Maintaining Luxury Brands used to be so simple …
Men hanker after luxury watches, women after luxury handbags. Or at least that was the case until the Chinese economy stumbled and the luxury market had its wings clipped.
Sales of luxury goods in China nonetheless continued to grow in 2014, thanks to the rising number of high net worth individuals and affluent households, as well as the middle classes with strong spending power and a new penchant for affordable luxury goods. Meanwhile, steadily increasing disposable incomes and continued urbanisation also stimulated consumption.
With an increase of US$9.6 billion in real terms over 2009-2014, aside from the US, the biggest luxury market, which increased by US$18.0 billion over the same time period, no other market came close in terms of absolute growth.
However, thanks to the decelerating economy in China, as well as anti-corruption measures implemented by President Xi Jinping at the end of 2012, the impressive growth fizzled out towards the end of the review period, leading many luxury brands to question their strategy for China as well as other emerging markets.
“ Luxury goods sales in China increased by $9.6 billion in real terms over 2009-2014 ”
In order to curb corruption and extravagance, in 2012, the central government not only implemented regulations to prohibit purchasing luxury goods with public funds, but also began to investigate officials who were exposed by the public as owning luxury goods.
Such effective efforts greatly clamped down on gifting in China, which used to form a significant part of luxury goods consumption in the country, resulting in the overall weakening of demand for luxury goods. Indeed, our latest research indicates that sales of luxury goods in China dropped from third to fourth place in our 2014 global rankings, and our forecasts for China have also been revised downwards.
While this anti-corruption drive is clearly positive and a step in the right direction, its ranking of 80th out of 177 countries in Transparency International’s Corruption Perceptions Index 2013 is unchanged from the previous year’s index out of 176 countries.
That said, it is clear that current measures are having an impact, with real growth in many key luxury categories considerably lower in 2013 and 2014, compared with 2012. For example, retail sales of luxury cognac fell by 11% in real terms in 2013, compared to a 16% rise in 2012, while sales of luxury watches fell by 9% in real terms in 2013, compared to a 6% increase in 2012.
Member of the Central Committee were noticeably forsaking the wearing of Luxury Brand watches, lest they hint at being perceived as soft on corruption. This sent shudders throughout the nation, and confused the affluent population to no end.
“ China ranks 80th out of 177 countries in Transparency International’s Corruption Perceptions Index ”
Chinese Economy Stumbles
After nearly three decades of uninterrupted growth, the world became accustomed to China serving as one of its major engines for growth. However, the economy has stumbled in recent years and real GDP growth slipped to 7.7% in both 2012 and 2013, down from 9.3%in 2011 and 10.4% in 2010 respectively. The slowdown was due to a drop in export demand in key markets, as well as weaknesses in domestic demand.
To help the economy, the government sped up approvals for the construction of new highways, ports, railways and sewage networks in the second half of 2012, with investment in infrastructure projects exceeding US$795 billion in the third quarter of the year. And in April 2014, the government announced a target of 7.5% real GDP growth during the year as a whole.
The government’s tolerance for growth slipping significantly below 7.5% is likely to be limited because 7.5% represents the slowest rate of growth since 1990. In fact, the government has already announced a mini stimulus, which involves bringing forward infrastructure projects and offering tax breaks for business.
If income growth slows and employment creation stalls, then a stimulus is more probable. However, any stimulus is likely to be targeted to avoid a further credit boom and added upward pressure on property prices. For the moment, all that can be said in this regard is “watch this space”.
Top Earners Are Over 40
The 45-49-year-old age group accounted for the biggest slice of the total Chinese population with an annual gross income of US$150,000+ in 2013, at 26.1%, slightly ahead of the 40-44-year-old demographic, on 24.8%. Members of this affluent age group have seen their careers coincide with their country’s rapid economic development and have also attained seniority in the workplace.
Some are successful entrepreneurs who have profited from first-mover advantage in an underexploited marketplace. Such individuals typically spend on luxury goods, high-end home furnishings, educational opportunities through private schooling and foreign travel.
By 2030, the segment of the population in the highest earning gross income category of US$150,000+ will contain a much more even demographic spread, with each 5-year age group aged between 35 and 54 years accounting for over 10.0% of this income band, although the 40-44-year-old age group is projected to lead, with a 16.0% share.
“ Such individuals typically spend on luxury goods, high-end home furnishings ”
This change will come as more Chinese enter the workforce during times of strong economic growth, spreading prosperity more widely. This will support spending on more affordable luxury goods and services.
However, the over 65-year-old age bracket, which accounted for only 2.7% of the Chinese population with an annual gross income over US$150,000 in 2013, will see its share of the total high-income population rise to 6.4% by 2030.
This will still be a relatively small proportion, but a significant rise nonetheless, as high earners in their 40s today will have moved on to join the over 65-year-old age group by 2030. Luxury brands looking to target Chinese high earners will therefore need to pay greater attention to this consumer segment over the coming years.
“ Annual disposable income is still expected to expand at 8.6% year-on-year in 2014 ”
Income Equality Eroding
Although China is no longer posting the heady economic and luxury growth seen in the period prior to the 2008-2009 global economic crisis, its annual disposable income is still expected to expand at a respectable 8.6% year-on-year in real terms in 2014, securing China fifth place among countries with the fastest income growth rates globally.
Healthy income gains, coupled with the sheer size and potential of the consumer market, have helped retain China’s status as one of the most attractive emerging markets.
Persisting and sharp inequality between inland, rural and coastal, urban households poses one of the greatest challenges to China, in that it breeds social discontent (potentially undermining business confidence) and polarises the consumer market (making it difficult for businesses to expand effectively). However, we expect that “harmonious society” policies will help to reduce inequality in China in the long term.
Luxury brands attracted to the substantial size and rapid growth of the consumer market in China have often overlooked significant regional disparities in economic development, market infrastructure and consumer purchasing power.In recent years, although income inequality in China has somewhat declined, owing to the government’s social welfare reforms, the country continues to see large income gaps between urban, coastal cities and rural, interior areas, which lead to different consumption patterns but also create diverse opportunities across China.
Understanding the regional disparities is vital for luxury businesses to devise effective marketing strategies to successfully penetrate the Chinese consumer market.
“ Households in the Shanghai region enjoyed the highest per household consumer expenditure ”
Households in the Shanghai region enjoyed the highest per household consumer expenditure, at US$16,605 in 2013. Being home to most international luxury brands, the coastal city of Shanghai is also China’s financial and commercial centre.
The region with the second highest per household consumer expenditure (US$13,857) in 2013 and also home to a high concentration of international luxury brands was the capital city, Beijing.
However, southwest China’s Chongqing and Chengdu municipalities, with populations of around 28 million and 14 million, respectively, are two of the fastest growing consumption bases in the world. They present hugely attractive opportunities for the luxury market, especially at a time of softening demand in Shanghai and Beijing.
“ Understanding the regional disparities is vital for luxury businesses ”
Governments and investors alike are starting to pick up on the retail opportunity presented by Chinese travel and tourism and nowhere is the footprint of Chinese travel and tourism more evident than in the luxury industry. It is estimated that Chinese consumers spent upwards of US$45.0 billion on luxury goods outside their own country in 2012, which was over double the value of the domestic (Greater China) market.
In Bangkok, growth in Chinese travel and tourism has fuelled a boom in the development of luxury shopping centres, for example. To support this, the Thai government is planning to cut import duties on luxury goods. With a cluster of new shopping centres set to open over the next three years, Bangkok is positioning itself as a new hub for Chinese shoppers, potentially competing with Hong Kong in terms of visitor traffic.This is where the problem lies and is one of the most challenging obstacles for luxury brands. While the likes of Harrods and Galeries Lafayette may love opening their doors to Chinese visitors, some luxury brands would rather that their products be bought by the Chinese in China, and not by Chinese in the UK or France.
Why? Because China is where these brands have beefed up investment most in recent years, and where they want a stronger return on their money. This is why so many luxury brands have pushed up their European price points, to bring them into line with Beijing and Shanghai and make London and Paris less attractive.
The strategy is not working however. Affluent Chinese consumers are splurging less in London and Paris, but they are splurging less in Shanghai and Beijing too. And the wider problem is that higher prices in Western Europe have derailed the domestic consumer base.
High import taxes within China are, of course, one of the reasons why Chinese consumers do the majority of their luxury shopping outside China. The same luxury handbag can often cost 40% more in Beijing than in Paris, for example. This disparity is unlikely to change significantly over the next five years. As such, affluent Chinese consumers will continue to have a big incentive to shop abroad.
While China’s rebalancing will continue progressing at a gradual pace, luxury consumption remains strong, and there are still plenty of opportunities for growth. We expect luxury expenditure to increase by 52% in real terms in the five years to 2019, driven by real gains in disposable income of 64% during the same time period.
To this end, China is on course to overtake Japan as the second biggest luxury market in the world, but this shift will now be delayed until 2019, as opposed to the previous prediction of 2015. This moratorium in China’s growth trajectory will also be fuelled by Japan’s positive outlook.
Further small-scale stimulus can be expected, and this could change the picture of China’s luxury market; stimulus was one of the main drivers of higher-than-expected luxury growth in 2014, following a disappointing 1% rise in real value sales in the previous year. Nevertheless, the heady days of 20% growth appear to be over for China’s luxury market.
“ The overall shift in direction of China’s luxury market has brought things to a head ”
Nevertheless, healthy income gains, coupled with brand expansions, new store openings and the sheer size and potential of the consumer market, will help to retain China’s status as one of the most attractive emerging luxury markets.
At the same time, we expect to see more spending by wealthy Chinese tourists outside Mainland China, as well as amongst Chinese Diasporas; many high-income consumers from the mainland are likely to look to relocate overseas, with the US, Europe and Canada top choices for a new home. As they move, so too will their buying power.
The overall shift in direction of China’s luxury market has brought things to a head, and the message moving forward is clear.
Yes, China is still a major long-term opportunity for the luxury industry. That much is a given. But, developed markets – and the US especially – need to be nurtured as much, if not more. Crucially, the fact that the millionaire class is growing in the US is no guarantee of growth for luxury brands.