China - “bottomless reservoir” of gambling demand?

Integrated resort projects being planned for Japan and South Korea all cite the potential of the Chinese gamer as a justification for multi-billion dollar investments. But if you build them, will they really come? The question of the level of unmet demand in China warrants serious discussion.

Matthew J. Landry*

Discussions of the revenue potential for integrated resorts in Korea and Japan focus on domestic populations and the underserved northeastern China market. While most industry experts agree that unmet demand does exist in the region, some consider China to be a bottomless reservoir. This dangerous assumption is not likely to be adopted by financial markets, warranting an evaluation. Although not necessarily demand related, the recent decline in Macau's VIP revenue supports the need for a calculated approach.

Clearly there are several factors other than demand that will impact the ability of Korea and Japan to attract Chinese gamers. These include the offering made by the operator and host government, the number of new resorts and gaming positions, the ease and expenses associated with obtaining visas, the availability of affordable and convenient transportation, the ability to transfer currency, and any potential reaction by the Chinese government. Each of these factors, and a host of others, clearly warrant consideration for all stakeholders. This article, however, focuses on demand.

The following map shows indexed levels of visitation for regions within China to Macau. The population-adjusted index measures the level that each market is penetrated relative to the national average of 1.0. As expected, Guangdong's location adjacent to Macau is the most successfully targeted market in the Mainland. Visitation from this market is more than five times the national average. Beijing, Shanghai, and Fujian are the only other regions that are above-average. Each of these regions is between 1 and 2, a significant discount to the Guangdong's index of 5.6. In fact, many of the regions in the northeast exhibit lower levels of penetration than Beijing and Shanghai, as well as southeastern China. Overall this is indicative of an underserved market.

The following table shows the ratio of Macau visits to the population for selected regions. In addition, an adjusted row shows visits originating in Taiwan to Macau and Korea combined.  Residents of Taiwan generally require a flight of approximately two hours to reach Macau. In comparison, Shanghai is about a three-hour flight to and from Macau and Beijing is four.  Taiwan generates two to three times as many population-adjusted gamer visits as Beijing or Shanghai. While not demand related, it should be noted that Taiwan's more proximate distance only explains part of this eased access difference, as residents of Taiwan do not require a visa to enter Macau.
 

Region                             Visits/ Population
Beijing                                     0.017
Shanghai                                 0.022
Taiwan                                     0.043
Taiwan (inc. visits to Korea)    0.047

In comparison, Beijing and Shanghai are between two and three-hour flights to Seoul and Tokyo. While a subtle difference in comparison to Macau, many industry analysts believe that three hours represents something of an inflection point in a leisure tourists' willingness to travel for a short vacation. This dynamic supports the premise that residents of northeast China will visit integrated resorts in Korea and Tokyo.

Recent experience demonstrates that Chinese gamers may be willing to travel significant distances to diversify their experience beyond Macau. Chinese visitation to Las Vegas has roughly doubled since 2007, helping to offset a sluggish North American market over that timeframe. Since its two integrated resorts opened in 2010, Chinese visitation to Singapore has doubled as well. It is likely that many of these visits originate in Beijing and Shanghai, which are large and relatively wealthy populations with international airports. Tourists from these cities are among the most independent in the nation and along, with Tianjin, are significantly more likely to take advantage of the Independent Visa Scheme to reach Macau compared to other parts of the country.

These factors demonstrate that urban parts of northeastern China appear to be underserved from a gaming perspective. Additional and particularly more accessible supply should serve potential clients better than Macau, the main existing option, and drive growth in this underserved market. Using Taiwan as a metric, participation in casino gaming could grow two to three times with more accessible supply. This is consistent with observations made by marketing executives and industry analysts.

Beyond unmet demand is the disposable income and depth of the opportunity. China's economy tripled between 2000 and 2010, making it the second largest economy in the world.  Between 2010 and 2020 the Chinese economy is expected to continue to grow at an average annual rate of 7.9 percent. Rapid urbanization is part of this story, as individuals and families move to eastern China's cities and seek out higher incomes and improved living standards.  Some experts estimate that 100 million more urban households will be established between 2010 and 2020.

Against this backdrop, the Chinese government is encouraging consumption by improving social security and service-sector employment. Consumption is growing in several basic parts of the economy, including improved basic living standards as well as increased discretionary purchases. Chinese citizens are among the top consumers of luxury goods. Many Chinese tourists specifically spend lavishly when they are abroad, purchasing luxury goods to avoid import tariffs and noting that the savings offset travel expenses in some cases.

Not only is the number of urban households growing, but they are also becoming more wealthy. Gross regional product ("GRP") per capita is significantly higher in China's cities when compared to other regions. Beijing, Tianjin, and Shanghai all enjoy GRP per capita over 85,000 yuan ($13,844), putting them in the top category. The combined GRP of these three cities is about 90 percent of Guangdong's, which has a GRP per capita of just over 54,000 yuan, putting it among a middle-tier of provinces along the east coast. The lower tier lies inland and to the west with GRP per capita of 20,000 to 40,000 yuan. While some cost of living elements may be higher in the cities and provinces along the eastern seaboard, there does appear to be greater disposable incomes.

According to McKinsey and Company, in 2010, 8 percent of all households earned over USD$16,000 annually. The vast majority of gaming in Macau appears to come from this population segment, which is expected to grow to 57 percent of all households in 2020. This level of wealth is the estimated threshold for the middle class, where a regional leisure trip is not out of reach. While this may sound low when compared to other countries, it is important to note that the cost of living in China is significantly lower than other countries. Statistics indicate that, for upper income families, approximately 60 percent of income is available for discretionary purchases.

Between now and 2020, the earliest that an integrated resort could reasonably open in Korea or Japan, the Chinese economy is expected to continue its meteoric rise. This dynamic is expected to lead to substantial growth along the already wealthier east coast, where the number of wealthy urban households is expected to increase four-fold between 2014 and 2020. This growth in wealth combined with the potential two to three-fold increase due to unmet demand, implies that the market potential for northeast China could be approximately ten times its current levels in 2020. Visitation levels imply northeast China was more than a $4.5 billion gaming market for Macau in 2013, and easily could have generated more than $6 billion between mass market and VIP play. This implies vast revenue potential from this region.  

This demand could support development in both Korea and Japan, provided the proper market structure were adopted. Primary considerations include the need to develop reliable parameters for domestic play; reasonable tax and regulatory structures, inclusive of junket operation; and the eased flow of tourists and capital. If both Korea and Japan meet these market-based needs, the game of picking real winners can begin.

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Matthew Landry is the Managing Partner of Strategic Market Advisors, a boutique consultancy supporting clients in the leisure and tourism space, and an AGB Advisor.