With more than one million millionaires, China is a core driver of growth in the global luxury goods market. Yet, Western manufacturers often fall short of their full growth potential in China because they struggle to understand the complexities of its consumption culture, and are thwarted by complicated routes to market. Paradoxically, by developing new positions in locally made mass-market brands, luxury goods manufacturers could unlock a solution to both problems.
When luxury goods meet fast fashion
Eyebrows were raised in luxury goods circles when it was reported last month that L Capital Asia, a private equity fund backed by LVMH Moët Hennessy Louis Vuitton, the world’s biggest luxury goods company, had snapped up a 10% stake in a Chinese fast fashion manufacturer called Trendy International Group, paying an estimated US$200 million.
Trendy, which is based in the southern industrial city of Guangzhou, operates around 300 directly-owned outlets, but also has multiple franchised stores across its four brands, of which the largest is Ochirly. The brands are virtually unknown outside China, and their middle-class customer base is a far cry from the high net worth individuals (HNWIs) normally associated with LVMH.
So, why is LVMH, owner of iconic luxury brands such as Dom Pérignon and Givenchy, muddying its hands with mass-market Chinese clothing? LVMH will argue that L Capital operates independently from LVMH and Groupe Arnault, and that L Capital is exercising its own interest in China’s rapidly growing fast fashion market. But, there is probably more to it than that. Specifically, the development of new positions in mass-market brands could be a clever strategy to boost LVMH’s luxury goods performance in China over the longer term.
China’s mushrooming middle-class a luxury goods opportunity in the making
Crucially, China’s burgeoning middle-class could be the sweet spot of future opportunity in so-called affordable luxury goods consumption. Firstly, middle-income wages are on the rise, secondly, exposure to retail sophistication is growing in middle-class neighbourhoods and, thirdly, upwardly mobile young adults have a level of material ambition that was virtually unimaginable among their parents’ generation.
By getting a better handle on what middle-income China likes to buy, LVMH will potentially have a valuable asset when it comes to developing luxury goods brands for the future. For example, it could use its new understanding of mass brands to build stepping stones to more aspirational purchases. Indeed, one of the biggest challenges for luxury goods manufacturers is to understand how China’s consumption culture is developing below the luxury goods radar. Herein lies the consumer base that will be looking to trade up to luxury goods in the future.
The sheer number of stores (and franchised stores) operating through a company such as Trendy could also give LVMH significant route-to-market know-how. In particular, local fast fashion stores will tend to have route-to-market experience in the interior of China, which is otherwise a virtual distribution whiteout for Western luxury goods manufacturers (and most Western fast moving consumer goods manufacturers to boot). As wealth filters from the coastal cities into the interior, so an understanding of landlocked distribution routes will become ever more critical if international players are to maximise their growth opportunities in China.
Affordable luxury and trade-up activity present growth prospects aplenty
So-called affordable luxury has been a lynchpin of growth in developed markets in recent years. And it has developed by building bridges between mass brands and luxury brands. Diffusion brands of luxury labels, notably, have helped entice middle-class consumers of mass brands into status consumption or new luxury-oriented buying patterns. Examples of diffusion brands include Armani Exchange, CK (Calvin Klein) and Miu Miu (Prada).
The prospect of tapping into China’s middle-class is enormously attractive given the vast size of the population. The number of inhabitants in social class C totalled around 178 million last year, according to Euromonitor International’s Countries & Consumers data. That is bigger than the entire population of Russia.
Luxury goods player Prada appears to have cottoned on to China’s C class potential. Following its 2011 Hong Kong IPO, the company announced plans to open 50 new stores in China over the next three years, and among them will be discount stores too, targeting China’s second- and third- tier towns and cities and the millions of social class C consumers who inhabit them.
Apparel retail sales totalled upwards of US$226 billion in China last year, according to data from Euromonitor International. Locally produced fast fashion brands comprised a substantial share of the mix, fuelled by demand from social class C consumers. Quite clearly, it makes commercial sense for the likes of Prada to grab a share of this spending, while at the same time nurturing a new aspirational customer base for its upper-tier portfolio.
India’s mass-market brands an opportunity too
The mass brand to luxury brand strategy applies to other emerging markets too. Indeed, L Capital Asia also recently acquired an 8% stake in the Indian apparel chain Fabindia, which specialises in ethnicwear for middle-income consumers. In 2010, Fabindia generated retail sales of around US$87 million, according to Euromonitor International.
Such is the allure of the luxury goods growth story in China and India that Western companies necessarily have to come up with innovative ways to maximise their performance potential. The pinnacle of luxury goods consumption is flying high on the back of a new generation of emerging market millionaires. But, it is the next generation of millionaires – many of whom currently languish in the middle-class – that present potentially an even bigger prize.