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Luxury Execs Eye Potential of China

Prada ceo Patrizio Bertelli told a luxury summit in Shanghai that China should be seen as an opportunity for the world, not as a threat.

SHANGHAI — “It’s paradoxical to raise import barriers, to raise a Great Wall to keep out China,” Prada chief executive Patrizio Bertelli said. “China should be seen as an opportunity, for the world and for Italy, not as a threat.”

Bertelli’s remarks, made during the opening address at the Financial Times’ Business of Luxury Summit here last month, touched off a discussion of the politics and practicalities of outsourcing, labeling and diversification that dominated the two-day conference, which also featured speeches by executives from LVMH Moet Hennessy Louis Vuitton, Giorgio Armani, Compagnie Financiere Richemont, Gucci, Brioni, A&G Group and Shanghai Tang.

While specific discussion of China and Asian markets was fairly limited, given the ceo makeup of the audience, the most-mentioned China topic was the growing importance of Chinese tourists as customers in European and other markets. A figure from the World Tourism Association that 100 million Chinese will travel to Europe by 2010 was widely cited.

Melanie Flouquet, vice president of luxury goods equity research at JP Morgan, explained that, due to value-added taxes driving Chinese prices up 30 percent, many brands sell more to mainland Chinese tourists overseas than they do in their China stores, and a few, like Louis Vuitton, sell twice as much. Flouquet observed that Chinese consumers buy abroad based on what has a presence and cachet in China — a point other speakers, including Bertelli, echoed, calling for a strategy of promotion in China to boost European sales.

Still, speakers cautioned that it will be a long time before Chinese tourists overtake their Japanese counterparts. Flouquet provided a market breakdown for luxury goods, outlining that emerging markets are only 7 to 9 percent of global sales, and emerging Asia markets constitute only 7 percent of that, or 14 percent if travelers are factored in. Japan is 38 percent of the global luxury goods market, with 18 percent from tourists and 20 percent domestic, while China in comparison is 5 percent and 3 percent, respectively. Russia is a total of 3 percent; India, 1 percent, and Brazil, 0.5 percent.

Flouquet added that, “The Russian consumer is very similar to the Chinese, with travelers also dominant, at a ratio of 2 to 1, and duties and locations are a problem, but women are dominant. India is extremely promising, with a fantastic demographic smattering, but few brands have exposure there now, because regulations are strict and good locations few.”

Giorgio Armani Group chief financial officer Paolo Fontanelli also stressed Japan’s continued predominance in the Asian market. He pointed out that, despite several high-profile China openings in 2004, the group was more aggressive about opening stores in Japan than China last year. Japan is now 6 percent of the group’s global sales, while Hong Kong and mainland China contribute only 2 percent.

Still, Bertelli and most of the speakers were cautiously optimistic about China’s long-term potential. Bertelli predicted that by 2010, the Chinese consumer will have $500 billion to spend on luxury goods.

“You see it happening now, with the popularity of Internet and cell phone use. China may even overtake the U.S. [as a luxury market] by 2020.”

Nonetheless, there are many challenges that must be dealt with before that potential can be reached. “Communication infrastructure and the publishing industry are limited,” Bertelli said. “Personal training and staff loyalty are poor. There are a lot of rules and regulations to be sorted out by the politicians. So we must expand with careful consideration, focusing on medium-term investment and careful placement, on interaction with film, music and art, and on using the Internet to brand and to promote sales. One has to create a market here, which requires a long-term commitment.”

Another major theme of the conference was the question of outsourcing. Arguing that the global diversification of production calls for a “Made by” label to join the current “Made in” designation, Bertelli said that internationalization of both manufacturing and sales has created a “less clear subdivision between luxury and nonluxury, a sort of pollution, or cross-pollination.”

The limitations on outsourcing in luxury apparel were pointed out by Michele Norsa, ceo of Valentino and apparel sector general director of Valentino’s parent, Marzotto Group. “Outsourcing in Asia is old news, but fashion is different from other industries because the timing must be fast, and the product must be limited.”

Pointing out that brands “make a choice whether to prioritize industrial costs” and that “for Gucci, ‘Born in Italy’ stands for quality,” James McArther, ceo of the Gucci brand, countered that the topic was blown out of proportion.

“Companies need to consider, first, their brand DNA, and second, whether consumer perception is based on the country of origin or the country of manufacture. I just went into a store here in Shanghai and in the same store I found products — sometimes even the same product — made in countries like Poland, Mexico and Slovakia along with the usual France and Italy. This was especially pronounced with bags and ready-to-wear. But who cares? A lot of consumers don’t, actually; the main resistance, in fact, comes from the salespeople, who are used to pitching the origins.”

Another industrywide focus of the summit was the possibilities and pitfalls of brand diversification. Abel Halpern, a founding partner of HMD Partners LP, a private equity investment firm that currently controls the Escada brand, brought the financier’s perspective to the fashion-dominated event.

“People equate awareness with value, and [you] can open 30 flagships with that in mind, but it is rarely worth the expense. There is a constant struggle to reconcile the creative business with the financial business,” Halpern observed. So from the financial business standpoint, brands “need to diversify, but not too much, in order to minimize their risk. But if diversification is badly done, companies can get very diluted. Which,” he added wryly, “is why public companies diversify more successfully than private companies, because they’re accountable to their shareholders, rather than someone’s aunt.”

Concetta Lanciaux, adviser to the chairman and ceo of LVMH, presented several case studies on the different diversification strategies of her group’s brands and the lessons derived from them. “Pertinence is what creates popularity,” she asserted, and so diversified products must remain pertinent to the original brand. On one extreme, she cited the example of Kenzo, which controls its main ready-to-wear business but has license agreements for products including fragrances, wallpaper and cars. “It seems stretched too thin, but it can sustain it because it is a comprehensive lifestyle brand.

“On the opposite end, Louis Vuitton follows a fully integrated diversification. The artisanal know-how is essential to the brand, so it completely controls creation, production and distribution,” Lanciaux continued. She cited how in the 1990s, to modernize the brand, Vuitton brought Marc Jacobs on board and he “injected new ideas, and restored Louis Vuitton by respecting the brand while updating it.” The results included watch and jewelry lines, but fragrances were rejected, as they would not fit into the schema of the store. She concluded, “Diversification has strengthened the state of Louis Vuitton as a global brand. A brand must go to its roots, gauge its customers and decide accordingly how or whether to diversify. The trick with diversification is that you don’t have to lose your soul.”