China is emerging as a very attractive international business destination. This situation arises from the growing middle class in the country. In the last two decades, economic growth in the country has spurred it into the limelight as a serious investment destination. Many companies manufacture their products in China because of the competitive labor costs in the country.
The manufacturing boom has contributed to the emergence of an economically empowered middle class. In the recent years, the portfolio of businesses setting up their operations in the country has expanded. The portfolio now includes businesses seeking to take advantage of the Chinese market in addition to its competitively priced labor.
This explains the interest of LVMH in the Chinese market. LVMH is the holding company of several French luxury brands. The company is interested in establishing businesses in China to take advantage of its emerging luxury market.
Any company that tries to enter into the Chinese market must take time to understand the operating environment in the country. The business culture in China is different from the business culture in the West. The Chinese people are historically frugal. Therefore, it is important to take time to understand their needs and expectations.
However, the country’s emerging middle class has a lot in common with any middle class in the world. Therefore, the main issue that a company needs to explore before getting into China is the correct market entry strategy. This report examines the business environment for luxury products in China. It also looks at the internal characteristics of LVMH in order to prepare a strong market entry strategy for the company.
Methodology
The method used to meet the two broad objectives of the project was a literature review. Literature review is an acceptable form of research that makes it possible for researchers to evaluate a broad range of issues. The range of issues that required consideration in this case exceeded the number of issues that could be covered using empirical research. This reasoning informed the choice of the research method.
In addition, the resources needed for an empirical research were not available. The second reason for choosing a literature review as the main research method was that a lot of research already existed in relation to the main issues defined in the research objectives.
It was unnecessary to carry out research into these issues from the scratch. The primary tools employed in the analysis of the data were the analytical instruments available to strategic planners. These tools include PESTLE Analysis, SWOT Analysis, and Porter’s Five Forces Analysis.
PESTLE Analysis of Competitive Landscape
Strategic thinkers use a PESTLE Analysis to conduct environmental analysis as the basis for determining whether an organization has the capacity to interact favorably with its operating environment.
A PESTLE Analysis involves an examination of the political, economic, social, and technological issues in a given location. In addition, strategic planners study the legal framework governing a business environment, coupled with the condition of the physical environment of the area being analyzed.
Two issues characterize the political environment of China. First, the communist government is very keen on controlling the key sectors of the Chinese economy. For instance, the country does not have an exchange rate that rises and fall according to the forces of a free currency market alongside other international currencies.
Instead, the government determines the exchange rate. This issue at times puts foreign companies at a disadvantage. The second issue affecting the Chinese political environment is that the country uses a communist system of government.
In the recent years, the country has started conducting democratic elections at the local level. However, the communist superstructure still allows the central government to control all the political activities in the country. In this regard, regional party officials tend to exert a lot of influence in the conduct of business.
On the economic front, China has experienced unprecedented growth in the last two decades. The country’s economy grew at almost ten percent per annum in the last ten years. This is the leading cause of the emergence of China as a significant market. Prior to the economic boom characterized by unprecedented growth in the manufacturing sector, China’s main attraction was its low cost labor.
International manufacturers set up shop in China to take advantage of its low labor costs. As more companies started manufacturing in China, the disposable income of the Chinese people grew. This turned the country into one of the largest markets in the world. Business is now shifting from manufacturing only, towards taking advantage of the growing market resulting from the emergence of the new middle class in China.
The social situation in China varies depending on the parameters in use. One of the best-known Chinese policies is the one child policy, which prohibits couples from getting more than one child. This policy is also an illustration of the tight control the communist government exerts on the Chinese people. In the recent years, a lot of Western influence has crept into the Chinese social scene.
For instance, China has become the one of the locations that directors from Hollywood plan to launch new blockbusters. The Western pop culture characterized by the idolization of media personalities is also taking root in China.
From a business angle, it means that the Chinese consumers are developing a taste for the Western cultural experience. This is fuelling demand for Western products. This explains the popularity of Western brands such as Apple, and in the recent years, the proliferation of Western style eateries such as MacDonald’s fast food stores.
The technological environment in China is very competitive. The Chinese have invested resources in manufacturing technologies turning it into what a commentator called, “the world’s workshop” .
The dual investment by the Chinese government on high tech production facilities, and the Foreign Direct Investments (FDI) from international investors trying to take advantage of the low labor costs in China, have made China a manufacturing and technology hub.
However, Chinese manufacturers tend to pay little attention to quality control. Unlike Japanese manufacturers who have a strong interest in efficiency through programs like Kaizen, the Chinese tend to compete on cost by making cheaper knock off items to sell them to the poorer masses.
The economy of China is difficult to analyze. The reason for this is that the Chinese government is the only body that releases economic data on China. The data at times seem unrealistic based on estimates made by other economists. In addition, much of the Chinese economy is state controlled.
For this reason, it is better to develop a business strategy that takes into account these factors. In spite of this, there is consensus that the Chinese economy, together with Brazil, Russia, India, and South Africa (BRICS), is growing very rapidly.
The physical environment in China is a major concern to international environmental agencies. Chinese cities such as Beijing are becoming polluted and have artificial fog brought about by industrial emissions. The state pays some attention to environmental issues, but it prioritizes economic the well-being of the country over environmental conservation.
Rivers and other natural features located in places with high population are becoming polluted. In the rural areas with smaller population densities, the environment is in good condition. In fact, China has some of the most spectacular sceneries such as rivers, waterfalls, mountains, and world life.
These areas can serve as the inspiration for including environmental protection measures as part of the Corporate Social Responsibilities (CSR) strategy when establishing a business in China.
Hurdles and Obstacles Facing LVMH
In order to discuss the hurdles and obstacles that LVMH will need to deal with before making a proper entry into the Chinese market, it is important to review the application of a SWOT Analysis because it is the most suitable tool for this purpose. Hurdles and obstacles to a business constitute the weaknesses and the threats a business must deal with in order to operate successfully in a specific market.
Weakness and threats are two measures within SWOT that examine the difficulties associated with a business situation. Weaknesses are internal issues that bar the company from growing optimally. On the other hand, threats are external issues that the company does not control that can hamper its business objectives.
LVMH, alongside other international brands trading in China have two main weaknesses. The first weakness is that the company has a wide portfolio in a very narrow segment of the Chinese market. Secondly, China is relatively new to luxury spending. Unlike Europe and America, many of the Chinese luxury spenders are people who have recently made money from the changing fortunes of the country.
While the short-term outlook is impressive, the long-term performance of the Chinese luxury market is difficult to predict. If the country runs into any economic problem, the Chinese luxury spenders will revert to their old spending habits. In other words, the new middle class of China is still skilled in frugal living. Those skills will come into play as soon as there is an economic bump.
The situation in the West is different because many luxury spenders grew up in affluent families. They do not know how else to live. If they cannot afford to drive an expensive car, they will look for one that is easier to maintain. In China, the luxury spenders can discard the car all together because they have lived most of their lives without it.
The threats that accost LVMH in China are as follows. First, the brands produced by the company will suffer from threats associated with the counterfeiting of products . The results of counterfeiting include loss of revenue and loss of brand reputation. The counterfeit system in China is one of the most organized counterfeiting operations in the world. Chinese manufacturing capacity does not match its R&D capabilities.
Therefore, manufacturers choose to take shortcuts in order to make profits from popular brands. This situation is compounded by weak legislation on the issue. The Chinese government tends to protect the local industries whenever there is a conflict with international manufacturers.
The problem with counterfeit products is that they usually do not meet the performance criteria of the original product. Their goal is to eat into the market of established brands. As a result, the products are cheaper to buy, but they are also of poorer quality. This damages the image of the brand.
The second threat that LVMH will need to be aware of is that the patenting system in China is weaker than in most advanced economies. The Chinese government views patents as a bottleneck in its manufacturing sector. This makes getting patents very difficult in China.
In addition, the enforcement of laws relating to patents is lackluster. In this sense, LVMH will be at the risk of losing its intellectual property rights to Chinese firms if the company does not take aggressive steps towards securing patents on all the products produced in China.
The third threat that most international organizations face while operating in the Chinese market is political interference. Chinese politicians are very powerful. They can frustrate the process of acquiring licenses, or the opening of new stores. In addition, they may make demands for kickbacks and bribes before giving approvals for various business initiatives.
While China’s bribery index is not as bad as many other countries, it is still a reality that everyone who does business in China must deal with it very often. The challenge with this situation is that by towing the line, a company can lose its international reputation. On the other hand, refusing to comply with demands for kickbacks and bribes may lead to the frustration of the business by government and party officials.
The third threat that LVMH needs to put into account is that it is not the only player eyeing the luxury market in China. The competition for the emerging luxury market in China is growing, from both international players and local manufacturers .
The competition in the luxury market is becoming more intense with time. It is anticipated that luxury goods marketers will soon opt for “diffusion strategies” to create rapport with the younger generation as a form of initiation into the luxury brands .
In conclusion, while China represents a significant opportunity for LVMH as a luxury products market, the company will face several stiff challenges over the coming years.
Strategy Recommendations for LVMH
In order to deal with the threats and weaknesses identified in the Chinese market, the company has several strategic options. This section examines the options available for use by the company in China based on PESTLE Analysis, and the examination of the weaknesses and threats the company will experience in the Chinese market.
The main issues regarding the business environment in China include a powerful political system that carries a lot of influence in the business environment, and a people who are subservient to the system. There new wealth in China is leading to the emergence of a luxury goods market. The market is projected to grow in the coming years.
The country has a very strong manufacturing sector, but the level of innovation is not commensurate with the manufacturing capacity leading to a culture of product counterfeiting. The economy of the country is centrally controlled.
This makes it impossible to determine the actual price of goods and services based on an open market system. The company needs to use two sets of strategic guidelines to deal with the strategic issues arising from the analysis. These two sets are internal measures, and external measures.
The internal measures LVMH needs to use include staffing, manufacturing decisions, choice of advertising strategy, and the choice of a distribution strategy. The choice of staff members to work in LVMH will have a significant impact on the operations of the company in China. The Chinese marketplace is very different from most Western markets.
It is imperative to find people who are familiar with the system and can run a profitable enterprise. At the same time, the choice of staff must reflect the desire of the company to maintain its corporate culture within the Chinese environment.
The best way to approach staffing is either to find Chinese nationals who have international business experience, or to find Westerners who have Chinese business experience. This issue can also be resolved by having a board and management team in China that includes local staff, and staff seconded by the headquarters.
Secondly, the company needs to consider its manufacturing decisions carefully. China has the best economics when it comes to manufacturing. The cost of labor is relatively low, and the availability of manufacturers is high. Manufacturing in China will also reduce transport and warehousing costs for the company.
The main threat associated with manufacturing in China includes the risk of losing proprietary information to local competitors, paving way for counterfeiting. There is also a threat associated with quality control, especially if the company employs local workers who have low regard for standardized production.
On the other hand, manufacturing in Europe may prove unsustainable in the end in light of the fierce competition for luxury products shaping up in China. The best strategy in this case is to maintain the main manufacturing sites in Europe, and to use local manufacturing for generic parts such as packaging. This way, no one will be successful in counterfeiting the entire product.
LVMH needs to be very careful as it develops its marketing strategy. The main issue of concern is the advertising mediums it will choose to market the products. As a young luxury market, China will not follow the same trends shown by countries with mature luxury markets.
The purchasing decisions will not be identical to the buying decisions of customers in other luxury markets. LVMH needs to develop a marketing campaign that is relevant to the Chinese market to ensure that is gets a proper foothold in the market. It needs to keep a keen eye on how consumer behavior changes when the economic conditions change.
The fourth strategic issue that LVMH needs to address is the distribution strategy that it needs to be successful in the Chinese market. The decision between opening new stores and using established distribution networks is important. While LVMH already has over one hundred stores in China, it still needs to keep reviewing the performance of these stores against the market potential of its products.
This decision will have an impact in the distribution of counterfeit products. A string of shops owned and operated by LVMH will ensure that customers are sure that they are buying original products.
However, the cost of establishing and operating an exclusive store may hinder the growth of the company by constraining profits. At this point, an exclusive chain seems like the best option. In the future, the company will need to consider getting distribution partners to increase its footprint in the Chinese luxury market.
The external issues that the company needs to consider are the development of a PR strategy, and becoming part of the advocacy efforts to make intellectual property rights more respected in China. The need for a PR strategy as part of the company’s strategic plan comes from the realization that the company will run into certain problems with government officials at one point or another.
It is important to declare and maintain a clear ethical line when dealing with officials. On the other hand, the issue of intellectual property rights in China is a common problem for all international firms that set up shop in China. Their combined voice will make it easier for the government to act on concerns relating to the breach of intellectual property rights. In the same breath, this will help to address the counterfeiting of products.
Porter’s Five Forces Analysis
The discussion in previous sections concentrated on the business environment and the strategic fit of LVMH in the Chinese market. There is a need to reexamine the competitive position of LVMH by using Porter’s Five Forces Analysis in order to develop further recommendations in line with the analysis.
Porter (1998) identified five forces that define the competitive climate of any business. These forces are the buyer power, supplier power, threats of new entrants, threats of substitutes, and the degree of rivalry in the competitive marketplace .
Buyer power refers to the control that the consumers of a product exert on the prices. In other words, it refers to the bargaining power of the consumers. This power can erode profits if the business has no way of dealing with it. In markets controlled by a monopsony, the purchasing power of the buyer can be very high.
The situation in the Chinese luxury market is such that the demand for luxury goods does not give much bargaining power to the customers. In many cases, LVMH can set its prices as high as it wants. Provided the price is within the reach of the intended market, the company can control the prices.
The second force that needs consideration is supplier power. The power of suppliers can also squeeze margins if the company relies on a monopolistic supplier, or a cartel. This situation may also result if the country in which the business operates uses price controls. LVMH has very many suppliers located in various parts of the world.
The only way the supplier power will increase to unmanageable levels is if the company decides to switch to local suppliers in China. In addition, the situation may change if the government institutes price controls or tax measures on inputs. Either way the price of inputs may rise.
The third force identified by Porter (1998) is the threat posed by new entrants. The nature of this threat can be evaluated by considering the entry barriers in the industry. The luxury market tends to handle high quality materials and uses rare production processes. In addition, it takes time to develop a reputation as a luxury brand.
Most luxury brands use the duration they have served the markets as a means of gaining competitive advantage over younger players. In this sense, the barriers to entry in the luxury market are very steep. However, the Chinese market is very young. A company that has the resources to position itself as a luxury goods provider will receive the same attention as the older companies such as LVMH.
Fourthly, the competitive climate of a business is determined by the threat posed by substitute products. Substitute products refer to items that can fulfill the same functions as the products marketed by a given company. The main threats from substitute products come from other international players in the Chinese luxury goods market. For instance, there is intense rivalry between Omega and LVMH in the Chinese market.
Substitute products usually present more challenges if they have better prices for the same level of performance. The Chinese luxury market is still in the stage where many people are making the transition from a low-income culture to a high-income culture. These consumers have not yet developed strong brand loyalties. Therefore, within the same performance climate, these consumers make choices based on the cost tradeoffs.
The fifth force that determines an organization’s competitive effectiveness is the degree of rivalry with other players in the industry. The degree of rivalry in the Chinese luxury market will increase as more players enter this market. The intensity of rivalry will also increase if the exit barriers in the industry are high. For instance if LVMH sets up production facilities in China, the company will find it difficult to leave China.
Advantages and Disadvantages of Domestic Firms in the Sector
The application of Porter’s Five Forces in the determination of the relative advantages and disadvantages of the domestic firms in the sector yielded the following results. The advantages that the local firms enjoy in relation to buyer power arise from their familiarity with the needs and the demands of the Chinese consumer. Local players in the luxury goods market know the tastes and preferences of the Chinese people.
In addition, local firms have a working knowledge of the purchasing behavior of the Chinese people. They can assess their prices better based on this knowledge. The main disadvantage that local firms have when it comes to the buying power of consumers is that the Chinese people do not have the same amount of confidence in local firms to produce high quality luxury goods.
On the question of supplier power, local players have the following advantages. First, the local players have greater knowledge of the sources of raw materials. Therefore, they can make buying decisions based on the market rates of the raw materials. This reduces the power of suppliers in their favor.
On the other hand, the power of local players in bargaining reduces the interest of local suppliers of raw materials to sell to them. There is little incentive to supply raw materials to a local firm that wants to negotiate prices downwards, compared to selling to a foreign owned firm that may buy the materials at a better price.
The threat of new entrants is not very serious to local firms. There are few players in the luxury market of Chinese origin. The advantage that local firms derive from this position is that any new player that comes into the market cannot be a local player.
This leaves the competitive advantage to the local firms because their only significant competition is from foreign firms. The associated disadvantage is that local firms have a harder time establishing themselves as producers of luxury brands.
The threat of substitutes is a challenge to local firms. The reason for this is that the local people compare their products to a wide range of luxury products in the country. In this sense, the main challenge these products face is the threat of competing with products from foreign firms such as LVMH.
Foreign luxury players seem to have a better reputation in the country because of the consistency in the quality of foreign products. On the other hand, local firms can adjust their offers to counter the prices of foreign firms based on their superior understanding of the local environment.
Local firms deal with rivalry better than foreign firms do. The reason for this is that the local firms rely on their knowledge of the market to determine how to position their products. They are also flexible to changes because managers are in contact with the daily operations of the firms and they make decisions locally. However, the strength of foreign firms can overwhelm the local firms.
This can happen if the foreign firms have the financial muscle to fight for market share and can leverage its competitive advantages. There is already a struggle for market share in the Chinese luxury goods market occasioned by the entry of many foreign firms to the Chinese market.
In conclusion, the main source of competitive advantage for local firms is their knowledge of local conditions, which include customer preferences and superior understanding of the supply chain. In addition, these firms are very flexible when it comes to making decisions to increase the profitability of their operations. These advantages are not impossible to surmount.
Advantages and Disadvantages of Foreign Firms in the Sector
The application of Porter’s Five Forces in the evaluation of the relative advantages and disadvantages of foreign firms yielded the following results. Buyer power works in the favor of foreign firms. The local market is relatively inexperienced when it comes to the pricing of luxury goods. In addition, foreign products feel authentic to the luxury market in China.
Therefore, foreign firms can set higher prices for their products. The disadvantage associated with this is that a foreign firm can price itself out of the luxury goods market. It can set prices that are too high for a significant portion of the luxury goods market.
Supplier power works to the advantage of foreign firms when it comes to availability, but it works against foreign firms when it comes to pricing. Local suppliers prefer to sell their products and services to foreign firms because they are usually ready to pay more for the same raw materials.
However, this comes at a price. The local suppliers set their prices to foreign firms above the prevailing rates to take advantage of their demand. Suppliers enjoy a lot of power when dealing with foreign firms because foreign firms tend to lack full knowledge in regards to the availability of raw materials.
The threat of new entrants is significant to foreign firms if the new entrant is another foreign firm. However, if the new firm is a local firm, the degree of the threat is lower. Foreign firms tend to rely on the same sources of competitive advantage compared to the local firms.
Dealing with a new luxury market tends to push foreign firms to select similar strategies, which results in fierce competition for market share. On the other hand, local firms rely on their understanding of the market to gain market share.
The threat of substitutes is also significant when pitting foreign firms against other foreign firms. If two foreign firms produce products that can substitute each other, they increase the options their customers have. In the process, these two products can become rivals in the market.
Substitute products from local firms become a threat whenever the foreign firm prices itself out of the market. The local demand will move towards the substitute products that have the same performance characteristics as compared to the products produced by the foreign firm.
The degree of rivalry in the marketplace usually works in favor of the foreign firms this advantage springs from stronger brands, and robust marketing efforts. Local firms are not big spenders on luxury advertising. At a certain level, all types of rivalry affect the businesses in the industry. Local firms cannot compete too well with international brands because of their brand recognition.
Conclusion
LVMH is in a good position to make money in China. However, the company needs to make several decisions regarding how it will establish itself as a player in the luxury goods market.
The company must remain vigilant to changes in the economic fortunes of the country. The luxury goods market is still very young. This means that it is still very vulnerable to economic changes. Therefore, LVMH needs to plan in a way that it can maximize its short-term profits and position itself for survival in case the luxury markets shrinks
On the issue of manufacturing, LVMH should organize itself in a way that makes it possible for it to take advantage of the low labor costs in China. At the same time, the company must ensure that none of its proprietary technologies falls in the hands of rivals.
Finally, LVMH must take into account the management needs of its business in China. It should be careful when selecting the board of directors to run the Chinese division. It must find people who understand the Chinese market well. At the same time, it needs to ensure that the corporate culture of the company survives entry to the Chinese Market.
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