December 12, 2018 – This post was written by Eric Johnson, Engagement Manager, and Sunny Xu, Senior Analyst.
In our previous post, we laid out the recent developments in the daigou e-commerce landscape that have involved new regulations from Beijing, arrests and fines in Shanghai, and a drop in stock prices around the world. For MNCs considering e-commerce in China or for those whose products are already in the daigou channel, understanding the impact of these events is critical to your China strategy.
Impact of new regulation will vary based on value-add and size of the daigou
In a poll FrontierView conducted among our network of daigous, only 20% reported that they were planning to take immediate action in response to the new law. The remaining 80% believed that either “the situation is not clear yet” and will wait to react, or that the new law is irrelevant due to their small size. While some daigous may delay immediate action due to uncertainty, there is clarity around the likely impact the law will have on the industry based on two characteristics of the daigous: value and size.
Value-add of daigous
Daigous provide value to their customers in two ways. The first is lower prices compared with retail prices due to avoidance of paying import duties at the border. Daigou whose business model relies solely on price arbitrage will be negatively impacted by the new law. These daigous will likely face a 30-50% import tax, placing huge pressure on their bottom lines—based on our recent research, most daigous achieve 10-30% margins—and potentially driving them out of business. However, not all daigous compete solely on price. In fact, many sell their products at a premium relative to the official brand price, as seen in the graph below.
These daigous commonly provide the second form of value to customers: a guarantee of authenticity and quality. Consumers tend to trust daigous more than traditional Chinese retail channels, which have been plagued by scandals of counterfeits and quality control issues (e.g., the ongoing baby formula crisis). These daigous are less likely to be impacted by the new law and will remain a vital e-commerce channel.
Many MNCs, even those who support the recent crackdown on daigous, such as LVMH, benefit from daigous due to this second type of value. Daigous that can provide assurance to customers are able to deliver products which would otherwise not be available, very similar to the way a traditional distributor functions.
In the map below, we can see the 40+ official Louis Vuitton stores across China and how they allow the company to access large economic centers with potential customers. While the brand has a very sophisticated presence across China relative to most MNCs, it still lacks an official footprint in 11 provinces, denying it access to many wealthy households, including approximately 26,000 that earn more than US$ 175,000 annually in Guangxi and the 1.1 million tourists who visited Hainan island in 2017.
Size of the daigou
Daigous vary greatly in size, from mom-and-pop shops making CNY 5,000 (US$ 720) a month in profit to those with 100+ employees. The new legislation is likely to have a differing impact depending on whether the daigou is small, medium, or large.
- Small daigous are likely to be unaffected by the new legislation, as they slip below the radar of government officials. These daigous, many of whom ship single orders directly to their customers, are not significant to multinationals because they are either too small or too unsophisticated for a working relationship.
- Medium-sized daigous are likely to face the largest uphill battle. These daigous will need to comply with all aspects of the new legislation, including filing tax returns and paying import duties on products purchased overseas and brought into China. Owing to the increased cost of doing business, many of these daigous will be forced out of business.
- Large daigous: Many of the customers who previously shopped with medium-sized daigous will now be prompted to shop with retailors, brands, or other daigous. These other daigous are likely to be larger and more sophisticated, and likely already comply with Chinese regulation or possess the resources to do so. If they can weather the short-term volatility in the industry, they will greatly benefit from customers in search of new dialogues and industry consolidations.
Major changes provide opportunities for MNCs to establish new channels
The daigou industry is on the verge of large change. The business model for many daigous that proved lucrative in the past is going to face increasing pressure, while other models will continue to deliver the same value to customers as they have been doing. The industry as a whole is likely to undergo consolidation as many daigous are forced to close.
In this climate of uncertainty and volatility, multinational executives will be able to establish new channels, reach additional customers, and grow their businesses with the right strategy. In our next blog post, we will explore how to adapt your existing approach and what new strategies will work in this changing environment.