Chinese buyers beware

BEIJING (Fortune) -- Last week, the Chinese government announced that nearly 20 percent of all food and consumer goods it examined in a survey were substandard or tainted, confirming to many outside China that "made in China" often means just poorly made. But most Chinese consumers - who have been dealing with this issue for years - reacted with a collective "duh," if they bothered to react at all. Indeed, the report simply showed what many already knew from painful experience: With government regulations eviscerated by corruption, the problem of tainted, substandard and fake products is almost all-pervasive in China.

Perhaps the most revealing measure of how frustrating - and how widespread - the problem has become for many consumers is not a number, but the fact that ordinary Chinese have developed a shorthand phrase - heixin, pronounced "hey sin" - to describe people who make, sell or profit from fake or dangerously low-quality goods, in addition to the illicit products themselves. Literally translated, it means black-hearted.

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Many of the most shocking incidents involving heixin products are truly worthy of that description; sales of fake milk powder that resulted in the deaths of several infants in Anhui province, for instance, and counterfeit medicines that killed four people. And recent investigations into children's snacks revealed that the products contained dangerously high levels of preservatives.

But the problems extend well beyond consumables. The China Economic Times, a Chinese language newspaper, published an investigative report last week about defective concrete used in the construction of China's flagship railway connecting Hunan and Guangzhou provinces. Less frightening but more common are reports of poorly made clothes, shoes and toys, and TVs and radios that don't work.

Ms. Wong, an elderly shopper at one of Beijing's traditional wet markets who would only give her last name, does not see an end to the problem any time soon. "It's very serious," she says, shaking her head. "They even have TV shows that teach you how to avoid the bad stuff. But it can't ever be fixed. If the government arrests someone, someone else will take their place. That's just the way it is, so we have to be careful when we shop."

For some, the answer is to avoid Chinese stores entirely and try to shop mostly in places like Carrefour, the French supermarket giant, and Wal-Mart (Charts, Fortune 500), especially for larger purchases, because of their reputations as sources of consistently high quality goods. In 1999 Carrefour introduced what it calls "Quality Line Products," to China. The Quality Line Products brand includes a limited number of items, mostly fruits, salmon and pork, whose key attributes are their guaranteed traceability and higher quality.

As James Zimmerman, chairman of the American Chamber of Commerce in China, notes, "Chinese consumers will pay a premium for genuine goods that meet international safety standards. Selling goods that meet international product safety standards is, in itself, a way to maintain brand awareness and profile, and thus a way to increase sales."

Indeed, Carrefour is doing extraordinarily well in China. The company operates about 240 stores nationally, and is planning on opening a total of 23 new outlets throughout the country by the end of the year. It expects to post 3 billion Euros in sales in China this year and achieved a 7.9 percent growth in sales from hypermarkets here last quarter, significantly higher than its growth in any other Asian country.

Wal-Mart, newer to the China market, struggled initially to adapt to Chinese consumers but may have found a footing in recent months, acquiring a share of Guangzhou-based but Taiwan-owned retailer Trust-Mart in an effort to grow its China business. It currently has 68 stores nationwide, and the Trust-Mart deal will eventually give Wal-Mart control of Trust-Mart's more than 100 stores in China.

But not everyone can afford to shop at international stores, and consumers of lesser means often turn to places like local Beijing supermarket chain Jingkelong as well as various convenience stores and super and hypermarkets owned by Wumart Stores Inc., which many say offer a decent, cheaper alternative, albeit with a drop in quality.

Both companies are in fact growing faster than Carrefour: Jingkelong's first quarter earnings rose 19 percent this year, as sales increased by 23 percent to 1.56 billion yuan while Wumart's first quarter profit increased by 25 percent from last year, as the company's sales increased by 50 percent to 2 billion yuan.

Many Chinese shoppers also frequent traditional wet markets where customers can purchase fresh produce, meat and seafood from small vendors on the street. While Chinese consumers often see produce at traditional wet markets as fresher and cheaper than at larger supermarkets, it is also less hygienic and traditional wet markets are significantly less regulated. Even less safe, however, are China's small, independent, cheap and totally unregulated mom-and-pop stores that sell everything from noodles to electronics and comprise a huge part of the Chinese retail market. Unsurprisingly, these are thought to be the largest source of heixin goods.

But, despite having acknowledged the problem, whether the Chinese government can do anything remains an open question - and few are optimistic.

It was (and still is) government corruption that allowed for heixin products in the first place. And market forces will continue to exacerbate the problem, as the glut of incredibly cheap, low-quality goods gives local companies an incentive to cut corners in order to compete. Moreover, at this point a sudden increase in unemployment presents the Chinese government with much greater political problems than rampant consumer dissatisfaction. As a result, on this issue, other countries - whose potential export bans on Chinese goods could easily put many Chinese out of work - have more leverage with the Chinese government than ordinary Chinese citizens do. While the whole calculus could change if the domestic heixin problem sparks more serious, organized outrage, for now better enforcement of China's export standards is a possibility, but major domestic changes are unlikely.

There are a few positive signs though, and the government has started to at least say the right things. On Monday, for example, Sun Xianze, the director of the department of food safety coordination under the State Food and Drug Administration, noted again that, "Our country is facing a period with high risks for food safety," and predicted - with some understatement - that authorities faced an "arduous task," ahead in fixing the problem.

To an extent, the government has also followed its words with action, recently cracking down on a few illegal and unlicensed factories and manufacturers. In addition, China recently sentenced to death two senior officials at its Food and Drug Administration, including the former head of the agency, Zheng Xiaoyu, for taking bribes - a harsh and well-publicized response that some see as an indication that government is trying to take corruption seriously. Zheng, 63, was executed on Tuesday.

But achieving lasting improvements in consumer protection will require the Chinese government to find a way to institute enormous systemic reforms in the country's legal and political systems to add accountability and eliminate the corruption that is cripplingly endemic here. "China needs to both objectively and uniformly enforce laws on product quality and consumer protection, and to penalize those companies and individuals that blatantly violate the law," says AmCham's Zimmerman.

In the meantime, Chinese consumers will just have to continue being especially vigilant and follow the old adage: caveat emptor.