As featured in Womens Wear Daily (WWD) on May 30th, 2018.
Growth of the middle class will boost sales of higher end goods, including luxury items.
While the growth trajectory of China’s economy is easing a bit, it’s still higher than that of its more mature counterparts in the West.
More importantly, consumer spending isn’t showing any signs of slowing. That’s good news for luxury brands at the high end and for mass and discount lines at the low end. And it’s the increase in discretionary spending by Chinese consumers that likely will give the government the impetus to maintain a “steady Eddie” pace of 6.5 percent growth for the balance of the year.
Michael McCool, a Hong Kong-based managing director at AlixPartners, said, “China’s growth is still positive, although from its high growth rate in 2012 [the economy] is glowing a lot less bright….When you look at Western economies, a growth rate of 3 or 4 percent is perceived as extremely strong. So for China, coming down from 15 percent to 6.5 percent looks like quite a jolt and seems to be a downturn, but in fact the economy is still growing.”
McCool said the history in China has been that whatever figure the government has targeted for growth, it has achieved. “The Chinese government would have preferred a lower growth rate, but there are huge expectations from the middle class. The priming by the government [to achieve] a 6.5 percent growth rate will ensure that it will meet the middle-class expectations that their quality of life will increase. As their income level rises to above average, that will tie the government into a 6.5 percent growth rate,” he said.
Erwan Rambourg, global cohead of HSBC’s Consumer & Retail Research, observed that as long as gross domestic product is solid, there’s “no reason for luxury consumption to falter as luxury demand is correlated to psychology — the feel-good factor — rather than to the GDP growth rate.”
According to Goldman Sachs Research economists Jan Hatzius and Jari Stehn, global economic growth is pegged at 4 percent for the year, versus GDP growth of 3.7 percent in 2017. By country, they are predicting a 6.5 percent growth rate for China this year. That’s in comparison with their estimate of U.S. GDP growth of 2.5 percent. Also at the 2.5 percent forecast level are Germany and Spain, with France at 2 percent and the U.K. at 1.3 percent. The emerging countries of Brazil and India are faring better, at 2.7 and 8 percent, respectively.
A more centralized government under President Xi Jinping suggests a framework for better economic decision-making and control, as well as confidence in the government’s ability to successfully micromanage at the sector level, according to a December commentary called “What Can We Expect in China in 2018?” by Gordon Orr, a director emeritus of and senior external adviser to McKinsey & Co.
Xi became the seventh president of the People’s Republic of China on March 14, 2013. It was Xi who spearheaded the plan to crack down on “corrupt” officials the year before he took office. He came to power in November 2012 when he was named general secretary of the Communist Party following the downfall of former Communist Party Chief Bo Xilai due to corruption.
Western luxury brands, particularly those that manufacture super high-end timepieces, were hit hard by the pullback on gift-giving to party officials during the three-year antigraft campaign. New guidelines were introduced in 2015, and the bigger issues for the country seem to be industrial recession as the government continues its shift to a consumption economy amid high debt levels.
Zhou Xiaochuan, governor of the People’s Bank of China, warned in December at a Group of 30 seminar in Washington that the country’s corporate debt was too high and that fiscal reform is needed to curtail local government spending. Some of that debt is due to borrowing to finance vehicles owned by local governments.
Containing what is a growing debt bubble is a tough balancing act, at least if one wants to avoid a hard landing. Stuart Brister, president of the Commercial Services Group at Wells Fargo, works with companies in the U.S. and in China on trade and supply-chain financing. With the increase in consumer spending, wage increases and more citizens joining the ranks of the middle class, he said the government has to take on a proconsumption mentality — one that it really can’t reverse. “The economy is growing so much faster in the cities than in the rural areas. They are thinking that if we don’t do something to help the situation, we’ll be dealing with unrest and social issues,” the banker said.
Looking ahead, there’s also the looming trade war between the U.S. and China. While the political rhetoric between the countries has its own ebb and flow, it’s also too early to predict what would be the precise impact on both sides regarding imports and exports.
Peter Navarro, assistant to U.S. President Donald J. Trump for trade and manufacturing policy and director of the White House National Trade Council, is a well-known critic of China, and authored a book in 2011 titled “Death by China: Confronting the Dragon: A Global Call to Action.” As economic adviser, he’s also been a vocal opponent of the North American Free Trade Agreement and the Trans-Pacific Partnership. Navarro believes that China’s unfair trade practices make it difficult for American companies to compete.
Michael Zakkour, vice president at global business consulting firm Tompkins, with a specialization in China that’s focused on e-commerce and its consumers, said some believe Navarro has an extreme view on trade protection, and that it’s his influence over the years that has guided the Trump administration’s stance toward China. While Zakkour said there’s been some mixup of facts, there’s also one thing that’s clear: “No one has ever made a good deal with China by scolding them publicly and making threats. Both sides stand to lose….The implications from a trade war between China and the U.S. is that no one will come out as a winner, even if each side claims short-term victories in specific battles.”
Meanwhile, China has seen a migration of younger consumers from the countryside to the cities. A McKinsey report — “Meet the Chinese Consumer of 2020” — by coauthors Yuval Atsmon, a principal in the consulting firm’s Shanghai office, and Max Magni, a principal in the Hong Kong office, projects that the rapid growth of wealth in China will grow the middle class to a group it dubs “mainstream consumers,” a cohort of 400 million by 2020 that would represent 51 percent of the urban population. That’s up from an earlier estimate of 200 million in the 2010 time period. The consulting firm projects the mainstreamers to average between $16,000 and $34,000 in annual household income. Those above $34,000 are considered affluent, but they would comprise an “elite minority” at just 6 percent of the population in 2020. Still, that 6 percent would translate into 21 million affluent households, or 60 million consumers, McKinsey said.
The growth in “mainstream consumers” would also shift the consumption focus from just basic needs along the value chain to higher-end goods, such as a family car and small luxuries, and eventually to an oversize television and overseas travel, the McKinsey report said.
AlixPartners’ McCool noted that Chinese consumers will spend on luxury products at the high end and discounted merchandise at the low end, while skipping the midmarket segments. An example he gave is the beauty sector, where consumers will spend “several hundred U.S. dollars on the high end for skin care, and at the same time use a mass-branded shampoo. It’s about the way they decide to spend money, what they value and where they purchase. The Chinese consumer will make those trade-offs.” He is forecasting that luxury spending will continue to grow, adding that the revenues lost by luxury brands from the government crackdown on conspicuous consumption has eased as spending by the consumer base continues to grow.
Apparel spending in China is flat in dollar terms, although there’s been “huge growth of online sales,” McCool said. He attributes that to price competition online. Moreover, the limitations connected with China’s infrastructure in the past have curtailed the growth of high-street fashion stores and malls. That means that today’s middle-class consumers jumping onto the shopping bandwagon are getting their first taste of consumerism for apparel brands and other consumer goods via the mobile channel.
At a recent Abercrombie & Fitch Co. Investor Day presentation, chief financial officer Joanne C. Crevoiserat spoke about the company’s transactions in China across Alipay and WeChat, and about a recent visit to the country. She said the overseas team challenged “us to spend the entire week on those two platforms. …It is amazing how customers in this market leverage those two platforms in their day-to-day lives. They are completely integrated with those platforms…”
Amitaabh Malhotra, chief marketing officer at digital commerce platform Omnyway, said, “The consumer engagement is between two and two-and-a-half hours a day spent on WeChat. That includes the consumption of media and gaming. All dayto-day activities are on WeChat — it has a tremendous monthly engagement of users at one billion.”
Omnyway’s platform helps retailers stay connected with consumers during the in-store shopping process through their mobile phones. According to Malhotra, the Chinese social media firm added payment as a function for its site about five or six years ago. A scan of a QR code links the user’s ID to a bank account for payment. Between Alipay and WeChat, there are 5.5 trillion to 6 trillion transactions annually, a number Malhotra said will go up. He noted that “even brick-and-mortar stores are on the system, including the local corner deli in China. Even for daily labor services such as plumbing, payment is made using WeChat.”
The criticism the chief marketing officer had about luxury brands in China is that not all have included WeChat as a payment platform option. “Traditional luxury is a little behind the curve on this one. Even on the digitalization of the e-commerce experience, most luxury brands are more focused on store design and events centered on the VIP experience. But with the way things move in China, [and the lack of a physical retail shopping infrastructure to start] consumers have leapfrogged into the market that has become hyperpersonalized.
“WeChat has become the single channel for consumers that have a lot of money and very little time. Because of trust issues [such as counterfeiting], the preferred shopping method is following someone you trust, and buying based on their recommendations. This is not shopping in-store for that touchy feeling, it’s shopping with a digital feeling,” Malhotra said.
But even if luxury brands have been slow in their learning of how to adapt to the Chinese marketplace, it certainly hasn’t stunted consumers’ thirst for luxury goods.
HSBC’s Rambourg said, “In terms of premium demand, we have seen the higher end outperforming the more accessible price points — in handbags and accessories, the upper-end European brands [are] outperforming the value for money propositions from the U.S.”
Rambourg expects Chinese luxury demand to remain strong this year. In his coverage group, he has a “buy” rating for Kering, Tiffany & Co. and Tapestry Inc.
“Clearly for luxury, consumers are buying at a younger age, and some of the megabrands like Louis Vuitton, Gucci or Cartier have done a very good job in terms of capturing the interest of that young, wealthy consumer. The average consumer of luxury in Asia is likely in her mid-20s, a lot younger than her European and American peers,” Rambourg said.
As for brands in the early stages of developing a presence in China, Rambourg believes that Tapestry is well-positioned for expanding its newest baby, Kate Spade, into the market. Tapestry, then known as Coach Inc., acquired Kate Spade & Co. in May 2017 for $2.4 billion.
“There is a great opportunity to seize for Kate [Spade] in China as the positioning is very young, feminine — the future of Chinese luxury consumption is female — [as well as] quirky and cute.…I am convinced the brand equity and personality fits well with Chinese aspirations,” Rambourg said.
According to Tompkins’ Zakkour, he considers LVMH Moët Hennessy Louis Vuitton as the proxy for the health of the luxury industry in China. “LVMH’s quarterly numbers were great, and they directly attributed that to growth in China, now their largest market,” he said.
In Zakkour’s observations of the luxury market, he said there’s no one key group that’s doing the bulk of the buying. “Whether it’s the upper class, the upper middle or the middle class, they’re all buying in different ways at different times for different reasons,” he said. One example he gave is the Millennial consumer, who will “only drink Hennessy cognac. They will pay a premium for that, but they’re also not the sixth generation of the wealthy consumer who is buying the $6,000 handbag.”
Even demographic changes suggest that there’s more room to grow as China moves toward a consumption-driven economy.
“We do know what does drive luxury in China — it’s the Millennials and younger generations. The average luxury buyer is 20 years younger than their cohort in the U.S. In the U.S., the average age is 33 to 55, while in China the vast majority are between the ages of 18 to 30.
“While there’s some price-sensitivity to some items, it’s not really present with luxury items. If you look at Hennessy, they don’t discount any of their brands, ever, and they’re doing pretty well. The big change for luxury is, where do they fit into the overall digital commerce landscape? Where do they fit into the strategic evolution of Alibaba and JD.com? [And] we’re seeing a desire by Chinese consumers to buy more luxury goods — including apparel and beauty — online.…What we have is the perfect storm coming together for mass digital commerce in China,” he said.
Zakkour explained that without any legacy systems to overcome— brick-and-mortar, banks and the financial system, landline infrastructure — it’s been easy for the consumer to adapt to the newest and latest big thing to come along. Smartphone adoption in China has been the highest in the world, and that has contributed to the growth in mobile and mobile shopping, he said.