Luxury Retail In China
- Team Best Retail Consultants
For newcomers, the first thing to understand about China is that it is not one market, but in fact every city and region is a different market.
The Chinese are new consumers of luxury goods and therefore not as sophisticated as consumers in mature luxury markets. Many western brands are already present in China, but as the average Chinese consumer is not as aware or knowledgeable about the history and style of each luxury brand, China is a battleground for media companies promoting brand awareness. As a result, the consumer is bombarded by media messages encouraging luxury spending.
Growth of Luxury Retail in China’s First-Tier Cities
1st Generation (Pre 1992)
- No shopping mall concept in China existed prior to 1992. Luxury brands’ initial market entry strategy was to open in the arcades of 5 star hotels for the following reasons:
- It was much easier to operate under a hotel’s business license umbrella, the hotels’ luxury images were positive associations, operation management of 5-star hotels are more systematic, brand image of the hotel’s interiors are suitable, and both were targeting similar consumers
2nd Generation (1992-1993)
- When China first opened up to retailers in 1992, department stores from Hong Kong, Singapore and Taiwan were among the earliest entrants.
- Some of these department stores were successful, but most were not. The hardware (namely fit-out with narrow corridors and concession counters) in early department stores were not ideal because there was not enough space for a full range of merchandise and brands could not project their image well.
3rd Generation: (2007-Now)
- Growth of mixed use development with more spacious shopping malls with commercial, residential, entertainment and hospitality services.
- It takes time to convert the Chinese consumer from the department store shopping model to a shopping mall concept. Consumers in first tier cities and young consumers accept shopping malls more readily than the older generation. The state-owned department stores are merged to avoid foreclosures. Customers of new malls are generally young and trendy. In secondary cities, department stores are still prevalent as they cater to the middle aged and older Chinese consumer.
4th Generation
- The next-generation of luxury shopping in first tier cities will be focused on architectural uniqueness, built around separate buildings, providing luxury brands with the opportunity to fully express their brand image and fashion statement to Chinese consumer segments.
- Concept of ample space for the establishment of creative global stores.
- Outdoor malls like The Village at SanLiTun in Chaoyang district, Beijing; Daning in Zhabei district Shanghai; 96 Plaza in Pudong district, Shanghai. Xintiandi is successful for food & beverage, but the retail segment is not performing as well.
- Open malls have existed in the West for many years, but the concept of outdoor shopping is new in China. Chinese Consumer’s convertibility to outdoor shopping is a slow process, and it will catch on. Weather is also an obstacle to outdoor shopping in China, especially in China’s Northern cities such as Tianjin, Shenyang and Beijing. The weather conditions in the North are harsh with severe snow in winter, sandstorms, rain and long hot summers.
Pedestrian Street Shopping in China
Most European cities have elegant pedestrian shopping streets of some kind where customers can walk in the open along street side shops– for example Via Montenapoleone, Rue St. Honore and Avenue Montaigne and Bond Street.
However, in China, pedestrian shopping streets are almost always low-end. Higher-end retail cannot survive in such an environment in China, the reason being that the sheer population and number of pedestrians is too large. For example, on average, 1 million people per day walk along Shanghai’s pedestrian Nanjing East Road. If luxury brands were to open a store on a pedestrian street, each store would typically get 100,000 visitors per day, trying on products, but not actually making a purchase. Display products will be worn out quickly and rendered useless, but more importantly, the customers who frequent pedestrian streets in China are not the target consumers for luxury brands in China.
Retail Operations – Set Up Checklist
VAT - When a retailer imports merchandise into China, the retailer is required to pay VAT or import duty at the point of entry. Therefore the retail price in the store includes 17% VAT on sales. For example, out of RMB100, the retailer gets RMB83 net. The VAT paid at import of merchandise can be offset against the retail VAT, meaning that the retailer pays for the VAT on the differential between in Retail Price and Import Price.
Fa Piao - Chinese customers expect a ‘fapiao’ or official receipts, from the tax bureau when making a purchase. Fapiao in China carry a 5% sales tax on revenue that is borne by the retailer. Fapiao acts as a verification of purchase - in the case of defective goods, the customer can claim for refund or exchange goods. The customer can even use the fapiao to claim a tax deduction on expenses.
Warranties in China
Brands usually provide a small percentage of sales for the exchange of faulty merchandise. In some extreme cases, consumers will buy new merchandise, and after a few weeks, return to the store to claim a refund. An experienced retailer can distinguish bona fide refunds from habitual claimers and these incidents are usually settled quietly by the retailer and the consumer.
Structure of Retail Operation
For retailers entering the Chinese market for the first time, there are 3 methods of retail operation:
- Franchise
- Most brands prefer this arrangement as their entry strategy into China. The benefit of this method is that the franchisee bears the cost of store fit-out, and therefore the brand’s initial investment is low and hence their risk is low.
- The problem lies when the brand franchises to an agent and loses control of the brand. Chinese Agents are more concerned with making a profit than the brand’s image, and in effect act as a middle man, sub-franchising the brand out in different cities to different franchisees and as a result, diluting control over the brand.
- Franchisees are usually small time operators in secondary cities with a few million yuan to spare. They pay for the fit-out, purchase merchandise and take all the risks. But middle-men are risk-free.
- Representative Company on Behalf of Brand
- The Representative Company signs agreement and uses its company as a front for the foreign company, so there is no investment. All investment and management is by the brand. The Representative Company uses its business license as an “umbrella” for the foreign company. Under this method of operation, the brand can maintain full control without the need to invest in office presence in China. The benefit is that the brand can start retail operations and does not need to undergo the complicated process of registering as a foreign company in China.
- Directly-Operated Stores
- Under Directly-Operated Stores, brands have full control over their stores and are responsible for everything from registering as a local company, usually in Shanghai or Beijing, to obtaining a retail license, signing of contracts, importing merchandise, store fit out, hiring of staff and retail management. This is funded by capital from the brands’ headquarters. In effect, a direct ly operated store is a branch of the brand’s overseas stores. This is the method of operation that is mostly used by luxury brands in China.
- Direct Operated Stores are suitable in China’s most mature markets, namely first tier cities like Shanghai and Beijing, because the Image and Quality consistency is evident.
- Franchise method is most appropriate for second tier cities like Hangzhou, Shenzhen, Guangzhou, Chengdu and Shenyang because the franchisee takes the risk and the stores are not so prominent or big.
- In the case where the brand does not want to risk too much initial investment, we recommend operating a management cooperation arrangement with a Representative Company and first operating through the latter’s business license umbrella.
Shanghai Team Best Retail Consultants provide turn-key retail solutions for developers of shopping malls and department stores comprising retail concept design, project development, direct leasing, A&P and mall management. For more information, please go to our website at www.teambest.com.cn.
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