Middle class reconsidered: New highs and lows for both the sector and consumers

A fast-growing middle class in Indonesia means more malls, products and higher sales. Recent numbers appear to demonstrate that this very dynamic, which has been heavily discussed and promoted over the past few years, was in fact holding in the country. After some signs of weakness in the middle of 2013, the retail market came roaring back with a string of strong indicators: retail sales were up 11.4% year-on-year in September 2013, 12.9% in October, 1.9% in November and 26.6% in December. The momentum continued into 2014, with retail sales rising 28.7% in January. But analysts and businesspersons caution that the phenomenon of the rising middle class is not as simple and straightforward as it was first believed. While people are in fact getting wealthier and this is translating into growth that will in all likelihood continue, the process will be complicated and prone to significant set backs.

Fluctuations

Indonesia is a large, diverse and, in many places, still a very poor country. A great many Indonesians are seeing their incomes rise and are passing certain thresholds that usually trigger a change in consumer behaviour. However, the buying capacity of the average consumer remains limited and prone to shocks. While Indonesians will be purchasing more, they remain careful and can be expected to pull back at the first signs of economic weakness. Still, some assert that the demographics are encouraging. “All the basic key performance indicators are positive in Indonesia: the number of children per family; growing purchasing power of the middle class and a new generation of consumers eager to access better products,” Philippe Broianigo, president director of Hero Group, told OBG.

The identification of an emerging middle class, many analysts found, was to a great extent a marketing idea that got ahead of itself. Consequently, consumers were surprised to find in 2013 that not that much has changed; that they are on average only slightly wealthier than they were a few years ago. Some Indonesian retailers are becoming more realistic as they examine their prospects. They are beginning to adjust their expectations as well. While global analysts like the Boston Consulting Group estimate that the current cadre of the middle and affluent class stands at 74m individuals – and is expected to reach some 141m by 2020 – local retailers say that these figures are likely an over estimation, and that the total may be closer to 40m-45m.

“There was a lot of hype that may not have been justified. Indonesians were reading that they are the next China and India, and they were believing the publicity,” Catherine Eddy, managing director at global market research firm, Nielsen Indonesia, told OBG.

Still Strong

Over time, Indonesian consumers will remain a force. While GDP per capita slips over key thresholds for more of the population in the future and the market could be volatile, this will not change the fact that there is strength in the sheer size of Indonesia’s population. “It’s a very exciting time for consumer industries in Indonesia because 50% of our population is under the age of 30 and our middle class is growing by 5m people, equivalent to the size of Singapore, every year,” Henri Honoris, president director of Modern Internasional, which manages 7-Eleven franchises in Indonesia, told OBG.

Global consultancy McKinsey estimates the average growth of consumer spending at 7.7% between 2010 and 2030. The fastest growing subsectors for this spending, according to the consultancy, are: finance, growing 10.5% over that time; leisure, 7.5%; health care, 6.2%; and education, 6.0%. It also noted that Indonesians are some of the most engaged consumers. They are extremely brand conscious, more so than any other nation at this stage of development, according to McKinsey. The figures suggest a country clearly biased toward spending, with household final consumption expenditure at 57%, higher than Malaysia (49%) or China (35%). “The middle class is price sensitive but can still afford things like basic health care and affordable goods as purchasing power increases every year,” Wendy Yap, president director and CEO of Nippon Sari Roti, told OBG.

Surge Ahead

The strength of the market and the interests of consumers can be seen in a recent Bank Indonesia (BI) retail sales survey. The study, published in January 2014 and which covered 650 retailers in 10 major cities, revealed that retail sales surged 14% year-on-year in November 2014, the fastest growth since July of that year. The market for information and communications equipment, for example, has exploded, with sales almost doubling in two years, and growing 70% year-on-year in January 2014. Other areas rapidly growing are clothing, up more than 25% year-on-year in the four months to January 2014, and cultural and recreational goods, which were up more than 30% year-on-year in the three months to January 2014. “Even with lower than expected GDP growth, Indonesia will not experience any retail slowdown as the domestic market is still growing internally,” Nugroho Setiadharma, the president director of Supra Boga Lestari, told OBG.

Wages & Salaries

Underpinning growth in retail sales is the fast increase in wages. In 2012 the minimum wage in Jakarta rose 44% to Rp2.2m ($220) per month. The following year, it went up to Rp2.44m ($244), but protesters were demanding a 50% raise. The impact is mixed. Many of these individuals are still living on wages barely enough for necessities, which are becoming more expensive due to of inflation, so the increase may not mean that much in terms of spending power. At the same time, retailers note that they are being squeezed by higher wages, which feeds through to costs. However, minimum wage remains under pressure, and the labour groups are becoming more militant in pushing for raises that exceed inflation and allow workers to enjoy real improvements in standards of living.

Kelly Services Indonesia’s 2013 salary report indicates that many jobs are commanding salaries that allow for significant consumption. A financial analyst with three to seven years’ experience commands anywhere from Rp10m ($1000) to Rp25m ($2500) per month. A call centre manager with five to 10 years’ experience can earn between Rp12.5m ($1250) and Rp25m ($2500) a month. A compensation and benefits specialist with three to six years’ experience can earn between Rp8m ($800) and Rp25m ($2500). Anecdotally, managers say that they are paying the most senior of their hires global or Singapore rates, and it can still be difficult to find the right people.

Various Demands

Indonesia has many different middle classes and they have a range of demands, different levels of resilience and respond to economic fluctuations in differently. Some people are just breaking $3000 a year and starting to contemplate the purchase of their first basic luxuries: the benchmark trinity of the refrigerator, television and motorcycle. This group has grown fast in recent years. According to Roy Morgan research, the number of households with all three key items went from 25% to 42% between 2006 and 2011. While this group will be an engine of growth because of its size, spending power will fluctuate with general economic conditions and people will remain careful with money.

At the same time, a considerable portion of the population will graduate into the globally recognised middle-class bracket, where they will shop much like people anywhere else. These people are earning high wages, have bright prospects and are far more cushioned from economic shocks. Their spending will fluctuate, but is far less likely to disappear. However, they are also well educated and well read. While they may be optimistic about their own futures, they also understand the dangers of the business cycle. A such, while they are more well off than those just entering the middle class, they too are quick to adjust spending during times of uncertainty.

Road Bumps

The year 2013 was one of volatility and uncertainty for the Indonesian consumer, and the myth of the monolithic middle class ended quickly. The rupiah fell some 21% in 2013, and the inflation rate rose, from about 5% to 8% during the course of 2013 and into 2014. The economy also began to sputter mid-year. GDP growth slowed to 5.62% in the third quarter of 2013, down from 6.17% a year earlier. Retail sales numbers responded accordingly, and a clear rough patch in the middle of 2013 was seen. Growth in retail sales slowed to 2% in August that year, with the sale of food, beverages and tobacco declining by 0.5%. Many consumers were living on slim margins between having disposable income and not, and many others were aware that despite high salaries, circumstances can quickly change.

The Shops

Retailers are finding this a growing but challenging market. They are facing not only rising wages, which may be improving sales somewhat and are also squeezing margins, but also increasing rents as a result of both the mall construction moratorium and the falling rupiah. The moratorium was first introduced in 2011 by Jakarta governor Fauzi Bowo and was extended in September 2013 by current governor Joko Widodo. Additionally, the status of the order was raised from gubernatorial instruction to gubernatorial decree. It is now closer to law than policy. Retailers say that is making retail space more scarce and causing rents to increase. They add that rents are generally denominated in dollars, meaning that the declining rupiah is proportionately increasing their rent in local currency terms, and that electricity prices are rising. Not all retailers see this development as a complete obstacle. “The impact of the proposed mall ban is yet to be fully determined.

Theoretically it would not be a negative thing for retailers to acclimatise and learn how to use their incumbent space which will likely improve future productivity,” Hitesh Bharwani, managing director of Kanmo Retail, told OBG. Still, the increased costs are leaving the retailers in a bind. They can increase prices and lose customers or keep their prices stable and see their margins shrink.

“On the retail side, everyone is bleeding,” Stifanus Sulistyo, a research analyst at Bahana Securities, told OBG. “People’s incomes are increasing, but it doesn’t translate to the bottom line. The top line is doing okay, but they got hit on costs.”

Sense Of Hope

However, the sector remains fairly optimistic. While the mall moratorium is certainly a challenge, new outlets are being built, and the governor has said that his office is fine if malls are built in east Jakarta rather than in central or south Jakarta, where mall concentration is high and traffic remains a problem. Recent financial statements suggest that retailers were doing well in the second half of 2013, with third-quarter results from eight companies showing revenue growth of between 9% and 27%, according to the January 2014 BI survey.

Singapore-based Lippo Malls Indonesia Retail Trust said its gross revenues increased to $30m in the third quarter of 2013, up 13.6% from the same period in 2012, attributing the increase to “contributions from six new malls acquired in the fourth quarter of 2012 and the positive rental reversions within the existing malls”. The situation is also bright in terms of new activity and the entry of international brand names. Indonesia has become somewhat of a favoured destination for global retailers. This has increased competition, and also helped to generate greater interest in shopping and style in general.

H&M, the Swedish clothing retailer, opened its first store in Jakarta in 2013. The flagship outlet was opened in Gandaria City, and the company plans to open two more locations, one in Pondok Indah Mall and the other in Grand Indonesia. However, most of the activity is from retailers from within the region. The Lotte Group opened a mall in South Jakarta in 2013. The mall is the South Korean firm’s first in South-east Asia, and it has plans to build an outlet in Bali as well. In 2013 Parkson, the Malaysian group with malls throughout the region, opened its first outlet in Jakarta at St Mortitz following its 2012 acquisition of Centro department store. Additionally, Thailand’s Central Group is planning to open a store in Jakarta in 2014, and Sinar Mas and Japan’s Aeon have signed a deal to develop 20 malls in Indonesia.

Resilient

To the same degree that Indonesian consumers can be quick to scale back and become tight with spending, they also seem to be prone to do the opposite. When the economy turns for the better, they quickly switch back on and become active once more. In early 2014, following the uncertain months in the previous year, Indonesian consumers demonstrated their resilience. As the gloom dissipated in the last quarter of 2013, the average Indonesian became optimistic again. In the Nielsen global survey of consumer confidence, Indonesians scored highest in the fourth quarter of 2013, at 124 while the global average was 94. The mood seemed to hold into the following year. The BI January 2014 consumer confidence index was 116.7, up from 116.5 in December 2013. This is up from the trough of 107.1 in September 2013, though down from the 120.1 recorded in November 2012.

Despite uncertainties and higher prices, Indonesians are heartened by the rise in wages and that inflation seems to be slightly tamer than expected. They also seem to feel as though the 2014 elections will be not be disruptive to the economy and incomes. Though income expectations are off recent highs in 2013, price expectations are down as well. Middle-class dynamics are still in early stages, but when the economy has some positive momentum, the new consumers will be quick to bounce back as well.

Regionalisation

A major trend that has not gone unnoticed is the move of retail sales toward areas outside Jakarta and its environs. The provinces have long been an afterthought to the major retailers, who saw them as interesting but not particularly compelling. However, consumers of these areas have proven to be quite active and have become increasingly so in recent years. While the capital appears to be caught in the doldrums, some secondary and tertiary cities are booming. Faced with an uncertain outlook in Jakarta, international and domestic retail firms are turning to the relatively untapped market of smaller cities and the capital's outskirts, according to Fernando Repi, spokesperson for department store operator Matahari Putra Prima. “Modern retail is still lacking in second-tier cities when in fact, people there have experienced economic and, therefore, income upgrades,” he told the local media in December 2013. In a December 2012 McKinsey Global Institute report, the consultancy echoed the sentiment, concluding that, “Many other cities are growing more rapidly, albeit from a lower base [than Jakarta...] These include Medan, Bandung and Surabaya as well as parts of Greater Jakarta.”

Role Reversal

According to BI statistics, retail sales growth in Jakarta was down in the last quarter of 2013, and saw only 4% growth in January 2014. Retail sales in secondary cities, meanwhile, have been growing rapidly. In Bandung, sales were up 40.6% in the first month of 2014, and during that month they were up 20.5% in Surabaya, 24.7% in Medan and 39.1% in Semarang. The trend appears to be long term. Surabaya’s retail sales index stood at 228 in January 2014, with the base having been set at 100 in 2000. In Jakarta, the index was 90.7. The provinces were more optimistic as well. Surabaya’s consumer confidence index stood at 137.1 in January 2014 against Jakarta’s 104.8.

Balancing Out

While the news has generally been good, concern is on the rise that consumption needs should be tempered in some ways. Given the country’s weakening balance of trade, imported luxuries are a target of the policy makers. To reduce the inflow of high-end imported goods, the government would like to increase the luxury tax on items like clothes, handbags and cars. The luxury tax ranges from 10% to 75%, with most electronic goods at the lower end. The move is in line with the country’s growing interest in developing more coordinated industrial and trade policies in order to aid the economy and help industry develop domestically. While domestic demand is good for the country, excessive imports are seen as a potential danger. Nevertheless, some believe this is stifling growth: “If luxury taxes were more relaxed, there would be a retail boom. The middle class continues to grow in Indonesia and we have a very strong domestic market because Indonesians love to spend. Indonesia could be a retail paradise if the right regulatory measures were put in place,” Irwan Danny Mussry, president and CEO of Time International, told OBG.

Industry analysts have indeed noticed a subtle shift in consumers’ tastes. While Indonesians are sometimes unaware of corporate origins of some products, they are increasingly becoming more nationalistic in their shopping habits, preferring to buy local when possible. A survey by Kanter Worldpanel found that nine of the 10 most popular brands in the country were domestic. Sedaap and Indomie, both instant noodles, were number one and two, respectively. Lifebuoy, a soap by Unilever, was number nine (and the only foreign brand in the top 10). Coca-Cola was not in the top 50. As a result, local manufacturers feel somewhat secure in this regard. “The 2015 ASEAN integration will not present an immediate challenge to the Indonesian food and beverage market because initially, it will be hard for foreign companies to tailor their products to suit local taste buds,” Warren Choo, director of ABC, told OBG.

Outlook

The outlook for retail in the mid to near term is clearly mixed. Waves of optimism will be balanced by periods in which economic reality holds back spending. The long-term trend, though, is positive. The economy will grow and more people will become active consumers. In the meantime the retail sector is going to have to work with what it has, catering to the very wealthy high end and providing other levels of shopping for the new middle class. Higher wages will at the same time create new demand and place pressures on the bottom line. Balancing these two will be an exercise in human resources management and the improvement of efficiencies.

The rise in nationalist sentiment in the face of economic difficulties could lead to more restrictions in the sector. These could reduce consumption, lead to a fall in foreign direct investment and reduced competition and innovation. The country is also working toward a coordinated industrial policy, and if it continues to pursue this sort of planning the retail sector could find itself under scrutiny. There have been several years of a relative free for all, with malls popping up in many areas, as well as international brands.

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The Report: Indonesia 2014

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