European Luxury Is More Chinese Than Ever
Designer labels will need to contemplate a wave of European store closures as they become more dependent on China for sales
The world's top luxury brands make much of their European heritage, but their future is looking more Chinese than ever. However this contradiction plays out in the long run, it poses one immediate problem: too many boutiques on their home continent.
Amid all the uncertainty about how the Covid crisis will change business, it is probably safe to say that designer brands will be more reliant than ever on sales to Chinese shoppers--and on Chinese turf.
Before the new coronavirus hit, labels like Birkin handbag maker Hermès and trench coat specialist Burberry were already making more than a third of their world-wide sales to consumers from China, who overtook Americans as the top luxury shoppers by nationality back in 2011. The crisis may amplify the trend as Chinese consumers recover their appetite for top-end handbags and watches faster than Americans and Europeans. Burberry, which reported its full-year numbers Friday, said shoppers have queued outside some reopened boutiques in mainland China.
The International Monetary Fund expects the current health crisis to hit the U.S. and European economies harder than China. And Chinese luxury consumers, who are almost two decades younger and less indebted than their Western counterparts, can afford to spend a larger chunk of their disposable income on designer baubles. Already there are signs of what stock analysts are calling "revenge spending" as lockdowns lift in Chinese cities and shoppers head to the mall. Consulting firm Bain estimates that by 2025, up to 49% of global luxury sales will be made to Chinese shoppers, an increase from the consulting firm's earlier forecast of 46%.
The expectation of a fairly rapid, China-led recovery partly explains why some luxury stocks have been resilient this year, despite forecasts of a 35% fall in industry sales this year compared with last--three times the decline recorded in 2009. Shares in Hermès are up 3% since the start of the year, while sector bellwether LVMH Moët Hennessy Louis Vuitton is down 14%. The Stoxx Europe 600 index has fallen 17%.
However, capturing spending by Chinese consumers is trickier now that worries about infection have hobbled long-haul travel. Last year, China's shoppers made 70% of their luxury purchases abroad or in Hong Kong, often on overseas trips to Europe where it is much cheaper to buy designer goods. A Louis Vuitton Speedy 25 handbag currently costs 46% more in Shanghai than in a European boutique, according to a price comparison by analysts at brokerage Jefferies.
As air-passenger numbers aren't expected to recover to pre-Covid levels until 2023, brands now need the Chinese to spend at home instead.
Bain estimates that sales made within mainland China itself will almost triple from 2019 levels to €88 billion by the middle of the decade. Some labels such as Gucci and Burberry already have plenty of boutiques in the country. Others like Christian Dior, owned by LVMH, have fewer. They are likely to open new outlets or invest heavily in online platforms and logistics to capture more spending through e-commerce.
Ramping up sales capacity in China has an awkward corollary in Europe. Brands will face tough decisions about whether they can afford to keep as many locations open closer to home--Prada currently has 230 stores in the region, for example. Last year, half of all sales made in European luxury shops were to overseas visitors.
Business has dried up overnight, with little immediate prospect of returning. Revenue generated in Europe is expected to be 14% lower by the middle of the decade than last year, Bain estimates. Labels understand the branding power of a store on the Rue Saint-Honoré in Paris or London's Bond Street, but less prominent locations may be quietly closed up or downsized.
Brands probably have less to worry about in the U.S., where stores are far less dependent on sales to tourists. That said, the outlook is far from clear: The key to continued demand for luxury goods among well-heeled Americans is how well the stock market holds up.
The luxury sector isn't as exposed to China as some other industries--mining giant BHP Group generates up to 70% of revenue there, according to RBC Capital Markets analyst Tyler Broda--but it has raced ahead of other consumer categories. Even Apple made just 15% of its net sales there in the three months through December, before the Covid-19 outbreak closed its Chinese stores.
This dependence on one nationality carries risks, even if luxury companies have no choice. Aside from the possibility of a China-specific crisis, there is the question of brand image. Among Chinese consumers, there was a certain cachet in traveling to Europe to buy designer handbags or clothing that often weren't available in local boutiques. And the marketing myth of European haute couture may be trickier to maintain when the locals show so little interest in the goods--though this has been the case for some years now.
As luxury brands turn further to the east, they will have to work hard to disguise an ever more lopsided look.