01/01/2007

China, the next Japan?
China has barely paused for breath this year in its rise to global power. For the third year in a row, its economy is on track to grow by more than 10%. China has spawned a new cast of millionaires and an emerging middle-class centred in large cities on the coast. This new wealthy elite is hungry for luxury brands. According to Merrill Lynch, in 2004 China already accounted for approximately 11% of global luxury goods sales. By 2014, it is expected to catch up with Japan and America and represent 23% of the market.

China nevertheless remains a two-tier economy with its wealth and economic development being concentrated in the Yangtze River Delta, the Pearl River Delta in Guandong and the Beijing-Tianjin corridor. Population estimates for these areas range from 250-300 million, of which around 7 million are estimated to be middle class; this compares to Japan’s total population of 130 million. The pace of development, as well as population growth (both organic and from migration) in these key areas are likely to be a more accurate barometer of luxury goods consumption than the development of China as a whole.

Luxury retail presence still limited
The bulk of luxury goods purchases by China are accounted for by Chinese tourists. The mainland market is believed to account for only 2 to 3% of industry revenues. Even though luxury outlets are opening up in key metropolitan areas such as Beijing, Shanghai and Guangzhou, Hong Kong remains the favoured shopping destination for mainlanders as, not only is there more choice, luxury goods are cheaper in Hong Kong than in mainland China, where heavy import duties and value-added taxes can add up to 35% or more to the price of luxury goods.

The retail presence of European luxury brands in mainland China is still relatively limited; for example, Gucci has only 10 stores in mainland China compared to 54 stores in Japan alone and 61 elsewhere in the Asia-Pacific. Currently there are no branded luxury department stores in mainland China. Luxury brands therefore have to rely on own retail expansion for sales growth, either through boutiques in hotels and shopping malls or standalone stores, rather than on developing a wholesale network.

Profitability remains an issue
It is estimated that only one out of ten consumer brands currently present in mainland China is profitable, as the market is not yet large enough to accommodate but the strongest brands. Leading players such as Cartier, which has been present in mainland China for 15 years and is one of the leading luxury jewellery brands there, are supposed to be barely breaking even as they continue to invest in building the brand’s image through heavy advertising (Cartier apparently spends about $9million on advertising) and a growing retail presence.

Manufacturing today, branding tomorrow
China has proven its credentials in terms luxury goods manufacturing. The country is shaking off its reputation as the counterfeit centre of the world and an increasing number of luxury brands are re-locating their production from Europe to China. Signs of homegrown design talent are also emerging – China’s fashion week is an established fixture, having celebrated its tenth anniversary in 2006, and a small number of up-and-coming fashion designers are already catering to China’s affluent.

China’s government is keen to foster young talent. It is estimated that there are more than 100,000 students attending fashion courses. During the last year, we have met a number of Chinese companies whose focus is on developing local talent and domestic brands. Could the pace of China’s evolution from a pure manufacturing concern to a developer of brands catch us by surprise?