PERSPECTIVE FEBRUARY 2013 THE ONLINE LUXURY BLOODBATH A SNEAK PEEK INTO THE FUTURE OF LUXURY E-COMMERCE IN CHINA. Thomas Wu, Jacob Jin, Sing Wang Ho

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1 PERSPECTIVE FEBRUARY 2013 THE ONLINE LUXURY BLOODBATH A SNEAK PEEK INTO THE FUTURE OF LUXURY E-COMMERCE IN CHINA Thomas Wu, Jacob Jin, Sing Wang Ho

2 The online luxury bloodbath Published by Value Partners Management Consulting Limited, 1402 Harcourt House 39 Gloucester Road, Wan Chai, Hong Kong February 2013 Written and edited by: Thomas Wu, Jacob Jin, Sing Wang Ho If you would like an electronic copy please write to: For more information on the issues raised in the report please contact: If you would like to subscribe or to be removed from our mailing list please write to: valuepartners.com Copyright Value Partners Management Consulting Limited All rights reserved

3 3 OVERVIEW AS CHINA S ECONOMY TAKES OFF, THE CHINESE ARE GETTING RICHER AND THEIR APPETITE FOR LUXURY GOODS IS EXPLODING. AT THE SAME TIME E-COMMERCE IS BOOMING. COMBINING THE TWO SOUNDS LIKE AN EXCELLENT IDEA AND MANY PLAYERS, BOTH DOMESTIC AND FOREIGN, HAVE ALREADY JUMPED ONTO THE BANDWAGON AND LAUNCHED VARIOUS PLATFORMS PROVIDING LUXURY E-COMMERCE SERVICE TO CONSUMERS. YEARS HAVE PASSED, NEW PLATFORMS CONTINUE TO APPEAR AND WE HAVE STARTED TO SEE SOME PLATFORMS ALREADY FAILING. THE TRUTH IS THAT, BEHIND ALL THE GLAMOUR, NONE OF THE PLATFORMS IS MAKING A PROFIT. IN THIS SHORT ARTICLE, WE AIM TO UNFOLD SOME OF THE CHALLENGES AND COMPARE HOW DOMESTIC AND FOREIGN PLAYERS DEAL WITH THEM.

4 4 Online Shopping Market (bn USD) B2B segment experiencing faster growth in the e-commerce % % % C2C business B2C business CAGR (%) Source: iresearch

5 5 THE BOOMING ONLINE LUXURY MARKET 1 iresearch Luxury e-commerce in China is showing rapid growth. According to China Daily, online luxury goods sales in China topped US$1.6 billion in 2011, a 69% increase over the previous year. The market is expected to grow by 30% per year in the coming years and by 2015 it is expected to reach around US$6 billion. Strong growth in demand for luxury This growth is supported by an increased demand for luxury goods and a growth in e-commerce. The sale of luxury goods in China is expected to reach $27 billion by 2015 up from $16 billion in It will become the largest luxury market in the world by 2015, succeeding Japan. Driven by an increase in disposable income due to rapid urbanization, Chinese are now more willing to spend on quality luxury goods. The lifestyle of Chinese is also changing. More and more Chinese are becoming fashion-conscious, seeking quality and items that match their personal style and taste. More and more Chinese are becoming fashion-conscious, seeking quality and items that match their personal style and taste. Increasing adoption of online shopping China e-commerce market is estimated to be US$189 billion in The growth rate is at a phenomenal rate of 65% in recent years. A 29% annual rate is expected going forward between now and In the past, Chinese consumers were not receptive to online shopping mainly because of counterfeit concerns. This is changing as consumers increasingly embrace the convenience of online shopping, stimulating growth in B2C market. Consequently, many B2C e-commerce platforms have emerged, the most dominant of which is Taobao.com s Tmall. Most of these platforms offer price competitive propositions as well as convenience to consumers. However, many buyers are bargain hunters looking for good deals online and big ticket purchases remain uncommon. For example jeweler Chow Tai Fook have launched a Tmall store, selling the same range of products on offer at their offline stores; about 70% of purchases are below RMB 2,000 while the average ticket size in offline stores is above RMB 3,700. Hence, it is clear that for big ticket purchases such as luxury goods, there is a need for a different proposition that can capture luxury shoppers.

6 6 Market share of online B2C shopping websites in Q ,4% Others 32,4% 17,2% 0,9% 2,4% 1,0% 2,3% 1,1% 2,3% 1,5% 1,5% Source: iresearch

7 7 EMERGING ONLINE LUXURY PLATFORMS 2 中 商 情 报 网 ( Investors have noted the rapid growth of the B2C e-commerce and luxury goods markets and married the two. In recent years, many luxury shopping platforms have been launched, especially in Amongst the top 20 platforms, an excess of US$500 million of investment capital has been raised in 2010 and Local companies made a head start, but foreign players and investors are also rushing in to capitalize on the growing market. NOTE: * Jiapin is owned by VIPStore group: - Macy invested 15 milion into VIPStore; - VIPStore also owns omei.com, a non-luxury European Website in China. Foreign players enter the online luxury market in a variety of ways. Net-a-Porter, a global luxury e-retailer, acquired Shouke.com and rebranded its website into Outnet.cn. Others such as Armani, DSquared2 and PPR group (which holds major luxury brands such as Bottega Veneta, Gucci, Yves Saint Laurent, Alexander McQueen, Balenciaga and Sergio Rossi) have used services such as that offered by Yoox which helps foreign brands host their own official e-commerce operations. Neiman Marcus invested $28 million into a Chinese fashion website owned by Glamour Sales Holding. Other foreign apparel retail companies have also targeted China s growing online market. For example, Macy s, holder of multiple mid-range fashion labels, invested $15 million into VIPStore and plans to release some of its lines in VIP- Store s non-luxury website, omei.com. Zara, which already has over 100 local stores in 40 major cities, has recently launched an e-commerce website. Launch dates of notable online luxury websites in China APRIL JANUARY JULY JANUARY AUGUST NOVEMBER MAY AUGUST DECEMBER OCTOBER JUNE SEPTEMBER MARCH *

8 8 Domestic and foreign websites positioning in China by price WHOLLY DOMESTIC DOMESTIC-FOREIGN PARTNERSHIP WHOLLY FOREIGN NO DISCOUNT DISCOUNT ON SELECTED ITEMS DISCOUNT ON ALL ITEMS

9 9 NO ONE IS WINNING With so many luxury e-commerce platforms in the market, competition is intense, especially for the multi-brand players. Several companies have either shut down or have shown signs of financial distress. Easynet shut down its website after less than one year of operation. Xiu and Shangpin both have cut costs by downsizing their teams and closing offices. What seemed like a lucrative market is no longer so appealing, and the cool down of interest amongst investors is a strong signal. For example, Xiu did not receive its third round of funding from its investors and Vipshop went to IPO reporting a loss and fell short of the capital it intended to raise. The majority of the platforms are positioning themselves as discount outlets, leveraging the Taobao value that is very much ingrained into the minds of Chinese internet shoppers. This price positioning puts tremendous pressure on profitability and there is no proof that it can ever be a viable model in China as none of the players are making a profit. While the discount players struggle, there are platforms that do not compete on price. They fail to capture the real luxury shoppers while giving up on the bargain hunters and are also not profitable. A much clearer value proposition targeting the real luxury shoppers is needed to steer them away from driving or flying to their favourite shops to get the full luxury shopping experience including the greeting, the tactile feeling of the goods, the smell, the services, etc. The list can go on. So what can online luxury shopping offer? Before we tackle the complicated issues of value proposition, positioning and targeting, we address the fundamental challenges facing all platforms: Sourcing, Marketing and Distribution These challenges affect all types of platform, but affect local and foreign players to varying degrees.

10 10 Sourcing the struggle to procure merchandise that consumers can trust Luxury brands rarely grant authorized distributorship to online retailers in China. Chinese luxury websites have resorted to sending buyers to Europe to procure goods from wholesalers and outlets, or even purchase directly from overseas retail shops. With such narrow and unreliable sourcing channels, Chinese luxury websites would end up only securing out-of-season, less popular, at times questionable condition and more importantly incomplete ranges of products from luxury brands. For those that have contracts with brands to become authorized online distributors, they are mostly limited to specific product categories that again limit them in offering a broad range of products to consumers. Aftersales service is essential for categories like watches, and thus getting the endorsement from brands and being able to provide aftersales services like maintenance, returns and repairs has become a key criteria for platforms to succeed. On the other hand, foreign players like Net-a-Porter and Yoox either carry or have already secured reliable sourcing agreements with luxury brands. These players would also carry fashion trend or brand media content to reinforce the authenticity and authority edge that they have over local players. A win for the foreign players Chinese luxury websites have resorted to sending buyers to Europe to procure goods from wholesalers and outlets, or even purchase directly from overseas retail shops.

11 11 3 Beijing Business Today Marketing and promotions still a race for traffic Due to strong competition, platforms have to spend a considerable amount in marketing and promotions to draw users to their platforms. Despite the large sum spent on advertising, online luxury platforms are not able to build customer loyalty. A large part of this is due to the homogenous offer and services of discount websites. This translates to non-distinctive marketing messages that revolve around low price and large variety. And for the ones that do not compete on price, there does not seem to be strong enough value proposition to gain traction yet. Overall, it is still a relatively simple game of generating traffic through links from other portals which end up being rather costly. Over the last two years, we have seen an increase of 31%-34% in online advertising prices 3. Distribution the last mile is always the most difficult Distribution networks in China are still heavily fragmented, with over 7,500 regional players operating in some 200 cities. Companies distributing nationally face many issues managing these regional players. Chinese courier services are still maturing, and it is not uncommon that packages are damaged, lost or stolen during delivery. Luxury goods are even more prone to these risks given the high value. As a result, luxury e-commerce platforms rely on International courier services like UPS and FedEx despite their premium prices. However, international couriers are only permitted to operate in eight cities in China and are required to operate as joint-ventures with local couriers in other parts of China, exposing clients to the same risk and nuances as working with a network of regional couriers. Some local players are affiliated with or are subsidiaries of large internet portals or corporations, providing an edge in online consumer understanding and access. However, they still lack the finesse in marketing luxury that established foreign platforms possess. On the other hand, foreign platforms may not have the access to consumers that local platforms enjoy. A tie Chinese platforms, in this instance, have the upper hand, as many are part of a bigger company or conglomerate with businesses in real estate or other industries providing a physical presence and knowledge in local markets. They can be very effective in identifying local logistics partners; and some players (e.g. VIPShop) have set up their own logistics operations to support the platforms. A win for the local players

12 12 CONCLUSION WOULD LOCAL-FOREIGN PARTNERSHIPS BE THE WINNING FORMULA THEN? Foreign and domestic players have their own strengths and weaknesses. While local players can contribute in their strengths in distribution and local marketing reach, foreign players can capitalize on their finesse in brand building and understanding as well as their access to authentic procurement sources. While several websites have formed partnerships between local and foreign players, none of them are profitable yet. Local player, Xiu.com, managed to partner with major brand label, Salvatore Ferragamo, but the brand only offer a limited number of product ranges to Xiu.com. American department store, Macy s, has acquired an 8% stake in local player VIPStore and offers their product line on the local platform. While local players can contribute in their strengths in distribution and local marketing reach, foreign players can capitalize on their finesse in brand building and understanding as well as their access to authentic procurement sources. However, they are still in the early days of promoting the platform and have not achieved the needed awareness to drive business. Clearly, a simple supplier-distributor relationship is insufficient and players still need to understand the roles of either party in the partnership. It goes without saying that both domestic and foreign players need to select partners that fit. They also need to actively play their strengths to build a distinctive platform. We would challenge that: 1. Current shoppers on the discounted luxury platforms are not real luxury shoppers, but bargain hunters 2. It would be highly challenging to make the discount model sustainable given the challenges we have mentioned 3. Online platforms should take a step back to understand who are the luxury shoppers that would shop online 4. Players should also try to understand what would appeal to the luxury shoppers and what experience they expect in an online environment as opposed to the retail shopping experience

13 13 We believe there are still opportunities in the market as long as the right play is called and the consumer proposition is strong. Should you wish to learn more about the topic, please feel free to contact Value Partners and we would be delighted to share our insights with you further.

14 14 AUTHORS THOMAS WU JACOB JIN SING WANG HO Partner of the Hong Kong office Associate of the Beijing office BA of the Hong Kong office

15 ABOUT VALUE PARTNERS Founded in Milan in 1993, Value Partners rapid growth testifies to the value it has created for clients over time. Today it draws on 25 partners and 280 professionals from 23 nations, working out of offices in Milan, Rome, London, Istanbul, São Paulo, Buenos Aires, Beijing, Shanghai, Hong Kong and Singapore. Value partners has built a portfolio of more than 350 international clients from the original 10 in 1993 with a worldwide revenue mix. Value Partners fashion & luxury practice provides advisory services to apparel, fragrance, personal care and jewellery brands in supply chain management, cost and budget control, go-to-market and market entry strategies. We also support companies interested in investing in the sector, particularly during the business due diligence phase. Besides the fashion industry, Value Partners also provides services in telecommunications, media, finance, energy, manufacturing and high-tech industries. In 2007 Value Partners acquired Spectrum Strategy Consultants a leading UK consultancy specialized in publishing, broadcasting, entertainment, IPTV and mobile thus further strengthening its international presence. Today Value Partners is a leading advisor in the telecom, media and technology sectors worldwide. For more information on the issues raised in this note please contact the authors. Find all the contact details on valuepartners.com Milan Rome London Istanbul São Paulo Buenos Aires Beijing Shanghai Hong Kong Singapore We have profound understanding of Chinese fashion and luxury industry. We have also assisted several European brands enter the fast growing market supporting them in setting up their local operations, seeking suppliers and devising growth plans. Copyright Value Partners Management Consulting Limited All rights reserved