The luxury brand market in general has continued to defy the global economic downturn, posting sustained growth especially in the East, with China continuing to grow at a much faster rate than the traditionally established markets of Japan, Italy, Europe and the U.S. However, China’s recent slowdown has affected the luxury industry, with a recent report by Bain citing that global luxury goods sales are expected to grow by 5 percent this year, compared with 13 percent last year. Despite that, the might of the Chinese consumer has vaulted the country into the top echelon, as it becomes the world’s second largest luxury market this year, topped only by the U.S. However, as the Chinese buyer grows increasingly more sophisticated, international brands face an evolving set of obstacles.
Luxury companies also continue to eye India; as one of the world’s fastest growing economies with an increasing number of high net worth individuals, it is well placed to capture a significant market share. Will the newly released FDI regulations give this sector the much needed boost it has been waiting for?
GUCCI AND GIVENCHY: GRAPPLING WITH CHINA
According to the Bain report, Chinese luxury goods sales are set to rise by 8 percent at constant currencies and 20 percent at current currencies, while last year they climbed to 30 percent on both measures. Burberry, Hermes and other brands have reported slowing revenue growth in Asia over the past year; however they have still performed well, with LVMH up 4.1 percent, Burberry up 17 percent and Hermes up 9.4 percent. Now, Chinese buyers make up half of all the luxury purchases in Asia. So what challenges do these international brands face?
“It’s not about the new brands per se; it’s not about entering China anymore,” says Helena Huang, partner at King & Wood Mallesons, “now, it’s about expansion within the country. Luxury brands are expanding from the first tier cities into the second, and even the third.” As these companies expand, Huang points out several challenges that arise, namely nailing down the correct legal structure for the brand. “Once you have regional headquarters in China, how many stores or subsidiaries are you going to set up there? You have to get this structure right from the very beginning because coordinating between different cities and different provinces can be very difficult,” she says.
Part of that legal structure and strategy is choosing your distributor and joint venture partner, another process that can be problematic. Gabriela Kennedy, partner at Hogan Lovells, elaborates that: “In China, the extra difficulties are how you are going to do your business in that market; are you going to choose a distributor? You have to be very careful and make sure that they have the right legal contract to protect your position. Are you going to trust and license a local party and enter into a joint venture? Brands need to have their exit strategy in advance, in case things don’t work out.”
Inevitably, data protection issues also raise an ugly head. Alongside fake shops and counterfeit products, market sources also point out that in their eagerness to enter China, many luxury brands do not ensure that they possess the best portfolio in terms of the protection that they need in the market. Kennedy says that: “Very few brands actually consider thinking about their Chinese brands; they come in with a foreign name but you have to educate your consumers on how that is pronounced. The reality is that most of the Chinese people will approximate, give up, and choose a Chinese name for you. If you’re not careful, it may not be the brand that you want.”
FENDI AND FERRARIS: FINDING A FOOTHOLD IN INDIA
Despite the flurry of attention devoted to India’s economy and its growing middle class, luxury brands have failed to find a firm footing here, with the sector worth only about $1.3 billion, accounting for 1 to 2 percent of the global luxury market. Myriad reasons underline this lack of growth, from scarcity of retail locations to incredibly high import duties. But industry experts point to foreign direct investment regulations as one of the primary obstacles.
Previously, India’s FDI laws capped foreign ownership of retail operations at 51 percent, but in a high profile decision earlier this year, the government officially lifted restrictions on foreign investment in the retail sector, which would allow international luxury brands like LVMH, Burberry and Gucci to acquire 100 percent ownership of their India operations. Aparna Mittal, partner at Luthra & Luthra says: “When the new policy was announced, there was palpable excitement in the market, anticipating that the market would really open up. However upon closer examination, there remain some ambiguities in the way that this policy has been drafted.”
The main requirement is that foreign companies intending to invest on the 100% route are required to source 30% of their production from India. Mittal continues that, as luxury brands are associated with a particular quality and sometimes even geographic associations, (such as Thai silk, or Swiss watches) sourcing from India may entail some significant commercial challenges. Many brands will be unable to alter their “Made in France” or “Made in Italy” specifications, leaving them no wiggle room in the new sourcing requirements.
FDI reforms aside, several other challenges remain. Jai Pathak, partner at Gibson, Dunn & Crutcher, recounts that, “In the new policy, at least $100 million must be invested in the relevant multibrand retail company, and 50% of the foreign investment proceeds must be invested over 3 years, in backend infrastructure. The foreign investor needs to factor that in to his financial model as he thinks about investment in multibrand retail in India.”
Distribution is also a sticking point, says Rahul Sharma, managing director of retail consultancy firm Neev Capital. Sharma comments, saying: “Up till now, the route has been to go to a five star hotel and set up shops there; the approach has been very piecemeal. The local customer comes to the flagship, but it’s a showcase; he will actually purchase the goods when he travels to Europe or the U.S. It’s almost like an advertisement as opposed to a serious approach of making the product available.”
A DIAMOND-BRIGHT FUTURE
It is evident that luxury brands still face hurdles when it comes to entering the subcontinent and the problem is far from resolved, even given the recent reforms. However, taking a long term view, Pathak says that “the government is moving very aggressively and clearly intends to push through economic reforms and attract foreign investment given the recent slump due to the uncertainty over tax treaties and taxable transactions.”
Sharma agrees, relating that the demand for and awareness of luxury goods is prevalent in the Indian consumer, and global brands need to start taking India more seriously as a potential market.
Hopping across to China, a similar outlook emerges. The number of rich Asians exceeded that in the U.S. for the first time this year (see “A Wealth of Opportunity”, in ALB’s September issue) as reported by Capgemini and RBC Wealth Management. Home to now 3.37 million high net worth individuals, 17 percent of Asia’s wealthy are based in China, and their appetite for luxury goods may be insatiable. Huang sums up, by saying: “There may be some adjustment in growth due to the slowdown, but Chinese wealth is still at a very early stage. This market has not matured yet, and has great potential.”
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