May 17, 2017 11:40 am JST
FT Confidential Research

Korea Inc's China problems go beyond anti-missile system spat

FTCR survey data show Korean names losing ground long before diplomatic row

A person walks past Hyundai vehicles in Shanghai, China. © Reuters

  • A diplomatic row over the Thaad anti-missile system has exacerbated longstanding problems facing South Korean brands in China, as competition from domestic companies in key categories erodes their popularity.
  • Retailers and car and smartphone makers are most vulnerable. Cosmetics brands may prove more resilient, although they face short-term pressure from official efforts in Chinese media to limit the spread of Korean pop culture.
  • Some brands that had already been struggling may not recover from these near-term shocks - geopolitical tensions have already encouraged one withdrawal from the China market and there could be more.

Chinese consumers are falling out of love with South Korean brands across key sectors, according to the latest brand survey data from FT Confidential Research. Despite a temptation to blame this on tensions arising from the deployment of a US missile shield in South Korea, we believe evidence of waning popularity in autos, smartphones and retail chains in the first quarter of 2017 represents the continuation of trends that began long before.

The diplomatic spat over the Terminal High Altitude Area Defense (Thaad) system is undoubtedly damaging to Korean brands in the short term. But our data show that competition posed by emergent Chinese brands is a far greater threat than geopolitics.

Long time coming

The popularity of South Korean brands fell across five of six key consumer segments in the first quarter, sustaining declines that began in late 2015 and early 2016 as Chinese brands gained (see chart).

  • In the auto sector, the combined popularity of Korean brands slipped 2.2 percentage points over the past year, while that of domestic brands rose 2.3 points. Among the top ten auto brands, Hyundai's popularity fell furthest (see chart). Its losses occurred in lower-tier cities, which are leading Chinese auto market growth. Although Hyundai's popularity edged higher among first-tier city consumers over the year, it slumped 3.7 points to just 2.6 per cent in third-tier cities and below.
  • The popularity of Korean mobile phone brands has slumped. Samsung's brand popularity continued its decline, falling to 4.8 per cent in the first quarter of 2017 from 14.7 per cent in the final quarter of 2015, hurt by the worldwide recall of its Note 7. Samsung has been eclipsed by Chinese brands such as Huawei and Xiaomi, although any buzz surrounding Samsung's Galaxy 8 phones could help the brand rebound.
  • The combined popularity of Korean personal computer and television brands slid 7.8 and 4.6 percentage points respectively over the past year. The popularity of Chinese brands rose 5.3 points for computers and 7.7 points for televisions.

Cosmetics the exception

With the exception of Samsung's phones, South Korean brands still do not have the reputation for quality enjoyed by Japanese and German goods and are generally priced accordingly, at levels that put them in direct competition with Chinese manufacturers. As local brands have upped their game, Korean companies have struggled to maintain their popularity. We would partly ascribe Hyundai's recent sharp drop in China sales, for example, to its failure to successfully respond to the popularity of low-priced SUVs produced by domestic firms, such as Great Wall Motors.

This may explain why Korean brands have proven more resilient in the cosmetics market, as viable domestic competition is yet to emerge. Collectively, the popularity of Amorepacific-owned brands, including Innisfree and Sulwhasoo, increased to 14.5 per cent in the first quarter of 2017, up from 12.8 per cent in the first quarter of 2016. The Seoul-based company has successfully leveraged the popularity of Korean pop culture and China now accounts for a fifth of its sales (see chart).

We believe the slight fall in the popularity of Korean cosmetics brands among younger consumers (see chart) is due to quiet restrictions on Korean culture in Chinese media, including unofficial bans on the broadcast of popular shows on television. But their popularity has grown among the over-30s, largely reflecting the success of Amorepacific's focus on older, more affluent consumers. This year the company launched a higher-end brand called Hera in China, specifically targeting this group.

The last straw

For some South Korean brands in China, the blow from the diplomatic spat may prove serious.

Lotte's brand popularity among supermarket shoppers fell to 1.9 per cent from 2.9 per cent in the first quarter of 2016, a reflection of its parent's direct involvement in the Thaad issue. After the company handed over land to the South Korean government for the missile system's deployment, Chinese authorities reportedly shut more than 90 per cent of its mainland outlets, citing fire safety concerns.

But the company's sales in China have been falling since the end of 2013 as aggressive expansion failed to counter the onslaught of domestic competition. Korean discount chain E-mart is reportedly pulling out of China altogether after two decades of losses. Thaad may have been the final straw but Lotte would not be the first foreign retailer to fail to crack the Chinese market.

Yet for those Korean brands in ruder health before the Thaad row, history suggests recovery may be reasonably swift.

Sales of Japanese cars fell more than 50 per cent as tensions between Beijing and Tokyo rose in 2012 over the Diaoyu, or Senkaku, islands. Despite nationwide protests, violence and damage to Japanese property, temperatures cooled and sales recovered after about six months.

We would similarly expect the impact of the current row to wear off, particularly as it is less politically contentious. This may offer some relief for Korean brands but it will not resolve the longer-term issue of how to respond to the emergence of more formidab

This article was first published on May 4 by FT Confidential Research.

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. A team of researchers in these key markets combine findings from proprietary surveys with on-the-ground research to provide predictive analysis for investors.

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