For companies like PPR and LVMH, who
have spent the past few years building stores across China, the
shift toward overseas spending is forcing them to adapt their
strategy in China to the tune of: if you can’t beat them join
them.

“Luxury companies’ results for Q1 certainly suggest that
sales to Chinese consumers outside of China continue to grow
faster than sales to Chinese consumers within China,” said
Vincent Liu, managing director of Boston Consulting Group in
Hong Kong.

He says about a third of luxury sales – from handbags and
shoes to cosmetics – to Chinese take place in China versus a
third in Hong Kong or Macau and a third in the rest of the
world.

Luxury goods in mainland China can be anywhere between 30-40
percent more expensive than in Hong Kong due to luxury and
import taxes as well as pricing strategies.

“Their real stores are in Hong Kong or Paris. Their Chinese
stores are just store fronts,” said Renee Hartmann, co-founder
of consultancy China Luxury Advisors.

Upmarket brands are increasingly holding private events in
Beijing or Shanghai for an exclusive clientele – events where
they pay deposits on items in the mainland and then are flown on
an all-inclusive trip to Hong Kong to complete the purchase.

This not only helps manage relationships with wealthy
clients, it also functions as an expensive marketing scheme.
Industry experts compare this to tactics used by gambling firms
to lure high-rollers to casinos by flying them in using private
jets and putting them up in five-star hotels.

“For their real VIP customers, they do whatever they think
is necessary,” said Torsten Stocker, head of Monitor Deloitte’s
China consumer section. “You see the same with high-end gambling
where people get flown to the casinos in Macau or Singapore.”

China’s new leader Xi Jinping earlier this year announced a
crackdown on corruption and urged the political elite to refrain
from flashy displays of wealth. This has had a negative impact
on the practice of ‘gifting’ – where executives or officials are
given luxury items in return for favours. This shift is forcing
luxury brands to re-evaluate the role of their China stores and
overseas stores.

“They are thinking less about ‘Where do I open my next few
stores’, ‘How can I speed up my expansion’ but more, ‘What role
do the stores in China play, what roles do the stores overseas
play and how many stores in China do I really need?’ That’s a
different way of thinking than maybe two to three years ago,”
Stocker said.

LVMH, the world’s No.1 luxury goods group, said this month
that demand in China in the past 9-10 months had been flattish
due to a weakening in economic growth and a government crackdown
on gifts for favours. Price increases in Europe have made
shopping in Paris and Milan less attractive for tourists from
Asia, but it still remains a top desination for Chinese luxury
spenders.

LVMH said earlier this year it had put the brakes on Louis
Vuitton’s global expansion.

The impact from the anti-corruption measures have also hit
watchmakers and jewelers. They too are taking to the ‘junket’
format as a way to facilitate the overseas spending.

Richemont’s Piaget, a Swiss luxury watch brand,
stages two all-inclusive trips each year for 50 VIP customers.
This year it plans to increase the number, Chief Executive
Philippe Leopold-Metzger told Reuters in an interview.

“This is the best way to talk about the brand and its
heritage and its legitimacy,” said Leopold-Metzger, adding the
number of visits would be “open”.

“Of course they buy, we don’t force them but they want too,”
he said of VIP’s spending on the trips.

AN EYE FOR A DEAL

Many wealthy Chinese customers have an eye for finding a
good deal overseas. Once the bargain is identified, they jump on
a flight to the destination, with the unique item code in hand,
and purchase the itime at the discounted price to the store in
China.

This trend was seen starkly during January to February, a
period encompassing China’s Spring Festival, one of the two
golden-week travel periods in China.

During that period, domestic luxury consumption fell 53
percent with leather goods and watches registering the biggest
falls of 63 and 95 percent respectively, according to a survey
by research firm World Luxury Association.

In contrast, overseas luxury spending by Chinese tourists
rose 18 percent to $8.5 billion, half of which was spent in
Europe, it said.

Christine Lu, the Los Angeles-based chief executive of
luxury experience company Affinity China said the brands still
need to maintain their stores in China to retain “mindshare” of
the customers when they travel.

“When they travel overseas maybe two or three times a year,
they are influenced by what they see in China. There are
probably many luxury companies who aren’t making any money from
those ridiculously high rents in Shanghai or Beijing but it’s a
sunk marketing cost,” Lu said.

Xiao Yu, a 21-year old student who visits Europe twice a
year to shop for luxury goods for herself and for resale to
others, says she spends around $15,000 each time, visiting
Chanel, Burberry and Louis Vuitton stores.

“The tax is just too high here, no one buys their bags in
China. Hong Kong compared to France and Europe is more expensive
and they are always out of stock for popular items,” Yu told
Reuters.

Yu, who sells her items by advertising on China’s
microblogging platform Weibo, is not considered a VIP client by
these brands and eligible for these “junkets”, still she travels
overseas to sate her desire for luxury.

“We may buy these brands in China if the price was lower,
but that’s impossible because of the tax. So maybe if they had
sales that would tempt us,” Yu said.

(Reporting by Melanie Lee; Editing by Jeremy Laurence)

Baidu posted on Friday its slowest quarterly profit growth
since end-September 2008, citing a rise in traffic acquisition
costs, or what a search engine pays to partner websites and
software applications to show its search box or results.

Traffic acquisition costs for the quarter were equivalent to
about 10.2 percent of total revenue, up from 7.8 percent a year
ago, and Baidu said it expects that margin to rise until the end
of the year.

“We have said very clearly that this year we will put a big
emphasis on sales and marketing promotional expenses to push our
products through the systems,” Baidu’s chief financial officer,
Jennifer Li, said on an earnings conference call.

“At this stage of the company’s life, we do not focus on
managing toward a specific margin target,” Li said. “We target
strategically important areas that make sense for us to invest.”

Baidu disappointed investors and reported net income for the
quarter ended March 31 increased 8.5 percent year-on-year to
$328.9 million, or 95 cents per American Depositary Share, short
of the $1.03 per ADS analysts had expected. It was the second
consecutive quarter that profit growth eased.

Revenue in the first quarter rose 40 percent to $961
million, also short of the $969.3 million expected by analysts
polled by Thomson Reuters I/B/E/S.

“It was the bottomline that people were disappointed about,
in terms of the high expenses,” said Dick Wei, a Hong Kong-based
JP Morgan analyst.

Qihoo’s share of the search market remains relatively small
compared to Baidu’s 80 percent holding, but it has ramped up its
search monetisation products this year to better compete.

Industry analysts warn that rapidly changing user habits and
competition in the search market could weigh on revenue.

Shares of Baidu, which have fallen about 12 percent since
the start of the year, were down more than 8 percent at $84.83
in after-hours trading on Thursday.

In addition to the increase in costs, the consolidation of
the results from Baidu’s loss-making online video unit, iQiyi,
also ate into profit margins.

Analysts said they do not envision iQiyi being profitable in
the near future given the high costs of the online video sector.

In the first quarter, content costs associated with iQiyi
were at 1.6 percent of revenue. Li said she expects content
costs to trend downward for the rest of the year.

Baidu’s sales and marketing costs increased 77 percent while
research and development costs rose 83 percent for the quarter.

For the second quarter, Baidu estimated revenue of $1.187
billion to $1.216 billion. Analysts polled by Thomson Reuters
I/B/E/S had an average forecast of $1.2 billion.

On Thursday, local media reported that Baidu was in the
process of acquiring Chinese online video firm, PPS Net TV, for
between $350-$400 million. Baidu declined to comment about the
report.

(Additional reporting by Alexei Oreskovic in San Francisco;
Editing by Richard Chang and Miral Fahmy)

The company said its incoming chief executive would join a
task force to combat piracy on its platforms.

Alibaba has been clamping down on the sale of fake goods,
but users of Alibaba’s Taobao Marketplace, which is similar to
Amazon.com’s marketplace, can still find knockoff Chanel bags or
Vera Wang dresses. Its Taobao Mall has storefronts where retail
brands can sell to consumers.

Industry watchers widely expect Alibaba to seek an initial
public offering as early as this year, and intellectual property
protection concerns may turn off some potential investors.
Addressing the issue now could help the company avoid some
uncomfortable questions during an IPO road show.

The company said it will partner with government bureaus and
ministries such as China’s Ministry of Public Security to fight
counterfeiting and intellectual property rights infringement.

“Counterfeits are the narcotics of the marketplace,” said
Alibaba founder and Chairman Jack Ma, who announced in January
that he was stepping down as CEO. “We don’t want Alibaba’s name
to be associated with counterfeiting.”

Incoming CEO Jonathan Lu will head the IP task force, which
will also include chief risk officer Polo Shao.

“We are committed to put as many resources as necessary to
tackle the problem,” Shao said in a speech at Alibaba’s
headquarters in Hangzhou, about an hour from Shanghai by
high-speed train.

The task force will cooperate with government bureaus to
report stores that infringe on intellectual property rights, to
share information and to help trace the source of fake goods.

In December, the United States dropped Taobao from its
annual list of the world’s most “notorious markets” for sales of
pirated and counterfeit goods because the company had
“undertaken notable efforts” to clean up its shopping sites.

In September, Taobao Marketplace signed a pact with the
Motion Picture Association (MPA), an affiliate of the Motion
Picture Association of America, to curb the sale of counterfeit
and copyright-infringing products on the platform.

Alibaba Group said in December the value of transactions on
its Taobao platforms exceeded 1 trillion yuan ($161.74
billion)for the first time in January-November last year.

“The protection of IPR and fighting against counterfeit
goods, if we don’t do it well, will be something I’ll regret,”
Ma said.

In 2012, Alibaba said it provided information to law
enforcement officers involving 72 brands, and 170 million yuan
worth of merchandise was taken down from its shopping sites.
($1 = 6.1826 Chinese yuan)

(Reporting by Melanie Lee; Editing by Emily Kaiser)

Not only does she spend nearly all of her own money, Guo also fritters away most of her father’s 1,000 yuan monthly pension on trinkets and clothes on Taobao. “Sometimes I feel guilty using his money, so I buy him some clothes.”

Guo, a Zhengzhou native, already owns an apartment – her parents helped finance the purchase last year – and is on the upward climb to join China’s burgeoning middle class.

As Beijing tries to engineer a crucial macroeconomic shift– toward more consumption and less investment, the crucial “rebalancing” China’s new leadership is committed to, and the rest of the world is counting on — it is young consumers like Guo Qian who may hold the key to the transition.

Raised in an era of unprecedented prosperity, Guo, like many other members of what is known as the `post-80s’ generation (anyone born after 1980) has a very different answer than her parents when it comes to a central economic question: whether to spend the money she has, or save it?

“I don’t save at all,” she told Reuters. ” Why should I?”

Her “spend it if you’ve got it” attitude, some economists argue, may help unlock the surge in consumption that China urgently needs to rebalance its economy over the next decade, ending an era of lopsided, investment driven growth.

“This 18-35 group, for a variety of reasons, are much more optimistic and more open to risk, because they haven’t yet experienced bad times at all,” says Benjamin Cavender associate principal analyst with China Market Research. “They tend to have high disposable income relative to their earning power, and they tend not to be saving heavily.”

This generational change in mindset, harnessed to the sheer number of people growing more prosperous in once poor provinces throughout the country – such as Guo’s native Henan – is recasting China’s economic landscape: both the composition of growth, and its geography, are about to change significantly.

VIDEO: China’s small cities gear up for big spenders: link.reuters.com/vev36t

GRAPHIC: link.reuters.com/quw47t

GO WEST YOUNG PEOPLE

Today, cities along China’s eastern seaboard account for about 35 per cent of China’s annual 18 trillion yuan retail spending. This reflects the extent to which cities such as Shanghai and Guangdong have prospered compared to the rest of the country since China’s economic opening 30 years ago.

Surging income growth in China’s interior – as companies shift manufacturing capacity away from the east, in search of less expensive labor and new markets – is shifting the economic balance of power in China.

“(There) will still be growth along the (east) coast. But it’s in the first band of inland provinces – Jiangxi, Henan, Anhui– where you will see more significant growth in the consuming class,” said Jeff Walters, Beijing-based managing director at the Boston Consulting Group.

“If you look at the coming years, you have a lot of younger consumers whose incomes are rising, and they are just about to cross the threshold into those levels of income where households are going to become more comfortable spending more.”

The emerging comfort zone has important macroeconomic implications. Today, China’s household savings rate is around 28 percent, among the highest in the world. Most economists blame a patchy, still-under-construction social safety net for keeping savings rates high and consumption low.

But continued strong wage growth is prompting Chinese households to loosen the reins on spending. In urban areas, average total income per capita has grown nearly 30 percent since the end of 2010 while disposable income per capita has also risen about 30 percent. Heleen Mees, an economics professor at New York University, forecasts the household savings rate will fall from to 24 percent by 2020.

WHERE THE GROWTH IS

The newly emerging economic landscape is most visible in Henan, the country’s third-most populous province, where bucolic pastures have long since given way to crowded cities and construction cranes.

The province grew by 11.6 per cent in 2011, in part due to a huge inflow of foreign direct investment. According to a report by the Economist Intelligence Unit, the province is now home to three of the fastest growing cities in China – Zhengzhou, Jiaozuo and Xinxiang.

Across China, the labor market has been steadily tightening, in part because China’s aging population is reducing the number of working age employees. In 2012, the number actually fell for the first time since China opened its economy more than 30 years ago.

In response, companies, both foreign and domestic, have been moving a massive amount of manufacturing capacity from the east to western and interior cities like Zhengzhou, taking advantage of lower labor costs and government tax incentives.

In Zhengzhou, the resulting jobs boom has lured nearly three million new residents to the city over the last decade – the overall population is now nine million – the vast majority coming from the countryside for the first time.

Partly as a result, by 2020 there will be nearly twice as many urban middle class and affluent households – defined as those making 75,000 yuan or more annually – in Henan than there are today in Shanghai, according to a Reuters calculation based on figures provided by the Boston Consulting Group (BCG).

“Provinces like Henan have a big population base, and on top of that, the people are becoming richer and richer at a faster pace,” said Louise Liu, deputy director of EIU’s Access China and co-author of a 2010 report on China’s fastest-growing cities.

Chongqing, Hunan, Hebei, Anhui will also experience a boom in urban middle class and affluent households, with their numbers growing to about the size of Shanghai’s currently, according to a recent study by Boston Consulting Group.

Not only are those regions now growing more briskly than cities in the east, the behavior of consumers, market researchers say, is changing across provinces in China’s heartland for concrete economic reasons.

Disposable incomes tend to be higher in places such as Zhengzhou and Chongqing, even if wages are slightly lower than they are in Beijing and Shanghai. A big part of the reason: for all the talk about a real estate bubble in China, apartments are much more affordable in smaller cities throughout China’s interior.

Guo already has her apartment, and she plans to buy another one with her boyfriend in two years.

“Lower housing and other costs in smaller cities mean households have more left over after basic living expenses to spend on discretionary items,” said BCG’s Walters. “This is a key reason why the lower-tier consumer who just crossed the middle class threshold tends to be more secure and willing to spend than their higher tier city counterparts.”

NO LONGER A SAVINGS MINDSET

Economists who believe China’s rebalancing is underway say population trends and income growth are only part of what will trigger a sustained increase in consumption’s share of the overall economy. Rising disposable incomes coincide with a change in psychology among younger consumers – a shift that means when it comes to money and spending they are decidedly not their parents.

“We don’t have that mindset to save all our money and worry about what will happen in the future,” said Han Lingxiao, a law student in Jiaozuo city, 90 kms (54 miles) from Zhengzhou. “We are more focused on how to improve our lives now.”

Han moved from a poor farming county near Jiaozuo to study law at a city university. She says her younger brother who is only 12 will also follow in her footsteps and move to the city.

For younger consumers like Han, three decades of steady economic growth means that “perpetual optimism is the driver,” said Ling Hai, China general manager for Mastercard (MA.N: Quote, Profile, Research). “They will not save as their parents have, and they will start to use tomorrow’s money.”

To be sure, a major economic shock of the sort that derailed the U.S. consumer in 2008-2009, could similarly undercut China’s. But absent that, many economists and market researchers now believe the shift in attitudes toward consumption will prove to be durable, even if the economy slows.

“China is fueled by a belief that tomorrow is going to be better than today,” said Tom Doctoroff, Asia Pacific head of advertising firm JWT and author of “Billions: Selling to the New Chinese Consumer.”

That psychology is evident in the evolving tastes of consumers. Like so many of their counterparts in the developed world, young Chinese, whether in Shanghai or Zhengzhou, now regard brands as investments reflecting their status in society, Doctoroff said.

BRANDS BETTING ON MIDDLE CLASS

Not surprisingly, with so many of those younger consumers located in smaller, more far flung cities, domestic and foreign consumer goods companies are making substantial bets on the anticipated surge in consumption.

L’Oreal, the world’s largest cosmetics company, forecasts that China’s middle class will expand by 260 million people by 2020, with smaller interior cities leading the growth.

“Tier three cities are really important for us. They’re growing really fast and are a way for us to reach this soaring middle class,” said Stephane Rinderknech, Vice President of L’Oreal’s luxury division in China at a press conference recently.

Sportswear maker Adidas (ADSGn.DE: Quote, Profile, Research) has already doubled its lower-tier city presence over the past two years as part of a plan to expand into 1,400 cities by 2015. And Starbucks (SBUX.O: Quote, Profile, Research) will increase the number of its stores outside wealthy cities like Beijing and Shanghai by 20 to 30 per cent over the next few years.

Ou Ye, 23, is precisely the type of consumer all three of those companies want to attract. The former model turned schoolteacher lives in Chongqing, a massive city in southwestern China and one of the places where the emerging consumer class is expanding most rapidly.

Wearing a fuchsia coat and black suede boots, Ou says she spends upwards of 70 percent of her 4,000 yuan per month teacher’s salary on clothes. Her favorite brands, she says, are Hennes & Mauritz (HMb.ST: Quote, Profile, Research) and Shanghai-based Lulualways. She picks up new fashion trends off the Internet.

“I used to make my decisions purely based on designs, now I think about quality. If something is more expensive but has better quality, I will buy it,” Ou said.

Back in Jiaozou city, Jiang Xiao, a fellow law student and friend of Han Lingxiao’s, expresses another sentiment that consumer goods makers – not to mention economists worried about China’s rebalancing – love to hear. “My parents and grandparents,” she said, “believe whatever you earned is whatever you saved. But not our generation. We are more Western in our consumption style.” (Reporting by Melanie Lee; Editing by Bill Powell and Bill Tarrant)

Not only does she spend nearly all of her own money, Guo also fritters away most of her father’s 1,000 yuan monthly pension on trinkets and clothes on Taobao. “Sometimes I feel guilty using his money, so I buy him some clothes.”

Guo, a Zhengzhou native, already owns an apartment – her parents helped finance the purchase last year – and is on the upward climb to join China’s burgeoning middle class.

As Beijing tries to engineer a crucial macroeconomic shift– toward more consumption and less investment, the crucial “rebalancing” China’s new leadership is committed to, and the rest of the world is counting on — it is young consumers like Guo Qian who may hold the key to the transition.

Raised in an era of unprecedented prosperity, Guo, like many other members of what is known as the `post-80s’ generation (anyone born after 1980) has a very different answer than her parents when it comes to a central economic question: whether to spend the money she has, or save it?

“I don’t save at all,” she told Reuters. ” Why should I?”

Her “spend it if you’ve got it” attitude, some economists argue, may help unlock the surge in consumption that China urgently needs to rebalance its economy over the next decade, ending an era of lopsided, investment driven growth.

“This 18-35 group, for a variety of reasons, are much more optimistic and more open to risk, because they haven’t yet experienced bad times at all,” says Benjamin Cavender associate principal analyst with China Market Research. “They tend to have high disposable income relative to their earning power, and they tend not to be saving heavily.”

This generational change in mindset, harnessed to the sheer number of people growing more prosperous in once poor provinces throughout the country – such as Guo’s native Henan – is recasting China’s economic landscape: both the composition of growth, and its geography, are about to change significantly.

GO WEST YOUNG PEOPLE

Today, cities along China’s eastern seaboard account for about 35 per cent of China’s annual 18 trillion yuan retail spending. This reflects the extent to which cities such as Shanghai and Guangdong have prospered compared to the rest of the country since China’s economic opening 30 years ago.

Surging income growth in China’s interior – as companies shift manufacturing capacity away from the east, in search of less expensive labor and new markets – is shifting the economic balance of power in China.

“(There) will still be growth along the (east) coast. But it’s in the first band of inland provinces – Jiangxi, Henan, Anhui– where you will see more significant growth in the consuming class,” said Jeff Walters, Beijing-based managing director at the Boston Consulting Group.

“If you look at the coming years, you have a lot of consumers whose incomes are rising, and they are just about to cross the threshold into those levels of income where households are going to become more comfortable spending more.”

The emerging comfort zone has important macroeconomic implications. Today, China’s household savings rate is around 28 percent, among the highest in the world. Most economists blame a patchy, still-under-construction social safety net for keeping savings rates high and consumption low.

But continued strong wage growth is prompting Chinese households to loosen the reins on spending. In urban areas, average total income per capita has grown nearly 30 percent since the end of 2010 while disposable income per capita has also risen about 30 percent. Helen Mees, an economics professor at New York University, forecasts the household savings rate will fall from to 24 percent by 2020.

WHERE THE GROWTH IS

The newly emerging economic landscape is most visible in Henan, the country’s third-most populous province, where bucolic pastures have long since given way to crowded cities and construction cranes.

The province grew by 11.6 per cent in 2011, in part due to a huge inflow of foreign direct investment. According to a report by the Economist Intelligence Unit, the province is now home to three of the fastest growing cities in China – Zhengzhou, Jiaozuo and Xinxiang.

Across China, the labor market has been steadily tightening, in part because China’s aging population is reducing the number of working age employees. In 2012, the number actually fell for the first time since China opened its economy more than 30 years ago.

In response, companies, both foreign and domestic, have been moving a massive amount of manufacturing capacity from the east to western and interior cities like Zhengzhou, taking advantage of lower labor costs and government tax incentives.

In Zhengzhou, the resulting jobs boom has lured nearly three million new residents to the city over the last decade – the overall population is now nine million – the vast majority coming from the countryside for the first time.

Partly as a result, by 2020 there will be nearly twice as many urban middle class and affluent households – defined as those making 75,000 yuan ($12,000) or more annually – in Henan than there are today in Shanghai, according to a Reuters calculation based on figures provided by the Boston Consulting Group (BCG).

“Provinces like Henan have a big population base, and on top of that, the people are becoming richer and richer at a faster pace,” said Louise Liu, deputy director of EIU’s Access China and co-author of a 2010 report on China’s fastest-growing cities.

Chongqing, Hunan, Hebei, Anhui will also experience a boom in urban middle class and affluent households, with their numbers growing to about the size of Shanghai’s currently, according to a recent study by Boston Consulting Group.

Not only are those regions now growing more briskly than cities in the east, the behavior of consumers, market researchers say, is changing across provinces in China’s heartland for concrete economic reasons.

Disposable incomes tend to be higher in places such as Zhengzhou and Chongqing, even if wages are slightly lower than they are in Beijing and Shanghai. A big part of the reason: for all the talk about a real estate bubble in China, apartments are much more affordable in smaller cities throughout China’s interior.

Guo already has her apartment, and she plans to buy another one with her boyfriend in two years.

“Lower housing and other costs in smaller cities mean households have more left over after basic living expenses to spend on discretionary items,” said BCG’s Walters. “This is a key reason why the lower-tier consumer who just crossed the middle class threshold tends to be more secure and willing to spend than their higher tier city counterparts.”

NO LONGER A SAVINGS MINDSET

Economists who believe China’s rebalancing is underway say population trends and income growth are only part of what will trigger a sustained increase in consumption’s share of the overall economy. Rising disposable incomes coincide with a change in psychology among younger consumers – a shift that means when it comes to money and spending they are decidedly not their parents.

“We don’t have that mindset to save all our money and worry about what will happen in the future,” said Han Lingxiao, a law student in Jiaozuo city, 90 kms (54 miles) from Zhengzhou. “We are more focused on how to improve our lives now.”

Han moved from a poor farming county near Jiaozuo to study law at a city university. She says her younger brother who is only 12 will also follow in her footsteps and move to the city.

For younger consumers like Han, three decades of steady economic growth means that “perpetual optimism is the driver,” said Ling Hai, China general manager for Mastercard. “They will not save as their parents have, and they will start to use tomorrow’s money.”

To be sure, a major economic shock of the sort that derailed the U.S. consumer in 2008-2009, could similarly undercut China’s. But absent that, many economists and market researchers now believe the shift in attitudes toward consumption will prove to be durable, even if the economy slows.

“China is fueled by a belief that tomorrow is going to be better than today,” said Tom Doctoroff, Asia Pacific head of advertising firm JWT and author of “Billions: Selling to the New Chinese Consumer.”

That psychology is evident in the evolving tastes of consumers. Like so many of their counterparts in the developed world, young Chinese, whether in Shanghai or Zhengzhou, now regard brands as investments reflecting their status in society, Doctoroff said.

BRANDS BETTING ON MIDDLE CLASS

Not surprisingly, with so many of those younger consumers located in smaller, more far flung cities, domestic and foreign consumer goods companies are making substantial bets on the anticipated surge in consumption.

L’Oreal, the world’s largest cosmetics company, forecasts that China’s middle class will expand by 260 million people by 2020, with smaller interior cities leading the growth.

“Tier three cities are really important for us. They’re growing really fast and are a way for us to reach this soaring middle class,” said Stephane Rinderknech, Vice President of L’Oreal’s luxury division in China at a press conference recently.

Sportswear maker Adidas has already doubled its lower-tier city presence over the past two years as part of a plan to expand into 1,400 cities by 2015. And Starbucks will increase the number of its stores outside wealthy cities like Beijing and Shanghai by 20 to 30 per cent over the next few years.

Ou Ye, 23, is precisely the type of consumer all three of those companies want to attract. The former model turned schoolteacher lives in Chongqing, a massive city in southwestern China and one of the places where the emerging consumer class is expanding most rapidly.

Wearing a fuchsia coat and black suede boots, Ou says she spends upwards of 70 percent of her 4,000 yuan per month ($640) teacher’s salary on clothes. Her favorite brands, she says, are Hennes & Mauritz and Shanghai-based Lulualways. She picks up new fashion trends off the Internet.

“I used to make my decisions purely based on designs, now I think about quality. If something is more expensive but has better quality, I will buy it,” Ou said.

Back in Jiaozou city, Jiang Xiao, a fellow law student and friend of Han Lingxiao’s, expresses another sentiment that consumer goods makers – not to mention economists worried about China’s rebalancing – love to hear. “My parents and grandparents,” she said, “believe whatever you earned is whatever you saved. But not our generation. We are more Western in our consumption style.” ($1 = 6.2143 Chinese yuan)

(Reporting by Melanie Lee; Editing by Bill Powell and Bill Tarrant)

Not only does she spend nearly all of her own money, Guo
also fritters away most of her father’s 1,000 yuan monthly
pension on trinkets and clothes on Taobao. “Sometimes I feel
guilty using his money, so I buy him some clothes.”

Guo, a Zhengzhou native, already owns an apartment – her
parents helped finance the purchase last year – and is on the
upward climb to join China’s burgeoning middle class.

As Beijing tries to engineer a crucial macroeconomic shift–
toward more consumption and less investment, the crucial
“rebalancing” China’s new leadership is committed to, and the
rest of the world is counting on — it is young consumers like
Guo Qian who may hold the key to the transition.

Raised in an era of unprecedented prosperity, Guo, like many
other members of what is known as the `post-80s’ generation
(anyone born after 1980) has a very different answer than her
parents when it comes to a central economic question: whether to
spend the money she has, or save it?

“I don’t save at all,” she told Reuters. ” Why should I?”

Her “spend it if you’ve got it” attitude, some economists
argue, may help unlock the surge in consumption that China
urgently needs to rebalance its economy over the next decade,
ending an era of lopsided, investment driven growth.

“This 18-35 group, for a variety of reasons, are much more
optimistic and more open to risk, because they haven’t yet
experienced bad times at all,” says Benjamin Cavender associate
principal analyst with China Market Research. “They tend to have
high disposable income relative to their earning power, and they
tend not to be saving heavily.”

This generational change in mindset, harnessed to the sheer
number of people growing more prosperous in once poor provinces
throughout the country – such as Guo’s native Henan – is
recasting China’s economic landscape: both the composition of
growth, and its geography, are about to change significantly.

GO WEST YOUNG PEOPLE

Today, cities along China’s eastern seaboard account for
about 35 per cent of China’s annual 18 trillion yuan retail
spending. This reflects the extent to which cities such as
Shanghai and Guangdong have prospered compared to the rest of
the country since China’s economic opening 30 years ago.

Surging income growth in China’s interior – as companies
shift manufacturing capacity away from the east, in search of
less expensive labor and new markets – is shifting the economic
balance of power in China.

“(There) will still be growth along the (east) coast. But
it’s in the first band of inland provinces – Jiangxi, Henan,
Anhui– where you will see more significant growth in the
consuming class,” said Jeff Walters, Beijing-based managing
director at the Boston Consulting Group.

“If you look at the coming years, you have a lot of
consumers whose incomes are rising, and they are just
about to cross the threshold into those levels of income where
households are going to become more comfortable spending more.”

The emerging comfort zone has important macroeconomic
implications. Today, China’s household savings rate is around 28
percent, among the highest in the world. Most economists blame a
patchy, still-under-construction social safety net for keeping
savings rates high and consumption low.

But continued strong wage growth is prompting Chinese
households to loosen the reins on spending. In urban areas,
average total income per capita has grown nearly 30 percent
since the end of 2010 while disposable income per capita has
also risen about 30 percent. Helen Mees, an economics professor
at New York University, forecasts the household savings rate
will fall from to 24 percent by 2020.

WHERE THE GROWTH IS

The newly emerging economic landscape is most visible in
Henan, the country’s third-most populous province, where bucolic
pastures have long since given way to crowded cities and
construction cranes.

The province grew by 11.6 per cent in 2011, in part due to a
huge inflow of foreign direct investment. According to a report
by the Economist Intelligence Unit, the province is now home to
three of the fastest growing cities in China – Zhengzhou,
Jiaozuo and Xinxiang.

Across China, the labor market has been steadily tightening,
in part because China’s aging population is reducing the number
of working age employees. In 2012, the number actually fell for
the first time since China opened its economy more than 30 years
ago.

In response, companies, both foreign and domestic, have been
moving a massive amount of manufacturing capacity from the east
to western and interior cities like Zhengzhou, taking advantage
of lower labor costs and government tax incentives.

In Zhengzhou, the resulting jobs boom has lured nearly three
million new residents to the city over the last decade – the
overall population is now nine million – the vast majority
coming from the countryside for the first time.

Partly as a result, by 2020 there will be nearly twice as
many urban middle class and affluent households – defined as
those making 75,000 yuan ($12,000) or more annually – in Henan
than there are today in Shanghai, according to a Reuters
calculation based on figures provided by the Boston Consulting
Group (BCG).

“Provinces like Henan have a big population base, and on top
of that, the people are becoming richer and richer at a faster
pace,” said Louise Liu, deputy director of EIU’s Access
China and co-author of a 2010 report on China’s fastest-growing
cities.

Chongqing, Hunan, Hebei, Anhui will also experience a boom
in urban middle class and affluent households, with their
numbers growing to about the size of Shanghai’s currently,
according to a recent study by Boston Consulting Group.

Not only are those regions now growing more briskly than
cities in the east, the behavior of consumers, market
researchers say, is changing across provinces in China’s
heartland for concrete economic reasons.

Disposable incomes tend to be higher in places such as
Zhengzhou and Chongqing, even if wages are slightly lower than
they are in Beijing and Shanghai. A big part of the reason: for
all the talk about a real estate bubble in China, apartments are
much more affordable in smaller cities throughout China’s
interior.

Guo already has her apartment, and she plans to buy another
one with her boyfriend in two years.

“Lower housing and other costs in smaller cities mean
households have more left over after basic living expenses to
spend on discretionary items,” said BCG’s Walters. “This is a
key reason why the lower-tier consumer who just crossed the
middle class threshold tends to be more secure and willing to
spend than their higher tier city counterparts.”

NO LONGER A SAVINGS MINDSET

Economists who believe China’s rebalancing is underway say
population trends and income growth are only part of what will
trigger a sustained increase in consumption’s share of the
overall economy. Rising disposable incomes coincide with a
change in psychology among younger consumers – a shift that
means when it comes to money and spending they are decidedly not
their parents.

“We don’t have that mindset to save all our money and worry
about what will happen in the future,” said Han Lingxiao, a law
student in Jiaozuo city, 90 kms (54 miles) from Zhengzhou. “We
are more focused on how to improve our lives now.”

Han moved from a poor farming county near Jiaozuo to study
law at a city university. She says her younger brother who is
only 12 will also follow in her footsteps and move to the city.

For younger consumers like Han, three decades of steady
economic growth means that “perpetual optimism is the driver,”
said Ling Hai, China general manager for Mastercard.
“They will not save as their parents have, and they will start
to use tomorrow’s money.”

To be sure, a major economic shock of the sort that derailed
the U.S. consumer in 2008-2009, could similarly undercut
China’s. But absent that, many economists and market researchers
now believe the shift in attitudes toward consumption will prove
to be durable, even if the economy slows.

“China is fueled by a belief that tomorrow is going to be
better than today,” said Tom Doctoroff, Asia Pacific head of
advertising firm JWT and author of “Billions: Selling to the New
Chinese Consumer.”

That psychology is evident in the evolving tastes of
consumers. Like so many of their counterparts in the developed
world, young Chinese, whether in Shanghai or Zhengzhou, now
regard brands as investments reflecting their status in society,
Doctoroff said.

BRANDS BETTING ON MIDDLE CLASS

Not surprisingly, with so many of those younger consumers
located in smaller, more far flung cities, domestic and foreign
consumer goods companies are making substantial bets on the
anticipated surge in consumption.

L’Oreal, the world’s largest cosmetics company, forecasts
that China’s middle class will expand by 260 million people by
2020, with smaller interior cities leading the growth.

“Tier three cities are really important for us. They’re
growing really fast and are a way for us to reach this soaring
middle class,” said Stephane Rinderknech, Vice President of
L’Oreal’s luxury division in China at a press conference
recently.

Sportswear maker Adidas has already doubled its
lower-tier city presence over the past two years as part of a
plan to expand into 1,400 cities by 2015. And Starbucks
will increase the number of its stores outside wealthy cities
like Beijing and Shanghai by 20 to 30 per cent over the next few
years.

Ou Ye, 23, is precisely the type of consumer all three of
those companies want to attract. The former model turned
schoolteacher lives in Chongqing, a massive city in southwestern
China and one of the places where the emerging consumer class is
expanding most rapidly.

Wearing a fuchsia coat and black suede boots, Ou says she
spends upwards of 70 percent of her 4,000 yuan per month ($640)
teacher’s salary on clothes. Her favorite brands, she says, are
Hennes & Mauritz and Shanghai-based Lulualways. She
picks up new fashion trends off the Internet.

“I used to make my decisions purely based on designs, now I
think about quality. If something is more expensive but has
better quality, I will buy it,” Ou said.

Back in Jiaozou city, Jiang Xiao, a fellow law student and
friend of Han Lingxiao’s, expresses another sentiment that
consumer goods makers – not to mention economists worried about
China’s rebalancing – love to hear. “My parents and
grandparents,” she said, “believe whatever you earned is
whatever you saved. But not our generation. We are more Western
in our consumption style.”

After coming under near-daily media assault for the past two weeks and facing the threat of penalties from two Chinese government bureaus, Apple apologized to Chinese consumers on Monday for poor communication over its warranty policy and said it will change the terms for some of its iPhones sold in China.

Greater China is Apple’s second-biggest and fastest-growing market, with sales up almost 40 percent to $6.8 billion in the final quarter of 2012.

The Chinese newspapers that threw brickbats at Apple a few days ago have since changed their tune.

“The company’s apology letter has eased the situation, softening the tense relationship between Apple and the Chinese market … Its reaction is worth respect compared with other American companies,” wrote popular tabloid the Global Times, published by Communist Party mouthpiece the People’s Daily.

The Foreign Ministry praised Apple for “conscientiously” responding to consumers’ demands.

“We approve of what Apple said,” spokesman Hong Lei told a daily news briefing on Tuesday.

Only last week, the People’s Daily issued a scathing editorial on Apple’s return policy saying the popular smartphone maker was filled with “unparalleled arrogance”.

Apple was first targeted in mid-March by state broadcaster CCTV during its annual consumer day segment. Volkswagen AG, which was also criticized on the same show, plans to recall vehicles to fix a gearbox problem.

“That Timothy Cook had to step up and respond from the CEO’s chair shows the importance of China and how critical it is as a market not just for Apple but for every multinational company here,” said Kent Kedl, Shanghai-based head of Greater China and North Asia for risk consultancy firm Control Risks.

Foreign companies who are adept at managing media crises at home find it much tougher to navigate China where state media outlets, pandering to different audiences, often have opaque agendas and intentions. Analysts also said that foreign companies need to remember that the bigger the brand, the bigger a target it will be, especially in China.

“What foreign companies need to pay attention to, is that nobody operates in a vacuum, nobody operates only on the good graces of a brand name … Five to ten years ago a report on CCTV would have rippled a little bit, now it goes viral and has a life of its own,” Kedl said.

NOT APPLE’S FIGHT TO WIN

Apple’s acquiescence in this setting, where the world’s largest technology company by market value was ironically the David going up against China’s Goliath state media machinations, shows its wisdom in not challenging a more powerful enemy.

Although popular opinion on the Internet swayed in Apple’s favor, against state media and the reported threats of penalties from China’s State Administration for Industry and Commerce as well as its quality and inspection bureau, it was not Apple’s fight to win, experts said.

Other foreign companies targeted by CCTV, such as fast food chain operator Yum Brands Inc, have also apologized and faced scrutiny from government agencies. Last December CCTV reported that two of Yum’s suppliers purchased chickens from farmers who used excessive levels of antibiotics in their animals. The report and subsequent investigations hurt sales at Yum’s KFC chain.

But Apple’s situation is somewhat different because CCTV’s claim was not completely new. Last July, a Chinese consumer rights group also slammed Apple for its after-sales policies. That time, however, Apple held its ground.

With the apology and warranty change, Apple’s mea culpa is significant not just because it comes from a tech firm that rarely apologizes, but also because Apple may be realizing that in China, it needs to be proactive.

“They’re out of the woods and into the weeds. Things will rarely be smooth for Apple in China – even if consumers love it there will always be factions in and out of government that are trying to take it down,” said Michael Clendenin, managing director of technology consultancy RedTech Advisors.

“Apple made it easy this time, but they have learned to be more proactive. The next time they stumble, it will be easier to recover,” he said.

(Additional reporting by Ben Blanchard in BEIJING; Editing by Emily Kaiser)

Apple and Volkswagen AG were singled out on March 15 by state-run China Central Television in its annual corporate malpractice expose. CCTV accused Apple of having discriminatory after-sales service in China compared to the rest of the world.

Other state-run outlets have also run articles and editorials criticizing Apple. On Wednesday, the Communist Party mouthpiece, the People’s Daily, ran an editorial attacking Apple for being filled with “unparalleled arrogance”.

The editorial was rapidly shared by thousands of micro bloggers on Sina Corp’s Weibo platform but panned by many users who discredited the newspaper.

“Shameless People’s Daily jealously scolding people… A brain-dead product of the Cultural Revolution, old and so disgusting,” said one micro blogger.

Other users were upset at the targeting of a foreign firm over a petty issue.

“We ordinary people feel that Apple is good and the government is trash. There’s obviously an implemented warranty policy, why must (Apple) be treated differently?” said one user.

Another user asked where the newspaper was when it came to reporting on corrupt on local ministries and poisonous milk.

“Do you wish to transfer our focus? Get the ordinary people to curse and blame useless things? There’s toxic air, toxic water and tainted milk…We are not fools!” said another user.

The intense push-back from Internet users indicates the strong reputation of Apple in China and shows the waning ability of China’s state propaganda apparatus to manage opinion online, analysts say.

“Some users may feel that there is an agenda behind focusing on Apple that has more to do with pointing the finger at a famous international brand than the desire to highlight genuine concerns for consumers,” said Torsten Stocker, head of Monitor Deloitte’s Greater China consumer and retail practice.

Foreign firms are often taken to task very publicly in China where their businesses and reputations are on the line. Late last year, Yum Brands Inc’s said its sales suffered after CCTV ran a report on the use of antibiotics in its KFC chickens.

That story went viral on Weibo, which has over 500 million users, and many Weibo users criticized Yum’s handling of the incident. Facebook and Twitter are blocked in China and Beijing faces the constant headache on how to balance censorship while letting its citizens blow off steam.

Apple said in a statement on Saturday that it respected Chinese consumers and that its warranty policies were roughly the same worldwide with specific adjustments to adhere to Chinese law.

“Apple has come out relatively unscathed in this situation because consumers have had largely positive experiences with the brand,” said Benjamin Cavender, associate principal analyst at China Market Research in Shanghai.

As for Volkswagen, CCTV said the direct shift gearbox transmission was causing some cars to speed up or slow down during driving.

Last week Volkswagen, which sells more cars in China than any other foreign firm, said it would recall 384,181 vehicles there to fix the problem.

(Editing by Kazunori Takada)

Local and global media had criticised the surcharge as being
discriminatory because it was applied only in China, at the
company’s Shanghai store, which staged a “soft opening” in
January as the company’s first bridal salon in the country, a
vast potential market as the numbers of wealthy grow.

A Vera Wang spokeswoman told Reuters that the 3,000 yuan
($480) charge was being scrapped as of Wednesday.

“Please kindly be informed that Vera Wang has abolished
appointment fees at her bridal salons worldwide starting from
March 27, 2013,” the spokeswoman said in an email, without
elaborating.

A company spokeswoman told local media earlier this year
that the charge was imposed to fend off copying of the elaborate
dresses, which fetch thousands of dollars in the original.

Despite the move, though, Vera Wang’s ivory tulle trains and
pinched bodice gowns had already found fans in the world of
pirates, with knockoffs widely available on Chinese e-commerce
sites for a fraction of the price.

Li, one seller of “Vera Wang style” dresses on Taobao
Marketplace, China’s largest e-commerce site, says he can
achieve up to 90 percent similarity to the namesake garments
without even seeing the originals.

A Vera Wang original can range anywhere from $2,000 to over
$10,000, but on Taobao some imitations go for as little as $100.

“For the experts you don’t need to try on the dress to
figure out how to copy it, you just need to see it or feel it at
the shop,” said Li, who declined to give his full name.

Li’s factory, based in Suzhou, a city near Shanghai, makes
Vera Wang knockoffs from photos of her creations, then sells
them online for between 600 yuan ($97) to 1,700 yuan ($270).

The Taobao sellers who hawk the look-alikes use organza,
satin and lace to recreate the ethereal bridal trains and
three-dimensional floral whorls on Wang’s dresses.

Most of the sellers online said they could achieve near 100
percent similarity to Vera Wang dresses but the complicated hand
stitching and high quality materials that go into an original
dress is something they can’t replicate.

“There will be slight changes… If you want 100 percent you
should buy the original,” said one seller of mid-range copies.

In 2012, China was the top source country for counterfeit
goods entering the United States and the European Union (EU)
with more than 70 percent originating from China, according to
the latest customs seizure reports from the U.S. and the EU.

Alibaba Group, which owns Taobao Marketplace,
said in a statement to Reuters the company works with
intellectual property rights holders to take down counterfeit
listings and will penalise stores caught.

Two of the four cities singled out by the provincial administration late on Monday – Guangzhou and Shenzhen – feature right at the top of the list of 70 cities that have seen some of the sharpest home price spikes so far this year, according to Reuters calculations of official home price data.

The selection of those two cities, which topped and tailed a group of 26 at the end of 2012 with similar rates of appreciation, suggests there could be a wider target group in the central government’s sights than the February data alone imply.

In 2012, Guangzhou’s average home prices on an unweighted index basis were tied for fastest rising among the 70 cities tracked by the National Bureau of Statistics (NBS), gaining 2.3 percent over the year to share the top spot with Urumqi in western China’s Xinjiang province.

Average home prices in Shenzhen rose 0.8 percent last year. Another 23 cities were in that 0.8-2.3 percent range.

Home prices in Guangzhou jumped 8.1 percent year-on-year in February, according to official data from the NBS, while those in Shenzhen rose 5.7 percent in the same period.

Of the other 68 cities the NBS tracks, only price rises in Beijing kept pace on an unweighted indexed basis, gaining 5.9 percent year-on-year in February.

On a population-weighted basis as derived by Reuters from official data, Guangzhou home prices jumped 18.6 percent in February from a year ago, while Shenzhen gained 11.4 percent.

If those two cities provide some guide to the potential upper and lower bounds of price gains that were deemed by China’s State Council, or cabinet, to be rising “too quickly” when it issued its latest property tightening guidance on March 1, up to 24 more could be in the government’s sites.

“These cities, including Beijing and Shanghai, where home prices have risen faster than others, face greater pressure from the central government and they are expected to unveil stricter detailed property cooling measures,” said Liu Yuan, a head of research at China’s biggest property brokerage Centaline.

“But we still need to wait and see the effect of the cooling measures as it depends on how local governments are going to enforce them,” said Liu.

On a weighted basis, Chongqing prices leapt 22.4 percent in February year-on-year, the highest in the country based on NBS data of the 70 major Chinese cities its home price index tracks.

Beijing was close behind, up 21.8 percent, while Shanghai home prices gained 14.6 percent.

CRACKDOWN COMING

The central government said earlier this month it wanted local governments, in areas where property prices were rising too quickly, to strictly implement rules which impose a 20 percent capital gains tax and higher down payments for second-home buyers.

The crackdown came after data showed China’s new home prices rose in February from a year ago for a second consecutive month.

Wealthy Chinese tend to park money in property because they have few other domestic investment options given relatively undeveloped mutual fund and bond markets and broad consumer distrust of local equity markets.

Chinese home prices more than doubled in 2009 after Beijing rolled out a massive economic stimulus package to combat the global financial crisis.

The central government has since been trying to rein them in with a series of campaigns that have variously curbed credit and tightened ownership rules. A lack of strict implementation has been largely to blame for patchy results, analysts say.

China property stocks marginally outperformed a down market .CSI300 on Tuesday, with traders gauging that the plan from the Guangdong authorities was in line with the central government’s directive of March 1, which had sparked a property share sell-off.

A Shanghai-based trader at a major Chinese brokerage said he expected more local authorities to release similar statements in coming days as the end-March deadline neared for them to reveal how they plan to toe the central government line.

Several Chinese property developers meanwhile have recently given relatively aggressive 2013 sales guidance while reporting 2012 earnings, suggesting they do not expect demand to be crimped too severely by the curbs, supporting share prices.

China Vanke (000002.SZ: Quote, Profile, Research, Stock Buzz) shares, up as much as 3.6 percent at one stage on Tuesday, were trading narrowly on either side of the flatline at 0653 GMT. They have retraced about half of a roughly 10 percent tumble on March 4 after the government’s original announcement.

(Additional reporting by Clement Tan in Hong Kong; Writing by Nick Edwards; Editing by Eric Meijer and Edmund Klamann)