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The pandemic is pushing the industry further away from cigarettes, alcohol and airports and towards China

February 21, 2021

HONG KONG AND PARIS

HAINAN, a TROPICAL island 450 km southwest of Hong Kong, used to be a sleepy backwater area populated by budget resorts that catered to Chinese tourists who couldn’t afford a trip to Hawaii. Today it attracts travelers with significantly thicker purses. Buying a Gucci dress or a Tiffany piece of jewelry in one of Hainan’s vast, posh malls is no different from shopping on Fifth Avenue in New York or Avenue Montaigne in Paris – until the cash register rings. Visitors from mainland China pick up their belongings at the airport on their way home or have them sent there directly. Under the rules, drawn up a decade ago, that Hainan is treated as a separate zone from mainland China for customs purposes, they are exempt from a variety of taxes and duties. This enables savings of 30% to be achieved.

Duty-free shopping conjures up images of overcrowded airport terminals. As the Covid-19 pandemic dumped these passengers, businesses inside have suffered accordingly. According to data from Generation Research, a consulting firm that hit $ 86 billion in 2019, duty-free sales plummeted by two-thirds last year. Another consultancy firm, Mauro Anastasi of Bain, predicts that retail travel sales will not return to these levels before the second half of the decade. Intercontinental and business travelers, the biggest donors, will likely take the longest to get back to heaven. Chinese tourists, by far the most valued by duty-free operators, eschew countries with poor track records in dealing with the pandemic.

Buyers will return to the airports one day. But when it emerges from the current crisis, duty-free shopping will have fundamentally changed: blatantly geared towards luxury, less connected to travel and closer to Asian high-rollers. Hainan shows the way.

Discount tectonics

Before Covid-19, selling goods to travelers was one of the few bright spots in stationary retail. This practice has been popular since cruise lines at sea that supplied their passengers with alcohol and cigarettes without government taxes. In 1950 Ireland applied the principle to aviation. When mass tourism took hold, airports around the world turned into tax-free shopping malls with departure gates. The roughly 8% annual growth in the last few years before the pandemic – double what other stores have seen – was driven by sales of cognac, sunglasses, wallets, and other bells and whistles. Sales have increased eightfold since the late 1980s (see graphic). Excited marketers called duty-free shops “the sixth continent”.

Covid-19 has drained that craze. As in many other areas, it has accelerated pre-existing trends that have changed the duty-free business. The first has to do with the mix of things that are sold duty free. Alcohol, and especially cigarettes, have shrunk over the years. Upmarket brands became the mainstays of the airport corporations, as they were good places for wealthy people, especially Asian passengers, in these cotton squares. Luxury goods, perfumes and cosmetics dominate travel retail today and account for two thirds of sales.

The second development is the move away from airports. Although the terminal remains its natural habitat, duty free shopping has expanded to more distant locations in recent years. The spending per passenger at airports was already falling before the outbreak of the coronavirus.

At the same time, downtown specialist shops in tourist hotspots have lured visitors to tax rebates if they repatriate what they buy. These locations, which are particularly popular in Asia, now account for almost 40% of all sales. The rules vary globally, but some also allow people with a weak link to travel, such as a ticket booked in a few months’ time, to shop.

Tax-exempt outlets are popping up in mainland China, targeting domestic travelers who have returned from overseas (and who plan to travel there soon in the future). For example, Chinese buyers in Hainan are now getting a duty-free allowance of 100,000 yuan ($ 15,500) thanks to a recent tripling of the tax break.

The last trend that can also be seen in Hainan is the migration of duty free to the east. In 2011, the Asia-Pacific region overtook Europe as the largest regional market. (America, where most of the domestic flights operate, has always been a latecomer.) Before the pandemic, Seoul’s Incheon, a two-hour flight from Beijing, became the largest airport store in the world. Prada and Hermès sales in Asia ex Japan increased over 40% in 2020, largely driven by waste in Hainan. Sales there are said to have reached USD 5 billion last year and more than doubled compared to 2019. Industry observers predict it could quintuple within a decade.

Although Chinese shoppers have been the world’s top luxury consumers for years, accounting for a third of global sales, brands have been reluctant to consider places like Hainan as prime luxury eateries. Around two thirds of Chinese spending on handbags, watches and other gadgets was made abroad. The Communist Party is keen to change that. The increasingly generous tax breaks for the well-heeled are “the key concept of a long-term government mission to maximize domestic consumption and repatriate travel-related purchases from abroad,” says Martin Moodie of the Moodie Davitt Report, a travel retail newsletter. Daniel Zipser of McKinsey, a consulting firm, believes the share of overseas luxury spending will decrease. As a result, the attitudes of luxury groups towards venues like Hainan “changed dramatically,” says Cherry Leung of Bernstein, a real estate agent.

If the Chinese continue to buy their bullets at home, it will take more business away from the duty free operators who have dominated non-Chinese airports in the past, such as Dufry of Switzerland and DFS, which are part of the LVMH luxury empire. Last year, China Duty Free, a state-controlled group, overtook Dufry as the world’s largest supplier of duty-free luxury goods. The market capitalization of China Duty Free, which is listed on the China stock exchange, more than tripled in the past year to USD 112 billion, making it one of the most valuable retailers in the world.

In recognition of the changing balance of purchasing power, some travel traders across Europe have tried to strengthen Hainan. Dufry has sold a stake in Alibaba in the hopes that the Chinese e-commerce giant can build its fortune there. Last month, Lagardère Travel Retail, part of a French conglomerate, opened a second store on the island.

Airports remain good places to find wealthy buyers. Bored people waiting for their flights to be called are perfect brands for luxury brands. Most retailers spend their fortunes to attract customers to their stores or websites, says Julián Díaz González, head of Dufry. “For us, it just means getting them from the corridor to the shops.” As the industry evolves, Mr. Díaz may find increasingly the issue of moving duty free shops to customers. ■