Re-examining Hainan: More Than a Duty-Free Market

Back in a world not yet overtaken by COVID-19, travellers contributed to 30 to 40 per cent of the personal luxury market. They flew around the world in search of more competitive prices, seasonal items, or simply to satisfy their holiday spending urge.

Today, international travel continues to be hampered as new variants emerge. Some countries have benefited from a repatriation in consumer demand (such as the V-shaped recovery in the American and Chinese markets), while others have struggled to compensate for the shortfall caused by the market's lack of tourists.

The loss of Chinese consumers accounts for a large portion of this gap. According to a study from Bain and Altagamma, 70 per cent of the 94-billion-euro luxury market comprised of Chinese shoppers travelling out of China in 2019. Despite the mainland China market maintaining a high double-digit growth rate over the last two years, China consumer global spending is expected to fall to between €59 billion and €65 billion in 2021. There is no doubt that a lack of international travel has curbed the enthusiasm of some Chinese consumers to spend.

The price difference between mainland China and Western markets for luxury goods is primarily due to three types of taxes: customs duty, VAT, and consumption tax. Although luxury groups have pushed for global price harmonisation in recent years to combat price arbitrage in a fragmented shopping environment, some brands continue to display significant pricing disparities across markets.

For example, the same medium-sized Prada Galleria Saffiano handbag priced at 23,000 RMB (approximately €3,190) in China costs only €2,300 in France (with a further 12 per cent VAT refund for non-EU visitors after departure).

It was once nearly impossible for mainland Chinese consumers to purchase discounted seasonal luxury goods through brand-owned channels. However, in the last two years, this has changed: in Hainan, a small tropical island off China's south-western coast, any visiting local tourist can purchase luxury goods at 20 to 30 per cent below current retail prices in the market.

Soaring To The Top

As the pandemic continues to rage on, Hainan's duty-free market has skyrocketed, with offshore duty-free spending in Hainan reaching 50.49 billion RMB (approximately $7.9 billion) in 2021, representing an 83 per cent increase year on year. In the last year, CDFG (China Duty Free Group), a travel retail group that holds more than 90 per cent of China's duty-free market share, surpassed its peers – Dufry, Lotte Duty Free, and LVMH's DFS – to become the world's largest travel retailer. The company reported an 83.98 per cent year-on-year increase in revenue and a 475.95 per cent increase in net profit in the first half of 2021.

Currently, only the Hainan FTP (Free Trade Port) in China, Jeju in South Korea, Okinawa in Japan, and Penghu, Kinmen, Mastu in the Taiwan Region are destinations where duty-free rights exist for domestic travellers – a policy known as ‘offshore duty-free’. In March 2011, Hainan announced its official duty-free policy, with the island residents and off-island travellers qualifying for duty-free shopping, as well as defining the duty-free product categories, number of items, allowance and age of consumers who can purchase duty-free products.

However, it was only when the updated policy on offshore duty-free shopping was introduced in June 2020 that the duty-free market in this FTP really took off. Since July 1, the annual offshore duty-free shopping allowance was increased to 100,000 RMB; the number of categories covered extended to 45 (including tablets, mobile phones, game consoles and alcohol); the previous single purchase limit of 8,000 RMB was removed; and the limit on cosmetics SKUs raised from 12 to 30. All of above policies were conducive in stimulating consumer spending within the Hainan FTP.

In the last two years, travel retailers with offshore duty-free licences, such as CDFG, Shenzhen Duty Free Group, and Hainan Tourism Investment Duty Free Co, have established duty-free networks in cities such as Sanya, Haikou, and Boao on the basis of favourable policies. This expansion is still ongoing.

Brands with a presence in the duty-free channel are also seeing growth in this segment. Jérôme Lambert, Richemont Group's Chief Executive Officer, noted in a conference call about Richemont's FY21 annual results in May this year that “thanks to the Group’s historical presence on Hainan Island, Richemont benefited from the impressive growth of this duty-free hub.”

Is There A Full-price Retail Opportunity?

With the expansion of the Hainan duty-free market, many well-established duty-free categories, such as accessible luxury, beauty, as well as wines and spirits, have seen strong growth in the region. “The price difference in a duty-free channel as a result of local tax, exchange rate differences, and pricing strategy is frequently regarded as a policy benefit rather than a short-term performance boost – like that offered by promotional activities,” says Iris Chan, Partner & Head of International Client Development at DLG (Digital Luxury Group).

That said, the duty-free channel is still somewhat a discount channel. Its presence remains a risk for the luxury industry, which is averse to discounting. “Chinese consumers are still price sensitive, and establishing a duty-free channel that creates a price differential within the same market may also create a grey market of daigous, which is also detrimental to the brand image,” she explains.

The Sanya International Duty Free Shopping Complex, owned by CDFG, is located on the shores of Haitang Bay in Sanya and has 72,000 square metres of commercial space. Despite the fact that this massive mall houses many top luxury labels such as Cartier, Prada, and Gucci, consumers cannot find brands like Louis Vuitton, Dior (except for the beauty category), or Hermès (except for the beauty category) on the entire Hainan Island.

However, this does not mean that Hainan is uninterested in these brands. Multiple sources told Reuters that Louis Vuitton was considering opening its first duty-free store in mainland China in Hainan. However, the company later stated – “we’re exploring opportunities in Hainan but not considering any options within the licensed duty-free market.”

Outside of its fast-developing duty-free network, Hainan continues to be the wild west for luxury retail. The Form, Haikou's most 'high-end' mall, only carries brands like Salvatore Ferragamo, Etro, and Moschino, while Sanya does not have a luxury mall for local consumers yet. The underdeveloped local luxury landscape contrasts sharply with the booming duty-free market.

According to the National Bureau of Statistics, Hainan's per capita consumer spending is currently at 16,046 RMB, ranking 13th in the country and up 19.26 per cent year on year – making it the fifth fastest growing province in the first three quarters of 2021. This momentum bodes well for Hainan FTP's future consumer spending potential.

The local luxury retail landscape in Hainan is changing – Chinese property developer China Resources Land intends to build five major projects in five Chinese cities by 2022, including The MixC in Haikou. According to a source, the project is internally classified by China Resources Land as an M1 project, the most high-end type of commercial project by the developer, and will likely bring together the most prestigious brands and facilities within the regional market. Only a few other projects are currently ranked at this level, including The MixC Shenzhen, The MixC Hangzhou, and The MixC Shenyang. The specific brands that are involved in the project have not yet been disclosed, but they will undoubtedly strengthen Hainan's local luxury retail landscape.

Hainan's full-price travel retail channels, such as airport points-of-sale, are also noteworthy. In 2021, 11 Hainan airports handled nearly 40 million passengers, with the vast majority departing from Haikou and Sanya. According to a source, during a reverse roadshow in mid-2021, Louis Vuitton stated that it would consider opening full-price airport stores in Hainan, with Sanya Phoenix International Airport, which is most likely to undergo renovations, being a priority.

In the last two years, Louis Vuitton expanded its presence at Beijing Daxing Airport, Shanghai Hongqiao Airport, and Chengdu Tianfu Airport, and it is expected to open 10 airport stores in mainland China in the next two years. According to the brand, the airport is an emerging retail scenario in itself.

“The recent influx of numerous luxury and high-end hotels, as well as government investment and construction, will also boost Hainan's traction,” Veronique Yang, Managing Director & Partner at BCG, told Luxury Society. “In addition, we have observed that more large and high-growth companies, both domestic and international, are establishing branches in Hainan. All of the abovementioned creates a consumer base for the development of full-price travel retail in Hainan.”

Just A Tourist Island?

Since the implementation of Hainan's new duty-free policy, this tropical destination has been compared to Okinawa, Hawaii, and even Dubai, allowing tourists to splurge large sums of money on luxury goods while taking in stunning beach views. But to China, Hainan is more than that.

To further establish the FTP, Hainan intends to close all customs offices by 2025 in order to become a completely duty-free market. This implies that brands are not required to collaborate with licenced local retailers in order to sell duty-free products in Hainan.

In this context, Hainan's updated offshore duty-free policy in 2020 will serve as a pilot project to test the market's dynamism. At the same time, Hainan will further implement a duty-free policy for island residents to purchase low- and mid-priced imported goods – facilitating the growth of duty-free marketing in the face of diverse consumers.

Yang also notes that big companies and high-profile talents are all making a beeline for Hainan, with conglomerates such as Huawei, Baidu, HSBC and Fosun Group all having set up shop on this island. At the same time, Hainan is currently offering a tax tilt, with enterprises entitled to a reduced CIT (Corporate Income Tax) tax rate of 15 per cent (compared to the 25 per cent general CIT), a benefit that is expected to be extended to all companies (except those in industries on the Negative List) by 2035.

IIT (Individual Income Tax) incentives are also pulling talent to Hainan, with tax rates capped at 15 per cent for designated high-end talent. Based on the existing IIT model, progressive tax rates for individuals can hit as high at 45 per cent.

Hainan's GDP is still at the tail end of China, and its retail market is heavily reliant on waves of tourists. However, with the upgrading of Hainan's industrial layout and the increased spending power of its residents, luxury companies should consider Hainan as more than just a duty-free outlet, but as another important part of China's vast luxury market.

What is certain is that, following the closure of customs offices in 2025, a duty-free Hainan will become a major luxury market for Chinese mainlanders, similar to how Hong Kong was ten years ago – but without the restrictions of exit-entry permits. But whether Hainan will be able to shift the Asian luxury market landscape remains to be seen, and will be dependent on the development of Hainan’s local economic and policies, says Yang.

Consumers can wait for their next shopping destination to materialise, but for brands looking to capitalise on the next opportunity in the Chinese market, now is time to act.