Emerging-Market Game Changers: Diaper Wars In China by Sammy Suzuki

The Chinese craze for pricey Japanese-made diapers may change the way you think about investing in developing economies. It’s just one of the many enduring trends we see incubating the next generation of emerging-market winners.

We’re keeping a close eye on the evolving shopping habits of the growing emerging-market middle class, which is showing a voracious appetite for premium-priced, upscale goods. Not only does this trend reveal valuable clues about future consumer-spending patterns, but it also shows that the best plays in emerging equities are not necessarily homegrown.

Diaper Wars In China – Nothing but the Best

For the past few years, affluent Chinese parents have insisted on swaddling their babies in Merries brand disposable diapers, made by Japanese company Kao Corp. Not only that, they’ve been paying a lot more for Japan-made diapers than for a similar product made by Kao’s Chinese factory (Display).

Emerging-Market, China, Diaper Wars

A little background: Procter & Gamble entered the Chinese market in 1998 with its Pampers brand. After a few missteps—mostly owing to the low quality of its initial product and the resistance of Chinese parents to the idea of disposable diapers—the market took off in 2007 when P&G introduced its “Golden Sleep” campaign that tied disposable diapers to sleep quality and improved child development.

Several other companies followed, including Japan’s Unicharm (in 2000) and Kimberly Clark (via a Korean joint venture in 2003). Kao was the last major global player to enter the market, only setting up shop in 2009.

As demand for disposable diapers has soared (Display), relative latecomer Kao has seen its market share in China surge, even while leading player Procter & Gamble (P&G) and local company Hengan International have lost ground (Display). And the Chinese appetite for Merries helped drive a nearly threefold increase in profits at Kao’s Human Health Care Business between 2012 and 2015.

Emerging-Market, China, Diaper Wars

Emerging-Market, China, Diaper Wars

Emerging Middle-Class Trends

What does this mean for investors who are trying to understand the new emerging-market landscape? We spot three key themes:

  • Premiumization. The desire for upmarket products is abundantly evident among the growing middle class in China, and it is breathing new life into the sales of many Western brands—from US-made Steinway pianos and Mattel Barbie dolls to Italy’s La Perla lingerie.
    But, as the diaper wars show, the trend goes beyond the luxury markets. While P&G pioneered the disposable diaper market in China, it has continued to target the mass consumer, relying on local production to manufacture lower-priced diapers. By contrast, Kao has focused on the premium niche. With its touted superabsorbent polymer technology—not to mention the “Made in Japan” label, which seems to guarantee authenticity—the Merries diaper has become a coveted brand among higher-end consumers. In fact, an estimated 90% of Kao’s sales come from premium products, versus 25% for P&G and 40% for Unicharm.
  • The best China plays aren’t necessarily Chinese. As consumer demand shifts toward more premium products—and as questions continue to arise about product authenticity—there may be an increasing number of attractive competitive opportunities for non-Chinese companies with manufacturing located outside of the country. We expect to see similar cases pop up across emerging-market economies, providing investors with what may be a better way to tap into local growth.
  • E-commerce on the rise. Kao began focusing on the online channel at the very moment when e-commerce was growing rapidly at the expense of traditional channels. The Chinese are avid online—and increasingly mobile-phone— shoppers. According to a proprietary Bernstein Research survey, e-commerce penetration of the Chinese household and personal care category rose from just 3% in 2013 to 21% in 2015. And the online channel is particularly appealing to higher-end consumers, owing to its convenience, higher likelihood of product authenticity (a major concern in China) and broader product assortment.

New eras call for new game plans. Emerging economies look very different today than they did not that long ago, and dramatic changes are rapidly unfolding. That means what worked for investors in the last decade isn’t likely to succeed in the years ahead. So, throw away your preconceived notions. Don’t assume the mass market is where the action is. Pay attention to trends in e-commerce. And, maybe most important, look beyond the borders for the success stories of tomorrow.

This blog was originally published in InstitutionalInvestor.com .

The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AB portfolio-management teams.