Brand new era

Wearied by weeks of home lockdowns, the fashion-conscious residents of Shanghai found a new way of lifting their spirits last month.

With virus prevention officials making periodic visits to residential compounds as part of citywide testing for Covid-19, locals started to hang shopping bags from the world’s leading luxury goods brands on their doors as drop-off points for virus test kits.

Soon there was a flurry of photos on social media of bags from brands like Prada, Burberry, Hermès and Chanel, reminding their owners of times when an hour or two of luxury shopping was no problem whatsoever. “Before the epidemic Shanghai people really were middle-class and they lived exquisitely,” remarked an admirer of one of the images.

The top executives at the expensive brands might at least console themselves that Shanghai’s shoppers are thinking of luxury, despite the lockdown. But the pandemic-related restrictions of recent weeks have made store visits much less likely in many Chinese cities, triggering a slowdown in sales that is hurting much of the sector.

Fortunately, the trends over the longer term signal that luxury retail will return to favour, however.

How has the luxury goods sector been faring in China?

2021 was an excellent year for most of the luxury brands with sales in the Chinese market reaching Rmb471 billion ($74 billion), almost doubling those of two years earlier, according to estimates from Bain, a consultancy.

Back then the Chinese economy seemed to be coming out of the pandemic ahead of other countries and wealthier shoppers were soon splashing out on watches, bags and designer clothes, sparking an increase of more than a third in revenues on the previous 12 months.

Globally, China’s share of the luxury market grew a little (by a percentage point) between 2020 and 2021, Bain says. But what was starkly different to the years before the pandemic was the focus on sales inside the country. Prevented from travelling overseas by Covid control policies, consumers went luxury shopping in their home cities, with long queues of customers seen outside the flagship outlets.

In the provincial island of Hainan, new duty-free outlets have served as a focal point for this “repatriation” of spending, reporting Rmb60 billion in revenues last year.

Some of the luxury labels  responded by opening new stores.  However, the benefits of this strategy then inverted when shopping districts began to be fenced-off in March because of a surge in Omicron outbreaks. Shanghai, which is home to about 15% of the country’s luxury stores, could finally start to emerge from a lengthy period of lockdown in the next few days, the city’s mayor said this week. But in Beijing, where another 13% of the country’s brand boutiques are based, there are risks of a new phase of restrictions, with many schools, restaurants and bars already closed.

Broader retail sales, the leading gauge of consumer activity, dropped more than 11% year-on-year in April, it was reported this week, with hundreds of millions of people around the country still subject to full or partial lockdowns.

And even in cities where business has been less disrupted, there are fewer domestic tourists making shopping trips, as well as problems with shortages of stock at many stores.

Shanghai’s free trade zone is a transit point for onward distribution of many of the luxury goods shipped into China. But six weeks of lockdown have knocked the supply chain sideways, with little sign of a recovery to more normal operations.

“The supply chain has basically been broken since the end of March and none of the goods can be delivered, which has had a massive impact,” the boss of a Swiss watch brand confirmed to ThePaper.cn. An operator of a luxury store for a French brand in Suzhou, about 50 miles to the west of Shanghai, also confirmed to the news portal that the outlet had initially survived on sales of dwindling stock, but was then affected when quarantine restrictions spilled over from Shanghai. “It’s already been a month: all the employees are quarantined at home and waiting for work to resume,” he lamented.

So is China losing its place at the centre of the luxury goods world?

The snarl-up in sales and distribution is feeding through into the share prices of many of the luxury labels. Shares in LVMH, the world’s largest luxury group, are down more than a fifth this year, following a rise of nearly 130% between mid-March 2020 and mid-August 2021, writes Nicholas Spiro, a partner at Lauressa Advisory, in the South China Morning Post.

The story is similar for sales at Hermès, where Asia revenues ex-Japan have been growing at half the pace of those in America and Europe. Business in China is much to blame for the subdued performance: “Since mid-March, Greater China has been penalised by new health restrictions and some store closures, particularly in Shanghai and Shenyang,” the company said.

Kering CEO François-Henri Pinault made similar references in outlining how strong sales of its best-known brand Gucci in North America and Europe had been “overshadowed by its exposure to China”. He added that “a more uncertain environment” since the tightening of Covid restrictions in March was to blame.

Commercial pressures like these are being contrasted with the performance of the luxury sector in the United States over much of the last two years, where investors have been surprised by the strength of consumer demand.

That said, China is still fundamentally important to the sector’s fortunes, with HSBC estimating that the Chinese accounted for at least  third of total luxury spending before Covid (this figure includes purchases made within China and overseas). That percentage is set to grow to 40% by 2025. A growing middle class, disposable incomes that are still growing faster than inflation rates, and government policies that favour consumption as a growth engine for the economy all point to a rosier future.

The trends mean that China is on track to take the title of the world’s largest luxury goods market within three years, agrees Bain, regardless of future international travel patterns.

This is why the luxury marques are sensitive to any change in circumstances that threaten sales in China. Eight years ago they scrambled to respond to the impact of President Xi Jinping’s dual campaigns against extravagant spending and corrupt behaviour of government officials, for instance, which was having a chilling effect on sales in the sector. And there was more nervousness last year when Xi started his push for ‘Common Prosperity’, with fears that a bid to spread the benefits of economic growth across a broader spectrum of the population might dilute the spending power of wealthier households.

Since then luxury bosses have argued that it is a misconception that their business success is based on high net-worth shoppers, even claiming that the Common Prosperity plan will be beneficial for the sector in spurring demand from millions of middle-class customers.

Jean-Jacques Guiony, LVMH’s chief financial officer, made the point again during a call with analysts last month, when he downplayed the risks from the new policy agenda. “Most of our sales are not generated by the very wealthy, but by affluent clients,” he explained. “The only impact we have had in China is pandemic-related.”

So the luxury brands are confident about their prospects post-Covid?

What stood out in HSBC’s most recent China Deluxe report at the start of this year, which surveyed more than 2,000 wealthier consumers, was the resilient mood from luxury shoppers.

Admittedly the survey was compiled before the resurgence of Covid concerns in many parts of the country. But there was little sign that demand had suffered any permanent damage from two years of disruption to international travel, which has made it impossible for the Chinese to splurge at stores overseas.

Indeed, 90% of those surveyed said they planned to travel abroad at least once a year when Covid-related restrictions were removed, while nine in every 10 respondents vowed to spend at least the same amounts on luxury shopping as before the pandemic.

Travel is no longer quite the same necessity for getting hold of high-end brands, of course, as more of the foreign labels bulk up their retail presence in China. But another major positive is that they aren’t coming under threat from Chinese rivals in the same way as other consumer goods categories, where local competitors are grabbing market share.

That was one of the points made on Monday at an interesting session on the consumer landscape at HSBC’s 9th annual China Conference, which has been showcasing two weeks of debate between executives, analysts, entrepreneurs and policy specialists.

It was pointed out that domestic brands are aggressive competitors in items for daily consumption like beer, while shoppers have also started to ‘lean local’ in their preferences for consumer electronics. It’s similar in sportswear, where demand is skewing towards local choices and brands like Anta and Li Ning have eaten into sales at Nike and Adidas. But international labels are still much preferred in luxury goods like fashion apparel and accessories, watches and jewellery, and even high-end chocolate.

Erwan Rambourg, global head of consumer and retail research at HSBC, has also made the point that local brands haven’t made as much headway in the luxury segment. “For the time being, we can’t think of many relevant Chinese brands in luxury, so the threat of local Chinese alternatives is more of a potential issue for sporting goods, milk powder or cosmetics at present. The two brands often quoted by investors, Shang Xia [fashion, leather goods and home furnishings] and Qeelin [jewellery] happen to be owned by Western assets, respectively Exor and Kering,” he says.

What to expect when Covid finally subsides…

HSBC’s consumer goods analysts still think there are areas where local luxury brands will start to be more successful, however.

Domestic labels are already creating high-quality products in categories like make-up, for instance, and they are often more adept at marketing them through social media and livestreaming e-commerce channels to the younger generations, especially Generation Z and Millennials.

Bain sees a profitable future for sales to the same two groups, which it thinks will make up 70% of the global personal luxury goods market by 2025.

Chinese Gen Z typically make their first luxury purchases at the age of 20, show more willingness to shop online, and put more emphasis on the “pursuit of fashion” as a reason for purchasing luxury, the consultancy adds.

Another prediction is that the focus on buying more luxury products at stores in China will see further erosion in the relative contribution of Chinese shoppers overseas (from two-thirds of the total to less than half when travel finally recovers, HSBC’s analysts think).  Part of the reason is that the price premium for high-end brands in domestic stores has narrowed markedly on those sold in outlets outside China, where it has traditionally been cheaper to go shopping. Luxury labels were much more expensive in China, in part due to import taxes but also because of the brands’ efforts to buoy up profits. That differential is declining dramatically, however.

“The premium, which added up to 80% on the same products in China a few years ago, meant a first-class flight to Paris for a shopping trip still cost less than the same spree at home. That price gap – the reason Chinese consumers have long been the most profitable for global luxury brands – has, since the pandemic, narrowed to an average of 30%. For some brands such as Chanel, the price differential between China and Europe is even lower – down to just about a tenth,” the Financial Times reported this month.

Another surge in business at the duty-free stores in Hainan could see the discounting trend accelerate, with unit prices of some of the beauty brands on the island already falling to as low as half of officially-listed levels. The brands themselves aren’t allowed to run their own stores in Hainan for another three years, HSBC reports, giving the duty-free retailers a brief period to maximise their revenues. But growing competition on the island risks a new round of discounting, which spills over into prices for the same goods in other parts of the country thanks to daigou (a term for professional shoppers that act as mules and carry luxury items across borders – daigou literally means “buying on behalf of”; see WiC433). They have been buying items in Hainan and reselling them in other cities.

Optimists on the sector, however, say discounting will be short-lived, albeit the timeframes will greatly depend on how quickly zero-Covid measures are relaxed within China. They forecast that as Chinese shoppers return to luxury stores and demand bounces back, inventory shortages should kick in and  return pricing power to the brands. That, of course, assumes that shoppers in Shanghai haven’t lost their penchant for luxury spending during their lockdown ordeal and return to the malls ready to open their designer purses and wallets with their traditional gusto.

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