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2014 China Luxury Market Study

Priming brands for redefinition

Jan 20, 2015

This information is confidential and was prepared by Bain & Company solely for the use of our client; it is not to be relied on by any 3rd party without Bain's prior written consent 2

Key trends observed in 2014

1

The 2014 luxury market was slightly down from 2013 by ~1% at ~115B RMB, impacted most by slowdown in watches, men’s wear and leather goods. Fundamental “rebasing” as customers evolve and shop for themselves and focus more on acquiring ready-to-wear goods.

2 Customer segments no longer clear-cut with common behaviors observed across demographic groups—increased diversity of preferred brands, and exclusivity, quality and value for money without logos becoming increasingly important.

3 As a result, shifts are occurring among top brands across categories. Like-for-like sales struggled the most, prompting conservative network expansion and increased focus on revamping core store networks.

4 At the same time, changes in choice of purchasing channel and location have evolved significantly; Daigou sales (parallel purchase) estimated at ~55B to 75B RMB, and travel to Japan and Korea growing ~60%.

5 In this environment, exclusivity and fashion have been the “winners” of the year—limited editions, fashion-focused portfolio and designer collaborations drove growth despite market headwinds.

6 Outlook for 2015: “Rebasing” likely is finished, but conservative growth expectations span categories as brands look to revitalize core networks and cater to more luxury products and experience-savvy customers.

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• First time China market has not grown—fundamental “rebasing”

- Continued impact of anti-corruption and frugality campaigns undermining “luxury gifting”

- Economic slow-down exacerbating the issue

• Women’s wear and shoes continued last year’s strong momentum as biggest “winners”

• Men’s wear and watches continued to decline, particularly at more premium price points

Note: Only premium cosmetics are considered luxury goods in the “cosmetics” category Sources: Brand interviews; Bain analysis

Overall Mainland China luxury market contracted slightly by ~1% to be 115B RMB

1

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Consumers increasingly likely to shop for themselves and try new brands, styles

“Why do you always switch luxury product brands?” “Do you always switch

luxury brands?”

Sources: Bain survey of luxury goods consumers in Mainland China 2014 (N=1,400); Bain analysis

1

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Influx of fashion and less established brands amplifying preference for brand diversification…

“Please select emerging luxury brands that you find attractive”

“Compared with traditional big names (Louis Vuitton, Gucci, Prada, etc.), you tend to buy

more emerging luxury brands in next three years”

Sources: Bain survey of luxury goods consumers in Mainland China 2014 (N=1,400); Bain analysis

2

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…with consumers perceiving new or aspirational brands to be just as desirable as established ones

Price level

Desire to own

High

Low

Sources: Brand interview; Bain survey of luxury goods consumers in Mainland China 2014 (N=1,400); Bain analysis

High Low

Emerging brands

READY-TO-WEAR AND BAGS BRANDS AS EXAMPLE

“There are more new brands in high-end malls nowadays, and I find them just as stylish and premium as those famous brands with a long history. I feel like I have a broader choice than before.”

-consumer in Shanghai

“We observed quite a few less established brands performing well with an exclusive fashion positioning. Consumers are putting more brands in their shopping basket.”

-luxury brand executive

2

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Logos continue to be less important as consumers become more sophisticated

“Will you purchase products with visible logos in the future?”

“What’s your opinion of luxury goods with an obvious logo?”

Sources: Bain survey of luxury goods consumers in Mainland China 2014 (N=1,400); Bain analysis

2

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These changing consumer dynamics are redefining luxury paradigms …

2013 2014

Sources: Bain survey of luxury goods consumers in Mainland China 2014 (n=1,400); brand interviews; Bain analysis

2

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…and more consumers are shifting share of wallet to experiential types of luxury

“Have you spent on the following luxury experience?”

Sources: Bain survey of luxury goods consumers in Mainland China 2014 (N=1,400); Bain analysis

“Will you increase spending of travel for leisure as opposed to shopping

tour in the following year?”

…AND EXPECT TO TRAVEL MORE FOR LEISURE

CONSUMERS SPEND ON A VARIETY OF LUXURY EXPERIENCES…

“I’m a bit tired of pure shopping tours as more channels have emerged to buy luxury goods. Nowadays lifestyle becomes more attractive to me and therefore I plan to spend more on pure travel rather than on shopping tour.”

-consumer in Shanghai

2

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In this environment, shifts in magnitude and dominance occur among the top five brands

Notes: Market value is composed of sales at retail value; “Accessories” includes stationary, scarves, sunglasses, etc.; “leather goods” includes suitcases and handbags, and smaller items such as wallets; Armani brand includes Giorgio Armani, Emporio Armani and Armani Collezioni Sources: Brand interviews; department store interviews; analyst reports; company reports and websites; Bain analysis

Total = RMB ~115B

Top five brands by category in alphabetical order

3

Ranking up in 2014 New top five in 2014

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This is starting to be reflected in types of brands desired, as “followers” gain momentum

Dominance of top 10 brands less prevalent

“What are the three brands that you desire most?”

Sources: Bain survey of luxury goods consumers in Mainland China 2014 (n=1,400); Bain analysis

2014

2013

3

Followers gaining higher awareness,

though from a relatively lower

level

Top 10 brands Select brands after top 10

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Established brands have been conservative with store openings as like-for-like sales suffered…

• New stores opened for select brands

- 2012: ~150

- 2013: ~100

- 2014: ~100 (including emerging brands)

Opened in 2014

Opened in 2013

Opened in 2012

Opened in 2011 and before

Emerging brands

3

Store closings mainly in men’s categories

Notes: Different series in one store are counted as one (e.g., Hugo Boss); Cartier and Bvlgari store data excludes watch counters, only include boutiques; Chanel store includes fashion boutiques only; Armani brand includes Giorgio Armani, Emporio Armani and Armani Collezioni (same location regarded as one store); Zegna’s underwear line not included; children’s wear and outlet stores not included for all brands Sources: Analyst reports; brands’ official websites; brand interviews; Bain analysis

• Negative like-for-like sales growth for most brands

• Some brands still positive, e.g., Chanel, Hermes, Tiffany

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…prompting a need to focus on core networks and revamp concepts and propositions

Luxury malls focusing more

on lifestyle concepts

Need to “crack” like-for-like sales

More demanding

VIPs

• Brands more stringent on store selection and focusing new or replacement openings on larger flagship stores due to declining like-for-like sales

- Several brands slowed pace of new openings in 2014, consolidating their exposure and closing down smaller satellite locations in lower-tier cities

• In response to increasing competition from e-commerce and overall declining luxury retailing, brick-and-mortar shopping malls now offer higher proportion of stores related to lifestyle retail

- Food and beverage, experiential shop and entertainment facilities increasing in shopping mall trade mix

• High-end brands are retaining exclusivity while elevating customers’ in-store shopping experience, especially for VIPs

- Multiple brands recently shifted their emphasis to service quality in key cities such as Beijing and Shanghai

“We slowed down new store openings and are now undergoing a lot of renovation and closings, with less focus in tier-3 cities and more in tiers 1 and 2.”

-brand executive

MAIN DRIVERS DESCRIPTION

“Lifestyle consumption remained active and boosted retail sector, leading to higher occupancy in shopping malls.”

-shopping mall manager

“We don’t have the urgency to expand in China. We are an exclusive brand and we want to stay exclusive, so it’s strategic to not be everywhere.”

-brand executive

Sources: Analyst reports; brand interviews; Bain analysis

3

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Channel choice evolving rapidly as consumers habitualize Daigou and overseas points of sale

*Daigou means parallel purchase Sources: Bain survey of luxury goods consumers in Mainland China 2014 (N=1,400); Bain analysis

4

Overseas purchases

Daigou* via friends and relatives, taobao agencies and professional agencies

Mainland China sales

~55%

~15%

~30%

“I love shopping luxury goods overseas where I can find richer product selection, lower price points and better services. In the coming year, I will definitely increase my spending in overseas countries.”

-consumer in Beijing

“Rise in online luxury retail becomes the horsepower of Daigou. Consumers are getting used to obtaining product information online and purchasing via Daigou agencies.”

-professional Daigou agency

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More purchases from e-commerce and brand aggregator but less from outlets

OUTLET STORE E-COMMERCE BRAND AGGREGATOR

“Have you purchased items in these luxury department stores/brand retailers?”

“Has your online spending on luxury goods increased in

2014?”

“Have you purchased luxury goods from outlets in the

past year?”

Sources: Bain survey of luxury goods consumers in Mainland China 2014 (N=1,400); Bain analysis

4

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Daigou continues to gain share of wallet; 2014 market size estimated at ~55B to 75B

HIGHLIGHTS

4

• Daigou market has grown quickly in China, mainly aided by

- Increasing number of bargain-hunters who are more aware of price differentials

- Development of professional Daigou agencies and cross-border logistics firms

• Estimated parallel/Daigou sales as of branded channel sales

- Cosmetics leading the way, followed by leather goods, watches and jewelry, with ready-to-wear having lower penetration of Daigou

Sources: Brand interviews; iResearch; Bain survey of luxury goods consumers in Mainland China 2014 (N=1,400); Bain analysis

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70% of consumers have bought on Daigou, and their spend is increasing

“Have you ever purchased luxury goods via parallel

channels (Daigou)?”

“If yes, would you increase your spending on parallel channels?”

“Why did you choose or will choose Daigou in the future?”

Sources: Bain survey of luxury goods consumers in Mainland China 2014 (N=1,400); Bain analysis

4

“I started Daigou this year through an agency recommended by a friend. It turned out to be a good experience.”

-consumer, Beijing

“It is likely that I will increase spending on Daigou as more professional agencies have emerged.”

-consumer, Shanghai

“Chinese consumers are now price savvy. The most dominant reason to choose Daigou is the price gap across channels and geographies.”

-Daigou agency

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Free trade zone (“FTZ”) expected to be an incubator for the prosperity of cross-border e-commerce

Daigou via friends and relatives

Overseas websites

Brick-and-mortar store

Cross-border e-commerce

in FTZ

overseas retail price

Consumption tax

Import VAT

overseas sales tax

Price to consumers

excl. shipping

Import duty

Notes: Jewelry import duty: ~20%-35% depending on specific product type if imported as goods, 10% if imported as personal goods (personal postal articles tax applied) in the case of cross-border e-commerce in FTZ; overseas websites uses different customs clearance methods when handling direct shipping to China: import duty and VAT applicable when imported as goods, personal postal articles tax applicable when shipped as personal item, or tax not claimed until customs require it, which therefore leads to a different tax range; consumption tax for jewelry is 10% Sources: China customs; literature research; Bain analysis

Order flexibility

Approximate time

HIGHLIGHTS

• Price advantage varies across categories due to different tariff and consumption tax rates

• Additional cost-saving opportunities in FTZ

- Less margin to distributors through direct sales

- Lower inventory risk in bonded area

- Lower Capex investment by taking advantage of bonded warehouse in FTZ

Convenie

nce

Purchase channel

Price

100 100 100 100

0~10 N/A N/A N/A

N/A 0~35 ~35 ~10

N/A N/A ~15 N/A

N/A 0~20 ~25 N/A

100~110 100~155 ~175 ~110

Low Moderate High High

Moderate Moderate Short Short

4

JEWELRY EXAMPLE (INDEX)

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Consumers continue to purchase more from overseas, with Korea and Japan hottest new destinations

4

Sources: China National Tourism Administration; Bain survey of luxury goods consumers in Mainland China 2014 (N=1,400); Bain analysis

Daigou included in non-mainland

sales

“I will go to Japan and Korea more frequently given convenient flights, simplified visa application and the exchange advantages. Above all, I will find the most fashionable items there.”

-consumer in Shanghai

Overseas

HK/Macau/Taiwan

Mainland

9%

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Exclusivity and fashion is becoming an important and iconic part of luxury dialogue

Sources: Literature search; Bain analysis

5

“Alexander McQueen is definitely an icon of cutting-edge fashion. I bought quite a few collections of its classic skull scarfs to mix and match with other luxury pieces.”

-luxury consumer

“I was desperate to own a pair of Jimmy Choo shoes after watching the Korean drama, but the model flew off the shelves in a few days. Owning a pair of Abel pumps undoubtedly makes you in-the-know fashion people.”

-luxury consumer

“In the past few seasons, MCM has emerged as a new breed of It bags. Its ubiquity in China manifests that the rivet-adorned bag has become a new fashion icon now.”

-fashion blogger

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• Appointed Nicolas Ghesquière as artistic director, one of the most influential fashion designers, who injected LV with innovative ready-to-wear

• Appointed Jason Wu as creative director; who applied his philosophy to the new Boss collections by adding fashion excitement

• Stuart Vevers previously worked for Bottega Veneta and Loewe, landed as creative director and brought new elements to the brand: youthful, playful and a bit twisted

• Stefano Pilati rejuvenated the brand by making its men’s wear more casual and stylish to manifest a more visible and contemporary personality

Sources: Literature research; Bain analysis

Traditional luxury brands taking initiatives to incorporate more fashion collaborations

NEW DESIGNERS TO REVITALIZE BRANDS FEEDBACK

“I can look at LV for more than monogrammed bags now—there are pieces that can be wardrobe essentials.”

-fashion blogger

“Profits at Boss rose 15% as Wu’s Fall 2014 collection reached stores.”

-fashion website

“I like the new design by Coach, more lifestyle-related, more relaxed and more fun.”

-consumer, Shanghai

“CEO Gildo Zegna hoped that he [Stefano Pilati] would help upgrade Zegna to a fashion brand.”

-Wall Street Journal

EXAMPLE

5

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• Opened the seventh worldwide concept store in Shanghai

- Designed by famous architect Gwenael Nicolas together with other artists

- Delivers the brand’s 100-year-old exquisite craftsmanship and special shopping experience that combines both the traditional and contemporary

- Shows off full lines of men’s and women’s apparel with private and independent space

• Opened Mansion Hermes in Shanghai, the fifth flagship store worldwide

- Located in a 1920’s building with more than 1,000 square meters spreading over four floors

- Displays almost the entire range of products

- Reflects the importance of the client shopping experience

Source: Literature search

Fashion and exclusivity are also reflected in vastly successful new store concepts

6

EXAMPLE

• New flagship store in Shanghai, a vigorous and luxurious environment for customers

- Offers widest range of Burberry products in Asia

- Integrates brand’s digital innovation into the design and function of physical stores

- Unique in-store experience, including offline events, original music and British heritage

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Outlook for 2015 is similar, more related to macroeconomics and consumer dynamics

• Consumer groups continuing to converge, and a new wave of middle-class luxury consumers emerging and developing

• Younger, more sophisticated and more knowledgeable about luxury, consumers increasingly seeking new definition of luxury—from expression of social status to personal identity, from pursuit of brand name to product design and services

• Cognizant and sensitive to value proposition, consumers now more aware of price differentials and switching to alternative channels such as parallel channels or Daigou and e-commerce platforms

• Overseas luxury spending also expected to continue the strong momentum, especially in Japan and Korea

• More consumers extending to full spectrum of luxury experiences

Overall

market

Fu

nd

am

en

tal

ch

an

ges o

f con

su

mer d

yn

am

ics

• Current “rebasing” of the Mainland China luxury market expected to be, by and large, completed

• Growth will be more impacted by consumer behaviors, the economy and the ability of brands to revamp

6

Source: Bain analysis

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Brand owners will need to step up their game 6

Exclusivity and VIP experiences

Consumer behavior-centric lens

Omnichannel touchpoints

• Ramp up VIP program and effectively train salesforce to elevate service standards for both current and emerging VIPs

• Customize and innovate store format and product category or collections to maintain exclusivity

• Slow down aggressive store expansion and shift focus to selection of right locations and right catchment area

• Rethink the approach to the more sophisticated and educated Chinese consumers through more fashion, design and exclusivity

• Think about strategy more regionally instead of China-specific to better serve customers and provide cross-border experience

• Introduce integrated Chinese websites to house brand stories, fashion shows, new collections, ad campaign, etc.

• Launch digital campaign and key opinion leader program on social media such as WeChat and Weibo

• Consider channel extension to e-commerce platforms

• Adopt an omnichannel approach to keep pace with savvy shoppers who shop online, on smartphones and in stores

Source: Bain analysis