Both L'Oreal (OTCPK:LRLCY) and Estee Lauder (NYSE:EL) have announced a reduction in prices for their imported products in China, after China's Ministry of Finance (MoF) recently announced the reduction of import tariffs. Effective June 1, 2015, the tariffs on consumer goods will be reduced on average of 50% and the duty on cosmetics will be decreased to 2% from 5%.
Why Did The Chinese Government Implement Reduced Tariffs?
In Q1 2015, China's economic growth slowed down to 7%, as against 7.3% in Q1 2014. Retail sales in April 2015 grew by 10% on a year-over-year basis. By comparison, retail sales in March 2015 experienced a slightly higher 10.2% year-on-year growth.
In 2014, domestic consumption hit a 24-year low in China. Private consumption accounts for more than 50% of China's GDP but lags far behind levels in countries such as the United States.
The policy makers are striving to boost domestic consumption by these reduced tariffs since the economy is already afflicted by industrial overcapacity and excessive corporate debt. According to a leading researcher at the Ministry of Commerce, if consumers spent even one-third of the money that they are spending overseas, domestic consumption should rise by 1% to 2%. China's luxury market shrank for the first time in 2014, down 1% from a year earlier, according to a report by Bain & Co. (China Focus: L'Oreal slashes prices amidst tariff cuts, Global Post, May 27, 2015)
Chinese consumers are estimated to spend $165 billion overseas in 2014. The driving factors were:
- China's surging outbound tourists that crossed 100 million in the first 11 months of 2014. This translates to an over 100% growth from 2009 (47.7 million).
- The Yuan's appreciation against the U.S. dollar and Japanese yen also propelled overseas consumption to reflect a 28% year-on-year growth in 2014.
- Also, Chinese consumers prefer shopping for premium products such as luxury cosmetics abroad because premium goods can be up to 50% more expensive in China, compared to its prices elsewhere. The inflated prices are a result of high import and consumption taxes on luxury goods.
L'Oreal Along with Other Luxury Brands Slashed Imported Products' Prices
Currently, L'Oreal enjoys the market leadership in China's $25 billion skincare segment, which is expected to grow to $35 billion by 2019, according to Euromonitor. In 2014, L'Oreal enjoyed a 13% share of the China skincare market, surpassing Japan's Shiseido Co. Ltd and Olay-owner Procter & Gamble Co. (NYSE:PG). (L'Oreal to lower imported product prices in China as tariffs cut, The Business Times, May 29, 2014)
Despite rising operating expenses and the limited impact that custom duties have on retail prices of cosmetics, L'Oreal decided to reduce its prices of imported products. In 2014, L'Oreal earned $2.3 billion in China, registering a growth of 7.7%. According to L'Oreal's China division, the custom duty reduction will have a limited impact on increased consumption. Hence, a further price reduction by the company is essential to boost sales growth.
French cosmetics giant Estee Lauder also slashed prices in the Chinese mainland market, in order to further support the Chinese government's import tariff reduction. The cosmetics company also believes that the policy, though having a limited impact on retail prices, will aid in the future domestic consumption in China.
Gucci, the Italian luxury brands has launched discounts up to 50% off, in several Chinese cities, according to Shanghai local news portal news.eastday.com.
Combating The 'Gray' Area
The reduction in prices by the luxury beauty companies is also a move to combat gray market sales of their products. The pricing difference between China and other international markets lead to thriving gray markets. The reduced prices for high-end handbags and luxury cosmetics abroad lead to gray market products resellers, that enables Chinese consumers to buy cheaper goods through overseas dealers and online sellers. According to Bain & Co., personal shoppers sending back such goods to Chinese consumers accounted for around 65% of the $18.5 billion luxury sales of 2014. (L'Oreal to lure China shoppers with price cuts, Wall Street Journal, May 26, 2015)
In an effort to combat such practices, French luxury fashion house, Chanel, announced in March 2015, that it will increase the prices of certain luxury handbags in Europe and slash the prices in Asia to reduce the pricing gap in the two markets. In China, the handbag prices were reduced by 21%.
Gray market sellers conduct their businesses with the aid of sites such as Alibaba's (NYSE:BABA) Taobao, which is similar to eBay (NASDAQ:EBAY). Luxury brands don't prefer this because it takes the product and retail experience they offer out of their control. Customer interactions help them build brand equity, according to some analysts.
Some of the luxury products prices can be 20% to 50% lower outside of China. These disadvantages can lead to uniform global pricing in the future. (L'Oreal to lure China shoppers with price cuts, Wall Street Journal, May 26, 2015))
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