China Consumer, Talking Point

Trouble in store

Luxury lags in Hong Kong but new book has high hopes for China’s shoppers

Mainland Chinese tourists wait outside a Chanel store at Hong Kong's Tsim Sha Tsui shopping district

Fewer of them this week: big-spending Chinese tourists were put off coming to Hong Kong by protesters

Roads blocked by thousands of demonstrators, confrontations with police using pepper spray and tear gas, and even thunderstorms and torrential rain.

After days of civil unrest on Hong Kong’s streets it’s no wonder that shops selling brands like Tiffany and Van Cleef & Arpels in Hong Kong have chosen to stay shut since last weekend.

But it’s also no surprise that visitors from China are showing less interest in shopping for luxury items in Hong Kong’s vibrant malls and flagship stores. The problem for the luxury labels is that some of the biggest protests are going on near the most-visited retail areas, prompting fears that the current slowdown in luxury sales in the city will soon show signs of a much steeper decline.

In fact, retail sales in Hong Kong rose 3.4% in August from a year earlier to $5.15 billion (they got a boost owing to the timing of the Mid-Autumn Festival, which fell in early September). But sales of luxury goods were much less robust, falling by 6.1% that month.

The luxury sector’s performance has been lacklustre for months, with fewer visits from mainland tourists blamed by most industry spokesmen. Even before this week’s events, the mood was apprehensive among retailers, with the potential for civil unrest said to be putting off visitors. One travel agency told Reuters that Chinese tours had dropped by almost a third, boding ill for the holiday period that started on Wednesday this week. Ricky Tse Kam-ting, chairman of the Hong Kong Inbound Tour Operators Association, told the South China Morning Post that mainland tourists would be down by half during the holiday compared with last year, when 920,000 mainlanders visited in the first six days of October. That leaves some luxury bosses wondering whether Hong Kong can recover its reputation as a haven for luxury retail. More broadly they also fear whether the boom in spending by Chinese shoppers is showing signs of abating too.

Blame the austerity campaign?

Luxury labels were reporting disappointing results long before Hong Kong’s streets went into lockdown with announcements about falling profits from brands like Prada, Gucci and LVMH. Richemont, the Swiss giant behind Cartier watches, also said it has been suffering from anaemic sales as demand from China wanes.

Most analysts are blaming President Xi Jinping’s austerity programme, saying it has curtailed gift-giving in the public sector and the wider business world.

WiC has tracked this new mood for some months with stories ranging from plummeting baijiu sales (see issue 252 for the most recent mention) through to hotels that are dumping their five-star ratings (see WiC225).

The estimates are that as many as half of luxury sales to Chinese customers were motivated by gift-giving in the past, which is why Beijing’s crackdown on corruption and lavish spending has been so significant.

For some product categories like watches and jewellery, the pain has been greater. Sales have dropped by as much as 40%, it has been reported.

Longer term, the prospects look rosier?

Nobody knows how long the anti-extravagance campaign is going to last. But looking beyond the immediate horizon, the future for the luxury industry looks a lot brighter, suggests Erwan Rambourg in The Bling Dynasty: Why The Reign Of Chinese Luxury Shoppers Has Only Just Begun, which was recently published.

Rambourg is global co-head of consumer and retail research at HSBC and begins his book by introducing the different types of luxury consumer in China. This is useful in adding some narrative colour to the bigger-picture estimates of market sizes and spending patterns that feature in so many accounts of the Chinese luxury scene. But what is soon clear is that these different layers of customer – ranging from entry-level “everyday luxury” shoppers to the most sophisticated “ultra high end” elite (see chart on next page) – make up a pyramid of purchasers, representing about a fifth of total luxury consumers worldwide.

They contribute even more than that in purchases – just over a third, globally – as the Chinese spend more than other nationalities too.

Apart from its size, what’s obvious about Chinese demand for luxury goods is its diversity. The pyramid structure makes that case plain, although Rambourg adds perspective by contrasting China with Japan.

Here he mentions the work of Professor Yamada Masahiro, who coined the term “parasite singles” for young, unmarried Japanese who live at home with their parents so that they can spend more of their income on luxury goods and travel. The best-known members of this group – the “office ladies” – went mad for luxury brands in the 1990s, Rambourg says, and 10 years ago half of Louis Vuitton sales were made to Japanese consumers.

But as the office ladies have got older they have lost their enthusiasm for luxury. And worryingly for the labels, there’s no new segment of shoppers replacing them.

In China the market looks in better shape because demand is more varied: from the newer shoppers in poorer cities excited about a visit to Starbucks through to the most experienced, affluent consumers trying to affect disinterest as they tour the most exclusive boutiques in Shanghai.

The overall prospects for growth look solid too. Benchmarking from a minimum income level of $23,800 a year, Rambourg says that there will be about 75 million luxury shoppers from China by next year. By 2025, the qualifying threshold will be higher at $30,500, but the total customer base will have grown significantly, doubling at least to 150 million, with spending on luxury items set to triple over the same period.

So the pyramid is going to keep on getting bigger as existing consumers trade to higher price points and are replaced by new shoppers entering at the base level.

“The 2015 pyramid is, in reality, only the emerged tip of the iceberg,” Rambourg predicts.

Sounds good for Hong Kong?

The surge in demand highlights another key aspect of the Chinese impact on the luxury world. Despite being home to 35% of the world’s luxury customers, only 12% of luxury sales take place inside mainland China.

The point is that many Chinese are choosing to shop overseas, a trend that is likely to accelerate as more of them start to travel internationally.

Hong Kong’s success in attracting mainland spending is the best example of this phenomenon, with a city of seven million people reporting the same luxury sales as China itself, with a population of more than 1.3 billion. Visitors from the mainland are said to account for 60% of the handbags sold in the city, for instance, and as many as 80% of the watches.

Hong Kong’s allure for the mainland Chinese is widely understood. Tourists enjoy the status of going on overseas shopping trips and they are more confident that the goods they are buying aren’t fake. Most of all, they can save 30% by avoiding import and consumption taxes, as well as the VAT, charged on the same items at home.

Hong Kong’s experience fits with the latest findings from Nielsen’s Mainland Chinese Luxury Shopper survey (from August) in which 97% of respondents said that shopping is the key activity when they travel overseas. And although the shopping may look frenzied, it is actually quite well organised. About 90% of shoppers said they have planned where they will shop before travelling, while 38% know exactly which products they will buy.

Further, Rambourg explains in The Bling Dynasty how the pyramid effect reappears in the way that Chinese shoppers head for different districts in Hong Kong.

Take three examples: Canton Road on the Kowloon peninsula is a magnet for the group tours shopping in the city for the first time (which is also why it is home to more than 20 Chow Tai Fook stores, the world’s largest jewellery retailer); Pacific Place on Hong Kong island is looking to attract a savvier shopper with a more understated, less frenetic experience (“It feels empty – which for a luxury shopper is actually the right feeling,” Rambourg says); while Hysan Place in Causeway Bay is dedicated to shoppers who want a hipper experience, especially younger visitors who like to hang out as well as shop.

Of course, visits to each of those shopping areas is going to be disrupted by the street protests this week, which have arrived during the National Day holiday, a peak period for travel from China.

That could contribute to a trend Rambourg identifies: more Chinese have been looking at alternative shopping destinations to Hong Kong. Japan is getting more interest as the yen has weakened, while Taiwan is more popular too, because of improved transport links with mainland China and the shared cultural ties. But South Korea is the most fashionable new spot, benefiting from the ‘new cool’ of Korean TV series and pop music.

So while Hong Kong is going to remain as a profitable hub for the luxury brands, it seems that other cities in Asia are going to increase their share of Chinese business.

Of course, another option is for jetset Chinese to buy top brands in Paris, London or even Venice (where WiC spotted a lot of this activity in August). But Rambourg says luxury sales in Europe are weaker too, in part because of the stronger euro, but also because retailers have been pricing their goods much more aggressively, aware that the same items are still more expensive in China itself.

How about other new trends in the luxury business?

China’s luxury market started out as male-dominated. This is changing – and the pace of the shift may even quicken because of the clampdown on gift-giving.

The future of luxury is much more likely to be female, Rambourg says, which should be good news for firms that sell jewellery and handbags, but less so for sellers of watches, for example.

How about another question: if millions more Chinese are going to start buying luxury brands, will they still regard them as ‘exclusive’ enough to justify the higher prices?

Rambourg remembers this as a danger for Louis Vuitton in South Korea, where the label earned a nickname as “the three-second bag” because you would see it every three seconds when walking around parts of Seoul. (He spent eight years as a marketing manager with LVMH and Richemont prior to going into banking.)

Factor in that the surge of these new luxury customers from China is going to be one-and-a-half times the size of the South Korean population and the dangers for brands suddenly being seen as too ‘mainstream’ are more apparent.

One response is to create scarcity value by restricting sales to small audiences at the highest prices. That’s the approach of some of the ‘max-lux’ brands, like top-end jewellers Leviev or Graff. But in modified format, the same idea can be applied in limiting the number of outlets at which a brand sells its goods. The more stores, the more sales potential. But opening too many shops creates the wrong impression – a brand that seems to shoppers more Golden Arches than gold (with stores popping up with the frequency of McDonald’s outlets).

Another tactic for brands is to highlight their heritage. This is an inviting strategy for firms with storied histories, as newcomers can’t respond in kind. Cartier makes clear it was founded in 1847, while Vacheron Constantin – the world’s oldest watch manufacturer – goes back even further to 1755. Consumers seem to respond to this too – “established heritage” mattered for four out of 10 respondents to the Nielsen survey of Chinese luxury shoppers in August.

A third strategy for the luxury firms is to go ‘lifestyle’ by extending the brand across a broader range of products rather than concentrating on a single one. Labels that try this may be suffering from stalling growth in their key product category, Rambourg suggests, or feel that they are losing some of their edge to fresher competitors.

One example of a label taking the ‘lifestyle’ route is Coach, the American leather goods brand, which has diversified from handbags into shoes, apparel, fragrance and jewellery.

Louis Vuitton has also undergone the ‘lifestyle’ makeover. After leading in luggage for almost a century and a half from its founding in 1854, the French firm began to offer men’s leather goods and other accessories in 1993. Then it started selling apparel and shoes, and has also launched fine jewellery, watches and eyewear. In 2016, it is expected to start selling fragrances too.

How the luxury firms handle the influx of new demand from China will determine much of their commercial future. And as an example of a brand that is prospering, the Financial Times suggests Paris-based Hermès, which opened its latest ‘maison’ or flagship store in Shanghai last month, bucking the gloomier mood about China pervading the rest of the sector.

Hermès is certainly outperforming. Like-for-like sales at LVMH, the world’s largest luxury group, grew just 3% in Asia ex-Japan for the first six months of the year, while revenues at Hermès jumped 17% in the same period.

Why? Hermès has fewer outlets in China than its peers, which might have protected it from some of the wider slowdown.

By focusing on the handcrafted nature of its products and offering less in the way of logo-heavy design, it may have been less affected too by the gift-giving clampdown (see WiC227 for an earlier report on the advantages of its positioning).

Also important is that fans of the brand’s silk scarves and leather goods are less often purchasing them to give away. “Instead, consumers tend to buy Hermès products for themselves,” the FT reports.

And in fact, this is the Holy Grail for most of the finer brands selling to Chinese customers. By offering goods that appeal on the basis of their fundamental quality rather than as a way of showing off to others, the luxury labels hope to wean clients from their earlier taste for gaudy conspicuous consumption and outsized logos.

At the more mature end of China’s luxury market, consumers are increasingly embracing the ethos of style guru Coco Chanel: “You live but once, it might as well be amusing”. In other words, worry less about impressing others; instead indulge in the very best and do so for your own gratification.

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