Covid-19 is global, by now it is also self-evident that the coronavirus pandemic goes beyond mere health crisis, and it is also an economic pandemic as national central banks project severe recession amidst the backdrop of an IMF chief dropping the “depression” descriptor on the global market. The resulting global lockdowns from covid-19 have also awakened many brands about the pitfalls of growing margins simply by shifting supply chains to China or depending on Chinese consumer demand.

Shanghai-based consultant Hervé Roland Rogazy told jingdaily that “China was supposed to be the answer for everything: supply chains, customers… Everybody wanted to jump into this huge and lucrative market. But [they are discovering] it is mostly smoke and mirrors.” Rogazy advises brands looking to expand in China.

Coronavirus exposes China Dependency problem: How it affects the Global Economy (and the Luxury segment)

Covid-19 exposes China’s precarious position in all tiers of the luxury market. Before the coronavirus pandemic, brands were jumping on the China production and consumer bandwagon; today, Rogazy says that it is now the Chinese factories who have come knocking instead.

Indeed, Zara owner Inditex began increasing output at its key Spanish logistic hubs in anticipation of a recovery in global apparel demand as nations approached their coronavirus peaks. With curve flattening measures in place, it appears the apparel giant expects imminent global recovery. In fact, the Spanish company has become the Apple Inc of retailers, a darling stock and a bellwether for the fashion and retail industry as a whole .

Zara proves diversification matters in fashion retail

Inditex was among the first European fashion companies to reduce their China dependency and diversify production in Morocco, Madagascar and native Spain. While they had shuttered their 3,500 Zara stores during the pandemic, they left vital production facilities producing medical gear and bed-sheets for Spanish hospitals, while their vaunted logistics and supply-chain expertise is also credited for delivering up to 35 million medical gear units (masks, ventilators and testing kits) from China, which were then distributed around the country.

China dependency was an issue which came into prominence during the early tit-for-tat trade war tariffs which exposed American fashion retailers to higher costs and smaller margins; the coronavirus pandemic only accelerated awareness of the issue as disruption to global trade highlighted the sky-high costs of lopsided supply and logistics. If the trade war alerted US brands to the pitfalls of China dependency, the global outbreak forced Europe to concede that the China solution was a shortsighted one as Chinese manufacturers and suppliers shut down during strict quarantine measures, breaking supply chains across all sectors including luxury.

Backlash over China’s NBA bullying prompted a rare reversal from Beijing

For decades, business owners and Chief Executives have pursued a strategy of exceptional profit margins by exploiting global inequality and now, those chickens are coming home to roost. Year on year, Chinese exports fell by 17.2% in January-February 2020; even as China re-opens for business, the world’s developed economies are re-thinking old supply paradigms with Japan first to earmark $2 billion dollars to help its businesses relocate manufacturing from the Chinese mainland.

Speaking to France Inter radio station, French Finance Minister Bruno Le Maire declared that the post-pandemic global economics would be vastly different, saying, “We have to decrease our dependence on a couple of large powers, in particular China, for the supply of certain products” and “strengthen our sovereignty in strategic value chains”, A move which the world’s biggest tech companies, Apple, Microsoft and Google have already begun exploring according to Nikkei. Google is producing its latest low-costPixel 4A  smartphone  as well as its flagship Pixel 5 in Vietnam while increasing production lines in Thailand.

China ignores soft diplomacy to its own detriment

In stark contrast of President Theodore Roosevelt’s “speak softly, carry a big stick” diplomacy, Beijing has grown increasingly thin skinned of late, after decades of enduring and dismissing calls for democracy and human rights, they became the world’s second largest economy. Once in that position, Beijing used newfound economic clout to force even the most strident democracies to take non-democratic positions on key human rights issues.

Over the years, this has emboldened President-for-life Xi Jinping to throw its economic and political weight around. Most recently, the European Union under pressure from Beijing, softened their criticism of China’s coronavirus response and management. NYT had received the report which used drastically different language from the initial document which cited that, “China has continued to run a global disinformation campaign to deflect blame for the outbreak of the pandemic and improve its international image.”

It is certainly understandable why western democracies and businesses would capitulate to Chinese demands: China was responsible for over a quarter of global economic growth from 2013 to 2018, and its rapidly growing middle class segment made it impossible for global corporations to ignore. Pre-coronavirus, the International Monetary Fund projected that China would account for 28-30% share of growth between 2019 and 2024. Post covid-19, it’s unclear whether the projections still hold true as the recent outbreak exposed strategic vulnerabilities and loss of national competitiveness far outweigh the loss of economic opportunities.

In 2018, President of the European Commission, Jean-Claude Juncker said, ”Europe is China’s largest trading partner and China is our second largest. The trade in goods between us is worth over €1.5 billion every single day.” Would it surprise you to learn that Europe’s biggest trading partner is itself? With member states trading close to €30 billion with each other and other external partners. Comparatively, China just represents slightly more than 5% of total trade in the Eurozone. For major European corporations and carmakers, China as a market is losing, or as a result of the pandemic, has already lost its lustre.

If emerging Asia economies like Vietnam and Cambodia (minimally affected by covid-19) including India follow projections to outpace China as the world’s biggest growth engines, then it stands to reason that brands who pivot out of China and start to seed fertile grounds in those regions would also stand to benefit the most as markets re-open.

If Not China, Who? Emerging Asia

Volkswagen’s operating results in China have dropped by15% from 2015 to 2019. Others like Daimler and BMW have seen their revenues stagnated over the same period. European investment levels in China fell by half to just under $8 billion from 2016 to 2018. In fact, PriceWaterhouseCoopers projected that emerging Asia (India, Vietnam, Cambodia, Myanmar) will overtake China as the world’s main growth engine. This is an economic realisation that the more traditionalist luxury industry is very slowly waking up to.

Reality Check: Luxury Goods Industry After Coronavirus

Psychologically speaking luxury goods appeal to a more metropolitan, well-travelled, global consumer with 20 – 30% of luxury revenues generated by luxury consumers outside their home countries. In 2018, Chinese consumers took more than 150 million trips abroad; McKinsey estimated that purchases outside the mainland accounted for more than half of China’s luxury spending that year. In general, Asian shoppers consume luxury goods outside their native territories to benefit from lower prices in Europe, but also because luxury goods shopping has become an integral part of the travel experience: buying a brand in its country of origin reinforces the authenticity and excitement. With the recent travel restrictions, an important driver of luxury spending has come to a halt, and McKinsey projects anticipate only a gradual ramp-up in international travel, even after the restrictions are lifted. Even then, as the 18 months closure of premier Asian airport hub, Changi International Airport Terminal 2 and the decimation of countless international air carriers suggests: returning to pre-pandemic levels of global air-travel might take the long term outlook, especially if a vaccine cannot be found.

So rabid was Japanese luxury consumption that Sanyo Shokai created the Burberry Blue Label brand for young ladies, adapting the popular checks into youthful expressions of favoured colours like bright pinks and reds

Emerging Asia including Japan to replace China as the new Growth Engine

There is no sugar coating it,” according to Javier Seara, Boston Consulting Group’s global leader for Fashion & Luxury. “Living through the COVID-19 pandemic is going to challenge fashion and luxury brands to the extreme.” BCG revised its annual forecast down by more than $40 billion especially with Italy, a pivotal fashion and luxury capital, hardest hit.

LVMH (Moët Hennessy-Louis Vuitton, the world’s leading luxury conglomerate), derived 37% of its ~€54 billion in revenues from Asia in 2019. Other big brands are exposed to the same or greater degree, such as Bottega Veneta with 53% of its revenues coming from in the region, along with Hermès (49%), Gucci (46%), Burberry (41%), Ferragamo (38%) and Versace (36%). Overall, the predicted impact for the fashion and luxury goods sector as a whole are in the region of $450 and $600 billion in losses.

Conspicuous consumption emerges in Vietnam as Middle Class grows with BCG projecting Vietnam’s “middle and affluent class” to double to 33 million people, about a third of the country, from 2014 to 2020

That said, if emerging Asia economies like Vietnam and Cambodia (minimally affected by covid-19) including India follow projections to outpace China as the world’s biggest growth engines, then it stands to reason that brands who pivot out of China and start to seed fertile grounds in those regions would also stand to benefit the most as markets re-open. It’s an assessment which rival consultancy Bain & Co. share.

In 2019, Vogue Business reported that a wave of “highly conscious” Japanese tech entrepreneurs was driving the country’s luxury market resurgence. While Vogue Japan’s Maya Nago focused on the emergence of the “Ikina-Rich”,  a group of young Japanese luxury consumers less interested in ostentatious watches and cars, and more interested in travel and summer homes for spending time with family and friends, evidence from Hublot, Ferrari and Rolls-Royce suggest that pre-pandemic spending for these high profile brands which led to record sales show that ostentation is still very much alive in Japan. So much so that LVMH Watchmaker Hublot worked with Yohji Yamamoto for All-Black Big Bang GMT Watch. Launched to commemorate the the opening of Hublot’s new flagship boutique in Tokyo, LVMH enlisted the famed fashion designer for the sole purpose of offering Yamamoto’s bespoke All-Black Big Bang GMT exclusively at Hublot’s new Ginza boutique on Chuo-dori Street when it opens in May.

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Bloomberg also reported on a pre-covid-19 Rolls-Royce boom in Japan citing CEO Torsten Mueller-Oetvoes’ announcement that deliveries jumped 30%, prompting the Goodwood luxury automotive manufacturer to open two more dealerships in 2017 with plans to double. Japan was also a growth market for Ferrari, rising over 30% during the last 7 years, and the imported supercar segment is such a fast-moving sector that in 2018, it became the subject of attention by Japanese tax authorities as over 20 resellers and distributors were penalised for intentionally hiding profits, or failing to report profits, from the sale of expensive imported supercars like Ferraris.

New opportunities for luxury conglomerates and private equity firms as “rare gems” become available on the market where a long term strategy (and some patience) could see high-potential but poor performing brands nurtured into post-pandemic viability

Post-Pandemic: Big Losers of the Luxury Industry

Experiential luxury like high-end hotels, resorts, cruises, and restaurants became one of the most dynamic and fast-growing components of the luxury sector, prompting luxury giant LVMH to acquire Belmond group as millennials (those born 1980–95) opted more for experiences and “Instagrammable moments” rather than luxury items and Baby boomers (born 1946–64), having already accumulated luxury products over the years, started to spend their retirement years on experiences. With tempered global travel and revenge spending on the rise, it looks like luxury goods again will once again take its prime position.

Luxury brand growth from entry-level (masstige labels like Michael Kors) to its highest tiers were already extremely polarised that it rendered little meaning to talk about the segment in terms of average growth rates and profit margins pre-pandemic because the best performers would report double digit growth and profits while the weaker brands would see negative growth even. The coronavirus outbreak will only serve to accelerate these trends; however, depending on the brand’s cash flow and its operational strategy (ability to pivot to or already invested digital channels) and the diversity of its supply chain, some clear winners and losers of the covid-19 outbreak will emerge. This development will lead to new opportunities for luxury conglomerates and private equity firms as “rare gems” become available on the market where a long term strategy (and some patience) could see high-potential but poor performing brands nurtured into post-pandemic viability. McKinsey predicts that this could result in further industry consolidation or even the formation of new luxury conglomerates.

Even if the speed of evolution left something to be desired, over the centuries, the luxury industry has reinvented itself time and again. Some brands will emerge from the crisis stronger, others will struggle to adapt. Much will depend on their ability to respond to the short-term urgencies related to the coronavirus pandemic but all signs point to undeniable fact – depending on China for growth is no longer a wise strategy, especially when there are new blue oceans waiting once the global economy restarts.