Does luxury discriminate against China’s lower tier cities?

Over the past year, various luxury players have observed 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 the exclusive malls of Wenzhou, a third tier city. These boutiques were packed with affluent shoppers, and the products would sell out quickly if not instantly.

27-year-old Li Shuang, now the mother of Gen Z who lives in Wenzhou, Zhejiang, remembers seeing her parents “queuing at the city’s Fortune Mall to buy Louis Vuitton.” But then that changed, as sophisticated consumers realized that buying locally often meant prices were three times higher than in Western countries. She is not surprised that the brands have come out. From the mid-2010s onwards they have left these lesser-known cities in droves.

And so high-end cities like Shanghai, Beijing, Guangzhou and Shenzhen (which had a strong domestic tourist influx as well as HNWI) became overcrowded with shops – and they still are today. Louis Vuitton alone has 21 stores in this metropolis. This high concentration means that premium houses not only suffer greatly from competition, but also run the risk of cannibalization among their own boutiques.

Louis Vuitton presented a women’s boutique at One ITC in Shanghai in 2020. Photo: Weibo by Louis Vuitton

The increase in domestic demand due to the closure of China’s borders has forced the houses to increase their market shares in the most promising and luxury-hungry lower tier cities. Prior to the Covid outbreak, Li asked overseas relatives in Europe or the trusted Hong Kong daigous to purchase the desired items as “the prices are much more reasonable”. Now she has repatriated her consumption. “Before, luxury didn’t ship a lot of merchandise to China. I had to go abroad to find what I wanted. But now they are giving priority to this market ”.

Indeed, 55 percent New bricks and mortar from luxury companies opened in the mainland in 2021. Many were located in the country’s lower-tier cities in an effort to acquire new luxury consumers. While this is great, it is still – considering the opportunity – cautious. According to BCG x Tencent 2019 report, nearly half of the country’s luxury consumption comes from tier 2 and tier 3 cities.

Here, Daily Jing talk to analysts to investigate the pros and cons of luxury brands expanding their presence in these developing areas.

The pros: new middle class, experience and financial incentives

In March 2022, Hermès opened its first store in David Plaza in Zhengzhou, Henan Province, and ran out of stock in its boutique on the first day. The question is obvious. The new middle class of regions like these has been the main force behind the recent expansion of luxury labels. McKinsey expects that by 2025 these affluent groups will exceed 500 million people, covering more than half of China’s urban population; it will reach their total disposable income $ 2 trillion (13.3 trillion yuan). Reaching them is essential.

In March 2022, Hermès opened a new store in Zhengzhou, Henan. Photo: Hermes

This was noted by Laura Pan, professor of International Business at the SDA Bocconi School of Management previously, luxury companies “expected wealthy consumers in lower tier cities to go to high-tier destinations” or “shop through their e-commerce platforms.” Ultimately, it was the latter that happened (mostly). 2021 has seen Twice as much as Tmall 11 record a 50 percent increase in new luxury buyers from tier three cities.

However, when it comes to expensive shopping, online isn’t enough – many Chinese consumers want a full-service experience. To satisfy shoppers, high-end gamers need to open boutiques closer to them. Li explained, “Getting to know the salesperson and receiving personalized services strengthens my bond with a brand.”

Xiaohongshu has many trending posts on the topic from accounts or KOLs sharing their VVIC retail experiences, such as birthday surprises in private rooms and in-store trunk shows. “It’s hard to imagine luxury brands having their customers travel for a few hours to the nearest upscale city to enjoy these personalized experiences,” continued Pan.

Another perk for the labels are the incentives offered by local governments to attract global names. Emerging cities such as Chongqing, Nanjing and Zhengzhou are building two or even three high-end shopping malls with the aim of becoming international shopping destinations. On February 8, the Chongqing Municipal Government introduced a new policy for international groups: whoever opens the first store in the city can benefit from a maximum of $ 158,000 (RMB 1 million).

A new growing middle class, a strong appetite for luxury brands and attractive incentives offered by governments lower tier cities could be a luxury gold rush.

The cons: HNWI shortage, inventory management and supply versus demand

But there is always a downside. Despite the growth of the new middle class in lower-tier cities, there may be a deficiency of HNWI (people with high net worth). There is still a significant gap between the percentage of wealthy households in first-tier and lower-tier cities.

The issue of luxury oversupply was raised by Jason Yu, the CEO of Kantar Worldpanel Greater China, a market research firm focused on consumer knowledge and insights. He affirmed it most tier 2 and tier 3 cities cannot host a range of high-end retail facilities and malls due to lack of infrastructure and tourist influx: “overdevelopment will mean supply over demand” .

In light of this, brands need to carefully select target expansion cities based on future economic growth prospects and the direction of China’s economic transition. Yu suggested focusing more on rapidly developing clusters of cities in the eastern and southern regions by reducing the presence in the northeast.

Inventory management and distribution is potentially another pain point for companies operating in multiple cities in a country. It can be a challenging task to meet the needs of different areas while avoiding inventory build-up. Pan posed the valid question: “How do companies increase sell-through per store and ensure there is no stock hoarding among sellers?” In this case, local teams and partners must perform their own due diligence before venturing into untested territories and prioritizing quality over speed.

2022 and beyond

Overall, the luxury goods market here is expected to grow 15-18% in 2022, he reports Yaok, the Chinese luxury research institute. This is an opportunity to increase sales in lower tier cities. Yu of Kantar predicted that for the remainder of 2022, expansion is likely to continue. Due to the ongoing pandemic, “traditional buyers will be more cautious with their spending, although demand for those basic personal luxury goods may remain strong,” Yu commented.

There is little room for further growth in high-end saturated cities, where luxury labels count 20-year-old boutiques. Online competition is also getting tougher. The luxury engine of historic homes is clearly moving elsewhere. To fully unlock the potential of a vast and profitable territory like China, brands have no choice but to get closer to where the new middle class is.