Is Now The Time To Invest in China?

COVID-19 continues to spread on a global scale, and it’s now clear the virus’ symptoms reach beyond its unpredictable illness. The pandemic is both accelerating and exacerbating economic problems that already existed before the outbreak. For example, the US and China’s ongoing tit-for-tat trade war had already weakened American fashion retailers thanks to tariff costs, and now, because of a severe disruption to the world’s international shipping and supply chain, manufacturing in China has become an even more removed solution. For foreign brands — especially smaller players — the sky-high cost of digital spending and shifting market and tech platform regulations have become barriers that are devastating their ability to operate in China. The Shanghai-based consultant Hervé Roland Rogazy, who helps foreign brands expand in an increasingly challenging Chinese market, has witnessed the drastic change in dynamics that the virus has brought forth. “China was supposed to be the answer for everything: supply chains, customers… Everybody wanted to jump into this huge and lucrative market,” he said. “But it was mostly smoke and mirrors.” And now, COVID-19 has undoubtedly brought China’s position in the luxury market into question. “These last few weeks, I received a lot of messages from some factories I know in China, asking for business,” said Rogazy. “But a lot of brands are now thinking about moving production to Eastern Europe. 15 years ago, everybody was looking for contacts at Chinese factories. [But] today, it’s totally the opposite.” It’s clear that COVID-19 has been a reality check for companies with any kind of business in China — from manufacturing to supply — and they need to consider their ROI when reaching out to Chinese consumers. So how have they reacted thus far, and what should these brands do in the future to survive on the mainland? For weak brands, a forced exit from China As social distancing cuts into retail traffic, brands that haven’t made a long-term investment in China will fall behind. COVID-19 has exacerbated those competitive advantages, forcing some brands to quickly depart from China or else find a local partner to help them dive further into the market. For example, the British multi-brand beauty retailer Space NK recently announced that it would shutter its businesses in China after two years of operating eight physical stores and an online Tmall store. E-commerce Agency Azoya pointed both to the brand’s lack of product range and its low-quality digital promotions as the reason for this sudden departure. Similarly, the Hong Kong- and Germany-based retailer Esprit will close its mainland stores by May 31. After that, it will reboot the businesses by forming a new joint venture with Mulsanne Group, a menswear manufacturer backed by the capital market company L Catterton. China’s market has grown increasingly saturated with overseas brands over the past ten years, intertwining it more with the rest of the world thanks to increased travel, trade relationships, and more. Because of this, many foreign businesses in China might have trouble bouncing back from the COVID-19 outbreak. Carson McKelvey, CEO of the omnichannel commerce solutions provider Tofugear, pointed out one additional challenge for these brands compared to those from ten years ago: Chinese brands have moved up the value chain, from manufacturers in the past to cutting-edge designers and brand owners today. McKelvey illustrated this evolution, saying that as foreign brands moved their manufacturing to new, cheaper hubs like Vietnam and Bangladesh over the years, domestic retailers have taken over production lines and are enjoying reduced costs. Those brands can then price more competitively and take higher margins, which offers them more leverage and bargaining power on the open market and with sales channels. This significant pricing advantage helps homegrown Chinese brands attract value-minded, middle-class Chinese consumers, and thus grab more market shares from the foreign brands that had to pull out of China. Others are increasing their stakes in China While acknowledging that some clients parted from manufacturing in China due to rising costs and tariffs, Grace Yang, an attorney at the Seattle-based international law firm Harris Bricken, stated, “Many of our clients who sell their goods and services to China, or are looking to do so, are moving into China or increasing their operations there. China is a huge country that is not going to go away, and it still has plenty of opportunities.” Marie Driscoll, the managing director of luxury and fashion at Coresight Research, also spoke confidently about the luxury industry’s growth in China. “The market continues to have a positive long-term trend with a growing middle class, its large population, and a government that is supportive of domestic economic development,” she said. However, increased competition means China is beginning to see a winner-take-all market, as the barrier to entry for smaller companies grows. “I still see a lot of companies wanting to enter into China, more tech than apparel businesses, ” said Vincent Djen, the director of Cheng Kung Garments and chief strategy officer of the fashion circular solution company REmakeHub. “A lot of regional brands have a hard time entering China because they are not a global company, and they don’t have the resources to tailor their product to [local] design, sizing, and color. The China market is increasingly saturated now, so if brands don’t have a differentiation strategy, it’s very hard to compete.” So while smaller brands have struggled to survive, large established luxury houses that adapted quickly to the new digital norms have remained healthy in China. The latest earnings report from LVMH group, a bellwether of the industry’s health, shows that the Fashion & Leather Goods category (namely the legacy brands Dior and Louis Vuitton) has been its most resilient, reporting only a 9-percent decline over Q1 2020 compared to the same period last year. Take Louis Vuitton as an example thanks to their fully-functioning omnichannel integration (which was built before the virus began), clients in China can order and receive products promptly during COVID. Even prestigious watch brand Swiss Hublot started launching new items exclusively on WeChat, ahead of other global markets. Prada has moved aggressively both online and offline, hosting a pop-up shop at Beijing’s SKP-S in late March to capture the early recovery advantage. A virtual WeChat shop mirroring offline stores’ experience is also available. Due to these reasons, China’s post-COVID-19 fashion market is likely to turn into the survival of the fittest. Early recovery is not going to be won by every single player still operating in China, but those that saved more of their budget and have a longer-term investment are likely to bounce back quicker than the rest. This shift should lead to more mergers and acquisitions from companies wanting to reinforce their core offerings. What should brands do to survive? As China embraces recovery, the latest consumer sentiment paints a new normal that brands must acknowledge and adapt to accordingly as they move forward. For example, sustainability and health-consciousness are trends on consumers’ radars, according to Tofugear’s latest consumer research report. “Foreign brands and retailers, operating in China in particular, need to re-evaluate their China strategies accordingly to streamline costs, enhance their competitiveness and strengthen their relationships with their customers or prepare to be culled from the market entirely,” said McKelvey. The traditional playbook of upholding certain brand values, particularly in the luxury industry, has been disrupted. Whether they’re relying on sales associates, livestreams, VR, or new social media tools, brands are now offering more human interaction. Driscoll reaffirmed that prioritizing the customer relationship was an important strategy in the China market. “We advised clients to engage and communicate and deepen the relationship and bond that luxury consumers have with brands,” he said. “Sales will suffer near-term, but relationships, dialogue, and communication are key for luxury right now.” Customer relationships aside, China doesn’t automatically offer international brands good earnings anymore. “Those with a false sense of security — who think they'll survive once the virus passes — will likely be very disappointed when it comes to the China market,” McKelvey emphasized. As Western countries continue to catch up to China’s speed of recovery, brands in China need to revamp their companies and embrace new consumption trends and relationships — both online and offline — to survive.

Is Now The Time To Invest in China?

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Published April 28, 2020

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Is Now The Time To Invest in China?