Resetting China’s Luxury Compass

Growth opportunities in the face of China's slowdown was one of the topics discussed at BoF’s recent VOICES event in Hong Kong. Stay tuned for more from VOICES, a series of invitation-only events on the fashion industry’s most burning issues, leading up to a special global gathering to take place in London in December 2016.

HONG KONG, China — Alarm bells have been ringing for quite some time. That an overreliance on China might one day prove problematic was clear the moment that the country became the world's largest luxury market. But few could have predicted the series of events that now has the luxury industry plotting a new course toward China, while searching for safer passage through the choppy waters of this heaving market.

The storm hit in 2014 when luxury spending contracted for the very first time in mainland China. As the economy began to slow, brands like Louis Vuitton quietly shuttered stores and analysts predicted that Prada, Burberry and other brands faced jeopardy in Hong Kong as mainland shopper numbers dwindled. Exacerbated by China's 'Black Monday' stock market crash — an event last summer that wiped trillions of dollars off global financial markets — these already worrying signs were soon followed by a slump in luxury stocks. Investors got spooked and the collective mood took a turn for the worse.

In August, the Savigny Luxury Index, an index compiling the stock price of major luxury groups including LVMH, Kering, Richemont and Hermès, recorded its worst monthly drop since the global banking crisis in 2008. More trouble was yet to come. Volatility shook the industry hard this month when the Chinese government twice froze the Shanghai stock market in order to prevent panic selling of stocks that were in free-fall. Now, it has come to light that 2015 was the year that China's economy grew at its slowest rate in 25 years.

While the anxiety caused by these events remains as strong as ever, most experts agree that China’s luxury market still has both short and long-term potential. China certainly hasn't gone from vogue to rogue, but no one is certain how much more stress the market can take. With so much instability in the air, just how concerned should the luxury industry be about China’s ‘new normal’ and how can they point the compass toward growth during an economic slowdown?

https://www.youtube.com/watch?v=xo_6rCmGwfA

BoF and fashion industry leaders explore the future of the Chinese market at BoF VOICES x Hong Kong event in December 2015.

Pivot toward womenswear and ready-to-wear

“I think it’s a question of expectations,” says Claudia D’Arpizio, a partner at Bain & Company, the consultancy that identified the one percent contraction in China’s luxury market.

“Overall, spending is expected to grow in double digits in real terms [on the mainland in 2015] but I think even the luxury brands themselves are struggling to understand this complex picture with currency fluctuations and everything else that’s changing around the global luxury shopping map.”

Despite the economic slowdown and other destabilising forces, D’Arpizio believes the fundamentals of the mainland China market remain “very strong for the medium term,” demonstrating “a new plateau of consumption” where people are buying for themselves, rather than the gifting culture prevalent before the government’s anti-graft campaign. “This is why the women’s categories are over-performing men’s now and why ready-to-wear is picking up over accessories too,” she reveals.

In 2015, the consultancy estimated that luxury goods spending in mainland China grew from €15.3 billion to €17.9 billion (about $16.5 billion to $19.3 billion) in real terms but shrank by 2 percent at constant exchange rates, which indicates a “stagnating, slightly declining trend.”

In August, the Chinese government devalued its currency, the renminbi [RMB], against the dollar and did so again earlier this month.  However, many Chinese now purchase luxury goods in Europe and Asia, where lower taxes make prices significantly cheaper than those in China – even when foreign exchange rates are not particularly favourable.

“While there’s very bad performance in Hong Kong and Macau, there are nice tourist flows to Taiwan from the mainland. These are now more high-end and sophisticated [shoppers] than those who have recently travelled to Hong Kong and Macau. But Japan is the most important destination for Chinese shopping right now,” D’Arpizio explains.

In 2014, mainland Chinese shoppers accounted for around 28 percent of the world’s total luxury goods consumption, but only 7 percent of global consumption was purchased in China. In 2015, mainlanders represented an even bigger share of the global pie, at 31 percent, but the proportion purchased in China remained unchanged. It is now estimated that around 80 percent of the total luxury spend by Chinese is made overseas.

Magnetic pull of Tokyo, Seoul and Taipei

"It's about a fresher 'T.S.T'," says Sham Kar Wai, founder of the multi-brand retail chain I.T, which is known for bringing edgy streetwear and designer brands like Comme des Garçons to cities around China and Asia.

“Instead of shopping in Tsim Sha Tsui [a neighbourhood in Hong Kong famous for its luxury boutiques along Canton Road], now they’re in the ‘T.S.T.’ of Tokyo, Seoul and Taipei,” he quips.

Alice Wong, president of ImagineX Group, a management and distribution group in China representing luxury brands like Marc Jacobs and Salvatore Ferragamo, believes the most recent wave of outbound tourism can be traced back to two major factors. "The currency fluctuation — with the RMB remaining strong in comparison with the euro and yen — and the crackdown on corruption are both favouring this," she says.

A new development affecting where shoppers buy luxury goods is the Chinese government’s response to daigou, the grey market buying agents abroad who have had a big impact on the business over the past few years. “China is now addressing this through the ‘cross-border channel,’ a form of shipping that provides preferential import duty rates, plus access to authentic goods and authorised dealers,” Wong explains.

The proliferation of counterfeit luxury goods in China continues to drive some Chinese to spend overseas where there is a perception that products are more likely to be genuine. David Zhao, the founder of Shangpin.com, a fashion e-tailer selling brands like Lanvin and Topshop, believes that the fight against counterfeiting still has a long way to go. “I think those of us in the e-commerce space have a special role to play,” he says. “Our cross-border platform is officially connected with the customs system so all merchandise now has to be pre-registered in the system and the customs clearing process is monitored [by the government who police it] with fines and punishment.”

With 668 million internet users and 594 million mobile users, China is one of the world’s most dynamic e-commerce markets and is projected to grow at an annual rate of around 25 percent over the next several years, according to the World Economic Forum. But in spite of the country’s e-tailing boom, analysts expect the surge of ‘TLCs’ (travelling luxury consumers) from China to continue even if their motivations are changing.

Shopping for luxury goods abroad is no longer just a status symbol or a quest for better value for money. Affluent Chinese tend to buy abroad for the luxury lifestyle experiences that accompany their shopping trips, such as wine tasting in California, art residencies in Europe, culinary expeditions around Thailand and Malaysia, spa tours in Japan or elite beauty therapies in South Korea.

Navigating the niche, exclusive, local and independent

"We believe there's a great opportunity to speak to this newly empowered and globally aware customer," says Andrew Keith, president of Lane Crawford and Joyce department stores. "It's particularly with brands that are new to the market and relatively limited in terms of distribution — or contemporary, younger brands that offer a distinctive creative perspective and encourage a sense of discovery by telling a compelling story."

Keith points to the increasing popularity of smaller, niche brands at Lane Crawford like Sacai, Ellery, Self-Portrait, Acne Studios, Nicholas and various denim labels and Chinese designers including Xiao Li, Qiu Hao and Huishan Zhang at Joyce.

"Some luxury consumers here now view Chinese designer collections as being more tailored to their preferences and body types. We've more than doubled our investment, expanding our 'Created in China' programme [at Lane Crawford] to over 20 brands. Young designers like Angel Chen and ShuShu/Tong will be working with us as their first-ever retail partner on an exclusive basis," he adds.

In addition to a more pronounced sense of brand differentiation, exclusivity and a growing interest in local design, China’s new luxury market reality requires a higher degree of retail flexibility. The ability to adapt a product assortment to the fast-changing taste of the Chinese consumer is now as important as rotating labels to ensure a sense of ‘newness.’ All of this has made China a much more challenging place for the luxury megabrands to do business.

“Overly aggressive expansion strategies and too many entry-level product lines have eroded the luxury megabrands’ premium,” says Justin Peng, chief executive officer of Dong Liang, a multi-brand store featuring Chinese designers with branches in Beijing and Shanghai. “That’s why consumers are shifting some of their budget to more independent, individual designer products like ours.”

Overcapacity and overexposure have caused a spate of luxury boutique closures and consolidations across China and Hong Kong. Burberry, Armani, Louis Vuitton and Prada are among the big brands that have either reduced their retail footprint or are in the process of reviewing it. According to China Retail News, Louis Vuitton recently closed stores in Chinese cities as diverse as Guangzhou, Harbin and Urumqi. While such closures make some market observers uneasy, others say it is business as usual.

“You have to consider this as a normal thing for retailers. We’re not foreseeing more major closings in mainland China. It’s more what we call ‘strategic maintenance of the network’. Some locations just opened too early and some malls were in the wrong locations. In fourth-tier markets only a few brands can really be profitable. That’s why there has been this correction happening,” says D’Arpizio.

Calibrating footprint to footfall

As the megabrands trim down their networks, other luxury players continue to expand their footprint — particularly the more discreet or independent firms. Hermès has been gradually opening boutiques over the past couple of years and Akris unveiled three this summer. Luxury retailer I.T recently opened designer franchises and multi-brand stores in cities as far afield as Qingdao, Shenyang, Chengdu, Nanjing and Xian.

Hong Kong’s fate, however, seems less certain. With the best assortment and overall selection, the city was historically the premiere shopping hub in Asia, welcoming wealthy consumers from across region. But as mass tourist flows from the mainland are now ebbing, it faces increased competition from first-tier cities in China, as well as other Asian shopping hubs like Singapore, Seoul, Tokyo and Bangkok.

“Many brands have 10 to 12 stores in Hong Kong. It’s clear to me that you can’t make that many stores profitable in just one city, so this is where brands needed to reduce number or size of their network linking their footprint to their footfall. It’s true that the role of Hong Kong has changed and I don’t think we’ll get back to previous levels of consumption there.”

Analysts are more bullish about prospects on the mainland.  Compared to the heady days of double-digit growth, China’s 2015 GDP rate of 6.9 percent may seem disappointing but it remains impressive when seen in the context of the wider world.  “It’s still one of the fastest growing economies in the world,” says Mario Ortelli, senior research analyst for luxury goods at Sanford C. Bernstein. “When the economy is growing [at this rate] and disposable income is growing even faster, people feel rich. They have the intention to trade up and spend more.”

According to Luca Solca, head of luxury goods at Exane BNP Paribas, consumer perception from within the country tends to be more positive than the verdict pedalled abroad. “People in China look more assured about the Chinese economy than observers from a distance in Europe and the US,” he says.

As it shifts toward a more service-based economy, the Chinese economy has been rebalancing around a ‘new normal’ model of sustainable growth for the future.  “At the World Economic Forum, we adopt the approach of being near-term realists yet long-term optimists about China’s long-term growth trajectory,” says David Aikman, chief representative officer and managing director of the World Economic Forum’s China Office. “From a long-term perspective, China’s consumption trends are positive and are projected to continue to grow.”

Aikman points to “enormous opportunities” for brands that cater more toward the elderly and young children in China due to the country’s ageing population and the loosening of the one-child policy last year. “[Other] factors that will continue to contribute to China’s consumption boom include a rapidly growing middle class that is set to double from now to 2025,” he adds.

Pointing toward diverse, discerning behaviour

“Attracting more middle class customers is the most important battleground for the luxury market in China right now,” says Justin Peng of Dong Liang. “‘Trading up’ is still one of the key growth drivers [so] this year, we lowered our product price range and increased the weight of more affordable brands. We’ll continue to do so next year, too.”

However, China’s middle class will remain elusive to many pure-play luxury brands in the short term, says Lifen Zhang of FTChinese.com. The founding editor of the Chinese edition of the Financial Times believes they are still “in a fluid state,” but advises that luxury brands must be “in it for the long game” for this demographic by providing them with knowledge and access now.

Another important caveat is that middle class consumers in China have limited spending power compared to their international counterparts and the current lack of global price alignment puts many entry-level luxury goods out of their reach. “These exorbitant price gaps with Europe simply can’t be maintained,” says Solca of Exane BNP Paribas.

But for the majority of existing luxury consumers in China, price is less of a concern. Speed, access and the ability to socially connect are key to this comparatively young luxury demographic. “Expectations of service are higher than in any other country and they look for best-in-class delivery and logistics,” says Keith. “But despite the fact that China is a big market, young and mobile, it’s all about building relationships and trust. We’ve really got to win hearts and minds.”

Increasingly diverse and discerning, Chinese luxury consumers are looking to be persuaded by powerful new brand narratives and more nuanced marketing messages from their favourite labels.

"They have their own opinion about what they like and what suits them now, instead of just rushing out to buy anything that the fashion authorities tell them without thinking," says Angelica Cheung, editor-in-chief of Vogue China.

“What this means is that brands should really start thinking about what they’re offering their seasoned consumers. What’s their point of view? What really makes their experienced consumers choose their products?”

To learn more about VOICES, BoF's new annual gathering for big thinkers, visit our VOICES website, where you can find all the details and apply to attend our invitation-only global gathering in December, in partnership with QIC Global Real Estate, hosted at the Soho Farmhouse in Oxfordshire in the picturesque English countryside, one hour from London.