quality supply chain products to replace brand products.

  7. Therefore, fast-moving consumer goods with strong functional attributes will find it difficult to obtain brand premiums in the future. Brand owners must provide consumers with emotional and social value beyond product functionality.

  8. Consumers no longer have problems with information asymmetry or insufficient purchasing power when shopping. Instead, the issues are product quality, purchase convenience, total cost, and communication efficiency with consumers.

Conclusion:

In summary, the essence of consumption downgrading is that consumers are becoming more mature. China has gradually begun to enter a fully mature, developed consumer market.

From a macro perspective, we should see that in the next 10 to 20 years, China will become the world's largest consumer goods market and will fully enter a golden consumption cycle. Consumers have money and the ability to consume. But consumption will differentiate, and consumers will become increasingly mature.

Distinctive Features of a Mature Consumer Market

1. Involution will become the norm.

The consumer goods field is one of the more fully open industries in China's market economy. Mature consumer markets generally have problems such as deep aging, non-growing total consumption, and overcapacity/involution.

But involution in mature markets is no longer the inefficient, low-quality, homogeneous competition of the high-growth market era. Instead, it is a free-competitive involution that combines the 'three highs' of high efficiency, high quality, and high service with the 'two lows' of low cost and low price.

Information is extremely transparent, supply chain efficiency is extremely high, and the competitive elements have shifted from single product differentiation to comprehensive competition in the industrial chain with total cost leadership.

2. The supply chain will be restructured.

Since traditional channel models cannot meet today's diverse retail scenarios, the reconstruction of enterprise value chains will be an inevitable result. Distributors will face huge challenges; traditional hypermarkets and mom-and-pop stores are rapidly shrinking, while a large number of new retail scenarios are served by supply chain platforms; emerging discount models will reconstruct the traditional distribution system through direct supply from brand owners and exclusive private-label stores. Distributors will gradually encounter a situation where there are no stores to supply.

For enterprises, the layers of R&D, production, distribution, wholesale, and retail will present various supply chain systems according to scenarios, needs, platforms, and transaction methods to meet market demands.

3. Innovation will become the core competitiveness of enterprises.

High-quality, affordable private-label products will quickly occupy the market. Products return to their inherent value, and premium space is flattened. Most so-called 'brands' will be exposed and fall into endless homogeneous competition.

For today's market, large consumer demands have basically been met, but structural opportunities still exist. If enterprises truly want to break through involution, they must rely on their own R&D capabilities and consumer insight capabilities, continuously improving their competitiveness through innovation.

I believe there are four directions for innovation in the current market: structural, functional, technological, and emotional.

Structural: population, consumption, model, scenario

Functional: materials, technology, process, design, packaging, specifications

Emotional: emotion, content, social, values

Technological: optimization of organizational processes, iteration of business capabilities and products, subversion of process packaging design

4. Emotional and social value will be highlighted.

In traditional retail, fast-moving consumer goods have stronger functional attributes than social and emotional attributes.

But in the future, when a product cannot bring social and emotional value beyond its function, its only competitiveness will be supply chain cost advantage.

We can foresee that from a marketing perspective, the model will shift from brand-based, channel-occupying, shelf-monopolizing promotion to a buyer model where platforms, retail brands, industry experts, KOLs, or KOCs use their own brands as endorsements.

From self-praise and persuasion to expert and KOL recommendations and seeding. The model of broad advertising becomes content communication based on the core value of the product.

Value is no longer determined by opaque information gaps, but by consumers' functional, social, and emotional needs for the product itself.

The author has a dogmatic view: China's FMCG marketing is gradually entering a 'liquor-ization' phase, where high-priced and low-priced coexist. High premiums have their logic, and low prices have their affordability. But returning to its essence, it is a new pricing model advocated by brand value marketing based on consumer demand.

5. Retail will enter an era of comprehensive discounting.

6. The retail industry will further differentiate into different retail and service scenarios for different groups and needs.

Although China's retail will see comprehensive discounting, there will still be many non-discount retail scenarios for segmented groups and needs.

For example, instant retail like 'lightning warehouses' is a new O2O format based on consumers' immediate needs. Consumers are not price-sensitive but time-sensitive. However, due to the high delivery costs that are difficult to overcome, this channel will obviously not see discounting.

Another example is vending machines, premium supermarkets, membership stores, and vertical communities based on hobbies. Different groups, scenarios, and needs will have different service methods.

Further differentiation of scenarios will be a unique feature of China's super-large mature market. From the perspective of brand owners, channels will become increasingly fragmented.

In summary, the changes in the mature, post-consumer market are roughly as follows: brands will inevitably concentrate; brand owners' channel distributors will gradually become public; product scenarios will be segmented; retail will be comprehensively discounted; and consumer transactions will be instant.

Six, Challenges of Competitive Involution and Retail Discounting for Distributors.

A revolution will occur in circulation. Traditional, inefficient mom-and-pop stores without centralized procurement supply chains will face a huge elimination reshuffle.

According to statistics from a well-known B2B platform, in the major cities they cover, the closure rate of mom-and-pop stores in the first half of the year was 17%. This means that the mom-and-pop store channel, which previously contributed the main gross profit to brand owners, has begun to shrink significantly, replaced by new near-field retail systems such as discount stores, CVS, and lightning warehouses.

The trend of discount stores removing distributors is very clear. Once discounts form a centralized procurement scale, they will inevitably bypass distributors and negotiate direct supply with brand owners to reduce supply chain costs. Therefore, for distributors, in the next few years, they must find a new ecological niche in the new value chain to cope with the arrival of the era of comprehensive retail discounting.

Distributors will fully platformize. Either they become supply chain platforms for regional retail stores, providing one-stop supply chain services for the regional market, or they become provincial platform providers, offering professional operation solutions for a certain channel or multiple markets of the brand. If they can do neither, marginalization will be very obvious.

Final Thoughts

The maturity of the Chinese market, in a sense, means that all brand owners and distributors must go through a cycle crossing, learning to quickly shift from high-growth, extensive growth to quality growth.

In business strategy, there must be choices: do something, don't do something. From a future development perspective, we must make the business solid, strong, and big.

Facing an era of low growth, how to achieve high-quality operations?

What needs to be adjusted according to market changes: strategy, brand, product, how to optimize organization, how to improve efficiency, how to make channel output more efficient—these are all strategic issues that every brand owner and distributor must consider.

We must constantly ask ourselves: what capabilities are needed to cross the cycle?

  1. The ability to endure low gross margins?
  2. The ability to have an extremely efficient supply chain?
  3. The ability to manage and operate digitally?
  4. The ability to continuously iterate and innovate?
  5. ......

I think everyone in the industry needs to think deeply about this. New Distribution has established a community themed around 【hard discount】 , sharing the latest information on the format, discussing development trends and responses. Add WeChat to apply to join the community.