Has Hermès' Strong Momentum Reached a Tipping Point in China?

The past year has marked the return to growth for the global luxury industry. According to a report co-published by Bain and Altagamma, the global personal luxury market was expected to reach 283 billion Euros in 2021, surpassing pre-pandemic levels.

Nonetheless, the market continues to experience highs and lows. When it comes to splurging, consumers are falling back on big, established labels especially given the volatile global economic situation – which is why global luxury behemoths such as LVMH, Kering, Prada, and Richemont are outperforming the broader market.

Hermès, known for its exclusivity, craftsmanship, and diverse product lines, is at the pinnacle of the luxury world, making it the most resilient luxury company during the pandemic. By the time the pandemic hit in mid-2020, the company had managed to maintain an operating margin of more than 20 per cent – compared to LVMH's single-digit margins – while many of its other peers still struggle to profit.

The group's revenue increased by 33 per cent over the previous year to nearly 9 billion Euros. The Asia-Pacific market (excluding Japan) continues to grow, accounting for 47 per cent of total revenue, and is the fastest growing regional market from a pre-epidemic comparable base.

Greater China, Australia, and Singapore were the primary drivers of growth in this market. As a result, analysts and luxury brands alike, including Hermès, are focusing on mainland China, a market that surged against the odds following the outbreak.

Expansion In Place

While travel restrictions across the world are starting to ease, there remains a significant group of consumers that are still unable to travel freely – especially those in territories that continue to chase a “COVID zero” policy. While most brands have slowed plans to expand their retail network, Hermès started opening new stores and refurbishing old ones in 2021, resulting in a 97-million-euro investment in stores and distributions in the first half of 2021, an increase compared to the same period in 2021, totaling 220 million Euro for the year.

The brand's new storefronts opened this year in Tokyo, Zurich, Detroit, and Miami, in addition to renovated stores in Paris, Istanbul, and Brisbane. According to Luc Hennard, Hermès' Chief Executive Officer of Greater China, the brand plans to open four new stores in China, including its fourth store in Shanghai at Taikoo Li Qiantan, as well as expand its network in second-tier cities like Zhengzhou and Wuhan.

The incredible local demand has given the company the confidence to double down on the Chinese market. On 11 April, 2020, just after the national lockdown eased and the day the Hermès store at Taikoo Hui Guangzhou reopened after renovations, sales exceeded 19 million RMB (approximately $2.7 million) at that store – a record for a single store turnover in mainland China on a single day.

Axel Dumas, Group Chief Executive and sixth-generation scion of the Hermès dynasty, stated during a recent conference call that the brand will expand in China at a rate of one new city per year.

Aside from geographical expansion, the brand has also been increasing its product penetration. Hermès made its official debut in the beauty sector – introduced as the brand's sixteenth Métier – in March 2020, with the unveiling of a stallion painting titled “Whistlejacket” during a press conference. Hermès' beauty products now span three categories: products for the lips, cheek, and hands.

The brand's entry into beauty has significantly lowered its threshold, and consumers can now enjoy the Hermès experience for as little as $45 (for a bottle of nail polish). Luxury brands are not new to the beauty sphere – from those with a long history in the industry, such as Chanel and Tom Ford, to newcomers like Gucci and Valentino. According to Citigroup's Thomas Chauvet, Head of Luxury Goods Equity Research, perfume and cosmetics sales account for one-third of Chanel's revenue.

Hermès has opened a flagship store for its fragrance and beauty products on Tmall Luxury, Alibaba’s B2C luxury marketplace, and recently made the global debut of its new lip colours on Tmall. The beauty category not only allows brands to reach out to lower-tier cities and younger consumers in China, but it also provides a low-risk space for innovative retailing as a non-core business for the brand.

“We Don’t Follow What Others Are Doing”

Along with supply chain risks and the global inflationary environment, luxury brands are raising their prices – Louis Vuitton raised the price of some handbags by 10 to 20 per cent in early February; Gucci raised their prices three times in the last two years; Chanel's Classic Flap handbag has risen in price, and now the small Classic Flap costs $8,200, up 60 per cent from November 2019 and almost rivalling the retail price of a Birkin bag.

Analysts are mostly optimistic about the price increases, citing a strong product offering and rising demand as reasons for their positivity. Pricing tends to be a concrete indicator of brand positioning – and the growing prices of Chanel's iconic handbags compared to the Birkin and Kelly also indicates that the brand is gradually edging closer to Hermès.

In China, on the eve of a price increase, a small uplift in brand sales is typically observed. Influencers and sales associates tend to communicate about such price increases on social media, or directly with consumers, to encourage them to place orders before the price hike kicks in. As a result, queues outside brand stores, even before official opening hours, are commonplace.

While price increases have become the new normal for leading luxury brands, Hermès stated at its results meeting that the brand will not use this as a means to boost growth. “My uncle Jean-Louis Dumas used to say, I don't look at what other guys are up to, because that might influence me,” Axel Dumas said in response to an analyst's question about whether the brand would follow its peers down this route.

However, due to higher production costs, the brand intends to raise prices by 3.5 per cent in 2022 – which is higher than its earlier price increases of 1 to 2 per cent in previous years but well below the price hikes of its competitors.

“I think that is one of the reasons we have been so successful during the difficult times, with the genuineness behind all of this.” He added, “The price you are paying at Hermès is the genuine cost to make that product. There’s a real rapport of trust between us and our customers, and I wouldn’t want to put that in jeopardy.”

To satisfy the digital appetite of emerging young customers, some brands are experimenting with various innovative digital businesses, such as NFTs and the metaverse. Gucci recently purchased a virtual land on The Sandbox, a virtual metaverse platform, to build an immersive experiential store for its Gucci Vault.

Following Hermès' prosecution of Mason Rothchild, the artist behind the MetaBirkins NFT collection, the industry is also interested to see how the venerable house will approach these emerging trends.

Another key point in maintaining brand equity, as Hermès sees it, is to remain cautious about trends and instead further enhance the value of its craftsmanship. At the conference, Dumas also noted that the brand would not enter the virtual business and continue to focus on “the tangible expression of handmade objects.”

The China Outlook

Another major source of concern for the brand is product availability. Hermès' fourth-quarter results were disappointing due to a lack of handbag supply, with the Asia Pacific region having the slowest growth rate. As a result, despite the group's healthy overall momentum, Hermès International's shares were down 8.4 percent following the meeting.

Inventory issues aside, Hermès' performance in China and Asia Pacific overall in 2021 is in line with the broader environment. The Chinese luxury market experienced subdued year-on-year growth in the second half of the year, following a rapid surge in the second half of 2020.

This is why it is critical that the brand's performance improves in the first quarter of 2022. Dumas remarked that, while he would not reveal specific figures, the general upward trend does not appear to be reversing at the moment. He also stated that the Lunar New Year remains the most important sales milestone for the brand's stores in China, and that the brand has increased its supply capacity during this time.

An analyst also inquired about the brand’s plans for Hainan, where the thriving offshore duty-free business is viewed as a key driver of development in China's luxury market.

Dumas stated that the brand has looked into Hainan's unique status, but that it currently does not have any specific plans to tackle this market – “Because there is a lot of duty-free business, we are operating duty-paid business more in China, so we will find an effective way to enter this market, but not in 2022.”

Hermès has long relied on its unique pace of development and market savviness to maintain sustained, healthy growth, but the figures are brutal. “Hermès is one of the last large-cap luxury stocks to report, and this does not quite echo LVMH, Kering and Richemont's recent results,” said Citi in a report.

With companies pulling out all the stops to keep the momentum going, Hermès' long-term growth might be challenged if product availability continues to persist in China. While having demand outweighing supply is generally a happy problem for brands, will this boon eventually become a bane for one of luxury’s most sought-after labels?