With contributions from Fergus Fleming, US India Strategic Advisors
Gold rush or long term investment?
From the press commentary and the increasing frequency of launch parties in Mumbai and Delhi, it would seem that India cannot get enough of luxury brands. Latest to stake its interest, Hermès has just announced it established a joint venture company to open stores in India, with a first unit expected in New Delhi. Many analysts indeed view India as the next untapped big market opportunity after Russia and China.
The India consumer growth story is well established: forecast GDP growth of 8% p.a. for the next ten years, with projected growth rates in the “sheer rich” to “super rich” category (annual income above $100,000) set to average at 25% p.a. over the next five years to over 500,000 households. The organised retail market is set to explode, from less than 5% of the current estimated $12 billion value of total retail spending to an estimated $25 billion in five years according to some surveys, driven by an unprecedented construction boom for in-town and out-of-town malls led by India’s most successful industrial groups including Reliance Industries, Bharti, Tata Group, ITC and Birla. Amongst many projections, Deutsche Bank estimates that, over the next three years, 600 new shopping centres will be developed in India.
Our concern is that much of the hype about organised retail sales growth is based on a number of self-reinforcing “chicken and egg” assumptions, and that the reality will be somewhat less than anticipated. Retailers often cite the rate of mall construction to support their total sales projections, and developers cite the projections of retailers to justify the investment being made in mall construction. A simple walk around Mumbai’s leading modern format mall, called Inorbit, suggests that the supply of sophisticated retail facilities does not automatically translate into product demand and strong retail sales (with the exception of the food court, which is packed). This is all the more telling as Inorbit continues to enjoy ‘novelty’ appeal and no meaningful competition.
The implications of similar assumptions being made in the luxury end of the market are potentially far more serious. Projections of growth in disposable incomes and the absolute number of ‘super-rich’ appear to have facilitated a simplistic approach to corporate decision making. When it comes to market entry decisions being taken by some luxury brands, it seems to be more ‘Field of Dreams’ (if you build it they will come), than decisions based on a clear understanding of the nature and challenges of the market.
Barriers to entry remain
A restrictive regulatory environment, the cost and availability of appropriate infrastructure, the lack of brand awareness and the very limited media outlets for marketing make establishing a successful luxury brand business model in India considerably more challenging than might first appear. Added to this, the potentially underestimated price consciousness of an emerging consumer class brings into question the widely held assumption that India is about to embark on a branded luxury goods spending spree from Armani to Zegna and a little bit of La Perla and Mont Blanc in between.
India remains a largely protected market with respect to foreign entrants, partly in order to afford Indian businesses time to establish a competitive platform before the market is opened to global powerhouses. Multi-brand retailers have to operate through franchisees and license agreements whilst mono-brand retailers can own up to 51% of their businesses in India.
Aggregate duties on imported luxury products are prohibitive: up to 35% on apparel, 45% on accessories, 60% on watches, shoes and perfume, all augmented by interstate duties (in some cases 8%) and VAT of 12.5%. Given that the wealthy Indian elite targeted at present by luxury brands is likely to be well travelled, the incentive to buy locally is not only diminished by the significant price premium but, arguably, also by the diminished cachet of buying a $3,000 bag at the local mall instead of, say, Bond Street.
Last but not least, the infrastructure necessary to support a commercially viable luxury brand development strategy in India is largely lacking. In spite of isolated examples of investment such as DLF’s Emporio in Delhi, the reality is that there is no retail infrastructure in India that can be compared to developments in other fast emerging markets in Asia, the Middle East or Russia, let alone Europe and the US. With the possible exception of LVMH which has the critical mass to drive a largely independent positional strategy should it wish, most luxury brands are opting for India’s premier hotels as a location solution out of necessity rather than choice. The problem with this is two-fold: firstly, the mostly international business clientele of those hotels does little to enhance sales to wealthy locals and, secondly, the cost of such retail space is usually prohibitive, both in absolute terms and as a percentage of sales.
The belief in the benefits of local partnership can be misplaced
The numerous challenges facing new market entrants have limited the preferred route of many international luxury brands and forced the alternative of either a joint venture with a passive or active partner or, as in most cases to date, a licensing or distribution agreement. Such joint ventures and license agreements will face substantial challenges. At the heart of those challenges will be the misalignment of economic expectations between the local partner and the luxury brand as well as the lack of genuine brand experience of the majority of potential partners in India.
International luxury brands may well view their entry into India as a long term strategy with a justification based more on brand building and the wallet of the international Indian, rather than expectations of meaningful returns from the local operation. However, large Indian retailers and local business promoters, who are striving to be the local partner to international luxury brands are arming themselves with inevitably optimistic sales projections and building substantial businesses out of nothing, with very significant license acquisition, real estate, fit-out, inventory, duties and salary costs, all of which are committed largely in advance. It is unlikely that most local partners or licensees in India will generate a positive return on their investment in the expected timeframe.
Whilst misjudging sales may not be directly meaningful for the brand owner, it can be hugely so for the local partner. The particular concern here is that the local partner might in turn attempt to improve its return by cutting costs where it can; more often than not this means marketing and brand development.
Zegna learnt this lesson the hard way. The company initially opened a licensed outlet at Mumbai’s then leading mall in 2000. In spite of the positioning and expectation at the time the store closed, not so much because of disappointing sales, but because of the adverse impact on the brand positioning due to a deterioration of the brand environment, which included a McDonald’s restaurant opening next door. The company has just reopened as a majority owned business in the Taj Hotel. Whilst Zegna’s near term earnings will be impacted by the cost of space at the Taj, they can control a long term brand building strategy based on appropriate pricing and control of their environment rather than be driven by the shorter term economic requirements of a local partner.
The long term opportunity for luxury brands in India is substantial. However the near term risk of potentially dysfunctional, brand-eroding partnerships and license agreements will compromise more than just near term financial returns. The lesson of Zegna, as for others, is to commit fully both in management time and money to build for the long term and accept that there is no short cut or low cost way to build a high value luxury brand in India. The alternative would be to spend a fraction of the money that it would cost to establish a retail infrastructure in India on an advertising campaign that builds brand awareness amongst a sophisticated and increasingly affluent and cosmopolitan Indian population. With the number of distribution and licensing partnerships which have been announced over the last couple of years, it seems that the majority of international luxury brands are taking a middle ground approach which many might regret.