China is beckoning mainstream U.S. retailers as never before.
This story first appeared in the June 24, 2010 issue of WWD. Subscribe Today.
With the country’s middle class growing fast — projected by Euromonitor to total 700 million people in 2020 — companies such as Gap Inc., American Eagle Outfitters Inc. and Bebe Stores Inc. are making their first forays into China. Others, including Guess Inc., Iconix Brand Group Inc. and Levi Strauss & Co., are enlarging their footprints.
The activity comes as China has decided to let its currency appreciate gradually against a basket of currencies, including the dollar, which could — along with rising wages for Chinese workers — boost the purchasing power of its consumers and make the world’s most populous nation an even more enticing market.
The push by retail and apparel firms in China, preceded by the expansion of luxury brands, has accelerated as they seek to diversify geographically because the international economic crisis exposed the vulnerability of developed markets while China’s economy grew 8.7 percent last year.
China has “progressed from an economy of only the very, very wealthy that can afford a lot of the American brands to an economy that is starting to support a middle class,” said Kelly Tackett, senior analyst, apparel, at the Kantar Retail consultancy, which forecasts China will trail only the U.S. with retail sales, excluding autos, of almost $1.6 trillion in 2013.
“That middle class is showing an increased appetite for American goods,” Tackett said. “There is an opportunity for some of the more middle-market brands like Gap, like American Apparel or even more aspirational luxury brands like Coach, to really get a foothold.”
China ranked first among global markets with the highest potential for retail development in A.T. Kearney’s ninth annual study of areas ripe for expansion.
Luxury firms from Tiffany & Co. to LVMH Moët Hennessy Louis Vuitton have banked on a prosperous sliver of the Chinese population that travels extensively, covets specialized products and has cash to spare. Mainstream American brands may have a tougher road to reach broader swaths of the Chinese public, identify suitable retail real estate and fine-tune advertising, staffing and product.
“You haven’t seen really a lot of American retailers open a lot of stores there,” said Jeff Van Sinderen, a senior analyst with B. Riley and Co. “U.S. retailers and brands have to be careful…not all of China is going to work. There are select areas that are going to work. There are certain brands that have an American sensibility that will work better than others.”
Nike Inc. is often singled out as an American success story in China, where it has fortified its brand over about three decades. The Beaverton, Ore.-based company has captured the largest share of the athletic footwear market in China and registered a 12 percent increase in sales there to $464 million in the fourth quarter ended May 31.
Over the next several years, Nike maintains there’s room for more growth and has promised significant investment in developing markets, which include China, and Central and Eastern Europe, to generate low double-digit annual sales increases and an additional $3 billion to $3.5 billion in revenues by the 2015 fiscal year.
“All evidence [is] that our premium distribution strategy and investment in China over the last three years to five years is paying off,” Charles Denson, president of Nike brand, said during a third-quarter earnings conference call.
Nike’s example indicates that persistence is rewarded in the Chinese market, a lesson that Guess vice chairman and chief executive officer Paul Marciano takes to heart. Over the past three years, the Los Angeles-based company has opened about 40 stores in China, and Marciano anticipates that number will increase to 200 in three to five years. This year, Marciano forecast Guess’ Chinese operations would break even or move into the black.
“We have a big plan for China, but it’s a country where it requires us to be very cautious, to go not as fast as you can but as carefully as you can,” he said. Speaking about retailers heading to China, he added, “It takes a strong office. It takes a big investment and it takes time to be patient to see some results coming. You cannot expect results in the first year or two years in China.”
Branded apparel giant VF Corp. has made China a priority, selling the Lee and Wrangler labels through about 400 brand stores and shops-in-shops, as well as having acquired the rights to sell The North Face brand products there. Chairman and ceo Eric Wiseman said this year that the Greensboro, N.C.-based company is targeting a 40 percent increase in distribution in China.
Iconix plans to open 50 Candie’s stores in China by the end of 2010 and 500 over the next five years, ceo Neil Cole said this week at a Reuters Consumer and Retail Summit in New York. The first unit is set for Shanghai in August. “We think the big growth comes from China,” he said.
Calvin Klein Inc. president and ceo Tom Murry and American Apparel Inc. ceo Dov Charney, both speaking at the Financial Times Business of Luxury Summit 2010 this month, tempered the China fervor. Murry said China — about a $200 million business for Calvin Klein — is a small slice of the company’s $6 billion in sales.
“There will be a gradual shift to that market over time,” Murry said. “China isn’t the only opportunity for growth….Our appeal there is driven by our cachet in other countries.” Over the next five to 10 years, he said Calvin Klein’s business will “skew to Asia.”
American Apparel’s short history in China — it opened the first of its three stores there in 2008 — bolsters the view that U.S. retailers outside the luxury sector should take the long view. Without a recognizable logo signaling status, American Apparel has had “challenges in China,” Charney said.
“They [Chinese consumers] are looking for the Rolls Royce right now,” he said. “They are not looking to buy the Volvo.” American Apparel has opted to test the waters because Charney said in a few years, “The most important thing will be that you are an international brand.”
The middle class is swelling, but it is still small and living costs are rising along with wages. In 2009, the average annual per capita income in urban households was 18,858 yuan or less than $3,000. China’s National Bureau of Statistics estimated that 17,175 yuan, or around $2,500, was disposable income, an almost 10 percent jump from 2008. About 36.5 percent of urban household income was spent on food.
“The market is split in two halves — the rich and the poor,” said Christopher Tang, a professor at UCLA Anderson School of Management. “For those who have disposable income, they go for the high-end brands. For those who are more price-sensitive, they go for the local brands….The middle range price for the U.S. market is still expensive in China.”
Companies selling consumer goods have been encouraged by news that the Chinese central bank will slowly unhinge the yuan from the dollar. Christine Chen, a specialty retail analyst with Needham & Co., indicated that American retailers with sales in China translated back to dollars would gain with the appreciation of the yuan. But Tang warned that currency appreciation must be coupled with strong wage increases to move the needle for retail.
Even if retailers must wait for profitability, many analysts believe leaping into China soon could be advantageous because the competition is mounting. They stress that a retailer’s domestic business should dictate whether an aggressive China strategy is pursued. A company without hundreds or thousands of U.S. stores may not be in a hurry. Millard “Mickey” Drexler, ceo of J. Crew, said, “We have enough growth in America. Except wholesale, online and in Canada, we don’t think we need to be [overseas.] When we do it we want to be online only. We might have a big flagship in one city to drive sales.”
J. Crew launched a partnership last month with the Net-a-porter fashion Web site, giving J. Crew instant presence in 170 countries.
Unlike J. Crew, B. Riley’s Van Sinderen said Gap has little room to expand in the U.S. “They have to grow internationally,” Van Sinderen said. “Either that or they have to develop a new concept.”
Chen said, “Now is a good time because the Chinese economy is starting to take off. The consumer aspect of it is very new, and there is a lot of wealth creation and getting in early [is important].”
The long-term goal of large retail companies going to China is stretching their business so it doesn’t rely too heavily on one region, with the ultimate objective of having an even split between sales in the U.S., Europe and Asia, she continued.
Gap is a long way from its Chinese enterprise contributing substantially to the balance sheet. Still, Glenn Murphy, chairman and ceo of Gap Inc., was emphatic in an earnings call about the brand’s Chinese debut in the fourth quarter. “We want to go in there and compete,” he said, adding that “it is going to take a while in order for me to put the investment in place that actually will return, not the ultimate return on capital, but get immediate return on four-wall contribution.”
Gap’s approach is to launch with company-owned retail. Other options for stores are to team up with a franchise or a license partner, or invest in a Chinese retailer. American Eagle has signed a franchise agreement with Dickson Concepts (International) Ltd. and will unveil three stores in Hong Kong, Beijing and Shanghai in 2011. Levi Strauss, which expects to have 650 units by the end of this year and plans to unfurl a new brand aimed first at the Chinese market, with 20 stores this year and 1,000 by 2015, has depended on the franchise model.
After 11 years in China, Wal-Mart opted to buy a 35 percent stake in Trust-Mart, a Taiwan-owned supercenter retailer with considerable heft in China, in 2007 to beef up its presence. The Bentonville, Ark.-based retail giant, which had 284 stores in China as of April 30, figured to purchase the remaining 65 percent of Trust-Mart this year. Kevin Gardner, senior director, international corporate affairs at Wal-Mart, refuted speculation in China that the deal was off. “We are working out complex administrative issues related to the closing,” he said.
David Solomon, president of NAI ReStore, a division of commercial real estate services firm NAI Global that works with Wal-Mart in China, estimated the retailer was looking to open 60 to 70 stores there this year.
“Any retailer who doesn’t want to be in China is missing a huge opportunity for growth,” he said.
For most American stores with ambitions in China, Yuval Atsmon, an associate principal in the Shanghai office of McKinsey & Co., said franchise or license partners are probably the best choice. They reduce the risk and retailers can benefit from local expertise. “They bring connections and the ability to do things much, much faster,” Atsmon said.
After accumulating experience in China, U.S. companies may be able to detach from local partners. Marciano said his goal is for Guess stores in China is to be 30 percent company-owned and 70 percent franchised. Tod Gimbel, senior director of corporate affairs at Levi Strauss’ Asia-Pacific division, said Levi’s eventual hope is that the mix of franchised and owned stores for its new brand in China will be 50-50.
In 2008, Coach Inc. acquired its retail businesses in Hong Kong, Macau and Mainland China from former distributor ImagineX Group. The accessories firm has 43 units in China and is on track to open 15 sites this year and 20 next year, and register $250 million in sales in China by the 2012 fiscal year.
Atsmon emphasized that U.S. retailers shouldn’t underestimate how difficult it is to decode the Chinese market. Retailers must find the right malls, the preferred shopping destinations for their brands and the right locations within the malls. Even if they meet the real estate demands, Atsmon said retailers could face issues involving fit, sizing, pricing and staffing.
“The reality is that churn can be very high and training people to the right level of salesmanship and support, especially for brands that people want to spend on for their service, is pretty challenging,” he said.
Forever 21 is fully aware of the tribulations of the Chinese market. The Los Angeles-based fast-fashion retailer had a store in Changzhou, a city about two hours north of Shanghai. The location wasn’t ideal and Forever 21 pulled out last December. Although stores in China aren’t planned in the next year, the country will factor into Forever 21’s future growth “if we find the right location in a major city,” said spokeswoman Linda Chang.
In five years, Kantar Retail’s Tackett envisions, “A lot more of the U.S. apparel and retailers will be looking to get into China, but I also think we will see an emerging Chinese fashion and retail industry that plays up to nationalism.”
Marciano agreed on the second point, but isn’t convinced American brands will saturate China. “If you don’t have a strong structure and a clear strategy for what you want to do, it is not obvious for anybody to enter that market,” he said.