Why Luxury’s Recovery in China Is Uneven
The wealthy may be in a mood to splurge but middle-class consumers remain cautious six months after the end of ‘zero-Covid’ policies due to mixed signals in the Chinese economy.
Chinese luxury spending is uneven across categories as cautious sentiment and limited outbound travel impact some consumer groups more than others.
Recovery is being driven by a smaller pool of high-net-worth individuals who are the most insulated from volatility in the wider Chinese economy.
Brands that are more heavily exposed to younger, aspirational shoppers could find recovery to pre-pandemic levels more protracted or challenging.
LVMH chairman Bernard Arnault is said to be planning a trip to China. His counterparts from Kering, Prada Group and Capri went there earlier this year to help steer their companies through the ‘post-zero-Covid’ era and now it’s Arnault’s turn. It is a critical moment for everyone in the luxury industry. While spending has already started to ramp up again in the all-important market, it remains a far cry from 2019 patterns.
In 2022, pandemic disruptions pushed the Chinese luxury market to contract 10 percent year-on-year, according to Bain & Company, its first decline in years. In addition to strict lockdowns and supply chain snarls, spending was impacted by dampened consumer sentiment, as higher unemployment rates, a fragile real estate market and broader Covid anxiety dented confidence.
Buoyant demand in the West — in particular, the US market — offset the slowdown for some players in China, helping companies like Louis Vuitton parent LVMH, Chanel and Hermès hit record revenue levels for another year straight. But now, as spending in the US begins to cool, the luxury sector is relying on a strong rebound in Chinese spending to continue to propel their top lines, especially after the ‘bumpy ride’ that many brands endured in the first half of the year.
The overall performance of companies reporting earnings in recent months seems to suggest that Chinese spending is well on its way to recovering in spite of muted sales in long-haul destination stores due to capacity issues in China’s outbound travel sector. But as the wealthiest shoppers are the most insulated from volatility in the Chinese economy, it is the most high-end brands that look set to benefit the most.
Chinese Recovery Underway
The strongest luxury brands have started the year off on the right foot, with a “robust rebound in domestic China demand” contributing to sturdy performance, said Deutsche Bank analyst Matt Garland in a recent note, pointing to Hermès, Moncler, LVMH and Richemont as examples.
Many brands first felt the impact of China’s reopening around the Lunar New Year holiday in late January. Ralph Lauren, LVMH, Chanel and Moncler were among the companies to report high double-digit growth in the region in the quarter following the end of lockdowns.
“In mainland China, we’ve seen a good recovery following the lifting of restrictions in January,” said Burberry CEO Jonathan Akeroyd on a call with media in April, noting that between January and March, spending by Chinese nationals was up 23 percent year-on-year.
Gucci parent Kering also reported “a clear recovery and acceleration of the Chinese cluster” in the most recent quarter, according to Kering chief financial officer Jean-Marc Duplaix, even though group revenue growth lagged behind market leading rivals like LVMH and Hermès.
Anecdotally, analysts and luxury executives visiting the mainland in recent months have reported buoyant demand and encouraging levels of traffic in the big cities. But even though data suggests that some big spenders are opening their wallets, other consumer cohorts crucial to China’s luxury market are behaving more cautiously.
The result is that not all brands are benefitting equally. Tod’s noted a slow start to the year in China, with sales only improving from the second half of January. At French accessible luxury group SMCP, parent of Sandro and Maje, recovery only became more evident in March.
Given the uneven picture, executives like Cartier parent Richemont’s chairman Johann Rupert have been careful to strike a more cautious tone.
“The Chinese have saved an enormous amount during the last few years, but being highly astute, they still have a bit of nervousness about returning to the pre-Covid lockdown, which was traumatic,” Rupert said on a media call in May. “Will it continue to grow? Yes. But it wasn’t the boom that we saw in the United States. They acted more cautiously.”
Fewer Shoppers Splurging
In the first quarter of 2023, China’s economy grew 4.5 percent year over year, beating the 4 percent estimate from a Reuters poll of economists. Looking ahead to the full year, the World Bank predicts GDP growth of more than 5 percent. Despite this, the broader macroeconomic situation in the country remains delicate, with various indicators suggesting post-pandemic recovery momentum is patchy.
In April, youth unemployment reached a historical high of 20.4 percent. Experts say this, coupled with a volatile stock market and a fragile housing market, continues to cast a cloud over mid-income consumers, a key consumer segment driving growth in the China luxury market in recent years. The country’s official manufacturing purchasing managers index — a measure of manufacturing activity which is often used as a bellwether for the wider economy — contracted for the second consecutive month in May.
“Four months into the reopening, China’s economic recovery can best be described as uneven, frontloaded, and still necessarily state-supported,” Louise Loo, lead economist at Oxford Economics, said in a May research note.
The knock-on impact is that luxury spending recovery is driven by a higher spend per capita among a smaller pool of high-net-worth individuals: less than one percent of customers could be driving as much as 40 percent of sales in certain key luxury malls in China, according to research by Morgan Stanley.
The current picture is a continuation of trends that emerged in 2022, as luxury sales in China skewed heavily towards brands’ top clients, according to Bain & Company partners Bruno Lannes and Weiwei Xing. Reduced foot traffic in malls hindered new customer acquisition, while the broader macro-economic slowdown mostly impacted entry-level luxury shoppers.
This shift, coupled with the fact that luxury consumption in China is “fundamentally more status-oriented,” will likely see the highest end luxury brands benefit, according to Morgan Stanley. Brands more heavily exposed to younger, more aspirational shoppers, could find recovery more challenging.
Many of these brands underperformed last year and, even though sales are beginning to bounce back, performance is uneven across companies.
Capri Holdings, which owns Michael Kors and Versace, saw Asia revenue rise 7 percent year on year in the most recent quarter, driven by China demand that was “a little bit better than we had even anticipated,” said group CEO John Idol. By contrast, Coach and Stuart Weitzman owner Tapestry raised its annual outlook after revenues in China rose 20 percent in the most recent quarter.
Tommy Hilfiger and Calvin Klein owner PVH saw sales rise 44 percent in China — although on a call with investors, chief executive Stefan Larrson acknowledged that “both Calvin and Tommy are underpenetrated” in the region, and noted the impact of their debut on Douyin last year.
Nevertheless, for more affordable small brands that have a limited presence in the market, the growth opportunity remains white hot. Ganni, which sells at a contemporary price-point while marketing itself as an accessible luxury brand, debuted two stores in Shenzhen and Shanghai last year and is now opening an additional five locations this year, across Beijing, Nanjing, Suzhou, Shanghai, and Chengdu.
“We see massive demand from the middle class, to actually buy into designer products at affordable price points,” said Andrea Baldo, noting that 70 percent of Ganni customers in China are under 30 years old. “We believe that there is a space for seven stores [opening] each year to bring in basically the presence in China very close to the presence we have in US.”
Meanwhile, pure luxury and mega-brands continue to invest in the region too. Burberry has been upgrading its stores and recruiting Chinese actor Chen Kun as an ambassador, while Hermès opened two new locations last year, in Zhengzhou and Shanghai Qiantan and Chanel is reportedly opening VIP salons in Guangzhou and Shenzhen.
Travelling Overseas to Buy
A forthcoming report by BoF Insights found that Chinese consumers across income brackets still expect most of their spending on fashion and beauty will take place within Asia between now and May 2024, with 87 percent of survey respondents indicating so. Tax discounts remain a crucial incentive for purchasing luxury goods while travelling for Chinese high net worth consumers, with 90 percent saying access to duty-free shopping factored into travel destination decisions.
Shortages of flights, which remain costly, and challenges securing visas have proven barriers for many wanting to shop abroad. In April, international airline capacity from China was still 63 percent below pre-pandemic levels, according to McKinsey, with prices for flights to popular locations like Japan and Thailand as much as double their 2019 cost.
Over the pandemic, duty-free shopping haven Hainan cemented itself as a key domestic shopping destination with a diverse range of tourist attractions. Thus far, mainlanders have mainly flocked to nearby shopping hubs like Macau, Hong Kong, Tokyo and Seoul — and more recently, Singapore and Dubai.
“We are seeing individual [Chinese] travellers with very pleasing results [in short-haul destinations]. But it’s not yet being felt, especially in Europe,” said Richemont’s Rupert. “We haven’t really seen, also, a normalisation of flight costs, they’re still at a pretty high level. I don’t think that tailwind is going to hit us this summer.”
Chanel, however, has already seen some of its wealthiest Chinese clients return to Europe. In April, spending by Chinese shoppers in France bounced back to just 14 percent below pre-pandemic levels, despite traffic levels remaining about 50 percent down, Chanel chief financial officer Philippe Blondiaux told the Financial Times — a huge uptick from last year, where spending by Chinese shoppers in France was down 90 percent.
Broadly speaking across the industry, once intercontinental travel becomes more accessible, price gaps between mainland China and Europe will likely lure more Chinese shoppers back to European fashion capitals — including grey market ‘daigou’ sellers, who have already started dialling up cross-border shopping services as lockdowns have lifted.
The discrepancies between the price of some luxury brand goods in mainland China and the rest of the world have narrowed “significantly” over the past couple of years, according to Bernstein analysis, with brands eager to encourage domestic consumption amid the pandemic. Cartier and Chanel, for example, are adopting global pricing strategies.
However, high price disparities remain elsewhere. Moncler, Prada, Miu Miu and Ermenegildo Zegna are among the brands for which Chinese shoppers will continue to pay a premium at home, Bernstein analysis shows.
“We expect these soft luxury brands with the steepest price gaps to benefit the most when Chinese travellers resume international travel to Europe,” said Bernstein analyst Luca Solca in a May note.