IKEA in China

IKEA in China

Over the past few decades, China has become an increasingly appealing investment destination for foreign investors attracted by the expansive population that provides both cheap labor and an expansive market. The country has undergone an economic restructuring that has boosted the Rural-Urban migration and driven up the demand for housing in the city. “In the last fifteen years, home ownership has gone from approximately 10% to 90%. The rate of Real estate development has been going up by approximately 20.2 % since the housing reforms of 1998 (See Exhibit 1).

However, many people have little sense of how to furnish or decorate a home. They are very eager to learn from the West and this has proved to be an invaluable market Niche for IKEA. Their Western-style showrooms provide model bedrooms, dining rooms, and family rooms showing how to furnish them. Their stylish and functional modern furniture is particularly appealing to young couples” (Wang, 2011). IKEA is globally renowned for its low prices and functional designed products. Nevertheless, when it decided to target the Chinese market it faced a set of complex and singular challenges. The preferences for furniture and spaces were different in other markets; for instance, “a kitchen was not even a necessity as many people simply cooked in a common area outside their room” (Wang, 2011), people that visited the showrooms occupied all the bedroom and living room sections “appearing very much at home. Older people read newspapers or drank tea and young children and teenagers cuddled or played with their phones. Most are sound asleep” (Wall, 2013). The low-price strategy at IKEA in China created confusion rather than a differential asset because its prices were higher than local competitors who were copying their designs mainly from catalogs used to advertise their furniture. Therefore, they had competitors selling replicas with prices they could not compete with. Despite IKEA experiencing such challenges in the onset, they gradually adapted to the new environment and became a resounding success.

Company Background

            Ingvar Kamprad founded IKEA in 1943 at the age of seventeen and created the name of the company from his initials (Ingvar Kamprad), his home farm (Elmtaryd), and its parish in Sweden (Agunnaryd). Kamprad began his business out of his family kitchen, selling cigarette lighters, fountain pens, and binders, which he purchased from third-party suppliers and advertised in a local newspaper (Andersen & Skjoett-Larsen, 2009). In 1948, to stay afloat, Kamprad added furniture along with small items to his catalogue, which became an instant success. To curb an increase in the number of products being returned, in 1951, he opened a display store in Sweden to allow customers to view furniture models prior to purchase. The stores success was so much that, IKEA stopped accepting mail orders and concentrated on brick and mortar sales (Andersen & Skjoett-Larsen, 2009).  In his later reflections, Kamprad said, “The basis of the modern IKEA concept was created [at this time] and in principle it still applies. Primarily, we use a catalog to tempt people to visit an exhibition, which today is our store. Then, catalog in hand, customers can see simple interiors for themselves, touch the furniture they want to buy and write out an order” (Barlett, Dessain, & Sjöman, 2006, p. 2).

With unprecedented success in product development through retailing and refinement, IKEA found they were up against stiff opposition from furniture companies that controlled Swedish businesses, thus maintaining high prices. This situation not only posed as social challenge but also diminished the social freedom of society, which Kamprad made it his mission to address. Looking ahead, with the business model in mind, Kamprad’s vision for IKEA was to “create a better life for the many people”. According to Kamprad, “a disproportionately large part of all resources is used to satisfy a small part of the population, and IKEA’s primary objective was to change this situation. We shall offer a wide range of home furnishing items of good design and function at prices so low that the majority of people can afford to buy them…we have great ambitions” (Barlett, Dessain, & Sjöman, 2006, p. 2). By 1953, IKEA transitioned from advertising from a small newsletter to a full catalog, which became a cornerstone of IKEA’s new feature: self-assembled furniture. This feature permitted consumers to purchase furniture in flat packages, transport, and assemble it at home. In addition to the convenience this feature offered, it assisted IKEA in saving transportation and inventory costs.  Consequently, between 1953 and 1955, its sales doubled from SEK 3 million to SEK 6 million.

Political Analysis

People´s Republic of China (PRC) is divided into 23 provinces, five autonomous regions, and four municipalities, including Shanghai, where IKEA opened its first store in 1998. All administrative divisions stand directly under the Central Government (CIA Factbook, 2014). China is a communist country rule by a single-party political system called China´s Communist Party (CCP), whose autocratic leadership has intimidated many investors. Elections are held semiannually; however, “in practice, only members of the CCP, its eight allied parties, and CCP-approved independent candidates are elected” (CIA Factbook, 2014). CCP´s decisions are to be passed through The National People’s Congress (NPC), China’s parliament and most powerful body in the country, which faces challenges since an economic system cannot be improved if activities are not being objectively regulated.

The Chinese government started working on becoming more attractive to foreign investors since 1978, when Deng Xiaoping initiated a series of economic reforms (Naughton, 1996). He did this with the intention of creating a politically stable system in the backdrop of which economic reforms could be instituted and economic growth spurred (Kennedy, 2002). Because of these reforms, the value of the Yan went up by nearly 20 folds in less than 20 year and by 1998 the economy of the Chinese peasants was four times higher than it was before the reform (See Exhibit 2) (Yihong, 2007).

China has been restructuring its legal system beginning in 1978 vis-à-vis Foreign Direct Investment (FDI). Since 1979, four Special Economic Zones (SEZs) in Guangdong and Fujian provinces were settled as coastal cities and special zones with incentives for the FDI, embracing tax reductions, exemptions, and significantly releasing tariffs for importation. Among those amendments, the Equity Joint-venture Law is one of the most important laws for overseas investors, which mostly comprised a western-styled framework that protects FDI from being nationalized (Barbara, Campbell & Potter, 1993).

Foreign companies reinvesting profits at least five years in China would receive a five-year tax refund and 40% refund on taxes paid on income shares (Organization for Economic Cooperation and Development, 2000). Nevertheless, taxing power remained part of the centralized government, meaning that sub-central governments lacked sovereignty of tax authority. Consequently, tax collection from assignment (sub-national taxes) or sharing (shared taxes) was determined by central administration. Although these policy implementations generated vast amount of opportunities for the FDI, excessive red taping and corruption have bitten deep into the earnings.  In 2001, China was finally given the opportunity to join the World Trade Organization (WTO), which has led the country’s compliance with international standards, making it more reliable and predictable, which encouraged more investors. According to The Economist, “The price of re-entry was as steep as the wait was long. China had to relax over 7,000 tariffs, quotas, and other trade barriers” to be able to enter the WTO.

Economic Analysis

 “China represents the biggest growth opportunity in the history of capitalism. The country is undergoing approximately ten times the economic hastening, more than 100 times the scale, causing an economic transformation that carries over 1,300 times the force of change than seen during the Industrial Revolution” (Daniels, Radebaughn & Sullivan, 2013, p. 88). However, it is worth noting that before he could commence on his economic reforms in earnest, Deng had to dismantle nearly 30 years of Maoist legacy embodied in the communist system that Mao Zedong had put in place. Alongside the SEZs and policy reforms, China also experienced market-oriented economic reforms that directed it towards liberalization, albeit in a cautious and progressive way.  These market reforms, initiated in 1978, helped to lessen centralistic style and to accelerate economic growth and social progress. China made a radical commitment to policies liberalization in its final accession to the WTO in December 2001, encouraging domestic and foreign stockholders to invest in the service industries. The World Bank states “by 2009, FDI in services increased 3 times from that in 2000, while manufacturing FDI in China increased 81%” (World Bank, 2010).

To refurbish its economy, China´s government increased promotional initiatives in the industrial and trading sectors. As a result, Foreign Invested Enterprise (FIE) inflows improved China’s export performance (Coughlin & Segev, 2000). Domestic firms registered some gains in the first half of the 1990s but lost ground afterwards, and in 1998 China held the same 1.9% share as in 1992 (Tang, Selvanathan & Selvanathan, 2008).  Some other relevant shifts in the economy were its welfare-system, which encouraged rural farmers to move to urban zones, provided greater rights for farmers on their lands, stepped-up financial strategies that would setup insurance secure systems, and State-Owned Enterprises (SOE) that paid more dividends to the government to be re-invested in social security (Ranasinghe, 2013).

There are also some setbacks in the economic arena. According to the World Bank´s China overview, “rapid economic ascendance has brought on many challenges including: high inequality, rapid urbanization, challenges to environmental sustainability, and external imbalances (See Exhibit 3) (World Bank, 2013). China also faced demographic pressures related to an aging population and the internal migration of labor” (Isler, 2009, p. 2).

Social and Cultural Analysis

The PRC has the largest population in the world “with a population composed of a large number of ethnic and linguistic groups”. It is estimated to have a population of about 1.36 billion, which represents around 19.3% of the world’s population (World Population Statistics, 2014). China has held the position of the world’s most populous country for centuries and this has resulted in among other things, the infamous one child policy instituted in 1979 to control a variety of population related social, economic and environmental issues. However, today, the state is comparatively flexible, and in some cases allows “couples to have two children if either parent is an only child (formerly, the law permitted two children only if both parents were singletons)” (Xiaoping, 2014). Nevertheless, times have changed, perceptions of reproduction have changed, and the Chinese people are now comfortable with having only one child, which has become a problem for China. Proof of this is that since the easing of the one-child policy “not as many married couples as expected are taking advantage of [the] loosening in China’s one child policy” (Moore, 2014). By the end of September in 1979, around 804,000 couples applied to have a second child, the National Health and Family Planning Commission announced in a statement, dramatically short of the annual two million new births projected by health officials because of the policy shift (Moore, 2014). The shortfall has wide implications for China: lack of investment by businesses, the country’s tightening labor supply, and the vitality of its economy.” It is believed that about 30 years from now, China will have a shortage in its labor force mainly due to its demographic distribution: more than 60% of China’s total population is between the ages of 25 and over (Moore, 2014).

China has one of the largest education systems in the world with a “state education system, which offers nine years of compulsory schooling and admits students to colleges strictly through exam scores (Gaokao) (Xiaoping, 2014). This system often hailed abroad as a paradigm for educational equality. The impression is reinforced by Chinese students’ consistently superior performance in international standardized tests. But this reputation is built on a myth.” While the Chinese government has worked on providing basic education for its population, it has also created a “system that discriminates against its less wealthy and connected citizens, thwarting social mobility at every step with bureaucratic and financial barriers. The huge gap in educational opportunities between students from rural areas and those from cities is one of the main culprits. Some 60 million students in rural schools are “left-behind” children, cared for by their grandparents as their parents seek work in faraway cities. While many of their urban peers attend schools equipped with state-of-the-art facilities and taught by highly qualified teachers, rural students often huddle in decrepit school buildings and struggle to grasp advanced subjects such as English and Chemistry in the absence of  of qualified instructors” (Xiaoping, 2014; Moore, 2014). It is believed that due to the economic growth the Chinese are facing, the number of poor is reducing day-by-day. However, there are many factors that still indicate a massive difference in opportunities offered to the people that live in the urban areas compared to those residing in rural areas (See Exhibit 4) (National Bureau of Statistics, 2012).

According to The Economist’s article “The rural-urban divide, ending apartheid”; if China is looking to implement an affective reform, its citizens have to experience more distribution of equality (1998). Migrants typically encounter barriers of speech, habits, and manners throughout the world, but in China these factors are heavily influenced by the hukou system, a household registration that permits routine discrimination against migrants by bureaucrats as well as by urbanites; a term defining city-dwellers who have no rural connections themselves (Liu, 2011).

Since the 1950s, the Chinese government has worked to implement public health programs, which by 2011 afforded 95% of the country with health insurance (Liu, 2011). Also, China has become the world’s third largest supplier of pharmaceuticals. Some health concerns in China include respiratory problems caused by air pollution resulting in 1.2 million premature deaths in 2010, a high portion of cigarette smokers, and lastly, obesity among youth in urban parts of China. The average life expectancy in China is about 75 years and infant mortality is 14 infants per 1000 births (See Exhibit 5) (The World Bank, 2014).

Many companies initially go to China because of low-cost labor but once they are there, they realize the potential 1.36 billion-consumer market available to explore (Daniels, Radebaugh, & Sullivan, 2013, p. 88).  Even if “Chinese consumers have always been a mystery to Western companies [and] little is known about their spending behavior and buying habits,” investors are willing to take their chances (Anthony, 2005). The Chinese consumer is made even more complex by the fact that China does not appear to have an official religion (Anthony, 2005). Chinese culture adheres to the theory of Taoism, which is reflected in how they live their lives, always looking for the balance and simplicity of things.  

Technological Analysis

Over the years, the Chinese market adopted a range of policies designed to create “indigenous innovation” and reduce dependence on the west for advanced technologies; and on the US in particular. “These policies include government procurement, competing technology standards, and requiring technology transfer from multinational corporations in return for market access” (Segal, 2013). “China’s own technology companies are challenging market leaders and setting trends in telecommunications, mobile devices, and online services” (Coughlin, 2000). This drive is mainly due to increase in investments in Resource & Development (R&D) by the industry in general.  However, it faces a serious challenge from its negative reputation; many international clients believe China is poor on the innovation front and that as a rule; Chinese goods are either fake or low quality.

Legal Analysis

The violation of Intellectual Property Rights is a major issue in China because the law does not safeguard companies against it. This is a common challenge that faces many Western and American companies that manufacture in China as they end up making major losses from copyright infringement (See Exhibit 6)  (U.S. International Trade Commission, 2011).

Consequently, IKEA had to contend with companies copyrighting, reproducing, and selling their products at much lower costs. However, with its entry into the WTO in 2001, China triggered the enforcement of several Intellectual property laws to comply with the obligations of the Agreement on Trade Related Aspects of Intellectual Property Rights (TRIPS). Manufacturing in China has its obstacles due to the lack of transparency within the legal system and the weak enforcement of intellectual property rights. Moreover, the employment systems laws are very unique and IKEA has on several occasions suffered from their misinterpretation of the same. For FIEs, the most complementary regulation for jobs is the PRC Labour Law, which is “created to protect the lawful rights and interests of workers, readjust labour relationships, establish and safeguard a labour system that suits the socialist market economy and promote economic development, and social advancement” (PRC Labour Law, 2014).

SWOT Analysis

STRENGTHS: IKEA’s main strength is their understanding of its consumer markets. The IKEA product development teams deploy their best and most innovative staff around the world to discover and develop new solutions to sustain the good design, function, and quality of its products while keeping prices low (IKEA, 2014). IKEA also organizes “thousands of home visits every year to learn more about people’s needs and dreams. This is the building block for every product [they] design” (IKEA, 2014). The story behind their products lies within the concept of “Democratic Design, which brings good design to the many people by combining a just-right mix of form, function, quality, and sustainability at an affordable price” (IKEA, 2014). To achieve this blend, IKEA works diligently to build sustainable and profitable long-term relationships with its suppliers.

IKEA is known worldwide as a leader in offering affordable, unique products “to the many people” (Barlett, Dessain, & Sjoman, 2006). IKEA’s values and strong vision have become a great strength by which the company lives by, making it part of their everyday operations “…to help more people live a better life at home” (IKEA, 2014). IKEA concentrates on improving quality of life for everyone by offering good quality solutions at the “best possible prices” (Barlett, Dessain, & Sjoman, 2006). Notwithstanding the immense variety of products, IKEA has market-standardized merchandise allowing them to generate economies of scale, a key factor to complement their low-price strategy. IKEA’s main competitive advantage in China comes from its aspirational and educational brand image, which teaches the Chinese culture about interior decoration. “Companies that invest in educating the [Chinese] market can expect to reap handsome rewards” (Wang, 2011).

WEAKNESSES: IKEA’s constant drive for lower costs generates a critical weakness for the company, making it more difficult to control quality standards for the entire organization. “Some countries, where IKEA products are made, do not implement the legislations to control working conditions. This represents a weak link in IKEA’s supply chain, affecting consumer views of IKEA’s products” (The Times 100, 2009). The company utilizes the IKEA Way on Purchasing Products, Materials and Services (IWAY), which is a supplier Code of Conduct that sets minimum requirements related to Child Labour and Environmental working conditions (IKEA, 2014). “The IWAY code is backed up by training and inspectors visiting factories to ensure suppliers meet its requirements’’. IKEA already had negative experiences in the past pertaining to the IWAY code, subsequently creating a bad brand image. A weakness whenever in business with a manufacturer is that you cannot monitor their every move, therefore creating a disadvantage for IKEA.

IKEA’s low-price strategy is a weakness as it is not a sustainable advantage in the long run. Companies have to seek attributes other than price to differentiate themselves from competitors and cater to the geographical market they are in. IKEA’s strategy of low-cost is achieved by offering standardized products, which attract a smaller segment of consumers. “Therefore, the business inability to offer better quality and more customized products allows its competitors to fill that niche and fortify their position in it” (Jurevicius, 2013).

OPPORTUNITIES: IKEA has stores in over 42 countries, yet there is still opportunity to grow and expand, especially in developing markets. IKEA is growing fast in China seemingly because they’ve learned to adapt to Chinese consumers. However, given a high percentage of the world’s population is located in China, this also means there remains a large quantity of potential consumers whose attention IKEA has not captured yet. This awareness represents an opportunity for them to continue expanding; they are planning to open three new stores every year (CCTV.com, 2013).

Demand for sustainable products is increasing which represents a good opportunity for companies to differentiate themselves. IKEA launched a sustainability report in the year 2013 and it has been working on having a positive impact on people and the planet, however, they still have a lot of ground to cover. “[They’re] just warming up” (IKEA, 2014). People are more interested in buying products that are environmentally friendly so they would be more attracted in buying from a company that is focused in developing these types of products.

E-commerce is an essential tool used for many companies presently, but IKEA has been very conservative with its online presence since it opened its website in 1997. It is hard to make customers experience the same feeling of buying at one of IKEA’s store as of buying from the web, also they get many consumers that go to the stores for a specific product and end up buying other things. This buying impulse is difficult to generate on the web. However, the web still represents an important opportunity for the company to work on. It is important to consider that every day it is becoming more usual for consumers to buy everything from the web and even to use their phones to do so.

THREATS: China’s legal system has poor enforcement of patent or copyright protection. Therefore, their direct competitors without any legal sanctions replicate a majority of IKEA’s products. This is a major concern for the company as it takes away the competitive advantage it may have held at one point or another above similar competitors. Another important threat for IKEA is the size of China. People within different regions of the country have varying and diverse taste in preferences and necessities. “China is not a single unified market but a recollection of local markets, each with different market demands, consumer behaviors, competition levels, and market access conditions (Lu, 2010). Additionally, the Chinese are not very familiarize with the “Do it yourself” concept, which may have been the basis for lower prices in other countries, and reason why consumers in other places do not mind building their furniture; it represents high savings but not in China.

PORTER’s Five Forces

• Rivalry among existing firms (Strong force):

This represents an intense degree of rivalry among competitors. Even companies that are not specialized in furniture have similar strategies as IKEA. “Companies face different levels of competition depending on the retail sector in which they operate” (Lu, 2010).  Among the big retailers are: Wal-Mart and Carrefour.

• The threat of new entrants (Low): The risk of having new competitors in the industry is very unlikely, especially from foreign investors. However, China still places limitations on foreign retailers and “foreign-invested retailers are required to go through stricter licensing procedures than their domestic competitors” (Lu, 2010). During this phase, competition and financial investments are high.    
• The bargaining power of buyers (Moderate):

IKEA had to adapt some of their strategies to accommodate the preferences of their Chinese buyers. Although they do not dictate what the company does, they do have partial power influence over the decisions made by the retailer. IKEA had to lower its prices so that consumers could see the difference in prices relative to the local competitors. Any company that considers its consumers important, is giving them power over their decisions.  

• The threat of substitute products and services (Low):

No other competitor that offers “Do it yourself” solutions has achieved the success of IKEA because they offer more than just home furnishing solutions, they are giving Chinese consumers the experience and education regarding home decoration. Besides, there are not many substitutes for home furnishing solutions on the market.

• The bargaining power of suppliers (Low):

IKEA works with different suppliers and sometimes they may produce only one product, therefore, IKEA does not depend on one supplier to manufacture all of their lines since IKEA has the capability to produce its own line of products.

Issues in China

            IKEA’s decision to enter the Chinese market in 1998 certainly was not without its challenges. Educating itself on the political and economic business practice conditions were just the first set of obstacles that would set the stage on which the company would show its influence. After China’s first store in Shanghai, IKEA quickly learned the scope of their challenge to be successful in the country. The psychology of the diverse cultures: how and where they live, spending habits, daily routines and living conditions, socio-economic classes, various sub-culture languages, and the environmental concerns, proved to be unique in comparison to the North American and European market environments. Extensive marketing research had to be carried out in order to attract both consumers and suppliers, and protect their investment in what would be discovered to be a competitive business in China.

            The biggest challenge IKEA dealt with was pricing due to other companies taking advantage of punishment-free laws that did not restrict replication of IKEA’s products. However, IKEA became imaginative in its marketing strategies. To establish more reasonable pricing for the Chinese consumer, the company developed manufacturing units in the country utilizing locally procured material. In addition, with the low cost of labor, IKEA is able to offer reasonable fee-based assembly services to customers.

            IKEA has constructed its stores near public transportation lines inside China’s major cities such as Shanghai, Beijing and Guangzhou. This is partly because only 20% of the customers own cars. However, the populous in large cities was not the only attention of the company. In order to attract consumers who do not entirely live in high-end lifestyles, IKEA had to adapt to a wider range of living needs. Extensive training for the employees and better supply chain management would also aid in resolving services to customers, and worked to handle low inventory concerns. IKEA went from a brand considered a luxury line in China, to an affordable image that practically any working family may afford.

   Even though some necessary adaptations were required for IKEA in China, the company has maintained its standards in its concepts, logistical and product characteristics. The brand was specifically built around the Swedish culture, the native names of the furniture, restaurants and colors of their Swedish flag, and with the founding strategy of positioning themselves with their global consumers. The adjustments undertaken in an unpredictable environment such as Chinese market has gained tremendous customer base for IKEA

Pricing Challenge

            IKEA is often viewed as a low priced furniture store, where items can be purchased at very affordable prices. With this successful strategy, naturally IKEA took its pricing model into the Chinese market; however, this proved to be a big problem, as the Chinese did not understand the “low-cost strategy” (Yihong, 2007).  The prices that seem affordable to the rest of the world were in fact viewed as highly expensive to most Chinese consumers. China viewed IKEA as an upscale western country retail store that catered to the middle and high-class population. For example, a sofa sold at Renmimbi (RMB) 3,299 in IKEA, compared to RMB 1,800 to 2,500 at local stores (Wei & Zou, 2007). This resulted in stagnant revenue, since IKEA could not compete with the local manufacturers located in China who offered even lower prices than what IKEA is known for. Local competitors had access to low cost labor as well as low cost material (Burt, Johansson & Thelander, 2011).