Go West Strategy in China Presents Risk and Opportunity for Luxury Goods

China’s interior provinces have potential to be a major growth engine for luxury goods, but as brands expand into the second and third tier cities of the West there is a risk too that they will dilute their cachet in the sophisticated first tier cities of the East.

The lure of southwest China

China’s interior provinces account for around two thirds of the population, but only a fifth of economic output. That disparity is narrowing, however. Infrastructure investment, retail
modernisation and economic incentives to entice manufacturers are empowering second and third tier cities in the interior and helping push wealth westwards.

Southwest China’s Chongqing and Chengdu municipalities, with populations of around 28 million and 14 million, respectively, are two of the fastest growing consumption bases in the world. They present hugely attractive opportunities for the luxury goods industry, especially at a time of softening demand in Shanghai and Beijing.

In particular, luxury goods companies have been falling over themselves to build new positions in urban Chongqing. Most recently, fashion house Gucci opened its Southwest China flagship
store (800 sq m over two floors) in the city’s revamped Golden Eagle Shopping Centre in June this year, selling the full Gucci range of leather goods, apparel and accessories.

Consumer expenditure in China

Louis Vuitton (LVMH), the world’s biggest luxury goods company, opened a 1,500 sq m flagship in the city’s Maison Mode shopping mall in the second half of 2011 (and a year earlier opened a similar size store in Chengdu’s Yanlord Square). Tod’s, Armani, Burberry, Omega and Lamborghini have also built new positions in Chongqing over the past two years.

What is more, sales in luxury goods outlets in Chongqing and Chengdu are outperforming comparable sales in Shanghai and Beijing. This is fuelling optimism within China’s luxury goods market that the burgeoning consumer-led growth of the interior will offset slower growth along the Eastern coast, in the same way that Shanghai, Beijing and Guangzhou offset slower luxury goods demand in Tokyo, New York and Milan over recent years.

Negative social attitudes threaten China expansion

There is a problem, though. There is evidence that the increased visibility of luxury goods brands in fast-growing interior provinces, such as Chongqing and Chengdu, is undermining the prestige value of these brands in the more sophisticated coastal cities of East China. This is tied up with deep-seated prejudices.

The attitude of people in East China towards people from the interior can – in its worst manifestations – take the form of open discrimination. Rural migrant workers in Shanghai are
routinely banned from upmarket hotels, restaurants and shopping malls, for example. Urban migrants have been the backbone of the city’s infrastructure modernisation, but are widely distrusted and often treated in a patronising way by Shanghai’s new middle class.

Such prejudices are common in cities the world over, but in China they could develop into a strategic problem for luxury goods brands as they expand into the interior. A sizeable proportion
of East China’s wealthier classes like to feel superior to people from the interior. That means if consumers in the interior are buying Gucci and Armani, the prestige value of the same brands in Shanghai risks being diluted.

The world’s leading luxury goods companies have been painstaking in their research into China’s interior. For example, the strategy at Louis Vuitton is to visit a target city and location at least 25 times at different times of the year before making a decision on whether or not to expand there.

What the industry does not appear to have bargained for is a negative reaction to its interior expansion from status-conscious consumers in the East. It is an issue that is bubbling and will become increasingly front-of-mind over the year ahead.