The New Habitat of China’s Luxury Market

The decline in luxury spending in China, coupled with the government’s anti-graft campaign, has led to a series of new trends

By Canice Kwan, PhD Candidate, Department of Marketing, CUHK Business School

After eight years of consecutive growth, luxury spending by mainland Chinese consumers recorded a negative trend for the first time in 2014. Since then, there have been controversies and concerns about China’s future market potential for luxury goods. In an attempt to sustain their profits, many luxury brands have adjusted their strategies. They have started to move the battlefield from the overseas market—where mainland Chinese tourists purchase a copious amount of name brand products—to the mainland market. By expanding the scope of domestic consumption, these companies seek to retain Chinese consumers on their home turf and thus earn more RMB, which has inflated considerably in recent years.

Many consumer analysts have kept an eye on the “price harmonization” strategy adopted by an increasing number of luxury brands. This reform is a critical experiment that steers away from the long-time price differentiation strategy previously used. Taking a lead in harmonizing their global pricing, the French fashion house Chanel and luxury group LVMH’s biggest watch maker Tag Heuer earlier announced price cuts in some markets, particularly China, while freezing the prices in the Euro market. For example, Chanel has slashed the prices of its three best-selling signature bags by 20 percent. This price cut has fueled the passion among Chinese luxury good enthusiasts.

Since the price-cut announcements were made, crowds of shoppers stormed the Chanel stores in mainland China and Hong Kong, with all inventory of the three bags nearly sold out. Seeing Chanel’s success, Gucci also offered the biggest discount ever in its stores in China’s first-tier cities. Other brands such as Hermès, Givenchy, Prada and YSL have also announced similar price cuts. Apparently, price harmonization has brought some success to the luxury brand companies, especially in seizing profits from the gray market. However, is it still too early to make such a conclusion?

The ‘Daigou’ Market

Since a decade ago, Chinese luxury buyers injected new blood into the global luxury market. According to Bain and Co, their spending has accounted for over 25 percent of the global market, with two-third of the spending made overseas (including Hong Kong and Macau). Surprisingly, the huge spending by Chinese shoppers overseas could hardly help luxury brand companies maximize their profits. One key reason is that the price differentials across countries were significant and this has given rise to a prosperous gray-market business, known as “daigou” (代購) in Chinese.

“Daigou” refers to an unofficial channel of commerce, in which an overseas agent purchases luxury goods on behalf of customers in mainland China and gains a profit from the price differentials. Almost all purchases of this kind are made online via some free social networking applications such as WeChat and Weibo. Once the customers have indicated their desired products and made the payment, the agent would help purchase the products and ship them back to China. According to the Bain study, this service had an estimated market value of RMB 55 billion (US$8.96 billion) to RMB 75 billion in 2014. Among the study’s 1,400 respondents, 70 percent reported that they used the service. Thanks to the convenience and competitive pricing, mainland consumers rely heavily on this service while many overseas Chinese run it as a part-time business. The interdependence between customers and agents has cultivated a thriving market for luxury products. However, this also poses threats to the manufacturers’ profit margins.

As Chinese luxury spending seems to be declining while the exchange rate risk is escalating, the threats arising from daigou service can no longer be ignored by luxury brand companies. As we have seen, these companies have opted for price harmonization to regain the lost ground in the mainland. To understand the effectiveness of this new strategy, we should take into consideration not only the temporary boosts in sales it brings, but also the extent to which it can reduce Chinese consumers’ reliance on daigou. It seems that it is not easy at all to counter the strong influence of daigou.Why?

The Challenges for Luxury Brands

Mainland consumers love using daigou not just because of the competitive pricing and convenience it offers. Though less apparent, the daigou service has created value that fulfils the emerging needs of Chinese luxury consumers. Let’s look at the three main trends that have emerged in the past few years.

First, Chinese consumers have become less conspicuous in luxury spending due to the anti-graft campaign initiated by the Central Government in 2012. Stringent measures were introduced to eliminate corruption among officials on all levels. A couple of senior officials were arrested because the media had caught them wearing luxury brand watches, belts and other clothing items. Nevertheless, there remains an insatiable desire for luxury goods. Even though officials are not allowed to consume luxury goods themselves, their spouses can still do so in an understated manner. Instead of purchasing from local luxury stores, a significant number of them prefer shopping overseas in an impersonal way via agents. This largely reduces the risk of being spotted.

Second, Chinese consumers have become more sophisticated and educated. A McKinsey report highlighted that a growing number of Chinese luxury consumers perceive showing off luxury goods as exhibiting poor tastes and would shun overt displays of wealth. Nowadays, they can acquire information on the latest fashion instantly through the Internet. Thus, they have become more educated about the cultural heritage of the brands and more aware of the product models that are not available in the mainland market. They would no longer equate the most expensive goods with the highest-quality ones. Given that there are differentials not only in price but also in the types of products available, many luxury consumers rely on the agents for acquiring unique products and private label items that have not entered the mainland market. With this new kind of sophistication, price harmonization may only be sufficient to retain loyal customers. Its effectiveness in helping companies enlarge their earning potentials is nevertheless elusive.

Last but not least, the changing demography of the wealthy population should not be ignored. The McKinsey report predicts that a considerable number of the newly rich will emerge from the developing cities such as Chongqing, Tianjin and similar-tier cities where most luxury brands have not fully penetrated. In this sense, not all potential consumers in China have found a way to purchase luxury goods in a convenient way. As the market leaders experiment with price harmonization in top-tier cities only, the emerging population of the newly rich in other provinces clearly do not benefit from this move. Due to convenience and other abovementioned benefits, these newly rich may need to continue relying on daigou. To feed their appetite, luxury brands should consider expanding their distribution channels.

In view of the new habitat of China’s luxury market, playing tricks in prices may not be sufficient to retain consumers and increase their spending. When defining the competitive landscape of the luxury market in China, luxury brands should not disregard the daigou market and the benefits it offers the consumers. Apparently, price harmonization is a critical step in the quest to boost luxury consumption in China. To survive, luxury brand managers have to update their understanding of Chinese consumers and consider factors other than pricing.