Luxury|Apr 07, 2016

Luxury Firms React to China Economic Upheaval

Luxury Firms React to China Economic Upheaval

with contributions from PAULINA SZMYDKE

When it comes to China and its ongoing economic turmoil, brands must look to the long term — and change strategy.

That is the consensus among analysts and industry executives regarding the fallout on luxury and fashion brands from last week’s stock market meltdown and interest rate cut. They agreed that the upheaval would likely have some impact in the short term, but brands must recognize that in the years ahead, the Chinese will remain key consumers — provided they target them in the right way.

In the meantime, brands already are beginning to scurry to trim their budgets in preparation for the reverberations from the China storm. As growth there slowed as a result of new shopping patterns and changing consumer tastes, many firms that had expanded aggressively began to either slow store openings or shutter stores in poor locations. That process is likely to only speed up, analysts said.

According to Franklin Yao, chief executive officer of Shanghai-based consultancy SmithStreet Solutions, there is little doubt that waves of economic pressure are difficult to spin as good news for luxury firms in the short term.

“There’s no way we can say any of the shocks in the Chinese economy are good for luxury brands. There’s no kind of miracle that is going to change this,” he said.

Despite today’s reality, Yao sees many firms slashing budgets and closing China stores as a long-term restructuring project to capture, over the next five to 10 years, the upper-middle class Chinese consumer. These consumers, who already number in the hundreds of millions and are increasing each year, are the major hope of luxury brands looking to replace the spending power of elite shoppers, hardest hit by both the Chinese government’s corruption crackdown, stock market fluctuations and currency devaluations.

“It’s a huge bracket of consumers. Of course, they won’t be spending the same per capita as the elite, but there are so many of them. Luxury brands have to be more patient and think long term. In the short term, they are going to be disappointed,” Yao said.

“The long term is going to be even better than we were seeing three years ago, just because of the sheer number of people coming into this upper-middle class group,” he added.

As for store closures and slashed budgets, Yao believes the changing nature of the Chinese luxury consumer necessitates a change in strategy, which shouldn’t necessarily be seen as a negative for growth potential.

Last year, Chinese luxury sales fell 1 percent compared to 2013 at 115 billion yuan, or $18 billion at current exchange rates, according to a report by Bain & Co. Last week’s stock market plunge in China — and subsequently elsewhere around the world — only stirred growing fears about the strength of the sector in the world’s most populous nation. Between Aug. 10 and 24, shares of the 16 main companies in the luxury sector — including LVMH Moët Hennessy Louis Vuitton, Compagnie Financiére Richemont, Hermès, Swatch, Burberry, Moncler, Christian Dior, Kering and Prada — lost 15.9 percent of their value, according to Erwan Rambourg, analyst at HSBC.

Brands such as Gucci, which had 63 stores in China at the end of last year, have seen sales flatten in recent years, and according to parent company Kering’s annual report, “The pace of Gucci’s network expansion has been reduced to focus on consolidation of the existing infrastructure, notably in Mainland China.”

Prada continued its aggressive openings in China throughout 2014, with stores added to outposts such as Xinjiang, in the country’s far west. Planning to add 10 stores to bring its China total to 60 by the end of that year, an unsuccessful financial performance, which saw year-on-year China sales drop 4 percent, is likely to lead to the firm scaling back its openings in second- and third-tier cities, analysts said.

As well as the increase in overseas spending and the changing nature of luxury consumption in China, where people now will spend more on experiences and balancing that extra expenditure by spending less on status-defining handbags, CMR China managing director Shaun Rein pointed to an unsustainable series of openings in tier two and three cities as a major reason for brands needing to rethink their number of stores in China.

Meanwhile, according to Rein, other brands are closing 30 to 50 percent of their points of sale in the country and “regrouping” in major, first-tier cities.

“There has just been a lot of poor planning by luxury firms. They saw the market was growing so fast here, they opened points of sale without thinking about the economic viability of the locations. It was just sort of helter-skelter, companies would come in and just jump on any spot in a mall that was open,” he said. “These malls in general are just blowing up because these sales to Chinese consumers in general were just never sustainable. But a lot of these luxury brands looked the other way because they got free rent or low rent for the first two or three years and now they actually have to start to pay rent, they are obviously losing a lot of money.”

Like Rein, RTG Consulting partner and ceo Angelito Tan believes that the current predicament of brands has less to do with outside factors, such as the government’s corruption crackdown and more to do with poor strategy from brands.

“Although brands traditionally known for high-end gifting were certainly affected, it is misleading to say that this was the major cause, and in my opinion, the impact of this factor has been exaggerated. Revenue and profit declines are also related to a strategy that wasn’t properly thought through,” he said.

“When speaking with retailers, it is astounding how many new entrants have not thought of some of these issues. They believe the myth that a retailer can just open a store similar to what they operate in other markets and the consumers will come flooding in. Often this couldn’t be further from the truth,” added CR Retail consultancy managing director James Rogers.

Smaller luxury brands, such as Lanvin, Givenchy and Stella McCartney, which have taken a more slow and steady approach to openings in the China market, still have room for some expansion, particularly in first-tier cities, according to analysts, as consumers turn away from large and overexposed luxury houses.

“Luxury isn’t dead, it’s just changing,” Rein said. “With the economic slowdown, luxury sales will drop, but they aren’t going to plummet much longer. But you’re going to see some bad numbers coming from some brands because consumers are moving away from them and looking for newer, more niche, and accessible luxury brands and some of the Chinese ones.”

In a note to investors, Exane BNP Paribas argued that “moderate RMB devaluation” would have a very low single-digit negative impact in luxury players’ profits. With reference to Chinese luxury demand, on the other hand, it suggested to “look at things by nationality, not by geography.”

Luxury goods sales in China have declined, but Chinese consumers are buying more around the world, driven by continued growth of a luxury-hungry middle class, it said.

China Luxury Advisors’ Avery Booker believes a key issue at play is a generational shift in Chinese luxury consumers that brands have either failed to grasp, or failed to market to with any great efficacy.

“When you see people like Prada blaming that on the China market leveling off, in reality if you dig around a little bit, they really haven’t changed their strategy for the market at all in the last two years. They’ve continued to operate these stores, kind of the same sort of marketing campaigns. They keep working with the same sort of influencers and KOLs [Key Opinion Leaders].

Really the key here is that the new consumer that entered the market in the last two years is very different from the traditional shoppers before the crackdown, the older generation,” he explained.

This generational change is a factor playing into the hands of smaller luxury brands, which are popular with these younger shoppers.

According to parent company Kering’s annual report, Yves Saint Laurent saw an overall increase for the year in Greater China of 42.6 percent last year.

Hermès has also taken its time with China openings and is planning to open “one or two” new China stores in 2015, according to Florian Craen, executive vice president of sales and distribution for the company. Axel Dumas, the company’s ceo, last week said he remained upbeat about China, echoing comments a day earlier from Michele Norsa, ceo of Salvatore Ferragamo.

Accessible luxury brands are also planning to continue opening stores in China for the foreseeable future, with brands such as Michael Kors, Tory Burch and Coach looking to capitalize on the growth in that sector among Chinese consumers. But the situation on the Mainland is distinct from that in Hong Kong and Macau, where brands at all levels are complaining that rents are way too high. Coach last week revealed plans to shutter its Hong Kong flagship on Queen’s Road Central, although it still has 21 other stores in Hong Kong.

Even as some firms may be trimming their store portfolios, analysts believe this is only a short-term situation and a rejiggering related more to consumer trends than to the aftershocks from the stock market meltdown.

“As Chinese consumers spend more of their luxury dollars outside of Mainland China, luxury brands may be looking to trim their retail network there,” said Luca Solca, analyst at Exane BNP Paribas. “This, I think, is the most likely action. Cutting brand support and communication does not strike me as a likely step, as you want to maintain visibility with your clients, wherever they are buying,” Solca said.

He added that trimming store presence is to be done with “extreme moderation.”

“You never know what happens to currencies, for example — and if the CNY weakened further, more Chinese would buy at home and you’d need stores to serve them,” he said.

Tan agreed. “I don’t see brands closing stores across China as a lasting trend. With smart brands acquiring a better understanding of consumers and the trends of the Chinese consumer, coupled with China’s vested interest in boosting domestic consumption, I believe the potential for domestic consumption is still strong. The Chinese luxury market is still very exciting. Smartly while reducing tariffs, the Chinese government is simultaneously enforcing customs to stem parallel importing. This means bringing prices closer to international levels to encourage domestic consumption.”

Even as this is taking place, though, Chinese tourism is driving luxury goods sales in countries like Japan and Korea — as well as in Europe and the U.S. The rise in spending by Chinese tourists contributed to a 27.5 percent increase in tourism spending in Europe in July and a 31.9 percent rise in global tourism spending, as reported, according to Global Blue data analyzed by Barclays.

Visa Europe calculated that non-French Visa cardholders spent 1.3 billion euros, or $1.42 billion at average exchange, in France in the month of July. That’s 10 percent more than in July 2014. China lead the pack, up 83 percent, followed by United Arab Emirates (up 78 percent), and U.S. (up 28 percent). Consequently, Chinese shoppers in France moved up from rank 12 to rank 6, by nationality.

With the growth in e-commerce, and more recently m-commerce, as well as the growing numbers of Chinese consumers purchasing their luxury goods overseas, rejigging a strategy to match the reality on the ground is common sense, observers said.

“Does Louis Vuitton need 80 stores across China? Or do they need really good stores supported with a global store network and omnichannel service platforms? You can match the same amount of sales with 15 stores,” Yao said.

For now, firms are taking a wait-and-see approach toward China’s recent economic turmoil, and whether it stems luxury spending long term. Dumas, for one, said it was too early to tell what impact the devaluation of the yuan and the slide on the Chinese stock market would have on his business.

“Will the Shanghai stock exchange negatively influence the consumer’s morale? It’s something we need to be vigilant about, but so far China has resisted well — and so has Hermès,” he deadpanned.

Exane BNP Paribas’ Solca cautioned that developments in China are to be watched closely. “A ‘soft landing’ shall be taken by luxury companies in their stride. A ‘hard landing’ could have very serious negative impact, as it would probably cause a global recession on the back of it.”

Antoine Belge, luxury and sporting goods analyst at HSBC, said, “It remains to be seen what impact the recent developments in China will have on Western luxury goods companies. It’s a question of psychology. You never know how that will play out.”

The article originally was published at WWD on August 2015:

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