China's Economic Malaise Will Widen the Gap Between Luxury’s Winners and Losers
How luxury players can survive China's prolonged economic winter, Chinese New Year campaigns take a turn for the bizarre, and why Chang’e 4's moon landing matters. Read China Decoded to make sense of the market.
SHANGHAI, China — When Apple CEO Tim Cook rang in the New Year by sending letter to shareholders warning of an earnings downgrade for the first quarter due to waning Chinese demand, stocks of international consumer goods companies, including some fashion and luxury players, shuddered.
With slowing GDP growth, the world’s worst performing stock markets in 2018, real estate uncertainty and an ongoing trade war with the US, there has been little in the way of positive economic news emanating from China in recent months.
“Urban households are in the doldrums as trade war fears, Xi’s financial de-risking campaign and a strict policy on real estate have dampened confidence. China’s middle class have now grasped that they are living in a very different world under Xi,” explained Diana Choyleva, chief economist at Enodo Economics.
Adding to the bad news pile, last week saw two high profile business leaders in China publicly and uncharacteristically warning that a protracted economic cold spell could hit the country.
Baidu CEO Li Yanhong, also known in English as Robin Li, sent a New Year letter to employees that in part warned that China's economic restructuring is “as cold and real as winter to every company", in spite of Baidu's positive performance in 2018, which saw the search engine surpass 100 billion yuan, or $14.6 billion, in revenue, a 20 percent increase over 2017.
This came only days after self-made billionaire Chen Hongtian, in a speech to the Harmony Club, an elite gathering of tycoons, warned that “winter will be very cold … it’s hard to predict and all that I can say is that difficulties [for private enterprises] are much bigger than people expected.”
The assumption that consumer confidence would also wane in the face of what are complex and serious macroeconomic challenges is therefore not an unreasonable one. It’s already being felt in the watch market, with the Federation of the Swiss Watch Industry reporting a slump in China sales in November, and the country’s watchmakers lowering their expectations for orders over the next three months.
“I don't have a very positive outlook for China's economy in 2019, I'm sorry to say," Sara Hsu, associate professor of economics at the State University of New York at New Paltz, tells BoF. "I think a number of factors have to change in order for China's economy to do well again and for people to start spending more, especially on luxury goods. It's possible that this will pick up again by 2020 but it will take significant reform of the Chinese economy,” says Hsu.
On the other hand, some consumer companies have reported strong China growth in recent months. At the end of December, Nike announced that its fourth quarter sales were up 31 percent in China, and Q1 fiscal 2019 results from international beauty giants Estee Lauder and L’Oreal reported strong sales growth in the country (even so, all saw share prices drop in the wake of Apple’s poor earnings forecast last week). Luxury players Tiffany & Co., LVMH, and Richemont have called out China’s economic malaise as reason for lowered expectations and results in recent months.
However, China’s so-called ‘coming winter’ masks a more complex market story. For luxury companies in particular, a more pertinent issue than an overall slowdown in economic output or consumer spending is the question of which consumer groups are most likely to be tightening their belts and whether there are other market forces contributing to the success or failure of individual consumer brands in the country.
Apple, for example, has seen intense competition in the Chinese marketplace from local smartphone makers who have innovated at a faster pace and offered similar quality products at a lower price point — Huawei last year overtook Apple as the world’s second largest smartphone vendor, and they, along with Xiaomi and Oppo, increased their market share in the third quarter.
In contrast, within the luxury fashion and beauty spheres, there is no domestic player to compete for market share with global giants such as LVMH and Gucci parent, Kering.
Mario Ortelli, managing partner of luxury advisors Ortelli & Co, is confident that China’s luxury spending will still increase in 2019, even if it is at a slower pace than that in 2018, with opportunities particularly apparent for those who have prepared for increased demand domestically.
“Repatriation of the luxury spend will continue and it will favour the brands with a strong retail network in China, established domestic e-commerce operations and relationship with the local digital platforms,” he said.
“I expect that the consumers will be more discerning and will polarise their purchases towards their favourite brands and therefore we will see an even higher gap between winners and losers.”
The increase of domestic luxury spend has been a major luxury industry story in China over the past 12 months, with recent research from HSBC predicting a 50/50 balance is “in sight” a far cry from the three-quarters of luxury purchases made by Chinese consumers outside of their home country as recently as 2016, according to data from McKinsey.
Some luxury companies that have become reliant on traveling Chinese spend have left themselves over-exposed to changes in consumer patterns.
“Brands like Tiffany & Co definitely run the risk of being exposed as they rely heavily on Chinese buyers shopping internationally and we may see consumers economising on overseas trips this year,” said China Market Research Consulting's senior researcher Benjamin Cavender.
The extent of the fall in overseas purchasing will be difficult to gauge until after the all-important Chinese New Year holiday at the start of February, when the extent of any overseas spending slowdown will become more pronounced.
In terms of getting an early 2019 read on overall consumption in China, the recent three-day public holiday to celebrate the Western new year saw retail sales grow more than six percent in Beijing and more than 10 percent in Shanghai over the same period last year.
China’s Ministry of Commerce is predicting a nine percent rise in retail sales this year, a similar rate to the 9.1 percent recorded over the first 11 months of 2018 (the most recent figures available).
“[But] the reality is that the majority of consumers who are driving luxury spending right now in China are still able to spend but they are worried about the future so may be holding back on purchases,” Cavender said.
“This means that there is still a lot of opportunity for luxury brands but they have to be tighter about planning their product launches and inventory and have to work harder to provide retail experiences that will bring consumers in store and get them to spend because consumers will be thinking more about each purchase."
China may indeed be entering a prolonged economic winter, but that doesn’t mean uniform suffering for luxury brands who remain responsive to the needs of Chinese consumers.