The doomsday prophecies of China’s hard landing are again exposed as exaggerations, as China’s consumers are leading a recovery in the world’s second largest economy. While retail fell off a cliff in Europe during October 2012, China’s retail sector gained 18% from the previous year. October was not an anomaly as the retail sector grew 14% in September and nearly 15% in November from the previous year. The report also indicated that domestic consumption has outpaced exports in this recovery.
The latest update from the China Beige Book, a survey conducted by private New York-based researcher CBB International LLC of more than 2,000 executives, revealed that the retail sector had the strongest revenue growth and business expectations in the fourth quarter of 2012. The latest report shows an uneven economic recovery lead by retail, real estate, and mining, but countered by rising inventories and lower corporate borrowing.
From the China Beige Book: "Retailers' mood remains quite hopeful, with 72% forecasting higher sales in six months, up four points on last quarter. A remarkably low 6% foresee declines."
Luxury Is Key
While retail spending rose slightly during the fourth quarter, luxury and durable goods sales -- including furniture, appliances, and automobiles -- skyrocketed at the same time.
China recently surpassed Japan as the second-largest luxury retail market in the world, second only to the United States. However, this ranking may not even accurately describe China’s appetite for luxury retail. One need only go to a Louis Vuitton
(PINK:LVMUY) store in Paris to see the crowds of people scrambling to purchase a handbag, the majority of which are Chinese. While luxury retail growth in 2012 is down from 2011, the outlook still looks promising.
According to a recent report by Bain & Co., a weaker euro and a growing willingness to travel for bargains have lead Chinese luxury shoppers to make 60% of their total luxury purchases overseas, making the Chinese luxury consumer the top purchaser of luxury goods in the world, accounting for 25% of total global luxury purchases.
(PINK:PRDSF) is a good example of the current trend in Chinese luxury consumption. According to a recent Wall Street Journal
article, Prada announced a 30% year-on-year increase in net income in the third quarter of 2012, with sales in China jumping up by 33% year-on-year in that quarter. The company also reported a 54% year-on-year increase in sales in Europe, which it attributed largely to tourists; I’m willing to bet that the majority of those tourists were Chinese. Reportedly some 50% of Prada's sales to Chinese consumers occur in stores outside of China.
One issue commonly faced by retailers (actually almost all foreign companies) in China is how to properly price their products. Chinese consumers are extremely price-sensitive and are always looking for the best bargain. Just look at the Best Buy
(NYSE:BBY) store in Xujiahui, Shanghai to see the failure of a Western brand without a proper China strategy. Best Buy opened its Shanghai store next to one of the largest and cheapest electronics markets in the city; it’s no wonder the store is currently closed up, leaving its unlit signage as a warning to Western companies trying to enter China without a tailored China strategy.
However, while bargains are important, China is still very much a society of “face” and appearances. The middle class in China is still far behind its Western counterparts, and average salaries are still around renminbi (RMB) 5000 (approximately USD 800) per month, and they are happy to spend months of wages to buy the newest Apple
(NASDAQ:AAPL) iPad or Chanel bag. They won’t pay RMB 300 (approx. USD 50) for a pair of Gap
(NYSE:GPS) jeans, but will gladly pay three times that much if they are made by a famous designer. This consumer mentality is exactly why pricing is so important in China; you must price a product high enough so that it's a status symbol, or low enough so that it's accessible by the general population.
It is quite easy to set up your own retail wholly foreign owned entity (WFOE) in China; the entire process only takes about two months. The registered capital requirements are also quite low -- less than USD 150,000. Additionally, a retail WFOE with a physical store can conduct online sales, and an online-only store requires only provincial level approval.
(See also: Cancel Your Sell Orders, Retail Investors: The China Ride Isn't Over Yet
David Hong is foreign legal counsel with King & Wood Mallesons in Shanghai. He is currently working with CRG, a multi-channel retail services company that assists retailers entering and expanding in China.
No positions in stocks mentioned.