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Making Luxury More Affordable in China

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Apr 27, 2016 8:03 AM   By Avi Krawitz
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RAPAPORT... Diamond dealers still see China as the engine of industry growth but Premier Xi Jinping’s government can do more to encourage its development. As the country transitions to a consumer-driven economy, luxury products such as jewelry are considered expensive in China, forcing shoppers to look abroad for their purchases.

That has presented new opportunities for the trade as Chinese jewelry demand is expected to grow across three important platforms: Domestic sales, e-commerce and tourist spending. However, the latter two seem to be a source of tension for the nation’s authorities who want to encourage domestic consumption. Premier Xi Jinping’s stated goal, after all, is to transform China from an infrastructure and export-driven economy to a consumer-centric one.

China’s latest move to increase taxes on products bought from online overseas websites – or so-called cross-border e-commerce – can be viewed in the context of government intervention that ultimately proves a negative for the jewelry industry. The policy, effective April 8, saw the tax on jewelry raised from 10 percent to 15 percent, and watches from 30 percent to 60 percent.

China is by far the world’s largest online retail market with sales of $630 billion in 2015, according to estimates by McKinsey. Directing traffic to local websites therefore forms no small part of the government’s goal to drive domestic consumption.

However, it appears the government’s strategy aims to make purchases abroad more costly. It might be more effective to tackle the core reason why Chinese consumers make their luxury purchases overseas in the first place: The same products are simply more expensive when purchased in China.

Pricing a product for Chinese consumers is a challenge in the luxury segment because of a significant price differential between identical products that are sold inside and outside China, McKinsey principles Fang Gong and Daniel Zipser explained in a recent podcast.

“That creates a big price-arbitrage opportunity for Chinese consumers who may purchase the product when they travel abroad or may use cross-border e-commerce to get products,” Gong and Zipser said.

Products sold in China’s domestic market are probably more expensive because of the high duties and taxes levied on items brought into and sold in the country.

According to the Hong Kong Trade and Development Council (HKTDC), a consumption tax of 5 percent to 10 percent is attached to jewelry sold in China, and import tariffs of up to 35 percent are charged for articles of jewelry or precious metal. As for loose diamonds, a 4 percent import tax applies to polished imports through the Shanghai Diamond Exchange (SDE), the official gateway for bringing diamonds into China. The consumption tax for loose diamonds and diamond jewelry sold at retail is 5 percent, according to the SDE website.

Lowering those taxes would help narrow the price gap between similar products sold in Chinese and overseas markets, and would also encourage domestic consumption. For now, Chinese shoppers continue to look for alternatives.

The contribution they make to the bottom line of foreign retailers is evident from a change in their buying behavior off the back of a weaker currency.

When the Chinese authorities devalued the yuan currency last year, largely to boost exports, it made shopping overseas more expensive for Chinese tourists. The impact was not pretty in the latest round of earnings reports from luxury retailers.

“We saw a marked deceleration in Chinese tourist’s spending in the fourth quarter in the Americas and frankly in most other regions as well,” Frederic Cumenal, chief executive officer of Tiffany & Co., said during the company’s fourth-quarter earnings call in March.

Tiffany, and others in the luxury space, noted changing trends in the behavior of Chinese tourist shoppers. While LVMH experienced a slowdown in tourist spending in the America’s, Europe, and especially Hong Kong and Macau during the first quarter, sales rose in markets such as Japan and South Korea where exchange rates were more favorable to Chinese visitors. Rather than buying local when the yuan depreciated against the dollar, tourists shifted focus to markets where they could bypass the greenback’s strength.

Shopping destination remains a key element of the travel decision for Chinese tourists. According to McKinsey, more than 100 million overseas trips are made from China each year and about a third of those travelers choose the location based on where it’s best to shop.

That’s a challenge for local jewelers. Chow Tai Fook reported sales in Mainland China were impacted by an “outflow of holiday consumption as a result of the increase in outbound travel” during the Chinese New Year quarter (January through March). Weakening consumer sentiment on luxury goods amid the slowdown in economic growth also had an effect, the jeweler noted.

As local jewelry chains such as Chow Tai Fook and Luk Fook roll back aggressive expansion across China, perhaps they should be looking abroad for growth opportunities. Then again, pricing might be challenging for them overseas, as it is for luxury brands trying to gain a foothold in China.

Either way, the Chinese government needs to incentivize domestic consumption rather than discourage overseas purchases. The two are not mutually exclusive. Chinese outbound tourism will continue to grow regardless of shopping patterns as the middle-to-upper income population seeks newer experiences. But they’ll continue to shop while having them.

The decision to raise taxes on cross-border e-commerce perhaps symbolizes a misguided approach. To further encourage domestic consumption, particularly of luxury goods, the government should lower taxes and duties associated with such products, and encourage retailers to set prices that are competitive globally.

That would enable better domestic sales while tourist traffic will continue to rise. It would certainly be a bonus for the diamond and jewelry industry, which can capitalize on such double-edged growth. In that way, Chinese consumers will continue to hold the key to diamond and jewelry industry growth - even through the country’s difficult economic transition.

The writer can be contacted at avi@diamonds.net. Follow Avi on Twitter: @AviKrawitz and on LinkedIn.


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Tags: Avi Krawitz, China, diamonds, Jewelry, luxury, LVMH, McKinsey, Tiffany, Xi Jinping
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