China’s Frills and Posh Market Springs a Leak

Imagine a luxury goods shopper so confident and flush with cash that one day he walks into a Shanghai handbag shop, flashes 300,000 yuan, and waltzes out with almost every bag in stock.

That’s what happened last year at a Prada store where Benny Lu worked as a clerk. The customer “entered the shop and pointed to the shelves,” she recalls. “Then he said, ‘Except this one and that one, pack all the others.’”

This kind of price-is-no-object customer, however, is becoming increasingly rare at luxury retailers in Shanghai and across China.

Sales of high-end jewelry, watches, and handbags have been slowing lately, some five years after the world’s luxury goods makers embraced wealthy Chinese consumers as important drivers for global business growth.

Market analyst Bain & Co. said luxury consumer product sales on the mainland rose to 260 billion yuan in 2011 from 140 billion yuan in 2008. Those heady days were marked by a dramatic 12 percent increase in upscale sales between 2008 and 2009 and a 30 percent jump between 2010 and 2011, Bain said, even while the rest of the world struggled through the global financial crisis.

The growth momentum first showed signs of weakening in October 2011, said Cliff Xie, a veteran analyst who follows China’s luxury market. “It started with jewelry and luxury watches,” he said.

And the slowdown could get worse in the wake of a July decision by the State Council aimed at fighting official corruption. The council imposed a new regulation, in effect since October, that bans luxury good purchases by all government agencies nationwide.

In the past, officials had routinely tapped public treasuries for money to buy all sorts of bejeweled and leather gifts for various associates in exchange for favors. Now that the practice is banned, said Bain partner Bruno Lannes, sales of many kinds of high-end jewelry, watches, handbags, and briefcases in China have fallen.

Chow Tai Fook Jewellery, the world’s largest retail jeweler, said its same-store sales on the mainland declined 8 percent year-on-year in the fourth quarter 2012. Mainland sales account for 80 percent of the company’s revenue.

Italian fashion house Gucci saw sales grow 2 percent during the first three quarters of 2012 in the Asia-Pacific region, compared to 7 percent globally. French luxury giant LVMH reported a slight decline in first-half 2012 sales in China, while the company’s other market areas reported growth.

Kent Wong, Chow Tai Fook’s managing director, blamed falling investment on the mainland for the decline in jewelry sales. Changing market conditions, he said, had forced the company to start focusing on low-end jewelry for younger customers.

Strategic Shift

Chow Tai Fook’s decision to adjust its business mirrors a wider search for new sales strategies among luxury-goods makers catering to rich Chinese.

For example, Lannes said, some companies are promoting obscure and niche brands of high-end products that lack the splashy labels of well-known brands such as LVMH, Hermes, and Gucci. Famous brands “with eye-catching logos” have for years been “the most popular gifts,” said Lannes, but that’s changing.

Company financial reports support Lannes’ point. French fashion group Pinault-Printemps-Redoute posted a mere 2 percent increase in last fiscal sales for its Gucci brand in the Asia-Pacific region. But the company’s niche brand Bottega Veneta saw sales jump 25 percent.

More adjustments are expected in the changing political environment, said Ren Guoqiang, a vice president for the consulting firm Roland Berger & Partner.

“The Chinese luxury market for a long time underwent abnormal growth supported by tax policies and gift consumption,” Ren said. “But recent anti-corruption measures and a subsequent [sales] slowdown will help the market return to a normal development pace.”

Gift-buyers are believed to account for up to 25 percent of all luxury product sales in China—a phenomenon that luxury retailers understand well and sometimes encourage through flexible invoicing.

A manager for a luxury brand watch retailer told Caixin at his company “there are flexibilities granted to stores for invoice titles and contents.”

Many stores offer after-sales services to customers who can’t provide an invoice. “A customer came in with a suit and asked to exchange it for a woman’s handbag because the size was wrong,” said a clerk at a luxury fashionwear store. “It obviously had been an unsuitable gift.”

Sometimes intermediaries are hired to buy goods at stores for gift-giving officials. Several government agencies in southern China, for example, hired a man surnamed Xia to purchase luxury products.

Xia told Caixin he once purchased one hundred men’s suits for government officials. The most expensive cost 110,000 yuan. As part of the deal, Xia collected “suitable” invoices worth several million yuan that could mask the officials’ spending spree and meet procurement rules.

The watch company manager said intermediaries are often hired by customers who don’t want anyone to know what they’re buying.

Lu said the man who paid 300,000 yuan for thirty handbags in Shanghai was probably buying gifts, as had many other customers before. She remembers being asked for invoices that inaccurately identified purchased goods as “office supplies.” Such demands gave Lu and her colleagues headaches because “according to the rules, shops can only offer an invoice that identifies exactly what’s purchased.”

“I had some customers who decided not to buy products they had selected simply because they weren’t satisfied with the invoice,” Lu said.

Luxury sales in China typically climb to an annual high during the weeks before the National People’s Congress, which is held every March, and spike again ahead of other annual meetings called by the Communist Party and central government.

Still in Business

Despite the changing environment on the mainland, luxury goods suppliers still count on Chinese consumers as a major force behind global sales.

For example, according to the auditing firm KPMG, luxury purchases account for 71 percent of all spending done by Chinese tourists when they travel overseas.

The Swiss shopping tourism company Global Blue says Chinese consumers traveling worldwide spent 2.1 billion euros at duty-free shops in 2012, up 68 percent from their 2011 duty-free spending pace.

An outlet store manager in Florence, Italy, said Chinese tourists and hired buyers have been contributing to the fast growth in sales of luxury products destined for consumers in China. These buyers include students and Chinese expatriates who help mainland customers buy overseas.

A Chinese lady living in the U.S., He Xiaying, makes a living by buying goods in the United States and shipping them to customers on the mainland. “This kind of business is costless,” she said. “We get an order and go to the shopping mall. Then we can send it out.”

China’s domestic market accounts for about 7 percent of world luxury sales, said Lannes, but Chinese while at home or when traveling abroad deserve credit for buying 25 percent of the world’s luxury consumer products.

“Overseas purchases by Chinese people greatly exceed their domestic purchases,” said Lannes. Indeed, he said, Chinese consumers are major luxury buyers in the United States and Europe.

“From London to New York to Milan, you can find clerks specially assigned to care for Chinese customers,” said Lannes.

Meanwhile on the mainland, an increasing number of luxury retailers have been expanding their presence beyond first-tier cities by opening shops in smaller cities. A common goal is deeper penetration of the Chinese market.

Indeed, fast growth for domestic sales between 2009 and 2011 encouraged luxury brand retailers to open more stores nationwide. According to Bain, fifteen luxury retailers opened eighty stores in China during the first eight months of 2010.

The pace of store openings was “even faster than what they did in Japan several years ago,” said Thomas, an employee of a big-name fashion company. “Everyone has been competing for market share.”

To keep the ball rolling, some industry insiders have called for the Chinese government to reduce taxes on retail luxury products.

High taxes have been blamed for encouraging consumers to buy overseas. Ren said luxury goods are usually subject to a 17 percent consumption tax and a value-added tax that can be as high as 45 percent. Luxury taxes in other countries are typically about 5 percent, he said.

A Bain report said a luxury watch in China can cost 40 percent more than the same watch bought overseas. And a handbag made by the U.S. company Coach can cost 30 percent more in China than in the United States.

But no one expects Beijing to change the tax regime anytime soon. One reason given is that foreign luxury brand companies directly operate their stores and sales networks in China without Chinese partners, giving them little incentive to push forward tax cuts.

And the minor role that domestic companies managed to play in foreign-owned luxury retailing has been cut since 2010, the year luxury goods companies increased their control of sales networks.

But Ren thinks these domestic stores will be affected as more Chinese consumers shop overseas. “The pace of new store openings in China will slow down, or even stop,” he said.

Lannes said some luxury companies have tried narrowing the gap between prices for their products in China and other countries by raising overseas prices. The watch company manager told Caixin his firm tried to boost mainland sales by increasing prices in Hong Kong, which is a popular destination for shopping tourists from the mainland. But such efforts have had a limited impact on buyer habits and company revenues.

“No matter where a customer goes, all purchases will be included in a company’s revenues,” said Thomas.