ANALYSIS-China retailers in price war with foreign rivals

* Foreign shops, restaurants in China change tactics

* Foreign discounting puts pressure on Chinese retailers

* Special offers aim to tempt cash-strapped consumers

By Michael Wei

BEIJING, Feb 27 (Reuters) - Foreign-owned retailers and restaurant chains in China are resorting to steep discounting to encourage consumers to part with their cash as the economy slows, a move that is likely to put further pressure on local rivals.

When they entered the Chinese market -- many of them in the 1990s -- Western consumer brands sought to set themselves apart from their local competitors by charging more and presenting the mark-up as the price to be paid for better quality and service.

But now under pressure in their home markets and in a bid to shore up sales, foreign retailers are jumping into a price war in China to secure their share of the growth of the world's third-largest economy.

McDonald's this month cut about 40 percent of its prices to produce what the hamburger chain calls "the best ever value meal combination" in China. Half of its menu items now sell for the same price, or less, than they did 10 years ago.

"As demand slows, foreign companies are doing whatever is needed to maintain critical mass and get economies of scale working," said Wang Haitao, an analyst with Shenyin Wanguo Securities in Shanghai.

For foreign consumer brands, especially supermarkets, the emphasis has now switched to top-line sales from bottom-line profits. "Some foreign companies...can even bear a zero profit margin to keep market share and retain customers," Wang said.

Faced with aggressive discounting by their foreign competitors, Chinese retailers such as Beijing-based Wumart have been forced to follow suit -- dealing a blow to share prices.

Falling raw material costs are partly cushioning the impact of the discounts, but Chinese retailers still suffer from a compression of margins because they generally operate on a smaller scale than their Western competitors.

They also trail when it comes to experience in logistics and access to funding.

As a result, foreign retailers enjoy a profit margin of about 3.6 percent compared with about 1.2 percent for their local rivals, giving them more room to discount, said Huang Guoxiong, a professor at China Renmin University in Beijing.

"When they start to reduce prices, it will be a challenge for domestic companies because their market share is bound to be affected," Huang said.

BEST PRICE

But foreign firms see opportunities in cutting prices.

"It is seizing the moment. It's the right time -- the consumer is very cost conscious," says Jeff Schwartz, McDonald's chief executive in China.

People tend to spend less on discretionary goods during economic downturns. More than a quarter of urban Chinese are expected to cut back on things such as travel, clothes and eating out, according to a Macquarie survey of 500 consumers in five major cities last December.

But a deteriorating business environment is now prompting even sellers of staple goods to follow suit.

During the week-long Chinese New Year holiday, the U.S. supermarket chain Wal-Mart Stores offered dozens of products, mostly food and everyday items, for a cut-price 8.8 yuan ($1.30) each. The discount was as high as 30 percent.

Wal-Mart said it would stage similar sales later in the year.

Another big supermarket chain, France's Carrefour SA, stepped up its special offers across China last November.

"When you start to be in crisis, people look at price. You should have the best price," said Patrick Ganaye, the firm's vice president in China.

A Carrefour store in western Beijing was festooned this week with yellow banners proclaiming the bargains. Durians, a Southeast Asian fruit popular in China, were on sale at 10.8 yuan ($1.6) a half kilo, down from 17.8 yuan. Shrimps cost 19.8 yuan a half kilo, down from 35.8 yuan.

"There used to be some promotions at the weekend, but this year special offers are becoming more and more common in supermarkets," said a middle-aged woman shopper.

TO CUT OR NOT TO CUT?

Chinese consumer firms say they see no choice but to go down the same track as foreign rivals in order not to lose customers.

A day after McDonald's launched its campaign, Yonghe King, a fast food chain known for its soybean milk, cut prices on some items by as much as 22 percent in over 100 outlets nationwide.

Wumart has put a range of products on special offer for only 10 yuan ($1.5) each, representing a discount of as much as 50 percent.

The cut-throat climate and poor economic outlook have taken a toll on the shares of Chinese retailers. Wumart's stock has fallen 36 percent from a peak of HK$8.50 last September.

China Resources Enterprise, a consumer-focused conglomerate, has slumped over 60 percent from its 52-week peak.

The government says it supports sales promotions that are based on supply and demand.

"However, overdoing it will have a negative impact," Commerce Minister Chen Deming said recently when asked about foreign companies' discounting. ($=6.84 yuan) (Additional reporting by Vivi Lin; Editing by Alan Wheatley and Dhara Ranasinghe)