GOME Electrical Appliances Holding Ltd.

BEGINNINGS OF A RAGS-TO-RICHES SUCCESS STORY

CONSOLIDATING ITS POSITION IN MAINLAND CHINA

BEGINNINGS OF A RAGS-TO-RICHES SUCCESS STORY

The story of GOME’s Success began in a poor farming village in the Guangon province of southern China, where GOME founder Huang Guangyu traded in used books and sold discarded plastic bottles in order to contribute to the family income. Huang, then 16 years old, and his older brother, Huang Jungin, left Shantou in 1986 with the ambition to enter the retail trade on a different scale. In their first venture together, the two brothers purchased $500 in radio equipment and watches at the low prices available in Shantou, then sold them in the northern provinces of Inner Mongolia, where such products garnered a higher price. They relocated to Beijing and reinvested sales income to purchase clothing for resale. They returned to the electronics trade on January 1, 1987, with the opening of an electrical appliances outlet in a rundown market stall on Zhushikou Street. Among China’s first private entrepreneurs, they profited by selling small, household appliances at prices lower than the competition and by offering customer service before and after the sale. Simply, the store succeeded through the combined ideas of “small profits, good sales, service comes first.” Furthermore, the business thrived as China’s “open-door” reform began to transform the country into a consumer-driven economy.

The company, operating as China Eagle Group, achieved success through real estate investment, as well.

In 1992 the company completed the Eagle Towers and Eagle Plaza development in Beijing. Eagle Towers, a commercial center with 7,000 square feet of retail space, was the largest such development in China, even a decade later. About this time, the individual business preferences of the Huang brothers emerged. Huang Jungin preferred the real estate business, while Huang Guangyu preferred retail. In 1992, they separated the two businesses according to assets, with Huang Guangyu obtaining complete control of the retail appliance business, and his brother taking the real estate business. Huang Guangyu retained the China Eagle Group name, but he operated the retail company as GOME Household Electrical Appliances Company.

EXPANDING WITH THE CHINESE ECONOMY

Though Huang did not finish middle school, he proved to be a sharp-minded entrepreneurial leader for the retail company and for China. The company opened several appliance stores throughout Beijing, and Huang became a primary mover in the development of Chinese retail chains by applying the GOME name to all stores in the network. Also, the company continued its business philosophy of low prices. Huang eliminated the markup cost of wholesale prices by dealing directly with manufacturers, and multiple store outlets allowed the company to obtain a high-volume inventory purchased at special rates. In turn, GOME offered appliances to Chinese consumers at a lower retail price than the competition. The lower prices often led to price wars, especially after GOME opened stores outside Beijing in 1999, the first in nearby Tianjin. Operating on high volume and low prices generated comparisons between Huang and Wal-Mart founder Sam Walton. The success of GOME prompted a management seminar attended by government officials and respected academics to deliberate business development strategies based on the GOME model.

Huang expanded the network of retail appliance stores, with new outlets in Shenzhen, Shanghai, Changzhou, and other major cities. GOME opened 32 stores in seven cities in 2001 and 47 stores in 11 cities the following year. The company began locating new stores in secondary cities, such as Guangzhou, where the company opened 11 stores in 2002.

GOME grew with China’s economy, both following and leading according to profit margins and consumer demands. In July 2001, as the market for mobile telephones exploded in China, GOME began to offer complete customer service, from phone purchase to calling plans and payment processing, in 20 cities. The company sold more than one million handsets in 2002 alone and another 900,000 phones during the first six months of 2003. As competition in refrigerators and other large home appliances decreased profit margins for those products, GOME expanded its small home appliance department, taking advantage of higher profit margins generated from market entry of those products. Moreover, GOME pressed the competition by purchasing a large inventory of specific appliances, such as televisions and mobile phones, thus instigating price wars in order to benefit the consumer and attract customers to its stores. When oxygen enrichment air-conditioners became the newest must-have appliance in China, GOME participated in market expansion for the product in China. GOME placed large orders of the appliance from Haier Group, which gave GOME initial selling rights, a sales lead ahead of other retailers.

COMPANY PERSPECTIVES

GOME’s mission is to best serve our customers. We are committed to providing our customers with competitive prices, wide product selection, convenient locations and professional customer service. We firmly believe that a good shopping experience is essential to building customer goodwill and loyalty. In order to maintain our market leadership and competitive strengths, GOME is seeking to expand our retail network, leverage the economies of scale, enhance our purchasing power, and improve our enterprise infrastructure.

In order to accommodate the widening array of available consumer products, as well as the growing demand for specific products, GOME initiated two new store concepts. One involved the development of specialty stores selling digital products exclusively. GOME began selling computers in late 2001, and in early 2003 the company opened its first computer specialty store in Zhongguancun Village in Beijing. GOME offered computers, hardware, software, printers, scanners, digital cameras, cellular telephones, compact discs, CD players, and other accessories. GOME planned additional stores for Shanghai, Guangzhou, Shenzhen, Xi’an, and Shenyung. The other store concept involved the development of larger retail centers. In December 2003, GOME opened its flagship superstore in Beijing Capital Stadium Shopping Center Supermarket. The largest appliance store in the chain, with 10,000 square meters, the superstore carried 120,000 kinds of electrical appliances available from over 600 brands. GOME opened a superstore in Dongguan, in Guangdong Province, in 2003, as well. At the superstores, GOME highlighted digital products and other high-end goods that provided higher profit margins. Overall, GOME opened a total of 79 stores in 19 cities in 2003, bringing the company’s total to 103 stores. That year, GOME became the largest retailer of household electronic appliances in China.

DOING BUSINESS IN HONG KONG

As the company expanded, Huang turned his attention to Hong Kong. Huang wanted to establish a retail presence in Hong Kong in order to gain a foothold for international expansion and to attract foreign investment. Both of the motives entailed becoming a publicly owned company through entry to the Hong Kong stock exchange. In order to expedite this process, and avoid China’s nine-month listing process, the company obtained a “backdoor” listing through the acquisition of Capital Automation Holdings, Ltd., and two other companies in 2002 by China Eagle Investment Group, another Huang entity. Huang planned to follow this listing with an initial public offering (IPO) of stock, but an unsatisfactory investor market stalled that process. In the meantime, GOME opened its first retail outlet in Mong Kok in November 2003. The store sold digital information technology and audiovisual products. An additional three home appliance stores opened in May 2004.

In February 2004 GOME announced a new plan for an initial public offering of stock on the Hong Kong exchange, but the IPO had to be postponed again, due to lack of confidence in the Hong Kong stock market during a crisis. By July GOME solidified its plans for the IPO. Because foreign investors cannot own more than 65 percent of a retail business in China, Huang divided GOME into two companies. China Eagle held a 65 percent stake in the retail chain, and Huang’s “parent group” retained private ownership of 35 percent of GOME stores. The publicly listed company carried the more profitable mature assets which would likely attract investment; Huang owned the stores with lower overall financial performance. Finally, in September 2004, China Eagle placed 300 million shares on the market at HKD3.98 per share ($.50 per share); the company offered 240 million shares to institutional investors. Of the 50 investors, about half were from Asia, 35 percent from Europe, and 15 percent from the United States. GOME raised HKD 1.2 billion ($600 million), which it applied to reduce debt, continue expansion, and upgrade the company’s computer information system. Upon completion of the offering, China Eagle took the name GOME Electrical Appliances Holding, Ltd.

The corporate structure after the stock offering assessed a 25.1 percent public ownership of GOME Holding, which owned 116 retail stores. Huang retained 35 percent of GOME Electrical through his 74.9 percent ownership in the holding company. Plus, he owned 100 percent of Beijing GOME, the low performing group of 56 stores. Through a subsequent sale of stock and convertible notes, Huang’s ownership decreased to 66 percent. GOME Holding planned to consolidate ownership of the retail chain at a later date.

CONSOLIDATING ITS POSITION IN MAINLAND CHINA

By the end of 2004, GOME had become the largest retailer of home appliances in China, and the company sought to maintain that position, through geographic expansion and acquisition. GOME made its first-ever acquisition in August 2005, with the purchase of Shenzhen e-Home, a chain of ten appliance retail stores in Shenzhen and Guangzhou. Shenzhen e-Home operated at a loss, and GOME executives believed that it would take three to six months to create profitability by merging the stores into the GOME sourcing and pricing strategy. The locations of the stores complemented GOME’s existing sites.

KEY DATES

1987:: Huang brothers begin selling small appliances in market stall in Beijing.
1993:: GOME brand name is applied to network of appliance stores.
1999:: GOME opens first store outside Beijing and begins national expansion.
2002:: China Eagle Investments acquires another company to obtain a “backdoor” listing on the Hong Kong stock exchange for GOME.
2004:: China Eagle Investments is renamed GOME Electrical Appliances Holding Ltd.; GOME becomes the largest appliance retailer in China.
2006:: New strategic directions involve raising profit margins and entering new retail sectors.

Geographic expansion involved an investment of CNY 250 million to open 130 retail outlets, nearly doubling the chain network of the listed company which had reached 144 stores at the end of 2004. While most new stores were to be located in China’s largest cities, including Beijing, Tianjin, and Shenzhen, other outlets expanded GOME’s reach to the coastal area cities with populations of approximately 500,000. The company opened 115 stores during 2005, expanding the company’s reach to a total of 69 cities. About half of the shops opened in the second-tier cities. These markets required more time to develop due to less wealth and, therefore, lower consumer purchasing power. Hence, the company’s profit margin suffered on a sales-per-square-inch basis. While revenues increased 42 percent in 2005, to CNY 17.96 billion, ($2.2 billion), net profit increased only 2.7 percent, to CNY 498.59 million. GOME viewed the gain in market share as essential for the immediate intention of expansion, expecting the profit to increase over the long term. GOME’s retail sector carried 6 to 7 percent of the mainland market, but the company aimed to achieve 15 percent market share by 2009. Moreover, the separate “parent group” owned by Huang had opened 120 stores in 2005 and operated a total of 176 stores in 61 cities.

In early 2006, GOME completed the consolidation of the 65 percent stake listed on the Hong Kong stock exchange with the parent group owned by Huang. GOME Electrical acquired GOME Appliance Company from Huang, allowing the Hong Kong listed company to control all assets. In conjunction with the consolidation, GOME issued 650 million new shares at HKD 8.05 in order to help pay for the acquisition of Huang’s shares. Huang’s shares were acquired in a stock exchange, with GOME issuing new shares to Huang. Thus, Huang’s share of the holding company increased, from 66.04 percent, to 75.67 percent.

GOME further consolidated its position in the appliance retail market through the August 2006 acquisition of China Paradise Electronics Retail, the third largest electronics retailer in mainland China, with 205 stores. GOME acquired 98.24 percent of the stock for $680 million. With the acquisition GOME intended to buttress profit margins as well as to reinforce its competitive position. GOME expected the acquisition to reduce operating expenses through streamlined supply chain management, thus continuing the company strategy of high-volume sales based on low prices. China’s entry into the World Trade Organization increased the presence of foreign companies, such as Best Buy, Wal-Mart, and Carrefour, into Chinese markets. Hence, the acquisition would strengthen GOME’s competitive advantage in China. GOME integrated most of the China Paradise stores under the GOME brand, but maintained the China Paradise brand in the Yangtze River Delta to capitalize on strong public recognition in that region. In addition to strengthening market share in retail appliances, the acquisition pushed GOME to second place among all retail chains in China.

During 2006, GOME changed its growth strategy. Rather than continuing rapid new-store development, the company planned to open only 30 stores between 2007 and 2010. Instead, GOME concentrated on improving profit margins. One aspect of this strategy involved developing special merchandising displays that gave prominence to higher margin goods in retail stores. The company had tried this strategy successfully for telecommunications products, then expanded it to home appliances during 2006. Similarly, in late 2006, the company initiated a retail cobranding agreement with Motorola, the best-selling handset brand at GOME. Under the agreement, Motorola’s presence would increase both quantitatively and qualitatively. Motorola’s sales space increased with the store-within-a-store concept and a shop design that highlighted the company’s brand identity. Also, Motorola would improve service with direct, in-store support through training GOME retail associates. Motorola shops were established at 30 of GOME’s largest retail outlets around China. To launch Motorola’s new image, GOME and Motorola offered special prices on the popular A780 handset during “Moto Month.”

GOME initiated a number of other strategies to increase profit margins, such as eliminating weekend discounts and seeking preferential access to new products which tended to carry high margins. In 2006 the company launched digital TVs through exclusive contracts from three major Chinese companies, Hisense Electric Company, Konka Group, and Sichuan Chang-hong Electric. Conversely, GOME reduced its reliance on domestic brand appliances when suppliers sought to reduce prices, opting for imported brands with higher profit margins. Also, GOME attempted to improve profit margins by establishing high-end shops under the name Eagle Electric Appliance. These stores offered specialized services and a more appealing shopping atmosphere. GOME opened one store each in the central business districts of Shenyang and Beijing. The concept failed, due to insufficient resources, so GOME turned those stores into regular appliance stores.

As the retail appliance market matured, high profit margins in other business sectors prompted GOME to pursue new opportunities. In the summer of 2006, Huang began negotiations for entry into the retail pharmaceutical and cosmetic industries through a partnership with Walgreens. Huang established a new entity, GOME Pharmaceutical Company, Ltd., and he planned to open ten stores in late 2006. Also, in early 2007, GOME began construction on the Eagle International Fashion Exchange Center, in Guangzhou, a high-end clothing exhibition center. With 600,000 square meters, 328,000 were designated for retail space, 30,000 for office space, 50,000 for hotels, and 12,000 square meters for exhibition space.

Mary Tradii

PRINCIPAL SUBSIDIARIES

China Paradise Electronics; GOME Pharmaceutical Company, Ltd.

PRINCIPAL COMPETITORS

Best Buy Company, Inc.; Shandong Sanlian Group; Shanghai Yolo Household Electrical Appliance Company, Ltd.; Shanghai Yongle Electronics; Suning Appliance Chains Group Company, Ltd.; Wal-Mart Stores, Inc.

GOME Electrical Appliances Holding Ltd.

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GOME Electrical Appliances Holding Ltd.

BEGINNINGS OF A RAGS-TO-RICHES SUCCESS STORY

EXPANDING WITH THE CHINESE ECONOMY

DOING BUSINESS IN HONG KONG

CONSOLIDATING ITS POSITION IN MAINLAND CHINA

PRINCIPAL SUBSIDIARIES

PRINCIPAL COMPETITORS

BEGINNINGS OF A RAGS-TO-RICHES SUCCESS STORY

The company, operating as China Eagle Group, achieved success through real estate investment, as well.

EXPANDING WITH THE CHINESE ECONOMY

COMPANY PERSPECTIVES

DOING BUSINESS IN HONG KONG

CONSOLIDATING ITS POSITION IN MAINLAND CHINA

KEY DATES

1987:: Huang brothers begin selling small appliances in market stall in Beijing.
1993:: GOME brand name is applied to network of appliance stores.
1999:: GOME opens first store outside Beijing and begins national expansion.
2002:: China Eagle Investments acquires another company to obtain a “backdoor” listing on the Hong Kong stock exchange for GOME.
2004:: China Eagle Investments is renamed GOME Electrical Appliances Holding Ltd.; GOME becomes the largest appliance retailer in China.
2006:: New strategic directions involve raising profit margins and entering new retail sectors.