China accounts for about one-third of the world’s multi-billion dollar luxury goods sector, but about 90% of those sales take place in-store, and as much as half of China’s luxury spending takes place outside the Mainland. With tech-savvy Chinese millennials accounting for 70% of luxury spending and lower-tier cities emerging as an important growth driver (but where luxury houses have a limited offline footprint), there is reason to be optimistic about luxury e-commerce’s growth prospects in China.
The global personal luxury goods market is expected to grow from RMB 2.4 trillion in 2018 to RMB 3.1 trillion by 2025, representing a CAGR of 3.7%. Much of the market’s growth is expected to be driven by a growing number of affluent Chinese shoppers who will drive China’s personal luxury spending from RMB 770 billion in 2018 to RMB 1.227 trillion by 2025 (representing a CAGR of 6.8%, nearly double the worldwide growth rate of 3.7%). China will account for 64% of the market’s growth during 2018 and 2025, and the country’s share of the global personal luxury market is projected to rise from 32% in 2018 to 40% by 2025.
Online sales make up just about 10% of total Chinese luxury spending; however, this is expected to grow to 12% by 2025.
These figures indicate China’s luxury e-commerce market will grow from RMB 93 billion in 2020 to RMB 147 billion in 2025, representing a CAGR of 9.6% during the five years from 2020 to 2025. This is higher than the 5.7% growth rate of China’s luxury market during the same period.
Low e-commerce penetration in China’s luxury sector is a pattern observed worldwide where the luxury sector is generally noted to be a digital laggard with research from Deloitte showing that physical stores account for about 63% of luxury goods purchases.
However, there are several factors that could propel e-commerce penetration of the luxury goods market in the years ahead. A deeper look into the online vs. offline shopping preferences of luxury shoppers revealed that mature market luxury consumers tend to shop in-store, while millennials, an increasingly important target market for luxury brands, tend to shop online; reportedly as much as 42% of millennial luxury goods shoppers make purchases online and this is becoming more popular across generations, notably upcoming Generation Z which is more technology-savvy than past generations and more comfortable with shopping online. This is particularly true in China, where millennials account for 70% of luxury goods purchases.
Furthermore, China’s lower-tier cities are fast emerging as the next frontier for luxury sales growth. According to a survey by Luxe Digital, 45% of middle-class consumers in Chinese tier-3 cities are interested in purchasing luxury goods, versus 37% in tier-1 cities. A report by Boston Consulting Group and Chinese internet behemoth Tencent (OTCPK:TCEHY) (OTCPK:TCTZF) reveal that more than 50% of China’s luxury consumers live in 2nd tier, 3rd tier, or lower-tier cities, suggesting there is tremendous untapped potential in China’s lower-tier cities. Yet, luxury brands have a limited footprint in these underserved regions, with a recent study estimating that more than 30% of luxury shoppers in China do not live within areas in which luxury brands have an offline presence. With luxury shoppers in China's lower-tier cities having limited opportunities to purchase in-store, they are likely to turn to online channels.
While these factors galvanize the term case for strong e-commerce capabilities in China (which is expected to be the growth engine of the global personal luxury goods sector), the COVID pandemic is likely to have accelerated this transition. With e-commerce emerging as a lifeline for luxury brands during the COVID pandemic when stores were shut, there is a strong case for the luxury goods sector to embrace e-commerce.
Apart from the discretionary nature of the luxury goods sector, its heavy reliance on offline sales means the COVID pandemic is unsurprisingly expected to have negative consequences. Companies with limited online sales channels are expected to be hit harder than those with strong omnichannel models.
According to estimates from McKinsey, global revenues for the personal luxury goods industry (luxury fashion, luxury accessories, luxury watches, luxury jewelry, and high-end beauty) are expected to contract by 35-39% in 2020 year on year. The average market capitalization of apparel, fashion, and luxury players dropped by nearly 40% between January and March 2020 – a much steeper decline than the overall stock market.
Furthermore, of Chinese shoppers - 30% or so share of global luxury spending - much of that is spent outside China. In 2019, globetrotting Chinese made more than 150 million overseas trips during the year, and McKinsey estimates that purchases outside the Mainland accounted for more than half of China’s luxury spend that year. With overseas travel not expected to return to post-COVID levels, luxury brands will be compelled to reach Chinese luxury shoppers (much of them millennials) on home soil which should serve as a major growth driver for luxury e-commerce in the Middle Kingdom.
Brand e-commerce penetration is just about 13% as of 2018, according to figures from Chinese research and information provider Gelonghui. However, there is tremendous potential for this to grow as rising incomes help increase Chinese shoppers’ appetite for branded goods.
Although it is sometimes referred to as “China’s Shopify” (NYSE:SHOP), Baozun is quite different in that Baozun offers integrated end-to-end e-commerce solutions while Shopify is an e-commerce SaaS provider. Baozun offers digital marketing, including digital marketing on social media platforms such as WeChat, IT services (including developing official brand websites), store operations including official brand stores on marketplace platforms such as Tmall (NYSE:BABA), JD.com (NASDAQ:JD), Vipshop (NYSE:VIPS), and Amazon (NASDAQ:AMZN), customer service, fulfillment services, and warehouse services with its network of warehouses in major cities in China such as Beijing spanning more than 500,000 square meters.
Baozun’s brand partners are primarily in apparel, appliances, 3C, home furnishing, FMCG, cosmetics, auto, and insurance. The company’s notable clientele include brands such as Nike (NYSE:NKE), Starbucks (NASDAQ:SBUX), Adidas (OTCQX:ADDDF), Heineken (OTCQX:HEINY), GoPro (NASDAQ:GPRO), Godiva, Panasonic (OTCPK:PCRFY), Johnson & Johnson (NYSE:JNJ), American Eagle Outfitters (NYSE:AEO), Häagen-Dazs (NYSE:GIS), Pizza Hut (NYSE:YUM), Oreo (NASDAQ:MDLZ), Microsoft (NASDAQ:MSFT), Tommy Hilfiger, Calvin Klein (NYSE:PVH), and Levi’s (NYSE:LEVI).
However, the company has bagged a few luxury brands including Burberry (OTCPK:BURBY), and Gucci as well as entry-level luxury players such as Tapestry-owned Coach (NYSE:TPR), Michael Kors (NYSE:CPRI).
Baozun’s niche as an end-to-end e-commerce service provider in China’s e-commerce market currently appears to be uncontested, which suggests Baozun is well-positioned to continue benefiting from China’s expanding brand e-commerce market. Given the company’s first-mover advantage, scale, fulfillment infrastructure, and proven expertise in brand-e-commerce operations and technology, it should be in a better position over smaller, lesser-known rivals to capture luxury brands seeking a brand e-commerce partner in China.
Baozun started off with a “distribution based” model in which Baozun played an active role in the brand’s e-commerce operations, where Baozun selects and purchases goods from their brand partners and sells the goods directly to consumers through official brand stores or marketplaces operated by Baozun (such as Baozun’s Maikefeng marketplace platform) on behalf of their brand partners.
But the company has shifted away from this capital-heavy model to an asset-light “non-distribution” model which comes in two flavors; the service fee model in which Baozun provides e-commerce services such as IT solutions, online store operation, digital marketing and customer service; and the consignment model where Baozun provides warehousing and fulfillment services in addition to all the services under the service fee model.
Source: Credit Suisse
Non-distribution GMV (gross merchandise volume) accounted for 91% of the company’s total GMV according to its last financial report, up from 86% in 2017. Services (which are generated through fees under the consignment model and the service fee model) accounted for 53% of revenue last year (up from 45.6% in 2017) while product sales (which are generated from selling products on behalf of customers under the distribution model) accounted for the rest of the 47%, down from 54.4% in 2017. The shift to an asset-light model helped improve profitability with the company’s net profit margins improving from negative five years ago to between 3-5% currently.
However, the company’s persistent negative cash flow over the past few years suggests that while the company is currently in a growth phase and shows tremendous potential for growth in the years ahead, it is worth keeping an eye on its balance sheet.
Alibaba’s Tmall Luxury Pavilion
Part of the reason for China’s low e-commerce penetration in the luxury sector is due to luxury houses being reluctant to set up stores on Chinese e-commerce platforms because luxury brands wanted a more controlled online experience for their customers (by separating value and ‘everyday’ products from luxury brands). Launched in 2017, Tmall Luxury Pavilion by Alibaba appears to be an answer to these concerns and the platform has emerged as the leading marketplace for luxury brands.
Source: Jing Daily
Tmall’s invitation-only Luxury Pavilion boasts more than 180 luxury brands including Cartier, Burberry, Versace, Stella McCartney, Kering Group (OTCPK:PPRUF)-owned Qeelin, LVMH (OTCPK:LVMHF)-owned Guerlain, Givenchy, Tag Heuer, Valentino, Tod’s, Maserati, and Alexander Wang, to name a few. Alibaba also signed up with YNAP to launch a Net-A-Porter flagship on Tmall Luxury Pavilion.
According to Gartner, 51% of 45 top global luxury fashion brands it tracks have official flagship stores in Tmall and the platform reportedly boasts more than 100,000 shoppers spending on average US$ 159,000.
Nearly one-third of Tmall Luxury Pavilion’s shoppers are millennials aged thirty and under, and they account for 45% of Tmall Luxury Pavilion’s sales. Tmall’s advantages of scale, wide assortment of customer engagement tools (such as livestreaming which are used by Burberry, Prada, and Bottega Veneta to name a few), merchant tools (such as aggregated data which provides insights on fashion trends) are competitive edges that helped propel the platform’s rise to a market leading position in China’s luxury e-commerce market. Tmall Luxury Pavilion also gives brands complete autonomy over their digital storefronts with brands having the power to control the look-and-feel, content, campaigns, pricing, distribution, enabling brands to better provide a unique experience to represent the brand and connect with consumers.
Once a brand is on board, it has the tools to target any consumer, whether it’s a Gen Zer or an urban silver shopper. Each user has different touchpoints, all targetable through our platform.”
- Christina Fontana, the director of fashion and luxury at Alibaba Europe.
British luxury goods marketplace Farfetch (NYSE:FTCH) which acquired JD.com’s luxury marketplace platform Toplife, and recently signed a partnership with WeChat could emerge as a competitor going forward. However, while Farfetch has the advantage of being a completely independent online space for luxury brands, it has relatively little brand awareness in China, and so it would take considerable time and investment to build the level of brand awareness Tmall Luxury Pavilion has already built among Chinese shoppers.
Secoo (NASDAQ:SECO) holds a very unique position as a one-stop luxury online and offline destination offering luxury products (including apparel, accessories, jewellery, as well as cars and yachts), services and content targeted at China’s elite. Secoo’s online platform serves as a channel for customers to conveniently browse and purchase products while Secoo’s offline experience centers are aimed at enhancing the luxury shopper’s experience.
As an example of Secoo’s offering, shoppers can view their favorite car models online, and experience the car at one of Secoo’s offline clubs while enjoying Secoo’s car-related services such as certification, annual inspection, car modifications, etc.
Secoo’s unique position as a platform exclusively focused on the luxury vertical sets it apart from the competition and unlike rivals such as Tmall Luxury Pavilion or Farfetch, Secoo is much more than a marketplace for luxury goods. Rather, it is a luxury lifestyle destination and given its first mover advantage, as well as its position as one of the few upcoming Chinese luxury players, Secoo has tremendous opportunity to grow. However, navigating the luxury market is tricky, and Secoo may need to invest considerably to build its brand, and reputation among affluent shoppers, particularly picky millennials who account for 70% of China’s luxury sales.
Secoo’s gross profit margin has improved marginally (from 16% in 2015 to 17% in 2019), probably the result of being better able to negotiate favorable terms with suppliers as sales grow, but net profit margins have declined from 3.5% in 2017 to 2.3% in 2019 partly due to interest expenses doubling year on year between 2018 and 2019, and nearly jumping six-fold from 2017 and 2018. Interest coverage has also declined from 10 times in 2017 to less than 2 times in 2019. Of particular concern is Secoo’s free cash flow which has been consistently negative over the past few years.
Secoo’s unique position as one of the few homegrown luxury destination platforms offers tremendous potential in a country where young luxury shoppers are increasingly gravitating towards domestic luxury brands. However, like Baozun, it is worth keeping an eye on Secoo’s balance sheet as the company expands.
Driven by tech-savvy millennials who already account for 70% of China’s luxury spending, growing demand from luxury shoppers in lower-tier cities where luxury houses have a limited offline footprint, and a potential slowdown in overseas travel as a result of the COVID pandemic, China’s luxury e-commerce sector looks set for growth. Figures suggest China’s luxury e-commerce sector is expected to grow at a CAGR of 9.6% compared with 5.7% for the overall Chinese luxury goods sector.
Baozun, with its first-mover advantage and proven expertise stands to gain as a brand e-commerce partner for luxury brands. Tmall Luxury Pavilion has emerged as a formidable marketplace for luxury brands, and is likely to maintain this edge going forward. Farfetch may emerge as a potential competitor but the company is relatively little known in China compared to Tmall Luxury Pavilion and thus does not necessarily present a major threat to Tmall Luxury Pavilion in the foreseeable future.
Secoo is positioned as a luxury lifestyle destination, one of the very few domestic brands in China in this space. Much would depend on how well the company executes its brand strategy in what is a tricky market to navigate. With Secoo currently in a growth phase, the company’s interest expense has been increasing, and interest coverage has been weakening, which are risks to keep an eye on. However, given the company’s unique position as a homegrown luxury lifestyle destination brand, the company has good growth prospects and may be worth a watch.
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