CONSUMER spending looks healthy, according to government data, but what the figures don't show is the changing face of shoppers, who are becoming much pickier as their household budgets get pinched by inflation.

The problem for retailers is to adapt their business models to cope with a new breed of buyers interested not only in value for money but also in purchasing goods of distinction.

"Consumers today are more and more difficult to please," Li Guoding, general manager and director at Shanghai Bailian Group Co, the listed arm of the Bailian Group, said at the World Department Store Forum held recently in Shanghai. "They are concerned about uniqueness," he said. "The profit margins for department stores are sinking."

For retailers, it's a matter of spending the least money to attract the most consumers to their stores and entice them to spend. The more shoppers get selective, the more retailers have to adapt to changing times.

The government is making efforts to boost consumption by raising salaries and offering subsidies on the purchase of household electrical appliances. The Chinese Academy of Social Sciences is predicting "consumption will gradually rise to be the key driver of the economy, with government support."

So how can department stores in China best position themselves to cash in on that idea?

One method is to veer away from the traditional practice of leasing concession space to brand vendors and concentrating instead on purchasing and selling their own stock with in-house sales staff.

The department stores sector in China is broken into regional fiefdoms without any big national chains. Within regions, competition for consumers is fierce.

Shanghai Bailian Group, China's largest retailer, met some stiff resistance when it tried to expand into neighboring Zhejiang Province, where retailer Intime Department Store holds sway. Intime has 23 stores in the province, while Bailian has two, according to a report by Shenyin Wanguo Securities.

And when Intime attempted to expand its reach by buying a major stake in the Wuhan Department Store Group Co based in Hubei Province, it met stiff objections from major shareholders of the Wuhan group, who filed a lawsuit charging Intime with violating investment regulations.

"Department stores across the country are almost the same," said the Bailian Group's Li. "It's time for a change if we want to have a national chain department store to take advantage of economies of scale."

Zheng Wanhe, chairman of Beijing-based Wangfujing Department Store Group Co, agreed with Li's assessment of the market and endorsed the idea of department stores jettisoning the concession leasing model and replacing it with in-house selling.

"The concession model was first developed in the early 1990s when demand was larger than supply," Zheng said. "For department stores that lacked in money, the model saved them a lot of initial investment."

As in Japan, South Korea and most Asian countries, 80 percent of department store business in China relies on concession leases that require brand sellers to rent space and shelves, provide their own sales staff and pay commissions based on products sold. In essence, the department store is just a landlord.

Concession lease

"This business model reduces the risk of department stores but it also reduces the profitability because large department stores cannot negotiate on price," Zheng said. "The larger the brand, the less the store can get from the deal."

Under that business model, department store profit margin was about 20 percent in large cities and as low as 10 percent in smaller cities because multi-level merchandisers ate up the profits, according to Zheng.

Eliminating that system means that department stores will have to pay for products and run the risk of poor sales, but they would also be able to select goods on their own and set prices. For many store managers, the benefits are attractive.

"We are the people who know our consumers best," Zheng said. "We can select products that are most likely to please consumers, and at prices we can control. Most importantly, we can offer what other department stores do not have."

Of course, the talk at the forum was nothing new. Discussions about transforming the business model of department stories has been around for at least five years. Moves to change it have been slow and difficult.

"Fifteen years ago I started to encourage the purchase of our own products and the running of our own brands in the department store," said Li with the Bailian Group. "We are still making efforts on this direction but the progress has been slow."

Li said only 5 percent of Bailian's retailing revenue comes from its own products, such as leather handbags and clothing bought directly from producers in European countries.

"Every price increase is sensitive these days, so that we have to reduce operational costs to ensure competitive prices for consumers," Li said. "Gross profit for the department store will rise to 45 percent if 30 percent of goods are brought directly under their control."

He said his push for change focuses on four factors: acquiring rights as general agent or exclusive distributor of foreign brands; organizing buyers to purchase directly from abroad; cooperating with original equipment manufacturers; and developing in-house lines through design, development and production.

The major barriers, according to Li, are in building logistics systems for distribution, in managerial reluctance to take risks, and in lack of professional buyers who can scout markets around the world for the trendiest products at the best prices.

"We need people who are good in both finance and fashion because they need to deal with issues of exchange rates and quality of goods," said Li, "And more importantly, we need store managers who are willing to display our own products on prime shelves in the store."

One size won't fit all in this retail transformation, the forum agreed.

"We tend to choose the products that aren't sensitive to seasonal changes, and we will leave the sectors such as women's clothes to other dealers because fashions change so quickly," said Li.

Chen Yougang, a partner with KcKinsey & Co, said property prices may also affect a store's business model. "Stores located in prime locations can do perfectly well with the concession model because the land itself is such a good source of income," Chen said.

In-house purchasing

He said 80 percent of the business in department stores in the United States involves in-house purchasing because most of the stores are located outside prime downtown areas where land prices are lower.

"There is no judgment on which business model is essentially better," Chen said. "But since department stores are expanding to less expensive areas in China, maybe those more outlying stores will feel more urgency in developing their own businesses."

In Europe, the trend is running the other way. The proportion of concession selling in retailing has grown the past 20 years, according to Paolo De Cesare, president and CEO of Printemps Department Store of Paris.

"Department stores in Europe were themselves both producers and retailers when they emerged some 145 years ago," said De Cesare. "It is only in the past 20 years that we began to realize that some brands, especially the luxury ones, are even better at selling their own products than we are."

The proportion of the two models now is around 50-50, De Cesare said. But relations between both are symbiotic. For example, all brands sold under concession contribute their latest trends to the seasonal promotional brochure put out by the department store.

"Consumers don't care what business model they are experiencing," said De Cesare, "The best thing we can do is to make sure they can find beautiful things to buy in the most convenient way."