When Eric Douilhet opened China's first Paul Smith and Moschino fashion boutiques in 2002, he didn't expect they'd be making money by now. He didn't think they'd be losing this much, either.
"I was definitely expecting sales to be higher; the losses to be smaller," says Mr. Douilhet, 43, president of Bluebell (Asia) Ltd., which also operates Jaeger clothing and Davidoff cigar stores in China. "People are too optimistic about China." He declined to quantify the losses.
China's luxury market is proving harder to crack than many overseas companies anticipated, even as incomes soar and economic growth exceeds 10 per cent. Dozens of high-end brands, from Cartier and Chanel to Hermès and Versace, are chasing the nation's limited pool of big spenders. That's made profits elusive for most.
"If you are not the No. 1 brand, if you are No. 2 or No. 3, the odds are good your fingers will be burned," says Ivan Kwok, a manager at Boston Consulting Group in Hong Kong. "China is a growing force in the luxury business, but the market isn't large enough yet to accommodate so many players."
Only about one in 10 overseas consumer goods companies -- including LVMH Moët Hennessy Louis Vuitton SA, the world's No. 1 maker of luxury goods -- is profitable in China, Mr. Kwok estimates. The winners are the ones whose products are seen by Chinese consumers as obvious symbols of wealth, he says.
Official statistics overestimate the size of the urban middle class, which controls the bulk of China's disposable income, says Jonathan Anderson, Hong Kong-based chief Asia economist at UBS AG. The group's real size is between 65 million and 75 million, not the 250 million to 300 million reflected in government figures, he says.
To succeed, luxury goods companies must woo the top segment of the Chinese consumer market -- the 15 million people who earn 250,000 yuan ($37,300) or more a year, according to data from market researcher AC Nielsen Co.
Making their jobs harder, China's steep import duties and value-added taxes mean luxury goods companies have to charge as much as 35 per cent more for their goods than in Hong Kong and many other markets.
At the Plaza 66 Mall in Shanghai, shoppers are courted by more than 100 European and U.S. luxury brands, ranging from Cartier and Prada to Paul Smith, Anna Sui and Brooks Brothers.
Cartier, the jewellery and watch seller controlled by Geneva-based Cie Financière Richemont AG, is barely breaking even after 15 years in China, even though it's the nation's top-selling luxury jewellery brand, says Nigel Luk, Cartier's managing director for China. He declined to give figures.
"If you are looking for quick profits, don't go to China," Mr. Luk, 44, says. "It takes a long time to be profitable."
Cartier, which has 14 boutiques across China, will need another 15 years to meet its profit targets, Mr. Luk says, without giving details. For now, rising rental and labour costs triggered by China's booming property market and economy are cutting into profit, he adds.
The company also spends about $9-million (U.S.) a year on advertising in China to raise brand awareness -- a "substantial part" of Cartier's global advertising budget, Mr. Luk says.
Brands such as Cartier and Paul Smith, the British fashion house known for its quirky twist on classics, lack the obvious status-symbol cachet of Louis Vuitton or Gucci among Chinese shoppers. That makes it difficult for them to compete at the same level, Mr. Kwok of Boston Consulting says.
"A luxury brand in China represents middle-class aspirations, so you can't be too hidden," he says. "A lot of products bearing visible logos don't do well outside China but are bestsellers in the country."
High-end brands seeking to tap China's rising wealth face another setback: People are saving more as the government dismantles its cradle-to-grave welfare system.
The cost burden on China's households has risen as the Communist government, shifting toward a market economy, phases out benefits such as free housing, education and health care.
"The Chinese middle class may be earning a good living, but they still feel insecure about the future," says Chen Xingdong, a Beijing-based analyst with BNP Paribas Peregrine. "That prompts them to save a large share of their income."
International luxury brands are willing to endure losses now to position themselves for an expected explosion in China's big-spending population.
The potential size of the country's luxury goods market is as large as 100 million people, estimates Claire Kent, a London-based luxury goods analyst at Morgan Stanley.
"The money is there," says Glen Murphy, 41, a Shanghai-based managing director at AC Nielsen. "The big challenge for consumer goods sellers is identifying who and where these people are, and to sell them what they want."
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Consumer watch
Even after more than doubling since 1996, the disposable incomes of China's urban households averaged just $1,327 (U.S.) in 2005 -- about as much as a single Louis Vuitton handbag costs.
China's aggregate savings ratio is as high as 50 per cent of gross domestic product, UBS economist Jonathan Anderson says. That compares with 30 per cent in Japan, 39 per cent in Hong Kong and less than 14 per cent in the United States.
The nation had 320,000 millionaires at the end of 2005, a 6.7-per-cent increase from a year earlier, according to a report by Merrill Lynch & Co. and Cap Gemini SA. That compared with 2.7 million in the U.S. and 448,000 in Britain.
China will be the world's top consumer of luxury goods by 2015, forecasts Jacques-Franck Dossin, a London-based analyst at Goldman Sachs Group Inc.
Bloomberg News
