By the JLJ Group
China is today the second largest consumer of fashion and luxury goods in the world, with an estimated value of US$ 9.4 billion – or over a quarter of worldwide sales. China’s luxury goods market is projected to overtake Japan and become the world’s largest market by 2014. This impressive trend is fueled by a burgeoning middle class, which is expected to expand from 250 million to over 700 million people within the next 10 years, most of whom will be in the 25-35 year old, fashion-conscious, age bracket.
Doing well in China, like any major project, requires time, patience, knowledge and resources. US designer brands entering China now face significant competition from earlier market entrants, particularly from Europe, and no longer have a first-mover advantage. Thus, success in China ultimately depends on three factors: (1) Understanding the complex challenges of doing business in the country; (2) Selecting the right entry strategy from a wide variety of options; and (3) Having the right advisory and operating partners. We discuss these factors below.
US designer companies must address a number of related issues when approaching the China market: consumer education, regional differences, counterfeit products, trademark registration, and more. Some of these challenges, if well managed, can actually turned into advantages if parts of a broad, overall sound entry and growth strategy.
From a cultural standpoint, for instance, most Chinese do not yet fully understand or appreciate the lifestyle associated with luxury goods, and have a low level of brand awareness beyond only the most popular and mainstream brand names such as Louis Vuitton and Dolce & Gabbana. Additionally, many purchase luxury goods merely as a symbol of wealth, and not as something indicative of fashion and style. As such, the China market will require that companies take part in fashion shows, special events, and public relations efforts aimed at educating Chinese consumers about a sustainable luxury lifestyle and culture.
China’s wide ranging geographical landscape means that the market is very diverse, with consumer preferences often differing significantly across regions. For example, Shanghai tends to have a preference for luxury goods of European origin, while Beijing tends to have a preference for U.S. goods. All this can pose a challenge to effective management of inventory and distribution channels to ensure that suitable products are brought to market. Retailers who overlook the importance of finding the right location to enter the market may find themselves following in the footsteps of fast-fashion retailer Forever 21, who had to withdraw from the China market after shutting down its business operations in Changzhou, a city two hours from Shanghai.
A common concern for luxury brands is the issue of counterfeit goods in China. An estimated 20% of all high end consumer goods may be counterfeit. At the same time, foreign trademarks are not recognized within China; companies must register their trademark upon entering the country. It is however important to emphasize that the overall protection of intellectual property rights (IPR) is getting better over time, and companies have ways to plan their IPR as part of their entry strategy in China.
Market Entry Options and Selecting the Right Partner
Foreign companies can enter the Chinese market through a variety of venues: distributors, licenses, joint ventures, wholly owned subsidiaries, and even combinations of these different approaches. Each venue must be properly understood and evaluated.
A distributor manages the promotion and sales of a brand’s products through department stores and other retailers. This approach has the advantages of ease, minimal investment of time and resources, and reliance on a local partner who is experienced and knowledgeable. The disadvantage is a possible conflict of interest between the brand’s long term objectives of building a business in the right stores promoted in the right way and a distributor’s goal of immediate financial returns. The greatest challenge therefore is to identify the right distributor.
A second venue is to adopt a licensing model – a common approach among fashion firms, such as Esprit and Vero Moda. The benefits of licensing include the possibility of rapid expansion of retail outlets across cities, and efficiency in local markets through leveraging licensees’ local relationships and familiarity with local regulations. However, adopting the licensing model comes with its own set of challenges. Finding a suitable licensee who can maintain service quality standards and respect for the brand has been a particular concern for the fashion and luxury retail industry. Some firms such as Dunhill, who entered China in 1994 by opening regional licenses, have bought back the majority of their licenses due to the issue of quality control. Luxury firms in particular need to be vigilant in approaching licensing in view of these risks to brand image and positioning.
As companies mature, they may want more direct control over their China operations, and can opt to form a joint venture with a local partner to enter the market or drive growth and expand existing distribution networks, as has been the case with German fashion house Hugo Boss. Hugo Boss, which already operates in China through a licensing model, has been looking to enter into a joint venture with their local licensing partner for aggressive expansion within China, aiming to open 20 new stores over the next 5 years. Though clearly operating already with a good understanding of the Chinese market, Hugo Boss chose to form a joint-venture to leverage the partners’ understanding of the target secondary markets beyond the coastal retail hubs of Beijing, Shanghai, and Guangzhou.
A joint venture allows foreign firms to work with a local firm with local expertise and to participate in the brand’s potential financial upside. Careful planning is needed to avoid common pitfalls such as cultural, linguistic, and business practice differences that could ultimately lead to a failure of the business.
Lastly, companies can also take advantage of China’s economic policy that allows foreign investors to establish their own wholly foreign-owned enterprises (WFOEs) and assume direct control of all operational aspects, as American apparel company Gap is currently doing in China. It is not only large multinational firms who can consider this option; mid sized firms can, with the right advisor, also pursue a WFOE. Luxury companies often choose a WFOE to control all aspects of their brand.
The benefits of setting up a WFOE and operating under the direct ownership model are the ability to closely monitor and maintain quality standards, tightly control the distribution channels, as well as gather information on Chinese consumer preferences. However, this option also entails greater investment costs and associated risks for the company as it must deal with all the local challenges as well as with hiring and managing Chinese employees.
Another possible approach is to adopt hybrid approaches to the Chinese market, such as entering into a JV, and then later buying back the business from the local partner to operate and manage directly after the brand is established. Or, in order to set the standards for your firm, to use a WFOE to build a few stores in China and then find licensees by region for its rollout. Coach has taken the hybrid approach of buying back its licensed 43 stores and believes it will generate $ 250 million in sales in China by 2012. Guess has a mixed strategy of owned and licensed stores with the ultimate goal of 30% owned and 70% licensed.
China represents an exceptional opportunity for US designer companies. However, in order to succeed, they must partner with the right companies to assist them in dealing with the market challenges, choose the right entry strategy, and select the best local companies.
The JLJ Group, an international consulting service provider with offices in the US and China, has conducted over 400 market entry and growth assignments in the past five years for US and European companies. JLJ has worked extensively with numerous luxury firms – Chanel, Bulgari, Dior, and Coach among others. JLJ is a one stop firm that offers services including market studies, market entry strategies, finding local partners, hiring senior management and staff level, and growth strategies for firms already in China. For further information, please contact: Andrew Traub, President of Andrew Traub Consulting. Call 203-595-0212 or email: firstname.lastname@example.org.