International companies have long believed that they must have a presence in China because they consider its 1.3 billion people to be potential consumers. But research raises question about who the country's middle class really are and the true meaning of their disposable income.
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A lot of international companies have long believed that they must have a presence in China because they consider its 1.3 billion people to be potential consumers, implying a seemingly endless stream of future revenue. The existence of a robust middle class, upon which this vision is based, is clearly growing at an accelerated pace in China, but an increasing body of research raises question about who the country's middle class really are and the true meaning of their disposable income.

Defining the middle class with accuracy is challenging at a time when China's economy has grown to be the world's second largest, yet 10 percent of the population remain classified by the World Bank as poverty stricken. Reputable sources disagree considerably about the size and scope of the Chinese middle class, and its purchasing power implications, but there is little doubt that it will be a force to be reckoned with in the current decade.

Recent definitions of what constitutes the middle class in China range from approximately 10 percent to nearly half of the population. In 2007, Goldman Sachs said it believed 100 million Chinese consumers should be classified as middle class, and estimated that by 2015 that figure would jump to 650 million. The Asian Development Bank (ADB) suggested earlier this year that by 2020 more than 1 billion Chinese will be classified as middle class. In 2006 McKinsey estimated that the disposable income of China's urban population was $622 billion; that same year, the Chinese government declared it to be $562 million.

In a study released earlier this year, the ADB defined the middle class in China as individuals earning between $2 per day (the low end of lower middle class) and $19 per day (the high end of upper middle class) in income. The Bank notes that in 2005, 35% of the Chinese work force earned just $2-4 dollars per day, another 30% earned $4-10 per day, and less than 5% earned more than $10 per day. The Bank defines "affluent" consumers in China as those earning more than $20 per day (or $7,300 per year), consisting of 44.8 million in urban areas and 11.1 million in rural areas of the country -- approximately 4 percent of the total population.According to a 2009 report in The Economist, the commonly accepted definition of income for the poverty line in the developing world is two dollars per day, implying that individuals above that income are by definition part of the emerging world's middle class. By contrast, the poverty line in America is $13 per day, but it would be difficult to imagine telling someone who makes $14 per day in the USA that he or she is not in poverty. By the same token, a person making more than $20 per day in China under the ADB's definition will hardly feel wealthy.While defining the middle class is a relative proposition, but what seems clear is that the number of people belonging to the middle class in China, and more generally in Asia, is rising. A 2010 report by the Brookings Institution suggests that Asia's middle class is projected to increase from 28% in 2009 to 66% in 2030 -- an increase of 235% in just 20 years. The report says that China's middle class is poised to rise significantly not only because of the country's economic growth rate, but because more Chinese will continue to break out of the ranks of the poor. By 2030 the number of Chinese making more than $10 per day should increase to 74% from 11% today.

In 2006 the China National Research Association (CNRA) defined six criteria for what constitutes middle class status in China, based on education, salary, profession, societal influence, savings and holidays. At that time, the income benchmark for being a member of the 'new middle class' was just RMB2,000 (approximately US$300) per month (or $3,600 per year). McKinsey notes that as of 2006, 77% of urban Chinese households lived on less than RMB25,000 ($3,676) per year -- meaning, that by the CNRA's definition, 77% of Chinese do not belong to the new middle class.

A 2009 study by China's National Bureau of Statistics found that even with an 8.8% rise in disposable income that year, per capita disposable income for the average urban resident was just RMB17,175 ($2,525) and RMB5,153 ($758) for the average rural resident of the country, and that urban dwellers earn 333% more than farmers. This is important because as of 2006, 70.8% of the Chinese population engaged in some form of agricultural work according to Xinhua in 2008, and 54.3% of Chinese live in rural areas, meaning the majority of Chinese have very little disposable income.

So the idea that the majority of average Chinese consumers will be owning a home or a car in the near future, appears to be mistaken. This represents the paradox of the Chinese consumer market, where according to the ADB, in 2005 the percentage of "affluent" households owning a radio, television, air conditioner, refrigerator, or car was lower in China than in the Philippines -- a country considered to be much poorer.

At the same time, a 2010 McKinsey study of Chinese consumers points out that in spite of the limited number of affluent consumers and individuals with significant disposable income, in general, Chinese consumers have become more sophisticated and demanding -- akin to their counterparts in the developed world. However, Chinese consumers tend not to be brand loyal, but rather value driven, and tend to do more research before making a purchase than typical consumers in the developed world, so they generally take more time to make purchasing decisions.

The challenge for any producer of products in China, then, is to transform the average consumer into a loyal consumer, based on value for money. In reality, this is no different than what is required in many other countries, but as the middle class and middle class consumers find their footing in China, arriving at a definition of what constitutes value for money is bound to be ever changing, as is the definition of what constitutes the middle class.

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