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China, Coronavirus And Catastrophe: Impact On The Global Luxury Industry

What happens when China – both ground zero of the epidemic and the locomotive of the global economy shunting the world’s fortunes — grinds to a halt? Luxury players brace themselves for a world of hurt.

China, Coronavirus And Catastrophe: Impact On The Global Luxury Industry

It was a scene Giorgio Armani had probably never imagined in his six-decade career in fashion: Presenting a show at Milan Fashion Week to a vacant theatre, and having to take a bow at the end to endless rows of empty seats last week.

The night before, hundreds of new coronavirus cases had been confirmed in Italy and the Italian fashion designer made the difficult, but safer, decision to proceed sans audience. Instead, the show was livestreamed to the world via the Armani website.

While the show went on for Armani, others like Chanel and Prada have postponed theirs planned for May in China. Shanghai Fashion Week, which was supposed to be staged in March, has also been cancelled.

And in a major blow to the Swiss watch industry, the plug has been pulled on two key industry events — Watches & Wonders Geneva and Baselworld — that was to be held in April and May in Switzerland, already previously postponed (due to unrelated reasons) from their usual slots in January and March.

These cancellations are symptomatic of the shake-ups in store as the devastating effects of the coronavirus, or Covid-19, begin to take root in the west.

In the two months since confirmed cases were first reported from Wuhan, China on 31 December 2019, the virus has already spread to every continent on earth save for Antarctica.

The number of those infected has ratcheted up to over 87,000 worldwide with a death toll of more than 2,900; the majority of which are concentrated on China — for now.

Altogether, 67 countries and territories are affected to date.

Schools and public spaces have been shuttered. Entire towns have come under lockdown. Governments have issued travel bans and restrictions. Some countries have even closed their borders to visitors arriving from China and other severely affected countries. Thousands of people had been stranded on a cruise ship quarantined off Japan due to a cluster of infected passengers and crew onboard. And scenes of empty supermarket shelves across Singapore, Hong Kong, Italy and the U.S. suggest doomsday is at our doorstep.

Welcome to a world on edge and on red alert; a world where the World Health Organization is, in fact, inching closer to declaring the coronavirus outbreak a global pandemic by the day.

Rest in peace posters of Dr Li Wenliang seen at Hosier Lane in Melbourne, Australia. Dr Li was the whistleblower who first warned authorities about the coronovirus outbreak, and passed away from the virus in early February.
(Image: Adli Wahid/Unsplash)

Wall Street has responded accordingly, plunging into a sea of red as it does when world headlines proffer a protracted daily digest of countries being ‘shaken’, ‘paralysed’ and ‘crippled’.

The S&P 500 suffered its worst week since 2008, tumbling 11% last week followed closely by the Dow Jones (12%) — effectively erasing US$3.18 trillion in market value in just one week.

Britain, Germany and Japan followed suit, losing 11%, 12% and 10% respectively.

Singapore’s STI also took a beating with its sharpest single-day drop since August 2015, closing the week down 5.3% on 28 February.

And the world’s wealthiest human, Amazon’s Jeff Bezos, was the biggest loser of all, with his net worth plummeting US$14.1 billion in the span of just five days.

Frighteningly, the bloodletting may not let up anytime soon, as the coronavirus has only recently made its way west, and it is impossible to predict with any certainty the extent of the contagion globally.

The massive sell-off, fuelled largely by concerns that measures to contain the virus would derail economic growth and curtail corporate profits, signals extreme pessimism amongst investors with widespread sentiment suggesting that the damage from Covid-19 could result in the slowest quarter for global growth since the 2008 crisis.

History, however, tells us the recovery is likely to be ‘V’; stock markets are expected to rebound quickly, as they have in the aftermath of past outbreaks such as Sars (Severe acute respiratory syndrome; November 2002 to July 2003), the H1N1 swine flu (March 2009 to August 2010), Ebola (December 2013 to June 2016) and the Zika virus from March 2015 to November 2016.

According to a JPMorgan assessment of the market impact of past outbreaks, stock markets bounced back swiftly after an initial sell-off triggered by each of those epidemics.

During Sars, for instance, the MSCI China index fell 8.6% but rebounded by more than 30% in the three months after April 2003. In Hong Kong, stocks fell by a fifth but also sprang back and made significant gains.

Historically, governments move swiftly enough to counter long-term economic distress via an injection of stimulus measures such as slashing interest rates and taxes, and flushing the economy with cash otherwise known as monetary easing. Should the outbreak worsen, affected countries will no doubt react accordingly, depending on how much stimulus the country can afford.

The current consensus on Wall Street, therefore, appears to be that the situation is unlikely to escalate into a global recession and will likely blow over in the next six months

While the V-shaped pattern has been replicated often enough in the past for investors to hold faith that recovery is inevitable, less discernible is the fate of broader industry and businesses should the epidemic spiral indefinitely.

Luxury Brands Hardest Hit

Trying to predict the full economic impact of the Covid-19 outbreak at this juncture is, admittedly, a fool’s errand. 

While the spread of Covid-19 appears to be easing in China, the virus is still on its earliest legs in the rest of the world. And with so many variables in play, a state of flux appears the most reasonable order of day.

What we can be certain of, though, is the speed at which the virus and its catastrophic effects have spread is indicative of just how much more vulnerable the world economy stands today compared with Sars which, incidentally, also originated from China.

Already, the death toll of Covid-19 has exceeded that of Sars.

Markets are today more intrinsically intertwined than ever, manufacturing and supply chains are more intricately latticed across the globe, and the movement of humans across international borders supersedes previous numbers each year.

What happens when our worst fears are realised; when China — both ground zero and the locomotive of the global economy shunting the world’s fortunes — grinds to a halt?

It could cost the luxury industry as much as €40 billion in revenue in 2020, says a new report by the Boston Consulting Group and Bernstein, the research arm of investment management firm AllianceBernstein.

The report surveyed 28 senior executives from various luxury brands to find out what impact they expect the virus to have, with 43% of those interviewed anticipating sales to be impacted for the next three to six months before levelling out.

Additionally, the National Chamber for Italian Fashion has cautioned that the epidemic could lead to a €100 million decline in Italian exports based on “optimistic” estimates, and up to €230 million for the first half of the year “in the event of a prolonged crisis”.

The luxury market finds itself especially susceptible in these uncertain times as the epidemic directly affects the travel and spending habits of its most significant customer base: the Chinese.

More than any other nationality, Chinese consumers accounted for approximately 40% of the €281 billion spent on luxury goods globally (including purchases within and outside China) last year, based on data from financial services company Jefferies Group.

They are also the ones driving up to 90% of the growth in global luxury goods sales, making the Chinese the fastest-growing demographic for luxury goods in the world, and giving luxury brands obvious reason to grow over-leveraged on the Middle Kingdom.

Of which, Burberry stands as the most exposed luxury brand to China, says Jeffries.

Early February, Burberry CEO Marco Gobbetti acknowledged the outbreak as having “a material negative effect on luxury demand.”

The British luxury brand has shut almost half its stores in mainland China — 24 out of 64 — with the remaining boutiques operating with reduced hours in response to a 80% decline in footfall.

The company, which derives about two-fifths of its revenue from Chinese consumers, altogether scrapped its financial guidance for the year ahead, and will be scrutinising and adjusting costs as the outbreak unfolds.

Usher In The Year Of The Rat With These Fashionable Releases Burberry
Burberry’s Chinese New Year collection released to celebrate the year of the rat in 2020.
(Image: Burberry)

The sentiment was echoed by Kering, which owns Gucci, Saint Laurent, Alexander McQueen and Bottega Veneta, where half its stores had also been closed in China with new openings postponed.

The group, which derives 34% of its sales from the Asia Pacific (excluding Japan), has begun shifting inventory to other regions, with Chairman Francois-Henri Pinault noting that the group has already started seeing the effects of fewer Chinese tourists in Europe and the US.

“Due to the evolving nature of the situation, it is impossible at this time to fully evaluate the impact on business and how fast it will recover,” he said.

However, Pinault expects the Chinese market to rebound strongly once the emergency is over, and said that Kering was ready to increase marketing spend in the second half of the year.

“Knowing how dynamic and resilient the Chinese people are, we expect things to return to normal promptly once the emergency is over,” he said.

Italian jacket maker Moncler is experiencing a similar fallout, with sales crashing 80% since the virus broke out.

Several leading American fashion groups have also slashed their profit projections this month.

Capri, which owns Michael Kors, Versace and Jimmy Choo, said it was reducing its sales forecast for the quarter by US$100 million after shutting 150 of its 225 stores in mainland China.

Meanwhile, Tapestry (Coach, Kate Spade and Stuart Weitzman) warned that sales may fall by up to US$250 million, as most of its stores across China remain closed.

Tiffany & Co has also reported widespread store closures across Chinese cities.

Other luxury brands that a Forbes report pips to lose big in this epidemic include Hermes with 49% of its revenue derived from the region, Richemont (38%), Salvatore Ferragamo (38%) and Ralph Lauren (16%).

Global luxury leader LVMH (Louis Vuitton, Christian Dior, Marc Jacobs) will also be hard hit, as 37% of its €53.7 billion revenue comes from Asia. And LVMH-owned Bulgari is at risk not just in the luxury goods sector, but in hospitality too, as it operates hotels in Shanghai, Beijing and Milan.

Engaging Customers In A Time Of Crisis

As the nightmare after Chinese New Year continues to unravel, both Bernstein and global financial services firm Morningstar are predicting that the short-term effect of the outbreak on luxury goods sales would be more severe than the Sars fallout due to one major difference: At the height of Sars in 2003, the Chinese made up 2% to 3% of global demand in the luxury market but today, they account for 10 times that.

Add the fact that many fashion brands including Tory Burch and Ralph Lauren make a good proportion of its goods in China due to lower material and labour costs, the protracted factory closures and supply chain disruptions will result in delayed delivery of inventory as well as reduced stock availability in the months to come, further compounding the fragile state of affairs. And brands that have substantial manufacturing and retail exposure to China will suffer the most this time round.

This is particularly problematic for sectors like fashion and luxury that operate on a capricious model of seasonable demand. Designs planned for next season will fall out of fashion should shipment delays stretch into months, and will need to be marked down in order to clear stock. Furthermore, brands under contract with retailers to deliver inventory by particular dates will experience additional strain.

With the collapsing of the whole demand story in China, the unthinkable has been realised, and this over-reliance on the China market and on Chinese consumers ought to give luxury players pause.

It’s time to not only reconsider China’s role as “the world’s factory”, brands need to recalibrate and restructure their entire business strategy.

For starters, they may need a refresher in Investment 101: Diversification.

Consider taking a leaf out of H&M and Zara’s production playbook. While they are pegged as the fast fashion brands with the most manufacturing and sales exposure to China according to UBS analysts, both also have supply bases in various locations such as Turkey and North Africa to provide some buffer against disruptions in China. 

What can brands do in the immediate interim, though?

Take the lead from the likes of LVMH, Richemont and Kering, and build goodwill all round. The three luxury groups have donated €2.3 million, €1.3 million and €1.1 million respectively to the Red Cross Society of China to help combat the outbreak and show their solidarity with the people of China.  

But the question brands are struggling with most right now, perhaps, is how to engage customers in a time of crisis, when human lives literally hang in the balance against the backdrop of a world economy in jeopardy and a global community in distress. Should they still push out promotional content and try to make sales or refrain from doing so altogether?

As the show had to go on for Armani, business — while not as usual — has to go on in view of bleeding bottom lines. But brands will need to exercise utmost sensitivity when crafting and communicating marketing messages, even when things begin to stabilise.

Because it is also possible that the Chinese consumer may evolve in a post-Covid-19 world, where conspicuous consumption just might be replaced by more conscious consumerism.

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