High-end brands stumbling in China's crowded luxury market

When Eric Douilhet opened China's first Paul Smith and Moschino fashion boutiques in 2002, he didn't expect they'd be making money by now. He didn't think they'd be losing this much, either.

"I was definitely expecting sales to be higher, the losses to be smaller," says Douilhet, 43, president of Bluebell (Asia), which also operates Jaeger clothing and Davidoff cigar stores in China.

"People are too optimistic about China," he said.

China's luxury market is proving harder to crack than many overseas frims expected, even as incomes soar and economic growth tops 10 percent.

Dozens of high-end brands, from Cartier and Chanel to Hermès and Versace, are chasing the nation's limited pool of big spenders. That's made profits elusive for most.

"If you are not the No. 1 brand, if you are No. 2 or No. 3, the odds are good your fingers will be burned," says Ivan Kwok, a manager at Boston Consulting Group in Hong Kong. "China is a growing force in the luxury business, but the market isn't large enough yet to accommodate so many players."

Only about one in 10 overseas consumer-goods companies — including LVMH Moet Hennessy Louis Vuitton, the world's No. 1 maker of luxury goods — is profitable in China, Kwok estimates.

The winners are the ones whose products are seen by Chinese consumers as obvious symbols of wealth, he says.

Even after more than doubling since 1996, the disposable incomes of urban households averaged just $1,327 in 2005, about the price of a Louis Vuitton handbag.

Official statistics overestimate the size of the urban middle class, which controls China's disposable income, says Jonathan Anderson, Hong Kong-based chief Asia economist at UBS. The group's real size is between 65 million and 75 million, not the 250 million to 300 million reflected in government figures, he says.

To succeed, luxury-goods companies must woo the top segment of the Chinese consumer market — the 15 million people who earn 250,000 yuan ($32,000) or more a year, according to data from market researcher AC Nielsen.

Making their jobs harder, China's steep import duties and value-added taxes mean luxury-goods companies have to charge as much as 35 percent more for their goods than in Hong Kong and many other markets.

Cartier is barely breaking even after 15 years in China, even though it's the nation's top-selling luxury jewelry brand, says Nigel Luk, Cartier's managing director for China. He declined to give figures.

"If you are looking for quick profits, don't go to China," says Luk, 44. "It takes a long time to be profitable."

Cartier, which has 14 boutiques across China, will need another 15 years to meet its profit targets, Luk says. For now, rising rental and labor costs triggered by China's booming property market and economy are cutting profits.

Brands such as Cartier and Paul Smith, the British fashion house known for its quirky twist on classics, lack the obvious status-symbol cachet of Louis Vuitton or Gucci among Chinese shoppers.

"A luxury brand in China represents middle-class aspirations, so you can't be too hidden," he says. "A lot of products bearing visible logos don't do well outside China but are bestsellers in the country."

High-end brands seeking to tap China's rising wealth face another setback: People are saving more as the government dismantles its cradle-to-grave welfare system.

The cost burden on China's households has risen as the communist government, shifting toward a market economy, phases out benefits such as free housing, education and health care.

"The Chinese middle class may be earning a good living, but they still feel insecure about the future," says Chen Xingdong, a Beijing-based analyst with BNP Paribas Peregrine. "That prompts them to save a large share of their income."

China's aggregate savings ratio is as high as 50 percent of the gross domestic product, says UBS' Anderson. That compares with 30 percent in Japan, 39 percent in Hong Kong and less than 14 percent in the United States.

Luxury brands are willing to endure losses now to position themselves for an expected explosion in China's big-spending population. China will be the world's top consumer of luxury goods by 2015, forecasts Jacques-Franck Dossin, a London-based analyst at Goldman Sachs Group.

The nation had 320,000 millionaires at the end of 2005, a 6.7 percent increase from a year earlier, according to a report by Merrill Lynch and Cap Gemini. That compared with 2.7 million in the United States and 448,000 in the United Kingdom.

"The money is there," says Glen Murphy, 41, a Shanghai-based managing director at AC Nielsen. "The big challenge for consumer-goods sellers is identifying who and where these people are, and to sell them what they want."

Paris-based LVMH has succeeded in doing that. The company, which opened China's first Louis Vuitton handbag store in Beijing's Peninsula Hotel in 1992, now counts China as its third-largest market.

All of LVMH's Louis Vuitton stores in China are profitable, according to Chris Hollis, the company's Paris-based director of financial communications.

For dozens of lesser-known brands, financial success is more elusive. For now, says Bluebell's Douilhet, the company is willing to lose money as long as it can keep learning about the Chinese market.

"If the time comes that we realize the money we spend is more than what we earn, then obviously we will reconsider our presence," Douilhet says.