Roundtrip for the Luxury Brand: Chinese Tourists Seeking Luxury Brand Discounts at Outlets in the United States

The Sacramento Bee published an article on Sunday, August 25, 2013, authored by Richard Chang, titled, “Big Spenders from China Have Outlet Malls Elated.”  The article discusses the financial impact of Chinese tourists (400 million and growing in the middle class!) seeking discounted luxury brand goods at outlet malls in the United States—specifically in California.  An outlet mall is a group of stores located, sometimes, in the same structure or in a group of structures, with each store, usually, selling one brand’s merchandise.  The brands are often luxury brands and some popular outlet stores in the United States are Polo, Nike, Adidas, Brooks Brothers, Coach, Levis and Calvin Klein.  The prices are usually discounted.  Sometimes the outlet stores carry overstock or merchandise that has failed to sell in “regular” stores and sometimes the brands, supposedly, manufacture goods specifically for the outlet stores, which may be of lesser quality than that sold in “regular” stores.  The article states:

The average Chinese visitor spends $3,000 on luxury goods, according to an analysis by TaxFree Shopping, a company that processes tax refunds for foreign travelers. That kind of spending has caught the attention of American retailers and mall operators.

"The Chinese want designer brands, and they want a bargain. That's why they come to Premium Outlets for our upscale stores," Eggan said.  . . .

Simon Property Group, owner of 11 outlet malls up and down California, has aggressively courted Chinese consumers since 2005. Eggan often travels to China, meeting both officials and tour operators. She was one of 80 business leaders who accompanied Gov. Jerry Brown on a weeklong trade mission to the Asian giant in April.

With the liberalization of their country's economy in the 1990s, the Chinese have grown accustomed to seeing Western styles and luxury brands. However, high tariffs make foreign imports extremely expensive, even though many of them are made in China.

In some cases, Chinese tourists say, the discounts on merchandise in the United States cover the cost of their trip.

Notably, the article also states that, “Cora Ip, a recent UC Davis graduate, said her parents – who live in Sacramento – spend hundreds of dollars buying gifts for relatives back home in Hong Kong.  "When you buy things here, there is quality control," said Ip . . ..”  Cheaper prices and quality control--very nice!  (Although, as alluded to before, there are “the dirty secrets of outlet shopping,” including the inconsistent quality between goods sold in a “regular” store and at an outlet—confused consumers?  Post sale confusion?). 

Luxury Goods and the "China Price"

There are few areas of the trademark and brand-driven business that I find more interesting than luxury brands. When trademark law took shape in the 19th century, marks and signs primarily served the honorable, but commercially boring, task of enabling merchants to communicate with the public about the source of a specific trader's goods. While the "good old source theory" of trademark law still serves as the conceptual underpinning for the trademark right, the commercial uses of trademarks have developed in various other directions. None is more distinctive than the development of luxury brands with international reach (indeed, at the Paris-based business school ESSEC, here, there is a full MBA program devoted to the topic).

Even for those of us who do not embark on a career in the luxury goods business (and who may treat luxury goods as primarily a spectator sport), developments in the area continue to fascinate. It is against this backdrop that I read with interest an article in the 6 December 2010 issue of Bloomberg Business Week entitled "Luxury Retailing: Chinese Shoppers' Long March Through Europe." What I found particularly compelling are the dynamics related to the pricing and marketing of luxury goods in Paris and Shanghai, respectively, especially in light of the increasing presence of the Chinese consumer in the flagship stores for these goods, be it in Paris or otherwise in Western Europe.

It is estimated that over 2.5 million Chinese from the mainland visited Western Europe in 2010 and the number is expected to increase to over 3 million by the year 2012. Looked at from a different angle, it is believed that one-quarter of all European luxury goods sales are being made to Chinese purchasers (others may complain about the perceived undervalued yuan, but its 12% appreciation vis-à-vis the Euro has certainly accelerated this process). As one Paris consultant observed: "Today, it's Chinese tourists that are brought in by big buses in groups."

So why should a Chinese consumer prefer to buy his or her luxury goods in Paris? One answer is selection, even if the number of boutiques offering luxury goods for sale in Shanghai has increased. Another is the elusive sum total of the shopping experience in Paris and other Western European locations.

The more interesting reason given is price. A Chanel Jumbo handbag costs more than $4,700 in Shanghai but only $3,900 in Paris. A Hermès product runs $8,800 in Shanghai but only $6,500 in Paris (in both instances, the plane fare differential is strictly extra). The price differential is ascribed to Chinese import duties (up to 20%) and value-added tax of 17%, although I cannot quite believe that VAT does not also apply to purchase of the product in Paris, given that France is the progenitor of the value-added tax.

In any event, what jumps out here is the question of how these luxury goods manufacturers can tolerate such large price differentials, even if they are due to taxes and the like, rather than to market forces. My impression is that the luxury goods business usually resists such differentials, not only because of the opportunity for price arbitrage by customers, but also because of the muddled message given to consumers by these different prices. After all, crucial to these products is a consistent sense of "what these products are worth", wherever they are purchased.

It is no surprise, therefore, that luxury brand manuacturers will apparently be
increasing the price of their goods in Western Europe by 5% to reduce this differential. If this occurs, it is a genuuinely fascinating result. Think about it: prices in Western Europe for these products will be elevated in order to come closer to the price of the equivalent product in China.

Thus, the visitor from the U.S. or Brazil, or the Parisian matron from the 8th arrondissement, will also see the price go up, even though such purchasers probably are otherwise uninterested in what goes on in China. If the foreign (non-Chinese purchaser) also has the misfortune to be paying for the product in a currency that is depreciating against the euro, the 5% increase will even be more. Alternatively, the would-be purchaser simply does not buy the item due to the increased cost of the item, although presumably that lost sale is more than made up by the increasing revenue received from each Chinese purchaser laying out 5% or more for the same item in the store in Paris.

For several years now, we read about the "China price", being the low cost of Chinese production that makes manufacture in many other countries uncompetitive by contrast. In the case of luxury goods, however, the "China price" seems to have the opposite effect, leading to an increase in the price for the same goods outside of China. How very, very curious.

Can Luxury Goods Survive in the Online Environment?

Finding business models that work for the on-line sale of goods continues to be work-in-progress. Perhaps the best-known attempt to propose an appropriate model is Chris Anderson's (editor of Wired magazine) notion of "the long tail." As set out in his book of the same name, the idea is that bricks-and-mortar distribution is characterized by severe limitations on space and the like -- such as a limited shelf space -- that have the effect of limiting the number of goods that can be reasonably offered. Liberated from the physical restriction of space, niche products -- the long tail -- can enjoy commercial success via online sale and distribution.

Different views have been expressed on just how generalizable is the notion of the long tail. I thought about this question in reading an article entitled "When Cheap is exclusive: Selling designer goods online, "that appeared in the September 5th issue of The Economist. The gist of the article is that a number of online sites have sprung up (in the current jargon--"e-tailers") devoted to the sale of so-called luxury goods online at discount prices. While the bricks-and-mortar luxury good stores, such as Bloomingdale's and Sax Fifth Avenue, are finding themselves stuck with increasingly large stock of unsold merchandise, the e-tail business for luxury is thriving, in large part as a discount price distribution alternative to dispose of this unsold inventory.

What is interesting is that the attraction of these sites (such Gilt Groupe, HauteLook, Rue La La and Vente-privee.com) is in fact a combination of discounted prices together with a customer structure that seeks to preserve the sense of exclusivity that is so important for the sale of luxury goods. Thus these sites may be used only by members, who themselves have been asked to join only another member. As well, the sites frequently run 24-hour sales on a frequent basis, thereby attempting to maintain a high level of interest by customer members.

According to the article, the same designers and purveyors of luxury goods who would resist widescale discounting of their luxury products in the traditional stores are prepared to do so in an online environment. The key to success of an e-tailer site selling luxury goods is how well the site creates a "theatrical environment", despite the discounting of the luxury brand.

So what is one to make of this development? Several thoughts come to mind.

1. A major ingredient of the sale of luxury items in a bricks and mortar world is the ability to manage selective distribution of the product, which thereby serves to support a premium price level. Customer exclusivity is a function of the drawing power of the luxury goods being sold, and of the ability of the brand owner to get the customer to pay the premium price.

2. However, selective distribution seems light years from this approach to selling luxury goods online. In the e-tailing experience described in the article, exclusivity becomes a direct function of limited access to membership at the site. This sense of customer exclusivity is reinforced by the fact that the goods at sale bear luxury labels, even if these goods are being discounted. This is no minor accomplishment. Try to count the number of discount retailers that you know where exclusivity is accompanied by material price discounting of luxury goods.

3. Given this seemingly unnatural combination of exclusivity, luxury goods, and price discounting, how will the discounting affect the long-term aura of the luxury brand? It is difficult to believe that a luxury good can maintain its upscale reputation in the face of a continuing public perception that the luxury product is being sold at a discount.

4. It is true that customer exclusivity could have the effect of softening any such blow, because the relevant public is thereby limited in scope. Nevertheless, assuming that the on-line customer base is roughly similar to the typical customer for the luxury product in the bricks and mortar environment, the word will get out to the relevant consumer population. This cannot be a very positive result for the brand owner.

5. Assuming that e-tailing of luxury goods online threatens the long-term value of the brand, perhaps the answer to the question raised in (3) is that the luxury goods industry is prepared to tolerate the discounting of its products online only for a limited period of time. Under this view, these e-tailer sellers of luxury goods serve to provide another channel of sales only as long as the economy remains sluggish and the exuberance of customers to pay a premium price for luxury goods is diminished. Once the economy recovers, the luxury goods industry will take dead aim at these online distributors.

The upshot is that the long-term relationship between luxury goods and the online environment remains unclear, whether long tail, no tail, or fairy tail. It is a saga worth following.

Pray for the Luxury Good