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This article first appeared in Knowledge Wharton China

Even as luxury goods consumption has fallen worldwide, China’s appetite for high-end retail has shown a strong momentum. Italian men’s brand Ermenegildo Zegna continues to see a strong flow of new customers through the doors of its 60 retail outlets in China. “More than I expected,” says Ken Kress, head of Zegna’s China operations. “The bottom line is that the overall economy and diversification of wealth have continued to grow.”

Zegna isn’t alone. Even while Wall Street was still reeling last November, LVMH (OTC:LVMHF) (the French luxury group with products ranging from accessories to spirits) reported double-digit sales growth during the third quarter of last year, according to LVMH’s 2008 Annual Report. The company has seen “dynamic” growth in China, led by high-end leather goods brand Louis Vuitton (LV). And, while wine and spirit connoisseurs around the world are showing restraint in purchasing pricey bottles, in China LVMH has reported “exceptional” sales of Hennessey cognac, and the country was the largest market for luxury spirits in 2008.

LV also made news this past July when it dropped product prices between 2% and 7% at all 29 of its China locations, saying it was not offering a discount or special promotion, but rather was reacting to changing rates of currency exchange between the reniminbi and the euro. On July 17th the company opened its fourth flagship store in Shenzhen and has announced plans to open stores in Inner Mongolia, in the north of the country, later this year.

In general, offering discounts on luxury products is a bad strategy, says John Zhang, a Wharton School marketing professor. “[It] can affect customer confidence in the integrity of the brand's pricing, and devalue the brand.” Customers who want to treat themselves with an expensive luxury bag aren’t likely to be looking for such a small discount, he says, which means it’s likely LV is telling the truth about its discount.

LV and Zegna aren’t the only luxury companies to expand in China recently. On July 24, Georgio Armani cosmetics formally launched its own counter in Mei Long Zheng Isetan, a high-end department store in downtown Shanghai, to target the fast-growing number of women consumers in the city.

German luxury carmaker BMW saw sales in China jump by 44% in June of this year, while U.S. sales fell by more than 20%. General Motors sold and exported 3,363 units of its luxury Cadillac-branded vehicles to Chinese buyers in the first half of the year, up from 3,227 units a year earlier. Sales of the recently released Mercedes S600, a vehicle that sells for roughly US$200,000, have increased between 50% and 60% over the last year in China.

And while some sit behind the wheels of their new luxury automobiles, others are taking to the seas. According to global wealth management industry monitor Wealth-Bulletin.com, super-yacht builder Oyster Marine opened an office in Hong Kong earlier this year, and expects sales in China and Hong Kong to grow from less than 10% last year to 30% over the coming few years.

Catching up with China’s Fast-growing Wealth

Consumers in China spend well over US$6 billion a year on designer bags, cars, clothes, accessories and cosmetics, with the country recently leapfrogging fashion-conscious Japan to come in second behind the U.S. in consumption of luxury goods, according to World Luxury Association data.

And the fourth-largest population of the world’s wealthy will live in China by the year 2015, says a mid-July report by McKinsey, titled, “Understanding China’s Wealthy.” According to the report, as of 2008, there were 1.6 million families in China with household incomes of over US$80,000. By 2015, it estimates that number will jump to 4.4 million, growing by up to 16% per year over the next five to seven years. “The luxury sector will benefit most if this trend continues,” says Jeremy Cheung, managing director (HK) of China luxury consultancy Impact Asia Limited.

In response to continued and growing sales, luxury brands are investing in China. French fashion brand Hermes announced plans late last year to open three to four new stores across the country during the next three years. Italian fashion house Versace is investing more than US$56 million to increase its presence in Asia, with a specific focus on China, and is slated to open 11 new stores across the region this year, according to statements by former chief executive Giancarlo Di Risio. The company gave its first fashion show in mainland China in November last year, at Beijing’s Legation Quarter, the former residence of the American ambassador that has been turned into one of Beijing’s trendiest venues.

A year earlier, celebrities turned out en masse for Fendi’s four-day party on the Great Wall, where part of the former defense shield was fashioned into a catwalk. And between November 2008 and January 2009, more than 60,000 patrons lined up to see Christian Dior’s art exhibition at UCCA Beijing, entitled, “Dior and Chinese Contemporary Artists.”

“All luxury brands are putting money into promotions and PR,” says Cheung. “They know that whoever invests now will get a better market share in the future.”

Understanding China’s Wealthy

Unlike the singular group often portrayed in media reports, China’s newly rich are a varied bunch, but they can be broken down into three general demographics, according to Shaun Rein, managing director of China Market Research, a Shanghai-based consulting firm.

The first are the super-wealthy. With incomes of US$10 million or more, China’s super-rich have been buffered from the worst of the current financial storm.

The second group, composed mainly of upper-middle management and white-collar workers making between US$200,000 to US$300,000 per year, are the aspiring rich, and are the apple of the mass luxury market’s eye. But this category was the worst hit by company restructuring and downsizing, and these consumers are now more cautious about spending cash on wear-only-once Versace dresses or purchasing expensive Starbucks lattes during office lunch breaks.

Luxury buyers in the third group have salaries that belie their combined purchasing power and are mainly office workers making roughly US$600 or more a month. According to a recent survey conducted by China Market Research, more than 70% of respondents in this demographic said they will open their wallets more in the coming six months versus the last six, according to Rein. The survey’s results also indicate at least a 20% increase in market consumption in this demographic, especially in cosmetics.

The majority of China’s wealthy are young, with 80% below 45 years old, compared to 30% in the U.S. and 19% in Japan, according to McKinsey. Chinese consumers are also more focused on the functional value of luxury goods, and hesitate to spend on items not suitable for daily use.

The past decade has seen an evolution in both the types of consumers in China and in consumer sentiment, says Kress. When money first began to flow into the country, a handful of Chinese got very rich, very quickly. New to the market, this group was hungry for a chance to display their wealth, but lacked sophistication and knowledge of luxury brands. Assuming that the most expensive meant the best quality, they searched for the highest price tag.

As recently as five years ago, many companies saw China as a dumping ground for last season’s styles, says Kress. But as the Chinese started to travel, they quickly learned there was a difference between what they saw on shelves at home and what was on offer in boutiques abroad. Their growing economic power forced luxury brands to take notice. Now, accounting for slight adjustments to suit local tastes, Chinese shoppers in Beijing will find the same clothes hanging on the rack as in designer boutiques in Tokyo.

As the market opened, general knowledge of brands increased and tastes became more sophisticated, Kress notes. People developed an affinity for customized personal items at an impressively fast pace, and luxury brands have had to adjust accordingly. Major designers, such as Chanel, whose recent show in Beijing featured clothing inspired by traditional Chinese dresses, or qipaos, are gearing new lines towards Chinese tastes.

The Chinese market of the future may very well resemble the current market of Japan, which has developed a more individualist, Western way of consumption, Kress adds. Previously brand slaves, Japanese consumers are now mixing and matching Uniqlo and Hermes garments in any way they see fit, an evolution that is indicative of an economy that has developed enough that a significant portion of people make their living from creative industries. These consumers will want to express their individuality through their consumer choices, he says.

The urban sprawls of Beijing, Shanghai, Shenzhen and Guangzhou house about 30% of the country’s wealthy as of today, but by 2015, 75% will inhabit cities like Chengdu and Wenzhou and others in non-coastal regions, as money is redirected into China’s interior, says the McKinsey report.

Brands also need to understand the significance of Shanghai and Beijing as cultural reference points for the rest of China, says Kress. Some companies have made the mistake of skipping these cities and heading straight for the potentially lucrative second-, third- and fourth-tier city markets, without realizing these markets take their cues on style and consumption from China’s major urban centers.

Other brands have bypassed the rest of China completely, focusing only on the Shanghai and Beijing markets and missing lucrative sales in lower-tier cities. These companies forget that to garner loyal customers out of China’s fabled one billion, exposure and access to products is essential, says Kress.

Integrated Marketing Strategies

According to Kress, “A wave of new entrants into the luxury brand market three years ago held the belief that if you build it, [consumers] will come.” Jumping in feet first, they neglected to take the necessary time to adequately train staff, or educate consumers. To the detriment of sales, they underestimated the strength of the Chinese need for comfort and functionality in products.

But selling to any consumer base is rarely that simple. Although Chinese consumers may have some distinctive characteristics, certain principles for marketing luxury brands are universal, experts say. Ye Jian, general manager of ING International AD, an advertisement company for luxury brands, says that successful marketing strategies of luxury jewelry brands like Cartier, Piaget and Tiffany (TIF) include four key points.

First, he says, the brands play up their often centuries-long histories through advertising that highlights connections with royalty and celebrities. Second, they invest in continually creating innovative designs that secure their roles as world leaders in fashion and luxury. Third, these brands use unified visual images to communicate with their intended audience.

Fourth, these jewelry brands are involved in socially responsible projects. In China, Cartier donated generously to charitable activities in Sichuan after the devastating earthquake last May. The company also initiated Cartier Woman’s Initiative Award, an international business plan competition awarding women entrepreneurs who lead creative, sustainable and socially responsible companies, and it created a non-profit art fund to sponsor artists and art events worldwide.

These luxury jewelry brands are also constantly on tour in different cities in China, organize online customer clubs and communicate with them regularly by sending art magazines and newsletters -- all effective marketing strategies that other companies can learn from, says Ye.

It certainly takes more than price strategies to win the hearts of China’s wealthy. “Luxury brands belong to an exclusive few in any society, and it is especially so in China,” says Zhang of Wharton. “Chinese consumers of luxury products are very conscious of their social status and class, and they consume those goods to feel different and sophisticated. They surely can afford to pay for those feelings -- meaning a low price strategy is not the way to go.”

Source: Luxury Brands Gain Momentum in China Despite the Global Slowdown