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COVID-19 accelerates repatriation of Chinese luxury goods spending

China's swift rebound from the economic disruption caused by the COVID-19 pandemic and continuing global travel restrictions look set to further increase both the level of spending on luxury goods taking place on the mainland and the country's importance to the industry's major companies.

Chinese consumers accounted for about 35% of the global personal luxury market in 2019, yet just 11% of the purchases were made on the mainland, according to consultancy Bain & Co. and Italian industry body Altagamma. Much of Chinese citizens' luxury spending has typically taken place in Hong Kong and various European cities during vacations.

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The standstill in international tourism is accelerating domestic spending, but this is a trend that precedes the pandemic. High-end handbags, clothes and jewelry have become more affordable in China since 2018 when the government reduced value-added tax from 17% to 13%. At around the same time, it began a crackdown on the practice of daigou, whereby agents or tourists purchase luxury goods abroad for resale in China.

More recently, the weaker Chinese yuan and protests in Hong Kong have also prompted more Chinese consumers to shop at home. Purchases in China are expected to account for 26% to 28% of the global personal luxury goods market by 2025, with Chinese shoppers making up almost half of the total market share, according to Bain & Co. and Altagamma.

China has stepped up efforts to expand duty-free shopping as domestic travel has resumed since the Labor Day holidays in May. The local government of Hainan is reportedly in talks with Galeries Lafayette Haussmann and the DFS Group LP for a potential partnership in the province's duty-free shopping zone. Duty-free sales in Hainan jumped more than 230% in July after the government tripled the quota for purchases to 100,000 yuan for every shopper.

The expansion of duty-free shopping, coupled with price harmonization by the luxury groups, will replace some of the purchases made overseas even when international travel resumes, said Veronica Wang, partner at consultancy OC&C.

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China affirmed its outsized importance on the luxury goods sector on Aug. 6 when LVMH Moët Hennessy - Louis Vuitton Société Européenne unveiled its spring/summer menswear collection at a fashion show held in Shanghai in front of a live audience. The French company said it experienced a "strong rebound" in China when reporting its second-quarter earnings.

Given the importance of this market to driving growth for the next few years, luxury brands must adapt their products and strategy to the needs of Chinese consumers. But it could be a tricky path to navigate.

The backlash suffered by Dolce & Gabbana Industria S.p.A. over a perceived racist advertisement in 2018 serves a lesson in cultural sensitivity, while Kering SA-owned Balenciaga's new handbag release for the Qixi festival, the Chinese Valentine's Day celebrated Aug. 25, has been criticized for its poor "rural" design, far removed from the European aesthetics that the Spanish brand is renowned for.

Local festivals such as Qixi; 520, another version of Chinese Valentine's Day that falls on May 20; and March 8, known globally as International Women's Day but celebrated as Queen's Day among young Chinese women, are prime opportunities for luxury groups to drive consumption.

"More brands began tapping into digital channels to engage with consumers starting with 520, but the outcome fell below expectations then because the market was just recovering then and companies did not have time to make adequate preparations," Wang said.

While luxury brands have built an online presence in the Chinese market over recent years, the pandemic has forced them to venture beyond their comfort zones. Louis Vuitton attempted livestreaming in March on social commerce platform Little Red Book to mixed reviews.

"Livestreaming for luxury brands is a different kettle of fish compared to what we usually see on Taobao Live [the popular Alibaba Group Holding Ltd.-owned livestreaming and e-commerce channel]. It is more content-heavy for new product launches, rather than focused on sales," said Chris Gao, luxury goods analyst at investment bank China Renaissance.

Methods such as livestreaming may not immediately convert into transactions but they help luxury groups raise brand awareness and reach out to consumers in lower-tiered cities where there are fewer stores, said Kevin Jiang, president of international business at JD Fashion and Lifestyle, during a webinar session hosted by the Jing Daily publication in August.

"In almost 100% of cases in luxury, the fundamental decision to buy a brand is decided before the person goes to the store. It is decided online. A consumer will not come to your store if you have not convinced him or her online," said Daniel Langer, CEO of luxury strategy firm Équité and professor of luxury strategy at Pepperdine University in California.

Tencent Holdings Ltd.'s WeChat messaging app is the most popular platform among leading luxury brands, according to Bain & Co., where its Mini Program function is used for various marketing and customer management functions.

The recent executive order by the Trump administration to ban transactions on WeChat may affect U.S. luxury groups including Tapestry Inc. and Capri Holdings Ltd.'s Michael Kors. However, the impact on the bottom line is unlikely to be material as very few transactions take place on the app, said Gao. Luxury brands are unlikely to reduce their presence on WeChat while the scope of the ban remains undefined given its large user base and entrenched ecosystem, she added.

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The short-term outlook for luxury goods companies looks grim. Bain & Co. and Altagamma expect the market to contract by between 20% and 35% in 2020 with estimated sales between €180 billion and €220 billion, while McKinsey forecasts a drop of up to 39%.

Against this backdrop, the importance of the Chinese market will only grow further. Though it will not completely offset weaknesses in other geographies, the 9% contraction in Chinese luxury spending in 2020 forecast by Altagamma compares favorably. Major shopping festivals toward the end of the year, including the Golden Week holiday in October and Singles Day festival in November, should deliver some relief to the luxury sector as long as the COVID-19 outbreak remains well under control in China, according to Gao.

"Every brand has to ask themselves: 'Is what we are doing relevant to Chinese consumers? Is our brand proposition, assortment relevant to Chinese consumers?'"Langer said.