Conspicuous Consumption "Here To Stay" In China: How Will Retailers Take Advantage?

    Although China remains one of the only bright spots in the world of luxury retailing at the moment, foreign luxury brands -- despite rapid growth in the mainland market -- often have difficulties convincing many of the country's highest-potential customers to buy their products within the mainland, because of the large luxury tax China levies on high-priced imported goods.
    Jing DailyAuthor
      Published   in Fashion

    Luxury Market In China A Mixed Bag For Foreign Brands, Who Fight To Get Customers To Buy Inside China Rather Than Traveling Overseas#

    We've discussed recent reports on the rebound of the Chinese luxury market (which didn't drop that much to begin with, despite global economic woes), and this year's findings in McKinsey & Company’s Insights China report that China is rocketing towards the top of the list of the world's biggest luxury markets. Although China remains one of the only bright spots in the world of luxury retailing at the moment, foreign luxury brands -- despite rapid growth in the mainland market -- often have difficulties convincing many of the country's highest-potential customers (the wealthy and super-rich urbanites in top-tier cities) to buy their products within the mainland, because of the large luxury tax China levies on high-priced imported goods.

    Possibly to combat this problem, as we've seen this year, many companies are looking towards second- and third-tier cities as a source of future growth, and perhaps leaving the top-tier cities alone and letting their Beijing or Shanghai boutiques function only as "showrooms" for ultra-rich customers who'll simply buy the products on their next overseas or Hong Kong/Macau trip. In these smaller urban areas, middle- and upper-middle class customers, who still want to differentiate themselves through conspicuous consumption but are most certainly not part of the economic elite, could be the key for luxury brands who want their China locations to actually sell things rather than simply show them off like a real-life catalog. Middle- and upper-middle class urban professionals in cities like Xi'an, Qingdao, Nanjing and Chongqing -- who make a decent living but can't afford to fly to Hong Kong or Macau (let alone Paris or Tokyo) for luxury shopping sprees -- are likely going to buoy luxury brands' losses in top coastal cities.

    Second-tier cities in particular present major opportunities for businesses in a range of industries. A 2006 U.S. Commercial Service in China study (PDF) indicated that lower competition and lower saturation in second-tier cities made them an excellent target for importers, and the relative novelty of foreign brands would give them a leg up on domestic competitors for the medium- to long-term. From the study:

    A less-saturated market also means one with fewer competitors, presenting a crucial opportunity for U.S. companies to be among the first to touch a market. This advantage also gives U.S. exporters the chance to win over a Chinese customer base, known for its strong brand- loyalty behavior and tendency to associate U.S. brand names with high quality. One exporter recently explained, “In big cities there is a lot of competition already. But in second-tier cities, we have an edge because fewer of our international rivals are there.”

    Even though this study is a few years old, the trend of increased spending on imports in second-tier cities seems to have not only continued but intensified. This summer, a joint report on China's luxury market issued by Ruder Finn Asia and Albatross Global Solutions found that purchasing patterns in first- and second-tier cities were only marginal, as consumer confidence and purchasing power in smaller cities shows signs of growth. As a Global Times article this summer pointed out, while first-tier cities will probably maintain their role as luxury brands' "crown jewels," with opulent showrooms in Beijing, Shanghai and Guangzhou, the important stores -- the ones actually selling items -- are the real key to long-term revenue in China:

    “While brands continue to allocate image-building resources in tier-1 cities, tier-2 cities are anticipated to be key to their long term and sustained success,” said Jean-Michel Dumont, chairman of Ruder Finn Asia.

    Despite optimism among many analysts looking into the second-tier luxury sector in China, uncertainty remains among others about the future of luxury retailing in China. This week, an excellent Luxury Society article investigates the two outlying concerns that many luxury execs have about the future of the Chinese market: consumer taste and prohibitive pricing (a byproduct of the aforementioned luxury tax). In this article, the author discusses the short- to medium-term prospects for luxury in China with a number of industry experts, and finds that there are no easy routes for sustainable revenue in the Mainland market. As long as wealthier customers can find luxury products abroad at a cheaper price, or can pop over the border to Hong Kong or Macau for a quick day-trip, even the most exclusive luxury brands will have trouble cajoling these customers to shop locally.

    [D]espite the allure of these glamorous and expansive retail establishments, many anecdotal reports suggest that a significant proportion of Chinese shoppers don’t use local malls as the primary outlet to buy luxury goods.

    [Simon Lock, managing director of IMG’s Fashion Asia Pacific division] explains: “At the moment, it’s all about the land grab for the brands, trying to establish spots in as many retail luxury shopping centres. These retail centres are acting more as showcases for the brand, which are distinct from actual retail sales. So you’ll find a lot of Chinese consumers will go into the Dior shop in Plaza 66 in Shanghai [for example] and they’ll look at the merchandise that’s in there. But because of the 30% luxury tax at the moment, their first luxury experience with the brand will actually be when they come to Hong Kong or Macau.”

    As Lock suggests, the high price of luxury goods in China is the foremost hurdle. Between tariffs and value-added taxes, prices in China can be up to a third higher than in Hong Kong. Hence, a quick and cheap flight to Hong Kong can deliver more bang for their buck since travel visas are relatively easy to acquire for wealthy Chinese customers. For the hardcore luxury addict, Tokyo offers more luxury options than anywhere else in Asia, becoming an increasingly popular destination with visa restrictions now also reduced. McKinsey found in its “Coming of Age” survey that the Chinese rarely justify their foreign purchases on price differential alone, as they also want access to the more expansive product selection in Hong Kong and Tokyo retail branches.

    But even if Hong Kong is driving away some sales from the mainland, boutiques in China do perform an important function within promotion and brand awareness, equally providing a critical communications channel for fostering sales abroad.

    Although this article is wide-ranging and incredibly informative, a fuller sense of the buying habits of second-tier, and even third-tier, cities would probably be necessary to get a better sense of where the Chinese luxury market is headed. Quoting an expert on luxury markets in emerging economies, the Luxury Society article noted that conspicuous consumption of flashy (or, some would say, gaudy) and expensive luxury items is a hallmark of societies with wide income disparity, and in China's growing urban areas this disparity is vast and, in some cases, growing.

    If this trend holds true, we should probably see a two-sided growth for luxury brands in second-tier cities, as more brands open boutiques or mall showrooms and income gaps yawn. Though both will, over time, slow down and probably reverse, for the medium- to long-term it looks like brands looking to build a real footprint in China and build real brand equity should look past the marquee cities in the east -- or at least understand that these eastern cities are just going to function as living catalogues for the Chinese urban jet set.

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