BEIJING — Brands should not rely solely on joint-venture partners in selecting retail locations in China or bank on the notion that opening in prime locations will lead to greater sales, according to a report by SmithStreet Solutions, a Shanghai-based consultancy.

This story first appeared in the October 2, 2014 issue of WWD. Subscribe Today.

The report pinpoints how brands must be increasingly strategic when choosing where to open stores, particularly as landlords of shopping centers employ unfair business tactics, such as unexpectedly increasing rent or choosing tenants based on an assessment of where the brands have existing retail space. For example, if a brand has a flagship in a prime retail space in Shanghai or Beijing, it is more likely to have more bargaining power when moving to a smaller city. Yet if the brand opts for a lesser-known development, it may be harder to snag a premium space elsewhere in the country, according to SmithStreet.

According to the study, brands have been asked to pay significantly more money for retail space if sales increase, which ultimately impacts their bottom line in China. Additionally, brands could be shut out of a retail development based on the reputation of malls where they have existing stores. This risk is greater if a brand opts for a new development in a second- or third-tier city that is not well-known among shopping mall operators elsewhere.

“In other markets, you will get a fixed rental fee,” Jules Falzado, a manager with SmithStreet, said. “But in China, you have the rental fee, but if your performance is higher, they will take a percentage of sales, thus they will also know if you are not performing well.”

The report notes that there is no Chinese regulatory body to enforce standard practices, such as rationalizing rents and pricing. Thus the operators of malls hold significant power over brands, including how much a retail space will cost, where a brand will be located in a development and whether to, on a whim, increase rent or move a brand to a suboptimal location within a mall.

“Information is not really visible on how decisions are made and on how rental prices are developed,” Falzado said. “There is a lot of supply in the market, but not a lot of premium supply so landlords have more bargaining power in the process. Everything is all over the place. If brands don’t have information on what is really happening, they tend to have no other choice but to accept it.

“Landlords will ask to increase the rent, and for some brands, the increase of rent is significantly high.”

He said issues with rent increases have particularly impacted luxury brands that have had high sales performance in landmark locations, resulting in a significant and unexpected increase in rent that “would make their performance a bit more unfavorable.”

Falzado added that shopping mall operators assess a brand’s performance in other retail spaces when determining whether to lease space and where that space will be within a development. Thus, one opening in a mall that results in poor sales could impact the brand’s ability to negotiate for prime locations elsewhere. He also said that brands must be cautious when opening in prime locations, which may have high foot traffic due to food and beverage offerings or other attractions yet actually generate few sales for retailers despite the high volume of visitors.

“Landlords may ask for a rent increase in malls that are considered prime real estate,” Falzado said. “But if you look at the crowds they attract, the productivity is much less than what they could get from other landmark locations. These are cases where brands come across inefficiencies and issues with rent increases.”

Falzado said brands must employ a more “data driven” approach when selecting where to open stores, particularly for those looking to expand beyond first-tier cities.

“Look at the image of the locations. The foot traffic that location gets. The performance of the stores already there. What are the likely sales one brand can get? And also what is the difficulty of entry and the bargaining power of the landlords in that location?” he said. “Having this data and information about each location will give brands a more comprehensive look at the options they have, and then they can be strategic.”

The report says brands should not aim to have stores in too many landmark locations, but rather select landmark locations that will not only generate sales but also give them more bargaining power when expanding into smaller markets. “When you pick a landmark location, you have to be selective,” Falzado said. “It could impact your future expansion plans. Choose ones that serve as a credibility reference to other retail operators.”

The report adds that brands should not discount what it calls “neighborhood locations,” which are defined as commercial centers on the outskirts of major cities that are frequented by residents living in the immediate area. Instead of jumping to a second- or third-tier city, opening up in a more suburban area of Shanghai or Beijing could be a better expansion location than a smaller city, Falzado said.

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