In China, a momentary pause for tech purchases

April 15, 2014: 8:00 AM ET

As subsidies end, the market for consumer electronics in China is slipping. But it won't stay back for long.

By Peter Suciu

A customer looks at a a display of Canon camera accessories and binoculars at the company's showroom in Hong Kong, China in January 2014.

A customer looks at a a display of Canon camera accessories and binoculars at the company's showroom in Hong Kong, China in January 2014.

FORTUNE -- For the first time ever, sales of consumer electronics last year in Asia, led by China, exceeded sales in North America. To industry observers and demographers alike, the rapid growth of the Chinese market for consumer electronics comes as no surprise: There are now more than 160 cities in China with a population of more than 1 million people. In the United States, there are just nine.

This year, China's gross domestic product is also expected to rise, to 7.4%, and it is rising faster than that of the United States. Despite this growth, the sale of worldwide consumer electronics in Asia is predicted to drop 1% this year, according to the Consumer Electronics Association.

The dip isn't out of line with the global outlook for the year: Worldwide tech sales are expected to fall to $1.055 trillion this year, down from $1.068 trillion last year. (Why? For one thing, the tremendous undertow that is price pressure: The prices for technology-related products tend to fall faster than demand rises.) Still, for a rapidly growing market, it is not unreasonable to expect China to buck the global trend.

Amid uncertain global economic trends, the Chinese economy slowed down. That led to a series of falling dominoes: first, a decline in consumer confidence, then, a drop in sales of products that are not considered to be daily necessities. Add the May 2013 cessation of government subsidies for consumer electronic products in China -- for several years, the country's consumer electronics market relied on them to help stimulate demand in rural and lower-class areas -- and the country's demand for consumer electronics began to flag.

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"We had seen stories where people in China were buying electronics because the subsidies were in place," said Shawn DuBravac, chief economist for the CEA. "People buy products when they have the means, and the subsidies were a big part of this. The products that the Chinese were buying included large-screen TVs -- it was like in the United States after World War II, when having a radio and later a TV was a sign of a rising middle class. This is true of all countries around the world, whether it is in Africa, southeast Asia, or China."

Though the subsidies from Beijing have ended, it won't mean an end to China's growing middle class, DuBravac said. "Subsidies have played a role," he told Fortune, "but they are not the defining role."

Officials ended the subsidies because they believe they are no longer needed to drive growth. Disposable income levels in China have increased, they argue, and the replacement cycle for some products will shorten as consumers increasingly opt to upgrade their aging electronics.

Until now, China's urban markets have driven the country's growth in consumer electronics sales. But researchers say that the relatively small consumer base in the countryside is poised for growth as the income gap between urban and rural Chinese narrows.

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"China's consumer market is young and educated, and Chinese consumers are keen on staying on top of the latest trends," said Josh Crandall, an analyst at NetPop Research. "To do this, they are constantly checking Weibo feeds, Renren updates, as well as tuning into news and information on television. They need their devices to stay in the game. Lowering governmental subsidies is a reflection of the market's current strength. While there may be short-term revenue shortfalls, the long view is strong for consumer electronics companies that serve the world's largest market."

Another reason for the consumer electronics slowdown: increased demand for smartphones, which Chinese consumers are now using to take photos, record video clips, and listen to music, threatening sales of dedicated imaging devices and portable media players. IHS Technology forecasts that shipments of digital still cameras in China by 2017 will have lost 75% of their volume compared to 2009, while personal media players during the same period will be down a debilitating 92%, mirroring trends seen in other areas of the world.

"Globally the smartphone market is about 1.1 billion people," DuBravac said. "Of that, 400 million is just China. The growth now is coming from domestic manufacturers, which is notable in a market that is worldwide dominated by Apple and Samsung. This is also true with most CE products, where more than 50% of sales are from Chinese makers. It is not a super-majority, but domestic sales are still very, very strong."

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Consumer electronics sales in China could rebound as early as 2015, even if unit shipments continue to decline slightly. In the meantime, Chinese consumer electronics manufacturers may look to new markets outside of their home country for growth.

"China's makers will continue to develop new markets due to lower or negative growth ratio in domestic, North American and European markets," said Horse Liu, an analyst at IHS Technology.

Further, manufacturers are expected to turn their focus away from shipments now that the growth-stoking subsidies have disappeared. Already, they are putting more energy into high-end products with larger margins to push sales revenue.

"China's leading CE makers will pay more attention to profit margin," Horse said.

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