Asia expansion shouldn’t end with China. Maybe it shouldn’t start there either.
International expansion is all the rage in retail today. And for good reason, as demand in North America and Europe slows and brands look for untapped markets.
Naturally, China is at the top of the international expansion wish list for many companies, who see its massive population and growing middle class as a prize worth claiming.
And while the argument for expanding into China remains strong, it comes with its fair share of challenges, while other countries like South Korea and several Southeast Asian countries may in some cases offer easier entry and significant opportunity.
As a result, we suggest looking beyond China to get a full picture of a brand’s potential Asian growth opportunity. While China will likely remain a part of most brands’ Asia expansion strategies, pursuing growth in other countries as well is an increasingly smart bet.
Challenges in China
Many brands still set their sights on China when they expand into Asia. These brands see its growing middle class with increasing spending power and strong demand for American and European luxury brands as an incredibly tempting launching pad for an Asia expansion strategy.
And this is still true, for the most part. China’s GDP is strong and expected to grow at over 7% annually through 2017, putting China on track to surpass the United States’ GDP by 2016.i (See Exhibit 1.) In addition, disposable income and consumer spending are on the rise as savings rates fall.
There are even rosier parts of this picture. Apparel and footwear are projected to grow at a combined annual growth rate of 9% from 2014 to 2017—even faster than the economy as a whole. And e-commerce is a significant opportunity for all brands as it experiences massive growth across China.
However, in China, the opportunity for significant gains comes with some risk. First, consumer receptivity may be beginning to taper off as a result of a government crackdown on lavish gifts and a growing preference to purchase luxury goods abroad, where taxes are lower. Credit Suisse estimates that 80% of Chinese luxury purchases occur outside of mainland China. Meanwhile, the number of outbound Chinese travelers hit 100 million in 2013, up 20% from 2012.ii
As a result, China may be on the verge of suffering an overstoring situation similar to the one we’re currently experiencing at home. Up to a quarter of the 700 malls, outlet and department stores currently being developed in China’s 30 biggest cities could fail.iii
This problem helps illustrate another challenge of expanding in China: Full-scale expansion requires substantial resources and commitment because of the sheer number of Tier 1 and 2 cities as well as an incredibly dense population. It takes a lot of marketing power to make an impact—significant brand presence is the price of admission.
At such a large scale, brand consistency and control are often harder to maintain, especially when handing the reins over to franchises, which can backfire. “Where [competitors] have gone franchise very, very quickly, they’ve lost control of their brand a little bit,” says Jeff Kirwan, Gap’s president of Greater China.iv
Finally, China is plagued by a high rate of counterfeiting, which has the potential to undermine any high-end brand.
Given these challenges, it’s not surprising that some of the world’s biggest luxury brands are slowing their expansion in China. Two-thirds of the 43 different luxury retailers studied by design consultants Knight Frank and Woods Bagot missed their targets for new store openings in China in 2013. And perhaps emblematic of a larger shift, LVMH, the world’s biggest luxury group, plans to slow its annual China expansion to 4% to 5% in 2014, about half the rate it recorded in 2013.
As a result of these factors, brands willing to look outside China for part of their Asia growth may be rewarded with significant payoff and an easier growth path. There are many Asian countries that present viable alternatives or additions to China.
First, South Korea and many Southeast Asian countries have the potential to contribute significant doors to a brand’s growth strategy. In fact, some Western brands have as many or even more doors in South Korea than in China.
A Kurt Salmon study of 11 brands actively expanding into Asia found that these players had an average of 70% as many stores in South Korea as in China, with Michael Kors having more than double the number of doors in South Korea as in China.
The first reason for this is that South Koreans are, on average, wealthier than Chinese citizens. South Koreans’ monthly average purchasing power parity is $2,903, the 10th highest in the world, while China ranks 57th at $656.v
Plus, South Korea exerts a powerful style influence over much of Asia. Korean pop culture, from music to TV, is widely consumed across the region, especially in China. For example, one Korean TV drama helped spark the sales of the products featured within it—including Jimmy Choo shoes, Celine dresses and Samsonite backpacks. In the case of Samsonite, sales of its entire backpack line were three times higher in February 2014 than in the same month the year before, and full-year sales in Asia are expected to double.
And Chinese consumers now flock to Seoul to shop.vi That’s why Diageo opened a high-end, six-floor “Johnnie Walker House” in Seoul last September. “Korea is an influencer for luxury items and lifestyle experiences,” James Lee, head of Johnnie Walker House Seoul, said. “By investing in Korea, we are impacting consumers across Asia Pacific.”
Many Southeast Asian countries represent another significant growth opportunity, offering easily a few dozen doors, or over 50% of China’s top-tier doors, by placing three to five stores each in Malaysia, Singapore, Thailand, Vietnam, Indonesia and the Philippines.
Among the group we studied, after China, Japan and South Korea, Taiwan and Hong Kong were the next most popular destinations, followed by Singapore, Malaysia, Thailand and Indonesia.
Thailand is definitely a destination to watch, as the number of luxury malls in Bangkok grows 25% a year.vii Thailand is also planning to allow Chinese tourists to enter the country without tourist visas and will also cut import duties for luxury brands, helping it compete with places like Hong Kong and Macau for Chinese tourism purchases.
Indonesia is hot on Thailand’s heels, as its luxury market has doubled since 2007 to $1 billion and is expected to grow 40% to 60% annually.viii And that number jumps to nearly $8 billion when including offshore spending by Indonesians in Singapore.
Given this positive performance, it’s no surprise that some of the biggest Western luxury brands are focusing on Southeast Asia. Tory Burch is targeting store openings in Malaysia and Indonesia in 2014, while Hermes is opening stores in Thailand, Malaysia and South Korea this year.
Western brands are flocking to these regions because it’s relatively straightforward to develop a presence there, compared to China. Many of these countries have established processes and structures for international entry, while China continues to be impacted by significant bureaucracy and corruption. In fact, China ranked 96th out of 185 countries on the World Bank’s 2013 Ease of Doing Business Report, while Singapore, Malaysia, South Korea and Thailand all ranked in the top 20.
In addition, there are just a few well-known, reputable licensing companies that work with many of the leading brands looking to expand, making the choice much easier when it comes time to pick a local partner. Plus, there’s a shorter list of desirable locations—making it easier to identify them and assess real estate viability and quality.
The most typical real estate strategy is to build in locations that are frequented by international travelers but are still accessible to wealthy locals, including top department stores and malls, hotels, and casinos in major cities. Coach had success with this strategy in Hong Kong and then replicated it with its more recent entry into Vietnam.
Finally, brands starting in South Korea or Southeast Asia can be much more gradual in their buildup. These countries create a good base for learning about Asian consumers on a smaller scale—ensuring any problems can be corrected before they are rolled out on a larger and costlier scale.
And once these smaller operations are established, retailers can buy out their local licensees, bringing the brand back in-house to exert greater control. Michael Kors, Coach and Kate Spade have all bought out licensees in countries like South Korea, Taiwan and Malaysia.
Looking ahead, India, Asia’s third-largest economy, may be heating up soon. International expansion there is still relatively minimal, due to significant restrictions, high tariffs and a thriving counterfeit market, but the country could be an area of future potential. Prada is looking at Mumbai and New Delhi locations, potentially in luxury hotels to capture tourists and wealthy locals alike. Gap is also looking into India.
It’s a safe bet that Asia will remain a compelling expansion destination for years to come and China will hold onto its spot at the center of much of that action. But by looking beyond China, U.S. brands can still access much of the same growth potential in a less challenging, more manageable environment, giving them the chance to increase their presence gradually while learning the ropes.
For investors looking to measure a brand’s international growth potential, it’s worth remembering that a significant portion of that growth may lie outside China.
i International Monetary Fund
ii Business Standard
iii Cushman & Wakefield
iv Women’s Wear Daily
v UN International Labour Organization
vi The Wall Street Journal
vii Credit Suisse
viii The New York Times