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Real Estate: “Daigou”, The gray market’s implications for China’s retail market
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“Daigou”: The gray market’s implications for China’s retail market


Sean Linkletter, Research Analyst, JLL Tianjin


WBT201509_0019_Real_Estate_01_Gucci_storeFueled mainly by rising incomes, gift-giving, and a wish to “stand-out”, the market for luxury retail products soared in Mainland China, seeing rapid growth for the greater part of the last decade. Luxury stores now light up the streets of core urban shopping districts and brands like Cartier, Gucci and Prada have expanded as far as Taiyuan and Nanning. The appetite for luxury goods grew so large that one high-end consumer said that Louis Vuitton has become “a brand for secretaries” – highlighting its growth across income levels. However, many international luxury retailers have seen sales slow recently as Chinese consumers become more sophisticated and price sensitive. More importantly, this characteristic is not limited to luxury goods. Mainstream consumers are no longer willing to pay the lofty price tags for imported goods in general, especially when they can buy the same products abroad for 20-30% cheaper. This has given rise to “daigou” (代购), a gray market for imported retail goods reported by the Wall Street Journal to be worth an estimated CNY 75 billion.

 

“Daigou” – representative shopping – is a phenomenon which has evolved over the past few years to help consumers buy luxury goods cheaper than they can in China, by avoiding locally leveraged taxes.  Initially a Chinese traveler would buy a few extra items abroad for friends or family and this is still common.  However, the scale of demand in China and the price discount for buying some items abroad has encouraged some mainlanders to focus on this as a business where they buy abroad and import directly. This business model may work because the shoppers are using their personal allowance to bring in goods duty free, but in many cases they may also be buying in quantity and avoiding reporting the goods to customs. There have also been media reports of Chinese students buying goods on behalf of customers when they return for school holiday and netting large commissions on each purchase. Many brokers utilise social media platforms like Weibo and WeChat to sell to their extended networks. Others sell on Taobao or other online marketplaces.

 

WBT201509_0018_Real_Estate_HighlightA decreasing euro and Japanese yen have fueled the “daigou” market, widening the gap between domestic and foreign retail markets. In late 2014, prices in Chanel’s European outlets quickly became 40% cheaper than in Mainland China. As a result, Chanel lowered prices in China by 20% in March 2015. Many other foreign retailers have followed suit by lowering their prices to stay competitive with the “daigou” market.

 

Contrary to some reports, higher prices in China do not necessarily result in higher margins for retailers. Tusting, which produces handmade luxury handbags and leather goods in the U.K., noted the shipping costs and import taxes do in fact drive up costs and keep margins in line or even lower than they are in their home market. Some retailers have opened up online shopping portals themselves to compete.  They are able to offer a discount from in-store sales since they can avoid the rental costs associated with prime retail locations.

 

The gray market’s looming impact on domestic retail sales has indeed caught the eye of local authorities. Not only does the gray market reduce retail sales, but it also leads to a significant loss in government tax revenues. In response, on May 15 this year, the Ministry of Finance announced that it would temporarily reduce the tariff rate on selected imported goods by about 50%. Affected imported goods include apparel, footwear, skincare, and diapers. The tariff cuts are intended to lessen the effects of “daigou” by helping to close the price gap on products sold overseas and in China.

 

It is unlikely that new rates will have a significant impact on domestic consumption. The import tariffs are only one of three taxes levied on foreign imports. Importers still need to pay consumption tax and a value-added tax (VAT), both of which were left untouched by the central authorities. Cosmetics, a major portion of the ‘daigou’ market, have a 30% consumption tax levied on their retail value in addition to17% VAT. Therefore, the small import tariff rate reduction from 5% to 2% will have a negligible impact on domestic prices. Additionally, Chinese customers often forego domestic consumption and buy internationally for uniqueness, quality, and product safety. For example, sales of imported baby formula surged in Mainland China following a safety scandal in the mid-2000s. Fake products also deter consumers from buying domestically.

 

The growing “daigou” market shows Chinese consumers’ increasing global awareness and price sensitivity. Consumers can easily go online to compare country-by-country prices to ensure they are getting the best value for their money. Additionally, many international brands have become common and no longer yield the “social premium” that they did before. They need repositioning to cater to a more sophisticated and well-traveled consumer base and cannot rely on branding to justify high prices. Nevertheless, until retailers’ costs reduce and prices reach global competitiveness, it’s unlikely the “daigou” market will be going anywhere.

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