China Consumer

Bags of trouble

The Chinese are making luxury knock-offs nearly as good as the real thing

A shop assistant arranges a "Metropolis" bag in the Furla flagship downtown Milan

Earlier this year Xiaomi’s founder and chief executive Lei Jun admitted that counterfeiting was seriously damaging the smartphone maker’s revenues.

“What is the biggest problem? If there were no counterfeits, our sales would be double or triple,” said Lei at a news conference in April.

Other smartphone makers may have enjoyed a twinge of schadenfreude; Xiaomi itself has been criticised for borrowing its designs heavily from Apple. But the story underlined the growing problem for brands struggling against counterfeiting in China.

The counterfeiting industry is threatening to spiral “out of control”, according to Bharat Dube, the Singapore-based CEO of SIPI, a group which protects brands by monitoring and shutting down online platforms selling knock-offs.

“Counterfeiting today has morphed into a big money game that is attracting an increasingly sophisticated breed of counterfeiter,” said Dube, who previously led the IP Litigation Team at Swiss luxury holding company Richemont. “The anonymity and global reach offered by the internet has changed the game.”

The size of the fake goods industry is estimated at approximately $250 billion, or 5-7% of overall global trade, according to the UN Office on Drugs and Crime. Brand protection and authenticating specialists like Opsec, SIPI, MarkMonitor, and NetNames, are increasingly sought out to help.

Luxury brands have a lot to lose. An authentic Prada handbag costs from $1,000 upwards, but a knock-off can be snapped up on a market stall for a fraction of this. Richemont Group was recently awarded over $600 million in a counterfeiting case in the US, showing the potential for heavy penalties. But stories like this are few and far between.

“The issue of counterfeiting is a problem that faces all brands who create aspirational products,” said Paolo Canali, marketing manager and third-generation family member of Italian luxury menswear brand, Canali. “We have a network of contacts locally who keep us informed of any potential threats of this kind. When they do emerge, we take immediate and full advantage of legal remedies.”

The global hub of counterfeiting is in China, where an estimated 70% of the trading in faked goods takes place, according to the UN Office on Drugs and Crime. With a population of 1.3 billion, the sheer size of the country means the offenders and their co-conspirators are relatively easy to hide. Although the State Administration for Industry and Commerce carries out raids to uncover infringers, the fines are usually a small price to pay for carrying out a highly profitable business.

But today’s major problem is that the dealing in bogus goods is increasingly globalised through the internet. The landscape has shifted from hawkers and street touts to products sold online which appear genuine to all but the expert eye. As well as being more difficult to police, these products are presented in the real packaging, even coming with genuine-looking guarantee cards.

The business of fakes has become a large scale enterprise where a single retailer can gross millions of dollars without being caught.

“Today’s counterfeiter is typically familiar with offshore banking, document forgery and technological manipulation,” said Dube.

As e-commerce becomes more important for luxury brands, it is a growing concern. Worldwide e-commerce sales increased by a fifth last year to reach $1.5 trillion, and will hit $2.3 trillion by 2017 according to eMarketer. Growth will come primarily from the rapidly expanding online and mobile user bases in emerging markets and the push into new international markets by major brands.

But Time Weekly reckons the luxury brands only have themselves to blame for the high quality of ‘fakes’ now in circulation. Last week it published a long investigative piece in which it interviewed managers in factories predominantly in Guangdong which have long made bags and other goods for top luxury brands. The strategy makes business sense for the luxury goods firms since these so-called original equipment manufacturers (OEMs) can make the products more cost-effectively, improving margins. But the outsourcing is kept quiet.

Time Weekly describes the whole process as an “open secret”, saying many of the most famous brands source 40% or more of their products from Chinese OEMs. Mostly the item is left unfinished, says one local manager. What then happens is that a bag or a garment is then sent back to Europe, to have final touches added, such as buttons and chains. That, he says, then allows the label to describe the product as made in countries like Italy, France or England.

One OEM told Time Weekly it had made a belt for €9 ($10.15), which went on to retail for €750.

But this profitable temptation has a downside. Many of these OEM factories – with their access to designs and materials – are able to offload a parallel supply of products. These are deemed to be fakes by the luxury brands but owing to shared production techniques they can be almost indistinguishable from those sold in the brand’s own outlets.

For example, a Thai tourist shopping in Guangdong told Time Weekly she’d previously bought a bag made by a prestigious European brand, and when she took it to their shop in Bangkok for maintenance, nobody twigged it was an OEM product.

Time Weekly also visited a shop in Guangzhou in which the owner admitted that all the bags on display were ‘high-level copies’ of top brands. He said the copying was made easier because the brands worked with so many OEMs locally. This meant it was possible to order exactly the same leathers, linings and other parts to reassemble a replica.

This may have been what Prada was getting at when it detailed among the risk factors in its 2011 IPO prospectus the following: “We have established a rigorous inspection and quality control process for all outsourced production and contractually require all third-party manufacturers to comply with intellectual property protections and confidentiality restrictions… However, the inability of third-party manufacturers to ship orders in a timely and appropriate manner or to comply with their contractual obligations could have a negative impact on our operations and business.”

Notably the warning doesn’t mention Chinese OEMs, as they remain a subject about which all the luxury firms remain tight-lipped. But the deputy director of the Shanghai International Fashion Federation has told the press that Chinese factories began working with luxury brands in the mid-nineties and have grown in importance ever since.

Over the past couple of decades these OEMs allowed the top marques to scale up production (and profits) in an era when newly brand-conscious consumers in the emerging markets were unleashing their spending power. But the strategy seems to have also backfired as the OEMs gained expertise and took a greater role in the supply chain.

Bosses at luxury firms are now feeling some of the consequences. Had they not cooperated with Chinese OEMs the quality of counterfeits would have remained low. Instead their quality is higher and thanks to rising online sales, they pose a growing threat.

Paradoxically, if they had not gone down the outsourcing route the luxury goods firms might not have grown as rapidly or reaped such vast profits in recent years.

But that very same strategy has had a regrettable consequence: it has given birth to a counterfeiting sector of such high quality that its output now increasingly competes with the luxury firms’ genuine products.

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