At the First Annual Luxury Brands Forum at the China Europe International Business School (CEIBS) in Shanghai, company executives, academics, economists, and consultants from many countries debated the current state of the luxury goods industry in China.

Forum participants made it clear they feel that China is the most important market in the world for luxury goods companies, because sales are growing so fast – by 50% a year – while sales growth in mature markets has slowed. Participants also noted that China is a relatively small market for luxury goods, accounting for less than 10% of global sales. Most speakers agreed that consumption is largely driven by China’s post Cultural Revolution generation, and that luxury goods are viewed favorably by most Chinese consumers.


The speakers also did not dispute the conclusion of a recent book called, Deluxe: How Luxury Lost its Luster, by Dana Thomas. The book suggests that luxury goods are no longer exclusive, but are mass-produced for middle class people, a point that seemed obvious to attendees at the forum. Some speakers argued that the term ‘luxury’ is an outdated concept, a 50-year-old anachronism, and said that it should be replaced by “prestige” or ”high-quality.”


Yet many questions were also raised at the forum, which was held on April 18-19 in Shanghai. For example, a vigorous debate ensued as to whether Chinese luxury brands will ever be able to compete with overseas brands. And several of the older speakers, representing a different generation than the youthful luxury buyers, were critical of the headlong consumption and self-gratification that luxury purchases represent.


Also discussed was the future expansion of luxury brands in China. Opening new retail outlets is an increasingly costly undertaking, as land, labor and construction costs rise across the country driven by competition for sites and by the steady appreciation of the RMB currency. Those higher costs will be passed on to luxury consumers. There was also discussion about whether Chinese buyers will pay these higher prices, or whether the luxury companies can sustain their current pace of expansion as costs rise. Second-tier luxury goods makers, which are not as well capitalized or profitable as the top companies, were said to be in the most danger. Some Forum participants suggested that to offset the higher costs, some brands — including LVMH, one of the world’s largest luxury companies — may be producing high-end goods in China, although they are reluctant to admit it.


Another question raised at the Forum – but not answered – was whether the recent spasms of pro-Chinese nationalism represent any threat to the luxury brands. The Forum itself featured a strong current of nationalism, as many of the speakers, especially those representing foreign brands, were peppered with antagonistic questions from the Chinese audience about Tibet and the Olympic torch, and the subsequent planned boycott of French retailer Carrefour and LVMH. As they expand their retail operations in China, the foreign luxury goods companies are expected to encounter rising nationalism in China, although this topic was not covered at the Forum.


Overall, as the Forum drew to a close after two days, a picture emerged of a market that is changing at rapid speed, a market where new brands — such as H&M and Zara, which were unheard of in China just a couple of years ago — can burst onto the scene quickly. The reason brands can appear and disappear so fast, said speakers at the Forum, is that the new generation of Chinese consumers has rapidly changing tastes. Those mercurial consumers, combined with the rapid sales growth, make China one of the most challenging and interesting of all luxury goods markets.


The China Market

China is a smaller market than most people realize, said Michel Chevalier, an industry consultant, former executive and author of a new book on luxury brands called “Luxury Brand Management”. “We estimate that the overall size of the luxury business worldwide is €170 billion to €190 billion, and China’s total is €9 billion, which is only 5% of worldwide business. It is the number one market in terms of priority and growth, but it is still a reasonably small market.”


Yet because it is the world’s fastest-growing luxury goods market, all the major global brands, and many of the minor ones, are active in the country. “The growth in China is extremely impressive – there is 30% growth in existing stores, and 20% in new stores, which adds up to 50%,” said Chevalier. “If you are not strong in China, if you do not have China in your marketing plans, your worldwide growth will not be as fast as it should be.”


As important as China is, it is not an easy market to crack, due to unpredictable consumers and rising costs. Ermenegildo Zegna, one of the world’s powerhouse brands, is a good example. The company has already opened more than 50 stores in China in more than 30 cities, and it continues to expand. “China became the number two market for Zegna in 2007,” said Paolo Zegna, president of Ermenegildo Zegna group, addressing the forum. Ermenegildo Zegna’s China sales rose 38% in 2007, year on year, and the company expects 50% sales growth in China in 2008, he said. That compares with 20% annual growth expected in Russia, 25% in India and 30% in Latin America.


But expansion in China is becoming increasingly difficult, Zegna added. “To find locations in China is not an easy task. It takes a lot of time and a lot of people, plus the money cost, so it is millions of dollars and a lot of work to open a shop.”


The rising expenses will put a partial brake on the luxury companies’ expansion plans in China, said Chevalier. “Because of these costs,  expansion in China is quite expensive and not necessarily profitable. Smaller brands like Kenzo and Givenchy: What do they do? That is not an easy question. Rents for the second tier brands are not three times less than they are for the top brands.”


To keep their costs down, some high-end brands are making luxury products in China, despite its reputation for low-end mass production. Andrew Wu, director of LVMH Group China, was asked whether his company, purveyor of such famous brands as Louis Vuitton, Hennessy, Dom Perignon, Fendi, and Tag Heuer, was making high-end products in China. Wu evaded the question.


In contrast, Zegna flatly stated that his company, Ermenegildo Zegna, is not manufacturing high-end products in China, although it may in the future. “We are not making those goods in China, not for the time being, because we see our customers acquiring a ‘made in Europe’ product,” said Zegna. “That is a must for brands like us. Despite improvements in production capabilities in China, ‘Made in Europe’ is what we offer.”


Chinese Consumers

In China, as elsewhere in the world, luxury goods are largely a middle class and upper middle class phenomenon. “The growth of the luxury sector comes exclusively from the middle class,” said Chevalier. “In Asia, it started first in Japan, then Korea, and now China. That has made the business grow, and not the brands moving into the lower ranges. With low prices, it is very difficult to break even when you open a new store in New York or Tokyo or Shanghai.”


A theme throughout the forum was that luxury goods, with some exceptions — such as very expensive cars and watches — are mis-labeled. Some of the attendees spoke against the word ”luxury”’ which was first used more than 50 years ago, and instead preferred terms like “prestige” or “high-end,” which imply good quality at a high but affordable price.


Most speakers agreed that Chinese buy luxury goods for two main reasons: as ‘aspirational’ goods, that is, as markers of their success; and because of the high quality. “Aspiration is the reason why luxury is so successful in China,” said LVMH Group’s Wu. “People are trading up in Asia, and they are looking for a better life. Consumption will have a glorious path of growth in the coming years.”


Market research seems to support this conclusion. “Among Chinese consumers, 64% of them think that luxury brands denote success, and just 1% think they denote superficiality,” said Pierre Xiao Lu, professor of marketing at Fudan University in Shanghai and a consultant for international luxury firms. Among the preferred brands in China, Lu said, are Patek Philippe, Rolex, Cartier, and Breguet watches; Hermes, Chanel, Ermenegildo Zegna, Louis Vuitton and Lacoste fashions; Mont Blanc and Cartier accessories; and Lancome, Guerlain, and Shiseido perfumes and cosmetics.


Yet the Chinese consumers, most speakers agreed, are changing quickly. In the early days, purchases were driven by the desire to show off. And while that is often still the case, Chinese consumers are also beginning to appreciate quality more than before. “The word we like most is “high quality”, and an appreciation of high quality is happening in Chinese society,” said Zegna. “At first it was more to show off, that you could afford it, but after 15 years, people are looking for quality. It is an evolution; the market is becoming more mature.”


Luxury buyers in China also tend to be younger than overseas buyers. “Customers of luxury in China are different from the overseas market,” said Wang Depei, vice chairman of China’s Economic System Reform Research Association and chief of the Shanghai Economic Forecast Institute. “Overseas buyers are 40 to 60 years old, and in China they are 20 to 40 years old.”


Because they are so young, and because they are the first generation of consumers in China – their parents and grandparents came of age during the Mao era, when there was almost nothing to buy – it is impossible to predict the tastes and preferences of buyers, said Wu of luxury powerhouse LVMH.


“There are four living generations in China, and each generation went through a very different revolution,” said Wu, explaining that the different generations experienced the Chinese Civil War, the Cultural Revolution, the Open Door Era and the current era of economic opening and growth. “There are very many faces to China, and this can confuse people. The consumers are young people who have seen nothing but economic growth in China. The changes are driven by that generation, which is a sizable market and a clever generation. So don’t jump to any conclusions too quickly about what luxury consumers are like. It is dangerous and wrong to draw conclusions from a small number of people, while forgetting that we are in the middle of a generational change.”


Chinese Brands

The strength of Chinese brands, and the quality and potential of those brands, was a point of contention at the Forum. Some speakers felt that Chinese brands are improving, and that they may soon challenge the overseas companies, while others disagreed. “It is not possible in the near future for China to have its own luxury brand,” said Zheng Yonggang, president of Shanshan Group, a private mens’ apparel company based in Ningbo, Zhejiang Province, that started in 1980 and now has 11,000 employees. “In the future, we (China) will have a (casual) brand like Polo that will be accepted around the world, but to have a Chinese luxury brand is not possible.”


Andrew Wu, of LVMH, also expressed skepticism about the future of Chinese brands. “Luxury brands change every season, like a flower,” he said. “It is not like steel making; it is more like ping pong.” Local players could produce a cheaper brand, he said, but he believes that the market is still limited.


However, Xia Hua, president of Eve Enterprise Group, said that Chinese brands are gaining a foothold and will soon become famous enough to expand overseas. “There are some good signs that Chinese people believe in our local brands,” she said. “Many successful Chinese people love our home grown brands, and some expats in China also love Chinese brands. And remember, Zegna and Louis Vuitton were first successful in their home markets before they went overseas.”


Non-Market Forces

In luxury, as in all other businesses in China, there are other forces at work besides the ultra-encouraging economic and demographic trends. The role of the government, as always, is a source of anxiety. Luxury goods are heavily taxed in China; most are subject to 10% consumption tax, 17% VAT and 24% luxury goods tax. “The government is worried about the flagrant displays of wealth, because the concept of luxury in China is not always positive,” said Wang, the economist.


As Wu of LVMH noted, there is a sharp generational divide in China, and that divide was on display at the Forum, with some of the older Chinese speakers expressing dismay at China’s obsession with consumption in general, and luxury goods in particular. “The job of a luxury brand is to satisfy the vanity of a limited number of people,” said Zheng Yonggang. “If everyone is crazy about luxury brands, it is not good for the consumer and it is not good for the country.”


Zheng also expressed some anti-foreign sentiments, which was a frequent subtext at the forum. “Plaza 66 was made by Chinese people, so why are the prices so high? Why are prices so high, but people are still willing to buy? It is a kind of blackmail,” he said, adding that foreign brands don’t understand the Chinese people, and that Chinese workers are more diligent than Italian workers. He also suggested that buyers support local brands.

Whether the recent nationalistic trend will worsen, remain as it is, or simply disappear, is hard to predict. Wang, one of the few speakers who addressed the issue, is not worried. “The anti-foreign sentiment is not a big deal – it will all pass by very quickly,” he said. “China is developing very fast, with annual double digit increases in GDP. It is one of the world’s most important countries, and everyone will have different reactions to this process.”