A First Appraisal of the China Risk for Luxury: the Shangri-La euphemism*

Given recent news flow out of China, including growing concerns on the real state of the economy following developments in the real estate and financial markets, we summarise why this may pose a bigger problem for Luxury than you may think – we had already flagged these issues.

In 2000 the retail value of the global personal Luxury goods market exceeded $100bn for the first time…the people of Shangri-La accounted for just under 5% of this. In 2022 the value had soared to around $340-345bn (that’s the beauty of these metrics – they are all intelligent guesstimates by the way as no-one really knows for sure) and the Shangrilans accounted for around 35% which was down on previous years due to Covid disruption. My best guess for 2023 is $370- 375bn with the Shangrilans flat at 34-35%…..in $ therefore the people of Shangri-La spend on Luxury has grown from $5bnish to $130bn or a CAGR of 15% which is a spectacular number given all that has happened.
Without the Shangrilans, over the same period, the market grew at a CAGR of just 5%.
The Shangrilans are therefore the only real driving force that mattered for the sector….not the Americans or the Japanese or anyone else.

What do we know about the people from Shangri-La?
The Shangrilans live in a socialist state yet have one of the highest Gini coefficients globally (a measure of inequality), probably behind only Brazil amongst the larger nations. This tremendously unequal wealth distribution appears to be getting worse, not only between urban and rural areas but within its megacities too. Inequality is good for Luxury in the short term, bad in the long term. So we see that a very unequal yet dogmatic socialist state is by some distance the most important originator of demand for Luxury goods – virtually all of which are manufactured in the West.

The Shangrilans are ruled by an all-powerful autocratic Party led by an élected’ leader that has just decided to self-appoint himself on a perennial basis and tolerate no dissent or deviations from its political dogma no matter how absurd this can be (just look at Shangri-La’s management of Covid). The Shangrilans are fully onboard with a very tight management of their lives and this is getting more so since Covid. A social credit ranking dictates their ability to travel, shop, live a particular lifestyle….facial recognition technology is being applied everywhere and in everything pretty much all at once to ensure order. In other words, control. So the Shangrilans are able/willing/keen to buy Western Luxury goods because the ruling Party sees this as a de facto tool of crowd control: a happy citizen is less likely to cause trouble and they do not want a repeat of past incidents that the Shangrilans are now told never actually happened anyway.

They are very keen on perceived status amongst their peers (not a very socialist thing but just one of many idiosyncrasies) as social ranking matters … a lot. Luxury is one of the key differentiating tools in this context as wealth equates with success (once again, odd I know). Status is also attained as Shangrilans climb up the social ladder – such as being perceived as ‘middle class’ and the optics of owning expensive/overpriced (you choose) western-made bags or shoes or bracelets is of great consequence. What their leaders do not like is the ‘vulgar display’ or the excessive obstentation of wealth which is inevitably connected with the rise of social media exposure and this they will crack down on – not the inequality but the perception of the same, as this can cause unhappiness and dissent, which, as I wrote, is not tolerated.

The people from Shangri-La have become a lot wealthier as a nation and as a cohort mostly by manufacturing almost everything that is not Luxury on behalf of the West. This they could do because they were a lot cheaper, there were a lot of factory workers (growing all the time) and frankly it solved the West’s problems. As is often the case, working conditions, racism, social welfare etc took a back seat and so the magic happened to everyone’s (well, almost) benefit. This growing wealth amongst the Shangrilans enhanced their spending power and in our case the ability to purchase branded Luxury goods (the appetite, as I wrote, was there).
It is the Shangrilans that drive Luxury spend globally – without them double digit growth is a chimera. Their appetite for Luxury is strong with different brands performing to different degrees according to the maturity of the Shangri-La customer.

The Shangrilan‘s leaders and the Luxury brands work together to make the magic happen and both share the view that more of them should and will buy at home.

So what can go wrong? Quite a lot, actually

What if the wealth of the Shangrilans took a hit and their economic growth forecasts, long known to be a work of fiction for the most part anyway, turned out to be wildly wrong.

The West was already looking for cheaper sourcing and the deterioration in the geopolitical scene was telling, as the Shangrilans turned increasingly inward and expats that lived there left in their droves post Covid.

The poor management of Covid had already impacted their economy, essentially resulting in a further spike in inequality and very significant unemployment levels amongst Millennials and GenZ.

Yet the appetite for branded goods from the West persists to this day and provided brands play to their rules the momentum remains reassuring – which is a must now for these European names to justify momentum and valuation.

However the local economy is fragile – without going into excessive details we know of the slowing output and consumption and of the weak stock exchange.
But the real threat is Real Estate: overdevelopment of residential complexes everywhere on a gargantuan scale. As this unravels with related financial impact one can only wonder as to the magnitude of the effects – a when rather than an if.
As its hugely indebted property developers struggle to survive and protect their assets through de facto insolvency the risk profile is rising fast.
Crisis management requires swift action and that has not always been Shangri-La’s forte. It also carries the risk of narrative shifing – focusing attention elsewhere….like deciding that certain neighbours should join the Shangri-La Empire sooner than later even.

Any significant slowdown would impact Luxury disproportionately: falling sales densities in what are becoming huge retail temples would have a very painful impact quickly.
As would political interference – say enforced price corrections to narrow the sizeable gap vs the West  which can be disguised under nationalistic fervour. Or what if inequality should actually be tackled seriously.

Perhaps restricting foreign travel (very easy to do now) or stepping up border controls would bring some solace to the local retailers, but in the short term only.

So, in essence, the cohort who buy more Luxury than any other and at a faster rate could start to decelerate, leaving the brands entirely reliant on the polical whim of the Shangrilans as to whether supporting a system whereby the local population continues to buy Western goods at inflated prices as one of the tools to be used in order to mitigate possible social unrest still makes sense.

 It still does today, but it looks like a storm is brewing so caveat emptor

*We referWe refer to Shangri-La as referenced by James Hilton’s Lost Horizons: a fictional place within a mystical, harmonious valley in Asia akin to a form of paradise to Shangri-La as referenced by James Hilton’s Lost Horizons: a fictional place within a mystical, harmonious valley in Asia akin to a form of paradise

(foto tratta dal libro “Orizzonte Perduto” di James Hilton pubblicato da Sellerio)