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The big debate

Luxury products have always been very expensive in China, initially due to the huge taxes imposed by the government as a means to claw back from those with the cash to buy them in the first place, many of who probably hadn’t paid any tax on their income anyway. The perennial problem of grey money here means that there is a lot of tax that is never ever paid, so the government takes it wherever and however it can.

This high price point has then become a benchmark to value ‘luxury’ and for many immature consumers the only measure of whether a product was luxury; if something is too cheap it can’t be luxury. Brands have also indirectly been encouraged to keep prices high to reinforce their luxury status, although we also cannot ignore the fact that if you are operating a luxury business in China, your operating costs will be high, so you need to cover them in any way possible.

Everyone in China loves a bargain, so high domestic prices have lead to consumers identifying where to buy the same products cheaper. The differential between China and Europe and the USA is large enough the make a shopping trip worthwhile, and if you don’t want to travel too far there is always Hong Kong. According to HSBC 35% to 60% of the revenues of luxury brands come from tourists and the Chinese lead this charge.High domestic prices have also spawned the grey market referred to here as ‘dai gou’ where a Chinese buys or brings in original product from Europe or the USA and sells it on for a profit. Although this practice has been allowed to run for many years, the government has been trying to clamp down considerably on it this year.

The big debate in government circles for a while in terms of the luxury sector is how to increase domestic consumption and stop money flowing out of China? The market in 2012 has been depressed compared to 2011, possibly due to the change of leadership mentioned previously, and as a result, so have tax revenues. Bain estimates the luxury market in 2012 will only grow 8% compared to 25% or more in previous years, the appreciation of the RMB and high tax rates are not helping.

Reducing tax may seem a simple way to restore the imbalance, but the fact is that although we are in China, a luxury brand does not need to pass a tax reduction onto consumers at all, or it may make some symbolic reduction and then bring prices back up again. Also remember, that a low price may reflect a lack of luxury status in the eyes of the consumers, particularly in the less mature tier 2 and tier 3 markets.

It’s not really surprising that the government hasn’t decided to do anything about the problem yet, particularly as we await a new leadership. However, luxury brands have started to respond themselves to the challenge. This month LVMH indicated that it would increase its European retail prices by 8%, and Prada boss Patrizio Bertelli said that there would be a 10% increase to compensate for euro depreciation, and hinted that prices may be reduced in China should the government reduce taxes. The story continues …


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