Emerging Markets: Luxury's New Breeding Ground
Until very recently, the world of luxury remained the exclusive bastion of wealthy consumers from Western Europe, America, and Japan, who not only desired the best, but also possessed the cash to afford it. However, this well-heeled club now has some new members: millions of consumers from emerging markets. These freshly minted shoppers in Asia, Latin America, Russia, and the Middle East have greater levels of disposable income than ever before, making them a significant force in the global luxury market as they snap up iconic cars, haute couture, watches, leather goods, jewelry, fragrances, cosmetics, wines, spirits, and even specialized hotel services as a way to show off their wealth among their peers.
As a result of this geographical shift in demand, large luxury conglomerates have begun to expand their brands' footprints, setting up shop in such places as Singapore and Mumbai, as well as lesser-known Chinese cities like Chengdu, in order to cater to the luxury segment's newest and fastest growing consumer groups. T. Rowe Price has an integrated team of research analysts who actively follow the global luxury market, two of whom recently spoke about how the luxury landscape is changing, what these changes may portend, and where they see potential opportunities.
Thanks to the political reforms, social shifts, and economic progress that have occurred in many emerging market countries over the last 15 to 25 years, the Chinese, Russians, Latin Americans, Indians, and Middle Easterners have become important players in the luxury goods market. By far the most important of these new luxury consumers are the Chinese.
It wasn't that long ago that everybody in China wore the same clothes and had the same status. It was a nation living under Communist rule for more than 60 years. But China transitioned from a homogeneous society into a more capitalist economy during the 1990s and early 2000s, and as economic success became important for the first time, it motivated the Chinese people to differentiate themselves from one another. That's what has made status-driven consumption such a social phenomenon in China.
The Chinese have rapidly become more sophisticated consumers. Three years ago, many brands had just opened their first stores in China, and the Chinese had very little familiarity with them. Today, they probably know more about the brands and the products than most European consumers who have lived with them for 50 years. In part this is because the Chinese are interested to learn about the origins of products and hear their stories. They have quickly and thoroughly educated themselves, and it shows. You see it in their consumption of fine wine—the largest market in the world for high-end French Burgundy is now in Hong Kong, and no longer New York.
You also see it in the cars they buy. China already controls almost half the global sales in the luxury auto market, and the luxury auto manufacturers have responded pretty well to consumer interest in China. Distribution has taken a two-pronged approach: They build cars at the lower end of the luxury spectrum (such as a BMW 1 Series, a Mercedes C-Class, or an Audi A1) on the mainland via 50:50 joint ventures. But at the higher end they build the vehicles in Germany and then export to the mainland via a very active dealer network.
Many consumers in China actually prefer vehicles that are imported and are willing to pay a premium for them. As a result of that, I think that having the appropriate dealer network becomes paramount. There are hundreds of dealerships being opened up every year in China, with mature networks in the Tier-1 cities like Beijing, Shanghai, Guangzhou, and the eastern seaboard being supplemented by growth in Tier-2 and Tier-3 cities.
Exclusivity is what makes a luxury brand so attractive to consumers. Many of these products are often produced in small numbers, with some sort of special design or material and very selective distribution, and then, of course, the consumer's ability to afford exclusive luxury products is a clear marker of their status. It's what makes them willing to pay $10,000 for a Rolex watch when they can buy a Timex that's just as accurate for $20.
One major development that continues to affect the global luxury market is tourists from emerging markets coming to Europe and buying products here. Despite last year's Euro crisis, Europe was the fastest growing region globally for luxury goods. It grew faster than both Asia and the U.S., all because of Chinese tourism. For some of the brands, sales to overseas tourists now account for more than half of their total sales in Europe.
Increasingly, the important names in luxury are concentrated within big groups. LVMH (Moët Hennessy - Louis Vuitton S.A.) is by far the largest and most diversified global company in the sector, representing about 10 percent of the luxury market. It's a Paris-based multinational luxury goods conglomerate with over 60 brands, of which Louis Vuitton is the biggest—it represents more than half their profits, and is also the biggest brand globally. Another big company is Richemont, a Switzerland-based conglomerate with about 20 brands. Its largest brand, Cartier, is the global leader in high-end jewelry, and also a very prominent watch brand. The third largest conglomerate is France's PPR (now called Kering), with 19 smaller brands in addition to its largest brand, Italy's Gucci, which represents around 60 percent of their profits.
As you can see, the luxury landscape is quite fragmented, even though these large conglomerates increasingly acquire individual smaller brands. The most important names consumers pay attention to remain these established European heritage brands. When they buy a luxury product made by one of these Old World European companies, they aren't just buying a product—they are also buying a piece of Europe that they can wear at home.
It's easy to look at the luxury goods category and see the incredible success that these brands have had selling their products in emerging markets and to emerging market consumers. But if you really want to understand these new consumers and where they are within the cultural lifecycle of wealth and consumption, you have to look back at Japan.
Japan is very different from other Asian countries, and probably 20 years ahead of where other Asian countries are, in terms of how it views luxury goods. If you were to plot luxury goods consumption versus the GDP per capita for all Asian countries, I think you would see a line—and Japan, being the richest country in Asia by far, would be way ahead. The behaviors we're seeing in China and other Asian countries today mirror what we saw here 20 years ago when Japan was growing very quickly. It's very simply a reflection of GDP per capita level. When a country starts becoming more affluent, consumers tend to buy luxury goods for status.
It used to be a socially competitive environment where people bought products to show off, but the beginning of the end was the late 1980s and early 1990s, when the Japanese economy started falling into a recession. Japan moved from being an industrial economy to a post-industrial economy, and with that, consumers now behave very differently than they once did. There is no social competitiveness anymore. There is very little interest in being rich or demonstrating that you're rich. The status element of luxury goods consumption in Japan now is almost completely gone. It's more understated. Japanese consumers want to buy high quality products that reflect their identity. It's a lot less mass consumption, and more personal consumption.
Hotels fit into the luxury category in this way because they're not about showing off what you have as much as they are about self-gratification. Japan has a very old, aging society, with affluent retirees driving strong growth in the higher-end travel category. They consume luxury goods and services when they travel around Japan, and it's a significant market—Japan is the only country where the population over age 65 is larger than the number of people below age 15. Other countries such as South Korea, Germany, and Italy are similar to Japan in this way, but not nearly as skewed.
The trend you have in Japan is both structural and cyclical. You see the evolution of society linked to affluence and development on one side, and in that sense there is no going back, because people are a lot less interested in money and status than they were 20-30 years ago. All countries go through this process at their own pace, and they're all probably on the same path. China will be like that one day, as well.
On the other side, you see a cyclical trend showing that when the economy is strong, people consume a lot more luxury goods. You probably saw an effect of this when currency reforms and monetary easing policies spearheaded by Shinzo Abe, the current Prime Minister of Japan, got people excited about the Japanese economy earlier in 2013. It actually triggered a spike in consumption of luxury goods. The yen weakened so much that consumers knew the prices of luxury goods were about to go up a lot, so there was a sudden burst of opportunistic consumption to take advantage of it. For example, the number of Ferraris sold in the first quarter of 2013 was the highest it has been in nearly 16 years. That's partly related to the exchange rate, and also related to the fact that people expect the economy to be stronger.
The "golden age" for luxury goods is when people buy luxury goods for status. That's where China is right now. That growth eventually has to slow down, but as one region's economy slows there will be other economies entering this fast-growth phase. Right now it's Asia—specifically northern Asia—but then it will be Southeast Asia, and then in 10 or 20 years it might be Africa. Declining growth in one region doesn't signal a death knell for any luxury brand, but the interesting question remains, "How do you sell luxury and keep growing it in a post-industrial society?" Until someone figures out the answer, it means that brands will have to take share from their competitors in other regions, and that's why you'll continue to see companies expanding and relocating to other countries and regions.
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BMW represented 0.99% of the T. Rowe Price European Stock Fund as of June 30, 2013. The following securities were not held by the T. Rowe Price Blue Chip Growth Fund, T. Rowe Price Japan Fund, or the T. Rowe Price European Stock Fund as of June 30, 2013: Audi, Ferrari, LVMH, Mercedes, PPR, Richemont, Rolex, Timex. The funds' portfolio holdings are historical and subject to change. This material should not be deemed a recommendation to buy or sell any of the securities mentioned.
T. Rowe Price Investment Services, Inc., Distributor.
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