China: The Future of Luxury?

I recently traveled to ShenYang, the capital of Liaoning province, ranked 7th among China’s provinces in GDP. Liaoning is one of three provinces that make up what is known as the DongBei region (Literally translated East-North.) that borders North Korea. (I read recently that North Korea has four touch points with the World Wide Web and all four are in ShenYang.)

ShenYang is the capital of Liaoning Province.  It is a Tier 2 city by Chinese standards.
ShenYang is the capital of Liaoning Province. It is a Tier 2 city in China.

Although larger than Boston or Chicago ShenYang is classified as a Tier 2 city by Chinese standards. It has surely prospered but has no indigenous source of wealth such as oil or coal.

The airport is very comfortable and fairly new. But as I sat in the terminal waiting for my plane I had this growing sense that there was something quite different about this airport. It took me a while but then I figured out what it was.

Like most modern airports, the developers of this airport (i.e. the local government) tries to entice travelers to spend a little money while they wait for their planes. Only in this case the retail space is not filled with travel accessory stores or gadget kiosks. And once you go through security and enter the gate area there is little in the way of food and not a single bar. Virtually every square meter of space is occupied by a high-end luxury retail shop. And almost all of them are extremely large for the format.

Luxury has prospered in China both because China has a gifting culture and the nouveau riche want others to know it.
Luxury has prospered in China both because China has a gifting culture and the nouveau riche want others to know it.

There is Armani and Coach and Bally and Ferragamo and Mont Blanc and, and, and. I literally gasped once I figured it out.

There are no duty free shops because this would not be a hub for international travel. These stores are appealing – or attempting to appeal – to domestic travelers. Each is staffed with numerous stylishly dressed associates.

And all were nearly empty. And judging from the faces of the consistently attractive young women working the stores, empty was not unusual.

Retail is an expensive business.  Luxury retail is very expensive.  And this is not Beijing or Shanghai.  This is ShenYang.
Retail is an expensive business. Luxury retail is very expensive. And this is not Beijing or Shanghai. This is ShenYang.

As a businessman the first thing that came to mind is the reality that there is no way these stores can survive in this environment. Retail is an expensive business. Luxury retail in a modern airport is an extremely expensive business. How could they ever generate enough traffic to even pay the rent?

This, I believe, is symbolic of one of the challenges facing China today. Most luxury goods manufacturers and retailers will tell you that China is their fastest growing market, just as Japan was two decades ago. And while there is a lot of wealth in China today the reality is that the average Chinese cannot and will not shop in these stores. Hundreds of millions of Chinese could afford nothing in them.

Luxury retailers have prospered in China, but they have done so on the backs of a very small slice of the Chinese population.
Luxury retailers have prospered in China, but they have done so on the backs of a very small slice of the Chinese population.

And, in the end, I am unconvinced that even those Chinese who can easily afford to shop here will continue to do so. While it is true that the Chinese have devoured more than their fair share of luxury goods over the last decade I’m not convinced they do so for the same reason Westerners buy them. I’m not convinced they see any real inherent value other than the name itself.

Many purchases made in stores like these are gifts, and that is one argument for putting them in airports. But it is the gifting rather than the gift that really matters. If you give someone a legitimate Coach bag they will know, without a doubt, that you value your relationship with them.  But the value is in the name rather than the product itself.  And brand appreciation is a fickle business at best.

In terms of return on investment, pride is not a viable long term strategy.
In terms of return on investment, pride is not a viable long term strategy.

As I laid out my predictions for 2014 I noted that there is an excessive inventory of luxury retail stores in China and that they could not possibly all survive, leading to a potential strain on the commercial real estate market. That didn’t happen – at least not in 2014.

And the reason it didn’t, I now believe, is that most of these luxury shops were financed with government money and the government has no investors to satisfy – it can sit on the loans forever.

Nor have the luxury operators of these stores been overly concerned because the cost of staffing these stores has been so low. I would guess that the pretty young women who work in these stores in places like ShenYang make $300 or less per month.

If the government doubles their wages over the next five years, as it has committed to do, however, these operators will ultimately bleed red ink. And then it won’t matter how patient the entity sitting on the mortgage is. Operating losses are real money.

There is some good news. During his recent report to the Two Sessions, Premier Li Keqiang announced that in 2014 consumer spending accounted for 52% of GDP growth, its highest contribution ever. That’s a remarkable increase that bodes very well indeed for the pivot to consumption that is the foundation of China’s economic re-engineering.

BUT, and it’s a big but, the Premier also noted that China now has 780 million citizens online, and almost all of them are shopping there. They aren’t shopping at the ShenYang airport.

I believe that the ShenYang airport is yet another symbol of why the government wants to liberalize and privatize more of the financial sector. These types of extravagant investment decisions would not have been made by private investors worried about risk and return. These are investments of pride and pride is typically not a viable long term investment strategy.

I still believe it’s all going to come together for China. But there will be bumps in the road. There is a lot of work to be done.

In the meantime, if you’re in the market for a Coach bag or an Armani suit you might consider passing through ShenYang on your next trip to China. I’m pretty sure there will be some excellent closeout bargains. The only question is when.

The Chinese retail market has been distorted by an incredible rise in wealth and the pride-oriented investment strategy of many local governments.  Can it last?
The Chinese retail market has been distorted by an incredible rise in wealth and the pride-oriented investment strategy of many local governments. Can it last?

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Copyright © 2015 Glassmaker in China

Notice:  The views expressed in this post are strictly those of the writer acting in a personal capacity.  They are not in any way endorsed or sanctioned by his employer or any other individual with which he may be personally or professionally affiliated.