AUTHORS

Jacques Penhirin, Partner and Managing Director of Greater China

Imke Wouters, Principal

FASHION RE-DESIGNED CHINA APPAREL 2020

2

THE WHIRLWIND IN THE CHINA APPAREL MARKET

In the last decade, expanding in China was an easy ride with high sales growth driven by

store expansion and same store sales increase... but that is about to change. This period

was attractive for both local and international apparel retailers in China as Chinese apparel

retail enjoyed double digit sales growth. The next decade will bring lower growth, a higher

importance of lower tier cities, a significant share for online and nationwide market share

gain for the new entrants’ generation. This will lead to a market that will be very different

from how we know it today, a market that will require different models to survive and win.

How should local and international apparel retailers respond to these changes and win in

this market?

To better understand what the future will bring, we conducted extensive interviews with

operators, analysts, mall operators and department stores supplemented by more than 500

in depth street interviews with Chinese apparel shoppers in tier 2, 3 and 4 cities in Central

China. Here is what will change.

3

FROM DOUBLE DIGIT TO SINGLE DIGIT GROWTH

In 2012, apparel sales slowed down in line with the overall economic environment in China.

For the coming years, we expect that growth will continue to slow down to single digit

growth in tier 1 and 2 cities (from high double digit growth in past years). We expect overall

growth to slow down to 9% to 11%, with this growth mainly driven by the continuing increase

of disposable income. Still an attractive number compared to most markets but not the

exuberant growth that prevailed for the last decade.

Exhibit 1: Retail sales development by city tier

Tier 1

Tier 2

Tier 3

Tier 4

YOY CHANGE, INDEX 100 = YOY GROWTH RATE IN TIER 1 CITIES

2004/2005

100

81

72

65

100

106

111

117

2009/2010

Source: City Statistical Yearbooks; Oliver Wyman analysis

4

70% OF GROWTH FROM LOWER TIER CITIES

The growth rate of retail sales in tier 3 and 4 cities will exceed the growth in tier 1 and 2 cities,

which have been the most important playing field for new entrants in the market in the last

decade. Whereas in 2011 lower tier cities already represented ~50% of the total apparel

market, we expect this percentage to increase to over 60% by 2020. The lower tier cities will

be contributing over 70% of the total growth in the coming years.

This is a growth opportunity that can’t be missed by any player who wants to be a winner

in the apparel market. When expanding into lower tier cities, companies should be aware

that consumer characteristics and needs are different. Brands are less important with

consumers mostly buying local brands today; though this could be driven by less choice.

But international brands are quickly catching up and brand will matter more. Sportswear

remains a bigger component, having a share of ~20% in the wardrobe of consumers in tier

3-4 cities compared to 5%-10% in tier 1 and 2 cities; however this share has decreased in

recent years and consumers expect it to decrease further.

Exhibit 2: Apparel market by city tier

RMB TRILLION

Rural

Lower tier

Tier 2

Tier 1

2006 2011 2016F 2020F

Share of growthby city tier

2.67%

22%

56%

15%

3.87%

20%

61%

13%

2.2

5%

18%

68%

10%

∆‘11-’20F

0.98%

23%

51%

19%

1.59%

23%

50%

17%

12%

11%

10%

Source: China Statistical Yearbook; City Statistical Yearbook; Euromonitor; Oliver Wyman analysis

Exhibit 3: Brands bought most often by city tier

Tier 2: Changsha

Tier 4: Yiyang and Loudi

Tier 3: Zhuzhou and Xiangtan

Source: Oliver Wyman street Intercept survey (Nov 2012); Oliver Wyman analysis

5

ONE OUT OF FOUR PIECES WILL BE SOLD ON LINE

The online channel has already become a major sales channel, representing 9% of total

apparel sales in 2012, up from only 2% in 2008. China’s online apparel share is already above

the level of the UK and South Korea and our analysis suggests that the online channel will

reach 25% in the next 5 to 10 years. Online apparel shopping is especially popular among

women, with an online share of 14% for women’s clothing compared to 7% for men’s clothing

in 2011.

Exhibit 4: Share of online apparel sales

CHINA’S ONLINE APPAREL SALES AND MARKET SHARE, 2008-2012RMB BILLION, %

Share of totalapparel sales

2008

2%

18

48

2009

4%

105

2010

8%

205

2011

13%

319

2012

19%

+105%

Source: iResearch; Euromonitor; Oliver Wyman analysis

With one piece out of four bought online it does not mean other channels will disappear.

Malls and departments stores will survive; but store economics will be more demanding and

under pressure from lower productivity. High streets will suffer more unless it transforms

into large destination flagships for the brands.

6

Exhibit 5: Change in channel mix of apparel spending by city tier

2 ye

ars

ago

2012

2 ye

ars

from

now

% OF TOTAL APPAREL SPENDING

2 ye

ars

ago

2012

2 ye

ars

from

now

Department store

Independent high street stores

Online

Shopping mall

Chain specialty high street stores

Wholesale markets

Hyper/Supermarkets

Other

TIER 2 (CHANGSHA)

N=124

TIER 3 (ZHUZHOU AND XIANGTAN)

N=191

TIER 4 (YIYANG AND LOUDI)

N=203

2 ye

ars

ago

2012

2 ye

ars

from

now

1004

8

10

11

20

38

10057

7

19

17

34

10047

5

21

15

37

100

16

17

4

29

26

100

15

16

11

23

27

100

13

15

15

19

28

100

4

10

27

100

10

10

28

100

11

9

29

495055

755

10109

Source: Oliver Wyman street Intercept survey (Nov 2012)

Tmall (~85% of online B2C), although less developed in lower tiers, is making impressive

inroads there and more brands with be offered to consumers who currently are geared

towards C2C platforms which mostly offer low priced, non-branded products.

In lower tier cities, low prices are still the main reason for consumers to shop online. But in

higher tier cities consumers also start to value the online channel for convenience and range.

Ten years from now, the increased wealth in lower tiers will also change consumer behavior

in the same direction while price will remain an important factor.

Exhibit 6: Online apparel purchase share by online retailer by city tier

% OF TOTAL ONLINE APPAREL SPENDING

Taobao

Tmall

Vancl

Moonbasa

Other2

100

Tier 2

Tier 3

Tier 4

483058

1

2170

2

45933

8

100

100

Source: Oliver Wyman street Intercept survey (Nov 2012); Oliver Wyman analysis

7

For these online apparel shoppers outerwear is the main category bought online, a high

proportion of them also buys their footwear, accessories, hosiery and underwear online.

Most consumers (~95%) do their online apparel shopping on their computers at home,

but the penetration of consumers shopping at their computer at work or on their mobile

is also significant. Alipay and online banking are most often used as payment method, but

consumers also frequently use cash on delivery or their credit card especially in higher

tier cities.

Exhibit 7: Reasons for shopping apparel online by city tier

Convenience

Cheaper

Easier to browse& compare

More brandsavailable online

Other

IMPORTANCE OF REASONS FOR SHOPPING APPAREL ONLINE BY CITY TIER% OF MAXIMUM SCORE

Wider range

Better quality

57

56

43

31

8

4

1

21

57

75

27

6

8

1

40

41

74

9

6

2

13

TIER 2N=64

TIER 3N=68

TIER 4N=66

Source: Oliver Wyman street Intercept survey (Nov 2012)

8

CONTINUOUS ROLL OUT FOR BIG CHAINS

The China apparel market is still very fragmented with the top 10 only representing

3%-5% market share overall (compared to 26% in the US and 11% in the UK). In tier 1 cities

like Shanghai however the top 10 players already account for around 10% to 15% where

successful entrants like Zara, H&M and Uniqlo have been enjoying good growth; the single

store sales of their most successful stores exceed US$ 20 MM. As these players are now

expanding into lower tier cities we expect that the overall China market will become more

consolidated and be more comparable to tier 1 cities in the coming years. In addition, new

powerful entrants are likely to come attracted by the competitors’ fast growth.

Exhibit 8: Timeline of international brand entry

Pre-2000 2000-2005 2006 2007 2008 2009 2010 2011 2012

Source: Company websites; Desktop research; Oliver Wyman analysis

9

WHAT DOES THIS ALL MEAN?

DECREASE OF SAME STORE SALES

Some local nationwide players are already experiencing negative like-for-like sales growth.

We expect a further decline of store productivity driven by the move to online and more

intense competition. As labour and rental costs will continue to rise, offline retailers will face

more and more pressure on their store margins.

Exhibit 9: Same store growth and store portfolio, Giordano

500

1,000

SAME STORE GROWTHYOY % CHANGE

1,500

-10

0

10

20

STORE PORTFOLIO #

‘11Q

1

‘12Q

3

‘11Q

2

‘11Q

4

‘11Q

3

‘12Q

2

‘12Q

1

‘12Q

4

‘11Q

1

‘12Q

3

‘11Q

2

‘11Q

4

‘11Q

3

‘12Q

2

‘12Q

1

‘12Q

40 1,

211

1,28

2

1,28

5

1,37

2

1,37

0

1,35

8

1,32

3

1,24

2

Source: Corporate Annual Reports; Analyst Reports; Oliver Wyman analysis

10

STORE PORTFOLIO ADJUSTMENTS

Early entrants used a franchise model to open a significant number of stores and get across

the country quickly. But the leading local players with a high number of stores are now

suffering from a sales decline driven by negative like-for-like sales growth and store closures.

Geo-marketing and clearer positioning of store formats will become essential.

To remain profitable they will need to further adjust their store portfolio to adapt to the

change in the market structure.

Exhibit 10: Sales development local players

0

-50

50

YOY HALF-YEAR SALES GROWTH, 2009H1-2012H2

-25

25

Giordano

Baleno

Semir

Li-Ning

Metersbonwe

Jeanswest

Bossini

Anta

Source: Annual Reports; Analyst Reports; Oliver Wyman analysis

11

Although online will capture a significant part of the market, physical stores will remain

important for brand building. Our research shows that physical apparel store visits are

still a main source of inspiration across city tiers and many consumers still prefer to shop

in the physical store when they can choose between buying online or offline from a new

international apparel retailer. So, when retailers are expanding their reach to lower tier cities,

online only will not be sufficient and physical stores for brand building in the new cities will

still be required. They may however need fewer stores than they might have a few years ago.

Exhibit 11: Inspiration sources for apparel shopping by city tier

% OF MAXIMUM SCORETIER 2N=124

TIER 3N=191

TIER 4N=203

Visit physical stores 60% 83% 95%

Friends’ recommendation 44% 20% 24%

TV shows/dramas 2% 5% 0%

Online social media 10% 6% 4%

Online browsing & comparison 26% 25% 25%

Personal daily observation 25% 26% 27%

TV commercial 12% 17% 0%

Print media 10% 2% 1%

Other 3% 3% 0%

Source: China Shopping Center Development Association of Mall China, Oliver Wyman analysis

Another adjustment will be on store format; high street stores are the store format that will

suffer most from the increasing share of online. Department stores seem resilient as they

have consistently been outperforming the market in recent years.

Shopping malls will continue to open at a hefty pace, especially in lower tier cities. Our

research shows that consumers expect to shop more in shopping malls in the future. This

will put even more pressure on high street stores (especially in the north and south where

shopping malls and department stores allow for much more convenient and enjoyable

shopping experience given the climate). Do not expect super prime location prices to go

down though! Yes, rents may go down in non performing malls and street but who cares?

12

Exhibit 12: Apparel sales of 200 main department stores vs. overall market

10

0

20

2008 2009 2010 2011 2012

YOY CHANGE, %

5

15

200 main departments’ apparel retail sales

China’s overall apparel retail sales

Source: First Capital Securities Research Institute; Euromonitor; CCAGM; Oliver Wyman analysis

Exhibit 13: Shopping mall openings by city tier

CUMULATIVE NUMBER OF OPENINGS

Tier 3Tier 2Tier 1

2004-2010

Before 2003

42

494415

913

218

550

X2.5

X2

X12

Source: China Shopping Center Development Association of Mall China, Oliver Wyman analysis

13

MORE INTENSE COMPETITION IN LOWER TIER CITIES

Currently, the lower tier cities are dominated by local and international brands who entered

the market years back. But as the international new entrants are expanding into tier 3 cities,

the local brands should expect fiercer competition like in tier 1 and 2 cities. International

players like Zara and H&M are accelerating their number of new store openings, now

opening around 30 new stores per year.

Exhibit 14: Store rollout of H&M and Zara by city tier

H&M ROLLOUT ROADMAP BY TIER# OF STORES

2007 2008 2009 2010 2011 2012

Tier 1

Tier 2

Tier 3

20122006 2007 2008 2009 2010 2011

ZARA ROLLOUT ROADMAP BY TIER# OF STORES

6 10 11

5 21 1

# of new stores

# of cities covered

12 12

9 12

19 27

18 29

37 21

33 42

43 30

45 53

9

120 122

77

40

21

93 2

10 10

73

37

29

47

19

7

4 21145

92

71

44

12

23

63

3933

4739

25

814 31

194 9

ShanghaiShanghai

11

Source: Annual Reports; Desktop research; Oliver Wyman analysis

CONSOLIDATION OF BRANDS

Not all brands will be able to survive in this re-designed marketplace. Consolidation in the

market, especially for the sportswear and local value players is expected.

14

A NEW PLATFORM TO WIN

Despite the high growth of online, the economic model of pure play online players is yet

to be proven. Although revenue of Vancl, the leading pure play online apparel player is

increasing fast, it is still years away from making money. The results of our Proposition Index

showed that Vancl significantly dropped in consumer ranking after not being able to deliver

its promise. It tried to increase prices to improve profitability which damaged its customer

perception. The race for size cannot last too long as apparel shopping is by definition a short

life cycle!

Exhibit 15: Vancl financials

SALESRMB BILLION

PROFIT MARGIN%

2009 20112008 2010 2012

c.-20

-15

c.-9

3.5

0.1 0.3 1.2

6.5

Source: Company website; Desktop research, Oliver Wyman analysis

15

HOW TO SUCCESSFULLY SURVIVE THE NEXT DECADE?

If you want to know more about our research, please do not hesitate to contact us. We will be more than happy to

share our detailed insights.

INVEST IN YOUR BRAND WITH BETTER CONTROL OVER EXECUTION

As the market gets more competitive, not all brands

will be able to survive. Winners will be the ones with

strong brands that resonate with consumers. Better

control in store execution will be key to deliver strong,

consistent brand messages, especially for operators

with franchisees. This means strict management of store

operations, integrated IT systems, and potentially buying

back franchisees.

CONTINUOUSLY RESTRUCTURE YOUR STORE PORTFOLIO

The future channel structure will be different from

today’s with a significantly higher share of online, fewer

high street stores and with department stores and

shopping malls the winning offline formats. To fully

capture the potential, adjustments in store portfolio will

be needed, including choosing the right mix of property

types. These different property types will require

other adjustments including store format, layout,

merchandising, and collections.

BE MORE RESPONSIVE TO THE MARKET

As the apparel market will become more volatile, winners

will need a model that enables quick responses to

market volatility. Integrated supply chain from design to

store and better management of factory outlets (online

and offline) for inventory clearance without harming the

brand will be essential.

DEFINE A WINNING ONLINE PROPOSITION

Pure online players have not found the right economic

model yet; maybe a combination of different online

platforms will be needed. In any case, a clear definition

on the roles of each off- or online channel and fine-tuning

of assortment and prices will be drivers of success. Going

straight for online could be a good strategic option

for entrants for testing and brand building; Forever21

and Topshop are examples of recent new entrants into

the market who first opened an online store to test the

market before opening physical flagship stores.

DEVELOP AN INTEGRATED MULTICHANNEL MODEL

The future will increasingly require an integrated

multichannel model where the internet should be

leveraged both as a selling platform and as a marketing

tool. An integrated model that allows consumers to

switch between channels smoothly at will (check the

latest designs in the flagship store, check prices and buy

online and maybe return products to the physical store)

will be more complex to operate but success will only be

at that price.

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