Case Study of Orenton Luxury Goods entry into the Chinese market

by lixintong0919gmailcom (student)

University Degree Business and Administrative studies

Group Consulting Project

Oroton

International entry and expansion strategy in China

Executive Summary

Oroton is an Australian owned company making luxury goods, from bags to clothing. This study first goes through a resource and capabilities analysis for the Oroton Company. We follow this with an external environment analysis and fashion industry analysis in Oroton’s host market, namely, China. In addition, this study is an analysis on their plan to enter the China luxury goods industry, through setup of a Wholly Owned Subsidiary with a view to using a “Focus” and “Differentiation” strategies. Last but not least, the recommendations are provided for Oroton in terms of how the company can enter into China’s market and further develop its international business efficiently.

Table of Contents

1.0 Introduction

Oroton was founded in 1938 in Sydney and built their success on luxury products with a relaxed style and high quality. Today, Oroton sells a wide range of products, from various clothing to jewellery and accessories such as wallets and even ties and umbrellas.

We selected Oroton due to an interest in whether or not an Australian fashion label would succeed overseas in a market with other larger global brands.

As Oroton has already successfully expanded into Hong Kong, Malaysia, New Zealand and Singapore (The OrotonGroup Annual Report, 2012) it makes sense that it would continue its expansion into additional foreign markets to continue this success. China has been chosen as the next market to enter for three key reasons. Firstly, neighbouring to Hong Kong means some of the liability of foreignness will have already been overcome, secondly due to the increased buying power of the emergent middle class and finally because of the strong market growth of the fashion industry.

2.0 Analysis of Orotons Resources and Capabilities

The Oroton brand is one of the primary value adding components of the company. This is because of the image that they have built up over the last seventy years of business, and the loyalty that their customers have developed towards the brand. Through social media and fashion recognition Oroton have been able to expand their brand awareness both domestically and internationally.

The brand itself is inimitable as there is only one Oroton brand, and the style of the products and the underlying quality underneath should not be underestimated as being one of the key items in Orotons success. The distinctive metallic mesh is the soul of the brand; this special design was born in 1951 and has become a symbol of elegance, luxury and sophistication (OrotonGroup Annual Report, 2011). Whilst styles can be copied, the style whilst combined with brand recognition adds a great deal of value.

Another key component of value adding is the staff within Oroton. From high quality designers to driven sales staff within the stores the staff play a key component in driving the success of the brand. Oroton encourage staff to contribute their ideas to the group and view change and challenges as an opportunity to grow. “We want to create a company where one person can and does make a difference” (OrotonGroup, 2012). This attitude which is embedded in the organizational culture of Oroton, and the staff who promote it add strong value to the group.

Ezquerro (2011) explains that the domestic management of Oroton within Australia over four years from 2006 to 2010 cut back on staff, reducing from one hundred and fifty down to fifty in a focus to cut costs. This was combined with further operational analysis on how they could increase their profit. These hard management decisions provided profit where other companies were struggled. This shows that domestically the management were adding value that other companies were not, and can be considered as strong competitive advantage.

There Oroton group also strong finances, enabling them to have a twenty million bank facility to support future growth plans (OrotonGroup Annual Report, 2011). Whilst this adds value to the company, it is neither rare nor inimitable. Oroton plans to use this capital to develop future products in the future.

3.0 Analysis of China’s External Environment

Chart 1 below shows the GDP of China has moved from 1,640 billion in 2004 to 7,298 billion in 2012 (adapted from The World Bank Group 2012). This clearly shows the fast paced growth of the China economy. Chart 2 (adapted from National Bureau of Statistics of China 2012) indicates the average GDP growth rate has shifted from 2.1% to 2.5% from 2011 to 2012.

Chart 1

Chart 2

Despite a small dip in the second quarter of 2012 the China GDP growth rate is beginning to recover. Also despite a small drop in the demand of luxury goods recently retail sales have grown steadily. Consultancy firm McKinsey & Co predicted that by 2015, China will be the largest luxury goods market in the world (China Daily, 2012).

Tariffs have been a main factor affecting the development of China’s luxury market. After joining the WTO in 2001 China committed to reduce tariffs. Despite this people still prefer to buy luxury goods overseas because the existing tariffs create higher prices. A survey of 20 luxury brands sold in China shows prices are 45% higher than in Hong Kong and 51% higher than in U.S (Lan, 2011).

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After 2001 tariffs for jewellery were 20%-35%, clothing 14%-20%, watches 11%-23%, and bags 14%-25% (WTO accession China tariff schedule 2003). Despite an announcement on June 15th 2012 from Yao Jian in the Ministry of Commerce that a further cut would occur on import tariffs the Ministry of Finance has said this has not been planned as yet. (Yu and Wang 2011)

This is a preview of the whole essay

China’s emerging middle class consumers are based from their relatively high-income level, which is around $12,500 per year. In addition, this group of consumers account for 10% of the disposable income in China’s urban areas (Farrel, Gersch and Stephenson 2006). Although high tariff will have little effect on leading consumer groups, who can afford the higher prices it may reduce the consumption of the middle-class. This however creates an important market niche for Oroton, to introduce a high quality series of goods that is priced cheaper than other products that can be afforded by the middle-class.

As China is a high-context culture (Lewicki, 2003) people prefer to focus on the collective instead of the individual. In luxury goods this creates a strong sense of in-group behaviour by owning the same brand. This also shows their individual economic strength and social status. Additionally with the changes in policy and rapid economy growth, Chinas consumers have become more open minded to foreign influences. This has affected the younger generations, who spend more than prior generations

Technological developments have also helped the economy. Specifically, more credit cards have provided the opportunity for increased spending. This has also made shopping more convenient through paying online; this in turn promotes the development of the online stores. Research shows that at the end of March of 2008, there are more than 104.73 million credit cards in circulation in China (Shanghai Daily, 2008). Research by MasterCard (2008) also shows that credit cards used on luxury goods purchases has increased by 50%.

3.1 Analysis of China’s Fashion Industry

The current rivalry among luxury brands could be considered high. The top three fashion brands in the China are Louis Vuitton, Chanel and Dior. Over 80% interest for Dior is specifically related to beauty. However, for Chanel, beauty represents less than 50%; fashion and accessories is around 40%. For Louis Vuitton 94% relates to fashion and accessories (Luxury society 2012). Other brands such as Gucci and Armani also share Chinas market. These brands can be considered “ultra-luxury” to Orotons “luxury” so whilst competition is high, it’s factored at the top of the pyramid.

The threat of new entrants is low due to some existing barriers. Firstly there is a high capital investment as most luxury goods require high quality manufacturing techniques and many brands need to be designed with limited editions by specific designers. Secondly is brand awareness. Because of Chinas culture, very few consumers will buy an unknown brand with high price. Thus, it is important to a new entrant to gain the recognition and fame when entry into a new market. This requires a great deal of advertising. The last barrier is the difficulty of distribution. In Chinas luxury market, the main mode to distribute is within stores located in shopping malls. Luxury brands need to establish their own store which is an expensive process.

The bargaining power of suppliers is low, because most luxury goods are imported. However, with more luxury brands recognizing the advantage of low cost labour and materials they have shifted the manufacturing to China. This has led to a slight increase, though the competition between companies to be a producer of luxury goods creates a healthy relationship between these local suppliers as a luxury brand that did not want to import could shift between local producers.

There is no doubt that consumers of luxury goods have strong purchasing power. As mentioned before the power of brand image will drive high sales. Loss of status among the public could have a large impact upon the sales of a brand, so the consumer becomes a double edged sword. Keep their interest in the brand and you have a strong purchasing side, lose them and sales could suffer dramatically.

In China the threat of substitutes comes from horizontal competition and can be defined as low. This is because most people regard luxury goods as a status symbol. Consumers want to show that they own this brand. Because a brand is something that people aspire to own, once your brand has become highly sort after it becomes hard for a competitor to try and substitute their products over yours.

4.0 Country Entry Strategy

Whilst the primary reasons to enter China is strong revenue driven from the attractive growth of the middle-class segment combined with what appears to be a gap in the industry for a middle classed luxury items that is cheaper than the other high class imported brands. These two items are further made important in the fact that Oroton already has some factories in China that are exporting goods elsewhere around the Asia Pacific Region. This means, that addition to an attractive industry from a pure revenue component, some of the costs that would otherwise impinge upon the entry such as complications with distribution chains will actually be simple to resolve.

If we examine the various modes of entry, from joint-venture, to strategic alliance, to acquisitions, we can see that none of them really provide any competitive advantage. Oroton does not stand to gather anything from performing a joint-venture with anyone else. As they have the capital to enter into China, combined with the knowledge of having operated internationally before, and even having a store located in Hong Kong, it does not make any sense for them to share risk, and therefore profits with another company. A joint venture could even be detrimental, due to the possibility of branching goals.

Possible acquisitions face problems as well. If you consider the facts that the actual company needs to be found that can be purchased, then you have to subvert capital that had been planned for product development into possible inflated prices due the acquisition premium in purchasing. After the actual purchase is done you then need to integrate a new firm into the Oroton brand, and turn it around from a performance. This leads to possible integration concerns and the possibility that you might not successfully fold the new company in.

The most attractive ways to view the entry into the China market is through the creation of a new arm, that of a Wholly Owned Subsidiary and that of a Greenfield setup. Whilst there are going to be initial setup costs, the entry can be done carefully, with the correct location of storefront, staff all being chosen by the current Oroton brand. This way be a little slower than an acquisition, but should end up showing growth quicker as we don’t need to worry about post acquisition concerns. This allows the new management of the China market to focus purely on driving successful sales and growth.

5.0 Post Entry Strategy in China

We believe for Oroton to compete successfully in China they need to have a strong strategy that has a focus on understanding and working with the informal institutions present within the country. This will be centred on the cultural structure of the country, from both internally within the company, and externally upon future customers and officials that Oroton will need to deal with as they look to open more stores.

The OrotonGroup Annual Report (2012) outlines their global strategy, as one that has a strong basis of international expansion, and also places a strong focus on engaging with customers via social media channels. This strategy is in play with the company having a voice upon Weibo, the China version of Twitter. Additionally they place a strong emphasis on the need to work as a team, and to strive towards achieving the results that they have set for themselves.

We believe a continuation of this strategy will serve Oroton well within China. International expansion will be continued, with a focus on penetration into the China market. We believe Oroton must focus on the generation of an in-group mentality within the new Wholly Owned Subsidiary, of the team being ‘first” above the individual. Additionally we believe that the perception of Oroton will be well received if they enter China for the long haul, with an aim to create more stores, with the end goal that China self-funds its own expansion.

The Hofstede Centre, (2013) describes how China stands out in the long term orientation dimension and has a very low individualism score. By emphasizing a strategy which tries to adopt these two core items, ie a long term view of our future in the Chinese market and also the trying to adopt a collective relationship instead of an individual relationship we believe we will differentiate ourselves further from other western retail companies trying to enter China.

On a product level we believe a focussed strategy, targeting a specific niche of the fashion industry underneath the ultra-luxury and luxury brands of Gucci, Versace or Luis Vuitton however above the mass products that don’t feature a label will be the most rewarding. This premium retail section allows us to capture a very large customer basis, and plays to the fact that we have more and more middle class Chinese with more disposable income.

Whilst we believe Oroton need to embrace a strong culturally focussed strategic mindset, above and beyond everything else we need to ensure that the company is able to adapt and build networks within China to aid in the ongoing expansion. Strategic Direction (2007) describes how “Guanxi meant developing good relationships with local government officials”. We can draw upon this and stress how important building relationships are within the China marketplace.

6.0 Structural Organisation

As Oroton has a strategy encompassing a great deal of international expansion this leads us to recommend that they adopt a geographical model structured around areas and locations. As we have described that Oroton should have a long term focus within China, (and other regions) it is important to maintain a separation of business units to allow transparency to know whether or not a region is profitable or not. This organisational setup will need to have a strong leader to represent the company within China, and we believe this individual should be sourced internally from within the company’s home country of Australia. If an individual can be found who comes from a Chinese background (bicultural or expatriate) additional competitive advantage.

With this geographic model, we believe Oroton should also have a localisation model from a knowledge management perspective, with a focus on acquiring pertinent information for their local markets instead of being reliant upon information being provided by the corporate headquarters within Australia. Whilst Oroton has expanded into other countries, because of these “standalone” styles of organisation (both knowledge sharing and location based).

Further building upon this having management close to the ground, with a good understanding of what is happening within their local area, allows them to make rapid decisions based upon the needs of the subsidiary within China. We believe this local decision making shows to the staff within China that they are empowered as an entity to drive forwards by themselves.

7.0 Summary and Recommendations

In general, there are four main recommendations for Oroton to consider when looking at entry and then the development of its business in China’s market.

Firstly, when Oroton focuses on China’s market, the company should be sensitive to the cultural distance between China and Australia during the entry and post-entry phases.

The Hofstede Centre (2013) states Australia is characterised as a highly individualistic and relatively power distance country. In contrast, China is characterised with a strong collectivism and high degree of power distance culture (Reuvid and Li 2006). As a country with collectivism, Chinese people focus on building the association and connection with each other, which can be seen with China defined as a relationship-oriented country (Reuvid and Li 2006). In addition, Chinese people respect hierarchy and are able to accept uneven distributions of power in the society, which demonstrates a strong power distance (Reuvid and Li 2006).

Secondly, from this we can see the importance of Guanxi, or relationship building in Chinese culture. Based on this collectivism and highly degree of power distance, we can see Guanxi has a strong influence within businesses operating within China. In a business context Guanxi means obtaining favours through building personal relationship or social network to facilitate business related activities (Ambler, Witzel and Xi 2009). One could consider the difference with Australian culture, where more arm’s length transactions would occur. In China, based on a good relationship with key stakeholders outside the company, strong relationships may help the company access further external resources in an easier way; meanwhile, developing a harmonious relationship with staff within the company also can enhance the business performance (Ambler, Witzel and Xi 2009).

Oroton should understand the importance of how Guanxi can be leveraged in doing business in China. The management must have an insight about building an effectively relationship with the company’s key stakeholders outside the company, such as local government, suppliers and customers. This relation building is equally important from an internal perspective, as any Chinese staffs are unlikely to voice their thoughts in an open manner. Management will need to be mindful that to develop the Oroton strategy, where each individual is valuable and important will require time and a certain style. This culture needs to be understood and developed for the company to succeed. Within the company, the management could also facilitate communication through intranet or survey to listen to their needs and wants to enhance the cohesion with employees and further develop intangible resources for the company.

Thirdly, given that stakeholders will not only focus on the company’s economic effectiveness but also social and environmental performance, which requires the company to achieve a balance between economic, social and environmental development (Peng 2009). Oroton should consider the development of corporate social responsibility policies in a manner to generate a strong brand image in China’s market. As discussed prior, the importance of brand in China is critical to continue to provide strong revenue and growth. A brand that lost its reputation and image could face problems to regain them.

To fulfil this need, Oroton could focus on fulfilling corporate social responsibility for the communities. For instance, Oroton has committed to establish libraries for children in Vietnam through using the fund generated by the sales (Oroton philanthropy 2012). Considering that Oroton aims at doing business for a long time in China, the company could continuously put effort on improving children’s level of literacy in some lower poverty areas in China. This could build an attractive brand image among the stakeholders.

Fourthly, after entering Shanghai, a first tier city in China, Oroton would consider developing its network in some selected second or third tier cities as an expansion strategy in China’s market.

Through leveraging on the advantages of well-developed infrastructure and consumer buying power in China’s first-tier city, Oroton would be able to establish its brand and gain a group of loyal customers. After gaining relatively strong brand awareness within this first-tier city, Oroton could consider moving to the second or third-tier cities to further explore opportunities and seize more market share. In comparison with the consumers in the first tier cities, potential customers who live in the second or third tier cities would confront more limitation to go overseas to buy luxury products (Rein 2006).

In addition, according to the research, around 40% of residents in China’s second or third tier cities are willing to give their friends or colleagues a luxury product as a gift, which demonstrates a greater number of people than first tier cities’ (Shi 2012). In consideration of the demand for luxury products in China’s smaller cities, Oroton could further established its retail shops in China’s smaller cities to reach the consumers there and obtain more market share in China. If we look at Chart 3 below (adapted from nextbigfuture), we can see that the salaries between third and fourth tier cities are starting to catch up with first tier cities.

Chart 3

(Wang,2011)

Overall, if the China Oroton market can become self-supportive through profits, growth in China can be effectively managed from within China and the Oroton group can continue to expand in other markets whilst China effectively generates a substantial profit for itself and contributes to further expansion across other countries.

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