When marketing experts predict fast-rising sales of luxury goods in China, Sue Song is exactly the sort of person they have in mind. Young, upwardly mobile and employed at a private equity firm, Song shops every few months for her favorite brands: La Mer cosmetics, Lancel and Gucci handbags, and Tod’s Italian shoes. “Those brands mean something to women,” says Song, a 34-year-old Shanghainese professional. “They are attractive and elegant. They mean a good lifestyle.”


The luxury lifestyle is hot, as evidenced by the 2007 Millionaire Fair held in Shanghai in June. The show, twice as big as the one in 2006, displayed 150 top global brands to 14,000 mainly middle-class consumers from major cities who paid RMB 600 ($79) each to look at assorted luxury wares.


Powered by glittery shows like the Millionaire Fair and by consumers like Sue Song, China’s luxury goods market is in excellent shape. Sales are growing 20% to 30% per year, and the top companies are still opening stores in the capitals even as they extend their brands deeper into second- and third-tier cities. Further, according to analysts, luxury sales should continue to grow for many years: Already the third-largest global market for luxury goods, China is poised to eventually take over the number one spot.


A luxury good, broadly speaking, is any product that a buyer will pay a premium for, above and beyond its utility. In a November 2006 report called, “Luxury Brands in China,” the Hong Kong office of KPMG defined luxury this way: “More often than not, luxury is … an inessential but desirable item or a state of extreme comfort or indulgence. What sets luxury brands apart is that they command a premium without clear functional advantages over their counterparts…. This makes the luxury market particularly interesting because it represents consumption at its most hedonistic and seemingly irrational. Purchasing [is done] for the personal pleasure it provides, despite the financial cost.”


Optimistic Outlook

The luxury goods industry in China is currently riding a wave of optimism, based on several key considerations: One is China’s rapid economic growth, which has generated a small but growing middle class, and a smaller, but also growing, newly rich class. These groups are the key buyers of luxury products. China’s expanding wealth is not in question, although the extent of it is sometimes overstated. For example, a middle class household in China, as defined by a Shanghai-based market research company called Access Asia, has an annual income of only $5,000.


Further fuelling the optimism is China’s unique culture, especially as it relates to consumer buying habits. The KPMG survey found attitudes toward luxury goods to be generally positive in China. Many people on the mainland wish to buy luxury goods, and relatively few of them have negative opinions about people who own and flaunt expensive handbags, handmade Swiss watches, pricey cars and other luxury products. By and large, most of them simply wish to buy those products themselves.


This unique buying culture is one of the key drivers of luxury goods sales in China, says Tom Doctoroff, CEO of Greater China for advertising agency JWT (J. Walter Thompson), and author of the book, Billions: Selling to the New Chinese Consumer. “Luxury sales as an aggregate are absolutely booming in China, and the reason is that luxury brands are tools for further advancement,” he explains. “China is a very hierarchical society, and very ambitious, so luxury products [not only] mark where you have traveled up to, but they also give you permission to continue succeeding. In China, success breeds success, so you can see that luxury brands in this context are very important. This leads to a much broader swath of the middle class population being seduced by the items.”


Other aspects of Chinese culture also bode well for sales of luxury goods. One is the tradition of gift-giving during the Lunar New Year, and another is the concept of face. “You have to look at the rationale for buying luxury brands,” says Rupert Hoogewerf, publisher of the Hurun Report, a luxury business magazine that also compiles the annual China Rich List. “Asians are concerned with face, and they also have a gift-giving culture. The high point for the fast turnover of luxury goods comes at the Chinese New Year when everybody gives each other presents. That would obviously include apparel, drinks, watches, Mont Blanc pens, etc. And from a business point of view, face is very important …. [So, for example], you would expect a big business to have a luxury car.”


Still another positive is the perceived quality of branded goods. The KPMG report surveyed 830 people across China, with the help of market research company TNS, about their luxury goods feelings and preferences. In that survey, more than 70% of the respondents, all of them with minimum incomes of at least RMB 3,000 [$396] per month and all of them living in first- and second-tier cities, agreed with this statement: “I appreciate the superior quality of luxurious brands, not simply the pursuit of famous brand names.” It was by far the most positive response to all the KPMG survey questions about attitudes toward famous brands.


“There was strong agreement in our survey that owning luxury goods demonstrates success and status, and it also showed that many people long for luxury goods, even though they cannot afford them at the moment,” says Anson Bailey, principal of business development for China and Hong Kong, at KPMG.


The profitable experiences of luxury goods sellers in Hong Kong are also fuelling optimism about the mainland market. Hong Kong was the first city in China to be exposed to luxury sales on a large scale, and as the people became wealthier, their appetite for luxury products soared. That combination generated huge sales, with Rolex watches strapped to the wrists of t-shirt-wearing 20-somethings, and expensive cognacs, cigars, handbags, belts, designer suits and luxury cars, including Rolls Royces, all much in evidence.


Doctoroff believes Hong Kong is a reasonable bellwether for what might happen in China. “What you have in Hong Kong is a more advanced consumer culture and higher disposable incomes,” he says. “So their awareness and fluency in brands and their ability to navigate a brandscape is much more sophisticated than the mainland Chinese. But the role of luxury in their lives, given people at similar levels, is still more or less the same.”


The “Ghost Mall” Mystery

Another big advantage for certain brands in certain locations, although it is an advantage that may not last, are low retail rents. Because of their perceived status, and because they are magnets for other fashion vendors, select companies often negotiate sharply discounted leases. Plaza 66 on Nanjing West Road, the top luxury mall in Shanghai, is a good example.


Visitors to Plaza 66 might well be puzzled over its obvious shortage of shoppers. Even during rush hours or on weekends, the mall is very quiet and empty, and the shops themselves often contain only salesgirls, while shopping bags filled with luxury goods are nowhere in sight. Yet according to experts, the answer to the riddle has nothing to do with the tastes of Shanghainese consumers. Rather, the luxury goods sellers in Plaza 66 don’t need or even want big crowds, because they pay little or no rent for their top-of-the-line locations.


“The lack of people in Plaza 66 doesn’t matter,” says Wang Lei, senior manager of retail sales at the Shanghai office of property consultancy CB Richard Ellis. “Plaza 66 targets very high-end shoppers, and high-end outlets aren’t supposed to be busy. Luxury brands don’t necessarily want the mall to be busy, because the number of consumers they target is just a few.”


In addition, says Wang, the landlord is willing to offer sharp discounts to the top brands. “For someone with power like Louis Vuitton, for these market leaders, the rest of the brands will follow them to a location. The landlord doesn’t necessarily need them to make money, so those companies can get away with quite low rentals. And sometimes the landlord will even throw in some free renovations, because the other brands will follow. This is the market practice.”


Giving favorable rents to “anchor tenants” is not unique to Shanghai, but according to Paul French, manager of Access Asia, Plaza 66 is an extreme example. “The government said it would like the top end of Nanjing Road to be luxury all along the ground floor, so the malls there have basically given away the space to the luxury brands,” he says. “They are paying virtually zero to be in those malls. Another reason is if you look at Plaza 66, which is owned by the Hong Leong group, how do they make their money? They lose money on the mall, but they have 66 floors of grade A office space — some of the best office space in Shanghai — which they have people fighting to get into. So they make their money off the office space, partly because the ground floor is all luxury goods, and it looks like one of the swankiest places in town.”


Major Challenges Ahead

Despite the reasons for optimism — occasional very cheap rents, an enthusiastic buying culture, the country’s rising wealth and the example of Hong Kong — luxury vendors in China face some tough challenges, such as understanding and overcoming regional differences and cultural barriers, as well as counterfeiting, high taxes and often, a remarkably poor understanding of the China market. It is a different market than the West, and consumers in China buy high-status products for unique reasons. In addition, it is a country with distinct regional differences, high taxes and rising rents. The success or failure of luxury goods companies and their products will vary enormously depending upon how they deal with these variables.


“There are very strong regional differences, and the history of overseas brands is quite varied in different regions,” says Hoogewerf, publisher of the Hurun Report. “The key one is that Shanghai prefers European products and Beijing prefers U.S. goods, but if you look at the drinks market, Remy has been very strong in northeast China and Hennessy has been very strong in the big cities. The regional differences are bound to come out strongly; there is a large geographical distribution, and I would be very surprised if the market were the same everywhere.”


As one of China’s richest cities, and the mainland city most exposed to western ways, Shanghai is another one of the key fashion bellwethers. And here, in China’s most cutting-edge city, there are some cultural differences that could spell trouble for luxury vendors. “Respondents in Shanghai were, in many respects, the most cynical in their attitudes to luxury and the least likely to own luxury brands as a status symbol,” says the KPMG report. In addition, the report notes, people in Shanghai were the least likely to regard owners of luxury brands as fashionable, successful or having good taste, and they were more likely to regard them as show-offs, nouveau riche and wasters of money. Those findings are significant, says Bailey. KPMG is currently conducting a second survey that may shed further light on the issue.


Another cultural barrier is the Chinese tendency to save money. Hard work and simple living have long been cherished virtues among the Chinese, plus a desire to save for the future. “That is something that mitigates against luxury sales,” says French. “Chinese at the moment are not obsessed with handbags; they are obsessed with assets, and what the Chinese are buying at the moment is property. This argument that everyone will make a lot of money on the stock market and go out and buy handbags — well, no, they won’t. They will pay their mortgages off.”


Taxes also raise the prices of luxury goods significantly: Most luxury goods in mainland China (but not Hong Kong) are subject to a 10% consumption tax, 17% VAT and 24% luxury goods tax. Those taxes, combined with the opening of Hong Kong to mainland tourism, have sent many would-be buyers to Hong Kong. Sue Song is a good example. When she travels to Hong Kong on business, she prowls the malls in search of bargains. “I frequently shop in Hong Kong because it is cheaper,” she says. “They have very specific promotion seasons, like before the Chinese Spring Festival and before Christmas. At those times, some of the big shops will send us email notices about their promotions.” 


Counterfeiting is another problem, says Bailey of KPMG, although perhaps not a particularly serious one. “In our survey, we noticed a correlation between the counterfeited brands and the most successful brands,” he says. “Rolex, Omega and Rado watches were popular. In clothing it was Versace, Chanel, Gucci and Valentino that were the most counterfeited. For bags and footwear, it was Dunhill, Louis Vuitton and Gucci. All the luxury brands I talk to say, on the one hand it is a serious issue, but on the flip side, these are all potential customers.”


Alarms for the Marketers

Some of the problems faced by luxury vendors are self-inflicted, and are often caused when companies fail in their market research. “The luxury cars are doing the best job of marketing, but many brands, particularly in fashion, tend to have a lot of their communications done centrally, out of Paris or New York, with very imagistic advertising that doesn’t connect to the aspirations of Chinese people,” says Doctoroff. “Very few people are tailoring their communications for the Chinese in China.”


JWT’s Doctoroff believes that advertising should be more directly aimed at the unique aspects of the China market. “Most fashion and luxury brands associate themselves with a feeling, an emotion, a lifestyle, without ever taking the structured disciplined approach to unearth insights,” he says. “So you have a lot of ice goddesses staring down from billboards on commercial streets, but nothing that provokes or engages. That is a big problem, because unless you can establish loyalty with all the new brands coming up, you will be hot one minute and cold the next. What you have now is a tide that’s coming in for luxury, and the entire luxury market rising collectively, but very few powerful brands.”


Then there is that time-honored tendency among overseas companies that target the China market: excessive optimism. “A lot of companies look at China’s 1.3 billion population and immediately think it is a pot of gold. That is absolutely not the case,” says Bailey. “There are a lot of risks. They need to do their market research, analyze it and weigh the risks. Many companies underestimate that aspect of it.” Among the other problems, he says, are those shared by all retailers in China: rising rents, finding and retaining the right staff, and vigorous competition.


The IPO Factor

The stakes are high, says Hoogewerf, because the companies that succeed now will be well positioned for future success. “The key thing is that it is first generation we’re talking about, so whoever builds their image today in a strong way has a very good opportunity to develop it later on. If you take Cartier, for example, in the West it is already three to four generations advanced. Sophisticated western buyers have a strong impression of Cartier, whereas in China, people first met Cartier just five years ago.” 

Of course, much of the optimism is predicated on future economic growth. “China will be one of the world’s largest luxury markets in the next five years,” predicts Bailey. “Today the Chinese are already more brand savvy than they were. The upper class people appreciate luxury products, and they are seen as a mark of success. Also, the number of businessmen and women is increasing. That number grows with every IPO that takes place in China.”