What luxury brands need to know about daigou and grey markets in China

Editor’s note: This is Part 2 of an investigative series co-published with Dark Luxury, a newsletter examining the intricacies behind the luxury industry. Read Part 1 here. How daigou thrive Luxury goods are typically cheaper outside of China, which encourages shoppers to shop abroad. It’s estimated that about two-thirds of all purchases of luxury goods by Chinese buyers occur outside of the country. These price differences stem partly from China’s taxes on foreign goods, including import duties, VAT, and consumption tax, which are designed to encourage sales of Chinese-made products. This discrepancy drives Chinese shoppers abroad, from Japan to a Bicester Village outlet near London, and also creates opportunities for gray market traders and daigou. “As long as there is a gap in the prices between Europe and China, daigou will exist,” says Max Piero, CEO of Re-Hub, a Shanghai-based consultancy that helps luxury brands develop strategies in China. He says opportunities for this arbitrage trade are hard to eliminate. “This will likely continue and keep growing unless brands take a radical approach and decide to fully harmonize the prices between Europe and China, which is nearly impossible.” The scale of the gray market in China is so vast that it’s hard to quantify. “For some brands, the gray market share versus their official revenue in the country might be in the low double digits,” says Piero. But for others, the gray market could be larger than their official revenue in China. The biggest risk is to brands like Prada and Valentino, which have wholesale channels for their products. For them, “this is a big risk because you are investing in the Chinese market, spending on marketing, opening stores, operating stores,” he adds. If those customers then access the gray market, “these Chinese consumers are paying against your wholesale margin… that is not sustainable for any brand.” Platforms driving sales According to Piero, merchants will use Taobao, China’s closest equivalent to eBay, to attract customers and then try to shift the conversation to WeChat. “Taobao may be the tip of the iceberg, because there might be a lot of transactions happening, but there is no visibility of that,” he explains. Relatively new platforms such as DeWu, which offers authentication services, have also begun selling luxury products. Its closest equivalent in the West is StockX, the sneaker-trading platform. DeWu has become so effective at discounting that it is now replacing some official channels. “Luxury has become a significant category for DeWu. It’s a platform with a very nice user interface. They claim that each product is authenticated, and they deliver it within 24 hours. It gives this reassurance for customers,” says Piero. “I think this adds an additional risk for brands, versus the old version of the gray market, which was this wild west.” Risks for luxury brands Brands that don’t sell to wholesale channels, such as Hermès and Louis Vuitton, are not immune to the gray market. “My understanding is that brands like LV are trying to implement measures to prevent daigous from buying, but I think the ingenuity of the daigous is becoming better and better. They are even trained to pretend that they don’t know what bag they want, to dress like they are luxury buyers,” Piero says, citing recent court cases in China. Beyond lost revenue, brands that don’t address China’s gray market issue face other risks, including the potential for counterfeits. “You cannot verify with 100% confidence the authenticity of products in the gray market," says Piero. Additionally, failing to address daigou means missing the opportunity to include these clients in the customer relationship management system, limiting the ability to directly interact with them in the future. With direct relationships with customers becoming crucial in the industry, and a significant portion of revenue coming from a small group of ultra-rich consumers, this could be one of the biggest long-term risks. Strategies to combat the gray market The first step in solving this problem is fully understanding its scope. As Piero points out, many luxury brands remain unaware of the extent of the Chinese gray market issue. Without this awareness, it’s very difficult to take effective action. “If brands want to address this problem, they need to implement multiple types of actions, from working towards price harmonization to thinking about how to implement wholesale excellence and having close monitoring of the different distribution partners to make sure that the products that are being sold to them end up in the right market,” he advises. “From our monitoring of brands’ prices and assortments across gray market channels in China, we have found a strong pipeline of wholesale products finding their way to Chinese e-commerce platforms, often via cross-border transactions, at prices below that which consumers could access at international retail with tax rebates,” he continues. With new EU legislation requiring luxury brands to conduct checks on customers purchasing items priced €10,000 or more, it’s clear where regulators are heading. A raised eyebrow is no longer enough when dealing with customers paying in cash, who could either be innocent tourists or part of a vast gray market worth hundreds of billions of dollars.

What luxury needs to know about daigou: Part 2

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What luxury needs to know about daigou: Part 2