Does luxury discriminate against lower-tier Chinese cities?
Over the past year, various luxury players have considered promising lower-tier cities to reach local consumers. Of course, this is nothing new. Ten years ago, you could see Louis Vuitton, Gucci, Prada and Burberry in high-end malls in Wenzhou, a third-tier city. These shops were crowded with affluent shoppers and the products sold out quickly. — if not instantly.
Li Shuang, 27, now a Gen Z mother living in Wenzhou, Zhejiang, recalled seeing her parents “queuing up at the city’s Fortune mall to buy Louis Vuitton.” But then that changed, as savvy consumers realized that buying locally often meant prices three times higher than in Western countries. Unsurprisingly, the marks came out. From the mid-2010s, they left these little-known cities en masse.
So major cities like Shanghai, Beijing, Guangzhou and Shenzhen (which had strong influxes of domestic tourists as well as HNWIs) became oversaturated with stores – and still are to this day. Louis Vuitton alone has 21 stores in these cities. This high concentration means that premium houses not only suffer greatly from competition but also run the risk of cannibalization between their own shops.
Increased domestic demand due to China’s border closures has forced homes to increase market share in the most promising and luxury-hungry lower-tier cities. Before the Covid outbreak, Li would ask overseas relatives in Europe or trusted daigous in Hong Kong to buy the items she wanted because “the prices are much more reasonable.” She has now repatriated her consumption. “Before, luxury didn’t allocate a lot of goods in China. I had to go abroad to find what I wanted. But now they prioritize this market.
In reality, 55 percent new luxury brick-and-mortar businesses were opened on the continent in 2021. Many were located in lower-tier cities across the country in an effort to acquire new luxury consumers. While this is important, it is still – given the opportunity – prudent. According to BCG x Tencent Report 2019, nearly half of the country’s luxury consumption comes from Tier 2 and Tier 3 cities.
Here, Daily Jing speaks with analysts to explore the pros and cons for luxury brands to expand their footprint in these developing areas.
The advantages: new middle class, experience and financial incentives
In March 2022, Hermès opened its first store at David Plaza in Zhengzhou, Henan Province and sold out all stock in its store from day one. The demand is obvious. The new middle class emerging from regions like these has been the main driver behind the recent expansion of luxury brands. McKinsey expects that by 2025, these affluent groups will exceed 500 million people, covering more than half of China’s urban population; their total disposable income will reach $2 trillion (13.3 trillion yuan). Reaching them is vital.
Laura Pan, professor of international business at the SDA Bocconi School of Management, noted that Previously, luxury companies “expected affluent consumers in lower-tier cities to travel to premium destinations” or “shop through their e-commerce platforms.” In the end, it was the latter that happened (mostly). 2021 saw Tmall’s Double 11 record a 50% increase in new luxury buyers from third-tier cities.
Yet when it comes to expensive purchases, online is not enough: many Chinese consumers want a full-service experience. To meet shoppers’ needs, high-end players need to open stores closer to them. Li explained, “Knowing the seller and receiving personalized services strengthens my bond with a brand.”
Xiaohongshu has many posts on the subject from accounts or KOLs sharing their VVIC retail experiences, such as birthday surprises in private rooms and in-store vault displays. “It’s hard to imagine luxury brands forcing their customers to travel a few hours to their nearest town to enjoy these personalized experiences,” Pan continued.
Another advantage of labels is the incentives offered by local governments to attract global names. Emerging cities like Chongqing, Nanjing and Zhengzhou are building two or even three high-end malls with the aim of becoming international shopping destinations. On February 8, the municipal government of Chongqing introduced a new policy for international groups: those who open their first store in the city can claim up to $158,000 (1 million RMB).
A new and growing middle class, a strong appetite for luxury brands and tempting government incentives — lower-tier towns could be a luxury gold rush.
The Disadvantages: Shortage of HNWI, inventory management and higher supply than demand
But there is always a downside. Despite the growth of the new middle class in lower-tier cities, there could be a shortage of HNWI (high net worth individuals). There is still a large gap between the proportion of affluent households in first-tier cities and lower-tier ones.
The question of an oversupply of luxury goods was raised by Jason Yu, CEO of Kantar Worldpanel Greater China, a market research company focused on consumer insights and insights. He stated that most Tier 2 and Tier 3 cities cannot accommodate a range of high-end retail facilities and shopping malls due to a lack of infrastructure and tourist influx: “overdevelopment will mean a supply exceeds demand.
In light of this, brands should carefully select their target expansion cities based on future economic growth prospects and the direction of China’s economic transition. Yu suggested focusing more on rapidly developing city clusters in the eastern and southern regions while reducing the presence in the northeast.
Inventory management and distribution is potentially another issue for companies operating in multiple cities in a country. It can be difficult to meet demands from different domains while avoiding storage. Pan posed the valid question, “How do companies increase sales per store and ensure there is no stockpiling among salespeople?” In this case, local teams and partners should do their due diligence before venturing into untested territory and prioritize quality over speed.
2022 and beyond
Overall, the luxury goods market here is expected to grow 15-18% in 2022, reports Yes OK, China’s luxury research institute. This is a chance to increase sales in lower tier towns. Kantar’s Yu has planned that for the remainder of 2022, expansion is expected to continue. Due to the ongoing pandemic, “mainstream shoppers will be more careful with their spending, even though demand for these basic personal luxuries may remain robust,” Yu commented.
There is little room for further growth in saturated top-tier cities, where luxury brands have around 20 stores. Online competition is also getting fiercer. The driver of heritage home luxury is clearly moving elsewhere. To fully unleash the potential of a vast and lucrative territory like China, brands have no choice but to get closer to the new middle class.