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By Ben Cavender and Jessica Lo

A version of this column originally appeared in China Business Review.

As the effects of the economic crisis ripple across the global economy and demand for expensive products plummets, luxury brands face gloomy prospects in North America and Europe. Except in China which saw 15% retail sales growth in Q1, consumer spending is in sharp decline as consumers retrench, look for value in their purchases and cut back on non-necessities.

The second half of 2009 does not present much hope for a rebound. Global luxury spending rose 6.5 percent in 2007 before slowing to 3 percent . Growth in mature markets such as Europe, Japan, and the United States suggest flat or negative growth in 2009.

In the face of reduced demand, luxury brands like Gucci are turning to China as a potential stronghold for consumer spending in 2009. Like the rest of the world, China is feeling the effects of the economic crisis, and real estate and exports have all taken a beating.

But consumer spending in China remains strong as CMR MD Shaun Rein wrote in BusinessWeek recently.

China’s $586 billion USD stimulus package which is designed to encourage consumption will also help maintain luxury sales. If luxury brands focus on the desires of Chinese consumers, they may be able to use China as a haven even as other markets falter.

Successful luxury players

Many key luxury players reported strong sales performance in China in 2008, despite the global downturn. For example, LVMH Moet Hennessy Louis Vuitton SA (OTCPK:LVMHF) reported “very dynamic” growth in China, led by strong numbers from its leading brand, Louis Vuitton. According to LVMH’s 2008 Annual Report, worldwide, China became the second-largest customer base for Louis Vuitton. In addition, LVMH’s wine and spirits brands, which have been struggling in other markets, enjoyed “exceptional” growth in China last year, with particularly strong performance from cognac maker Hennessey. China was the largest market for Hennessy cognac last year. Furthermore, in November 2008, LVMH reported that Parfums Christian Dior experienced “excellent” double-digit growth in China through the third quarter. And in its selective retail division, LVMH attributed the recent strong performance of duty-free retailer DFS Group LP to continued expansion of Chinese clientele.

Even though Gianni Versace SpA has had management control issues recently, they are still upbeat on China. Versace is also optimistic about China’s prospects and is focusing efforts on China growth in the coming months, including by opening new boutiques in China in 2009. The company expects Asia to surpass the United States as its second-largest market in 2009, driven largely by growth in China.

China sales also boost the Gucci Group (OTC:GUCG). Gucci Group’s global 2008 sales were up about 8 percent over 2007, with the highest growth rates coming from Asia and led by China. According to a 2008 annual report, Gucci’s sales in Greater China grew 42 percent over 2007. Last fall the company said it expected steady consumption growth in China and other emerging markets and would likely continue to prioritize these areas

Reasons for luxury’s success

Consumer spending-and demand for luxury goods-has remained strong in China for several reasons.

Consumer optimism

First, Chinese consumers--especially consumers in their mid-twenties to mid-thirties--are optimistic. In the last several months, the China Market Research Group (CMR), has conducted what we believe is the most extensive consumer insight research in China by interviewing consumers in Beijing; Chengdu, Sichuan; Fuzhou, Fujian; Guangzhou, Guangdong; Shanghai; and Xi’an, Shaanxi about how they have adjusted or are planning to adjust their spending because of the economic crisis. 70% consumers said that they will spend more in the next 6 months than they did in the previous 6. Optimism remains high with a full 80% saying they have the full trust that the Chinese Government will implement the policies needed to invigorate the Chinese economy.

A middle class that wants to spend

China’s young, emerging middle class is beginning to equate accumulation of possessions and leisure opportunities with quality of life, and it is this group that is largely responsible for China’s falling savings rates and rising consumption rates, especially in major cities. group have also been instrumental in driving the growth of the luxury market within China, as they try to display their success and status with luxury hand bags and high-end mobile phones, such as those made by UK-based luxury phone maker Vertu (a Nokia subsidiary). This group remains optimistic about its future. Much of China’s middle class has little to no stock market exposure, and those with experience expect that the market will rise again. The group also expects 10-15 percent annual salary increases and strong economic growth over the long term. despite the short-term difficult job market.

Superrich still spend on luxury

Global slowdown in demand and slowing exports from China are unlikely to change the lifestyles of China’s superrich, another key consumer group for the luxury market. Versace is counting on this, as described above, as is high-end luxury retailer Hermès. Hermès has seen sales drop in Japan, where many of its customers are middle class. In China, where Hermès customers mainly come from the superrich consumer group, sales have not shown any impact of the downturn thus far. The Asian region, excluding Japan, posted 21 percent growth through the third quarter primarily because of increased demand in China. Hermès is bullish on China, and last September announced its plans to open three to four more stores in China each year for the next three years.

Trust in the government

In general, Chinese consumers trust the PRC government to make sound policy decisions regarding the economy. Whereas in the United States there is little faith that Congress will respond adequately to the economic crisis, Chinese consumers are extremely confident in the government’s ability to respond to economic strain and stimulate growth.

Strategies for success in Luxury goods.

The strong growth reported by luxury heavyweights LVMH, Gucci Group, Versace, and Hermès, combined with the factors above, are reasons luxury retailers can be cautiously optimistic about the China market. Even if sales dip in the short term, China will likely be a major long-term growth engine for the global luxury market. Meanwhile, luxury retailers should consider the following strategies to improve the luxury shopping experience in China, secure the loyalty of Chinese consumers, help weather a sales slump if one occurs, and be well-positioned for stronger growth when demand picks up again.

Prepare to serve a wide range of customers

Luxury retailer on the mainland must be able to serve a wide range of consumers, from the first-time luxury purchaser to the superrich. Salespeople must be able to provide guidance and education to newer entrants to the luxury market, especially for fashion items. According to CMR research, women are generally interested in learning how to apply cosmetics and about the most recent fashion trends, and men are interested in learning how to match items, such as suits with shirts and ties, and choose gifts for wives, girlfriends, and clients or business partners.

Improve Service

In CMR interviews with new luxury shoppers, many respondents have described mainland luxury retail salespeople as unhelpful, intimidating, and sometimes rude. Salespeople must be trained well to make shopping a pleasant and luxurious experience and represent their brands’ lifestyle to shoppers.

Offer lower-priced luxury items

New luxury shoppers also need access to starter luxury items, including signature accessories--such as belts and key chains--and lower-priced bags and wallets. CMR research shows that shoppers want to touch and try these items in the store before purchasing them. Retailers should accommodate these needs by making such items easily accessible.

Offer top-of-the line items too

In addition to starter items for new luxury shoppers, mainland luxury retailers must offer the newest, top-of-the-line items to satisfy China’s seasoned superrich--shoppers who are typically looking for items that will make them feel special and stand out. According to CMR research, many of these experienced luxury shoppers are unable to find the newest products and brands they want on the mainland. Many have been going to Hong Kong, and the superrich have been traveling to the United States and Europe to gain access to the latest fashion items.

Educate consumers about the brand

Besides educating consumers about products and fashion, luxury retailers need to educate consumers about what their brands represent. Versace communicated its high-culture, high-fashion image well in its first fashion show in China, held in November 2008. Versace chose Beijing’s new Legation Quarter--a new “lifestyle development project” near Tiananmen Square and the Forbidden City--for the show’s location. Local elites and celebrities such as Jet Li attended the event, which included a dinner and auction to raise money for victims of the May 2008 Sichuan earthquake.

Though Versace’s fashion show communicated its brand image to those in China’s super-elite ranks well, next year Versace and companies like it should also communicate to those who aspire to join those ranks. For example, when Salvatore Ferragamo Italia SpA chose Shanghai as the venue for its eightieth anniversary celebration, in addition to hosting fashion shows and parties for the city’s elite, it erected a giant replica of its famous rainbow-cork-wedge sandal outside its Shanghai location to be viewed by the masses. Given that the number of millionaires in China in 2007 rose about 20 percent over 2006, according to a Merrill Lynch and Capgemini estimate, companies must target China’s aspiring middle class today to reach next year’s millionaires.

Cautious Optimism

Because China is an integrated part of the world economy, growth in Chinese demand for certain luxury products and brands may slow as a result of the current downturn. But considering strong numbers from key players thus far, government initiatives, and existing trends in the Chinese economy, such as record-high growth in retail sales, CMR remains cautiously optimistic that China will remain a strong growth source for luxury brands. Luxury brands should continue to prioritize China as a key driver of global growth in the coming months.

Ben Cavender is senior analyst, and Jessica Lo is managing director at China Market Research Group (CMR), a strategic market intelligence firm headquartered in Shanghai.