There is much discussion about what a slowing economy in China means for the luxury industry. Euromonitor highlights the latest numbers and what it means for the industry.
Over the past decade, China and moreover the Chinese have led the world in luxury shopping. Retailers, luxury brands and property developers alike have fallen over one another to cash in on what they perceived as a burgeoning middle class, their love of all things luxury and a propensity to spend rather than save. As a result, by 2015 China offered more luxury retail selling space than Japan and was fast catching up on the US, and the Chinese accounted for over a third of all global luxury spending.
Indeed, wealthy Chinese tourists in particular have been key drivers of global luxury goods sales for more than a decade. According to Euromonitor International’s latest travel data, the Chinese made almost 3 million trips to the US in 2015, an increase of almost 8% on 2014 and a massive 206% increase in the last five years since 2010. During the same year they made 2 million trips to France, 5 million trips to Japan and 285 thousand trips to the UK, with many of these trips including shopping excursions to prestigious luxury retailers and shopping hotspots.
However in 2014 and 2015, mainland China posted its lowest growth in sales of luxury goods since our records began (a real decline of -3% and +1% respectively). Amongst other factor being impacted, this slowdown in growth also means that China will not overtake Japan to become the world’s second largest luxury goods market in the world in the next five years and is expected to maintain its third position ahead of France and the UK in the short to medium term.
“ Growth in real GDP has been falling steadily in recent years and dropped to 6.9% in 2015. ”
Overview of the Economy
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 cooled in recent years. Growth in real GDP has been falling steadily in recent years and dropped to 6.9% in 2015.
Beijing faces some serious challenges. The government wants to change strategy by reducing its reliance on debt-fuelled investment in construction and heavy industry and boosting consumption. On the supply side, the service sector will replace industry as the primary contributor to growth. Another challenge is to address the worsening distribution of income. The division is sharpest when comparing rural and urban households. Growth has continued to slow but this can be viewed (in part) as a by-product of Beijing’s efforts to change its development strategy.
Individuals aged 45-49 are the largest group amongst top earners
Backed by the country’s strong economic expansion, China’s per capita gross income (in US$ constant terms) surpassed the Asia Pacific average in 2009, and is expected to display steady growth through to 2030. Although individuals aged 30-34 commanded the highest average gross income in 2015, the age segment 45-49 represented the largest proportion amongst Chinese in the top income band (ie individuals with an annual gross income over US$150,000) in the same year. By 2030, the age group 40-44 will have become the most prominent amongst the country’s top income earners, representing opportunities for luxury services and high-end family orientated goods (especially given the relaxation of China’s one-child policy)
“ China is expected to add in excess of 3.4 million additional individuals to this wealthy population ”
In terms of total gross income, the highest concentration can be observed in age group 39-51, owing to China’s demographic profile, and to the relatively high average gross income for this age segment. This profile of individuals usually corresponds to middle-class household heads with existing dependent offspring, who are an attractive market for categories including household goods and services, clothing and transport, with a value for money proposition.
Between 2015 and 2030, China is expected to add in excess of 3.4 million additional individuals to this wealthy population, making it the fifth largest market in the world in terms of HNWI’s. During the same time-period South Korea is set to leapfrog both Switzerland and the Netherland in terms of HNWI population to join the top 10, clearly highlighting the potential that major cities such as Seoul have for luxury goods.
Income gap is expected to remain wide over the long term
China’s income inequality levels are amongst the highest in the Asia Pacific region, and are also high by global standards. One of the main determinants of income inequality in the country is the condition of urban/rural households, which also affects migrant individuals working in the city, but whose household registration (or “hukou”) is in a rural area.
Notwithstanding measures by the Chinese government to try to make income distribution more even (including the launch of an ‘Income Distribution Plan’ in 2013), income inequality is expected to remain high in the long run. This is partly because marked differences in public benefits and living conditions between urban and rural households are expected to persist, which will continue to polarise the Chinese population and create opportunities for businesses serving both ends of the income distribution.
“ The impact of a weakening economy is unlikely to stop wealthy Chinese consumers from travelling to buy their luxury goods ”
Luxury brands need to re-think their growth strategies
Thanks to slower economic growth, which is being particularity felt in the interior of Greater China’s, the financial returns on many luxury shopping mall investments are looking much less attractive today than they were five years ago. Crucially, as shopping mall footfall slows and as retail sales subside, so luxury brands will need to re-think their growth strategies for the interior. The implications for the luxury industry as a whole are potentially far-reaching, given that China’s interior was formerly seen as a beacon of future opportunity.
If we look outside of Greater China, much of the positive sales momentum witnessed in 2014 and 2015 in the developed regions was actually fuelled by wealthy visiting Chinese tourists. However, after the Chinese government devalued the renminbi in August 2015, China’s foreign spending power has taken a turn for the worse. Added to that, the Chinese economy is set to continue cooling. These two challenges combined will almost certainly have an impact on the industry’s geographical sales mix, potentially triggering another shift in global revenue power in 2016.
The impact of a weakening economy is unlikely to stop wealthy Chinese consumers from travelling to buy their luxury goods, but it might change their destination of choice as well as total in-destination spend. Short-haul destinations such as South Korea and Thailand could reap the benefits. If Chinese consumers cut back on foreign trips further afield, then we could start to see yet another shift in the balance of power between the regions. Spending in North America, Western Europe and Japan could go down, while spending in China could even go up.
It is difficult to predict how the situation will develop in the future. What we can say, though, is that, according to our new research, 2015 turned out to be one of the most strategically critical years ever for the global luxury goods industry.
China’s grey luxury goods market
China’s latest effort to curb wrongdoing in luxury consumption is a crackdown on the grey market, which has prospered due to major price differences between luxury goods sold inside and outside of China – in the case of some Swiss-made timepieces, the price difference can be as high as 90% between Western Europe and China.
The main players in the grey market are professional shoppers, known in Chinese as daigou, who travel abroad to buy luxury goods in bulk (in effect, by filling their suitcases). They return home to sell their wares either directly or online, and it has developed into a business worth billions of US dollars.
This month, to combat the grey market, the government has stepped up its customs controls and increased penalties for false declarations, with the result that growing numbers of daigou are now being caught. But this is only one part of the crackdown. Beijing has also introduced tougher taxation laws in key categories, hiking tariffs on watches from 30% to 60%, and on jewellery from 10% to 15%.
These tariffs apply to goods purchased legitimately via the internet and delivered to China in packages, as well as to goods purchased abroad (either legitimately or otherwise) and brought back into China. The government has also put a cap of CNY100,000 (US$15,473) per card on annual withdrawals at foreign UnionPay cash machines. This is a big deal for well-heeled Chinese tourists who like to do their shopping at luxury department stores such as Harrods in London, Barneys in New York and Galeries Lafayette in Paris.
For many of the world’s leading luxury retailers, this new legislation has potentially huge implications. In 2015 spending on luxury goods in China (mainland) totalled US$22.5 billion, but that pales in comparison to Chinese luxury goods spending abroad, which was more than double that amount.For department stores such as Harrods in London, Chinese footfall has become a crucial revenue stream. Harrods even has in-store UnionPay ATMs and a dedicated Mandarin-speaking sales team. The cap on UnionPay ATM withdrawals seems almost certain to harm sales, at least in the short term.
Many brand leaders in the luxury goods industry have been bemoaning unfavourable global trading conditions for some time, and their impact on China’s formerly fast-growing luxury goods market. This new clampdown on overseas spending by Chinese shoppers is another headwind to contend with, and could be the most disruptive to date.
The Chinese government hopes that the higher tariffs will encourage stronger luxury goods demand in the domestic market. However, the price differences between China’s formal market and the grey market will continue to prevail, and, if anything, could on the one hand turn the grey market into a more attractive shopping platform but on the other hand it could encourage fake branding which is already commonplace in the grey market.