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THE HIGH-END ROAD TO CHINA

Western luxury retailers are finding a fertile market in China’s wealthy consumers

By Curt Hazlett

Today’s China would not seem to be what Mao Tse-Tung had in mind. The man behind the Cultural Revolution, during which millions were imprisoned or starved to get them to reject the “bourgeoisie” lifestyle, would probably be chagrined to see Chinese entrepreneurs driving Bentleys around Beijing and queuing up to buy Rolex Oysters.

Then again, Mao did want China to be a winner, and it is. In the 30 years since his death, China has leaped from an agrarian backwater to a manufacturing powerhouse that supplies the rest of the world with cheap goods. Now, with dollars and euros streaming in, more and more Chinese are developing personal tastes that are anything but cheap.

Jewelry from Cartier is hot. So are Burberry coats, Armani suits, Prada bags and just about anything made by French luxury juggernaut LVMH. There is demand even for the flat-out frivolous: Bejeweled Vertu cell phones — at prices ranging from $5,000 to $90,000, depending on their degree of ostentation — are selling briskly. And as strong as it is, the Chinese luxury market may still be only in its infancy. China is now the third-largest consumer of high-end goods in the world, accounting for 12 percent of the market, says a report by Goldman Sachs. By 2015 that could rise to 29 percent, the investment bank says.

With so much money at stake, the world’s luxury retailers are beating a path to China, creating a retail development land rush unprecedented in Asia. This, in turn, is providing an intense cultural education all around.

“There is an extraordinary amount of retail deal flow in China today,” said Morgan Parker, president of the Taubman Asia unit of Taubman Centers, which plans to open as many as a dozen shopping centers in Asia. “The activity we’re seeing across the board, but specifically in shopping centers and luxury goods, is at an all-time high, and I’ve been involved in retail real estate in China for almost 10 years.”

Signs of the retail rush are everywhere. Saks Fifth Avenue will open its first store in China in 2008, in Shanghai, under a licensing deal with Roosevelt China Investments Corp. Tiffany & Co. is set to unveil new stores this year in Beijing and Shanghai, both of which already have one Tiffany store each. New York City-based watch retailer Tourneau opened two stores in Shanghai in August, the first of 30 it plans to have in China within five years. Cartier operates 12 stores there now and has five more under construction. The company anticipates that 10 percent of its sales will be coming from China by 2012.

This taste for luxury in China can be traced to some simple facts. Chinese consumers have more money than ever before, they are optimistic about the future, and they are eager to flaunt the fruits of their hard work.

Ernst & Young published a report last year on the Chinese luxury market that says 13.5 percent of China’s consumers can afford luxury items. Most of these are between 20 and 40 years old and have a “spend now and worry later” attitude, the report says. The most active consumers are men.

For Tourneau, China was a market it needed to enter, and sooner rather than later. “It’s a perfect time for us and an opportunity to get in fairly early,” said Alan Goodman, Tourneau’s vice president of licensing. “Chinese men are no different from Western men in the sense that there are relatively few items they can wear to show who they are. The watch is a statement of who and where he is in terms of his affluence and success.”

Taubman Asia’s Parker concurs. “The nouveau riche are looking for ways to express themselves and their success,” Parker said. “And owning a brand of luxury goods is a way they can do that at a relatively low price point.” Or sometimes at a not-so-low price point: Ferrari sold 96 of its sports cars in China last year, with prices starting at $200,000.

Tourneau is teaming up with another U.S. company, International Watch Group, and with Peace Mark (Holdings), of Hong Kong. Goodman says Peace Mark has proved invaluable in getting the deals done. “The key is your partner,” he said. “You have to find people who understand culturally how to work with each other.”

Parker agrees that cultural understanding is crucial in a business that is inherently tricky. He first came to China in 1997 to develop residential projects for Australia’s Macquarie Bank and says real estate development is still a challenge.

“Real estate is still built on leasehold land,” Parker said. “The competition has increased probably 10-fold, and the sophistication of local developers has increased dramatically. Many foreigners would argue that developers are still relatively unsophisticated, which is probably true on a local basis. But they’ve come a tremendous way, and they’ve gone from being underskilled and undercapitalized to being able to complete very large projects.”

Still, frustrations are common, Parker says. “Because of the language differences, meetings and negotiations of all kinds take longer,” he said. “And it’s more than just the language. There’s really a knowledge gap that exists. Developing a shopping center is a process with thousands of decisions, which we’ve been doing for 50 years. They are learning along the way. There is always an educational element to all business in China. It takes patience and a willingness to help your counterpart understand. They educate you, and you educate them.”

So far the only U.S. mall developers to enter China are Taubman and Simon Property Group. Simon announced a partnership last year with the state-owned Szitic Commercial Property Co. to develop a dozen shopping centers in China. Singapore-based CapitaLand Group says it will open 50 malls in Asia within three years, a large number of them in China.

The burgeoning retail presence in China complicates life for developers. “The big challenge is understanding future supply,” Parker said. “When you have a hundred shopping centers being delivered every year, you have to be acutely aware of where they are going to be and how retailers are going to respond to all that supply. It’s giving retailers a tremendous amount of choice, which is holding down rents in anything but prime locations.” Fortunately for developers of top properties, he says, demand is still strong for the best. “Most of the supply is illogical and poorly planned.”

Parker says Taubman is investigating deals in China he describes as atypical. “We’re looking at about six deals very seriously in first- and second-tier cities,” he said, “and all of them are either acquisitions of existing assets, acquisitions of partially completed assets or repositioning opportunities, where we would take something in an A-grade location that’s underperforming and rehabilitate it.” The first Taubman center will open in late 2009 or 2010, he says.

The big question is whether the demand for luxury goods will remain at red-hot levels. The likely answer is yes. With the number of millionaires rising fast (Merrill Lynch estimates that there were just under 400,000 of them at the end of 2004), the appetite for Gucci and Prada seems assured.

“We’re just seeing the tip of the iceberg, and that’s why the retailers are taking the risk of opening new stores,” said Parker. “They are compelled to do so. They feel there’s a lot of depth to this and a lot of sustainability.”