Chinese Luxury Gray Market Structure

Disclaimer: This interview is for informational purposes only and should not be relied upon as a basis for investment decisions. In Practise is an independent publisher and all opinions expressed by guests are solely their own opinions and do not reflect the opinion of In Practise.

Thank you very much for taking the time. Maybe we can start with a bit of background. I'd love to hear about your role over the years in sourcing inventory for the gray market and how you got into it.

You want to start with how I think about the gray market?

Yes, how did you get into it and what have you done over the years? A bit of context around this would be helpful.

Let me share something with you. Can you see that?

Yes.

I screenshot this from my personal introduction. These are the countries where I have suppliers. You can think of these as gray marketplaces, where all the suppliers are because I always work with them. This is the territory I include in my personal introduction. Later, you can see I also list the resources I provide when working with other marketplaces. I work with brand distributors, under distributors there are tax-free, showrooms, parallel traders, marketplaces, multi-brand department stores, etc. These sectors are key players in the gray market, even the brands themselves. I pulled the number directly. Here you can see it's a chain.

This is a chain from the purple one, which is the keychain. From the brand, this is how the product flows, either in the gray market or, as we say in Mandarin, the brand market. If I translate directly, this is how the product flows from the brand into the showroom. They also have a direct boutique. They take the product directly from the brand, and then you see the buying office. Sometimes the showroom works with a buying office because they might not have many distributors, so they use the buying office as well.

You can see there are boutiques, distributors, like regional distributors, and also the past season distributor and also the marketplaces. I'm going to talk about the blue part. The blue part is like you still have a showroom and buying office around the brand because they provide the brand with information on which market might be better. Some showrooms advise the brand on what to do for the season or their product. In the middle sector, you see PT and DG, with PT being parallel traders and DG means Daigou. These two started from a very early stage.

Yes. Just to quickly recap to ensure I understand correctly, obviously, the brand has a showroom and there they display the new collections and all that. A part of that goes direct to their own stores that they have all over the world. Other parts go to the show to be basically sold to like distributors or boutiques.

No, DG is Daigou, a distributor already in a third layer.

Yes. So, the Daigou would go into the showrooms and the owned stores by the brand. For example, you might have a Chinese buyer who goes into a boutique, like a Louis Vuitton store in Milan, and buys items there. That's what you mean, right?

This is really defined by the brands. For instance, Louis Vuitton might work with a regional distributor in some markets, like in Southeast Asia. However, in other countries, many brands used the Covid-19 pandemic to reorganize everything. This meant removing showrooms, eliminating middlemen, and restructuring distributors or those who can sell their products. This is generally how it looks. But if you look at the top brands, they don't operate this way. I'll tell you more about others in the gray market later. You'll see boutiques and subparts, and there are also parallel traders and Daigou; Daigou in the third layer, you see WHS, cost plus, and RRP. WHS refers to the second layer, where pricing is based on a wholesale price. WHS means wholesale price. Showrooms typically take a 10% to 25% commission from the brand based on the wholesale price. The buying office takes a 5% to 25% commission from a showroom. Direct ones range from 0% to 30%. In the third layer, cost plus means the wholesale price plus a certain percentage, which becomes the price you pay. This varies depending on the brand's popularity, category, specific items, materials, or types. Hong Kong parallel traders are the best in the world. If you want to know which brands sell best, or even which items, colors, or sizes sell best, everyone looks to Hong Kong.

Who, for example, are these parallel traders? You mentioned they're in Hong Kong. Who are they? Can you describe what a typical parallel trader is?

What do you mean by typical? Do you mean a name or what?

Yes, if you know the names of companies that do this, that would be helpful. But I'm trying to understand who they are and how they are organized. For example, is it just five people, or is it whole groups of hundreds of people?

It's a bit complicated because these parallel traders are known as such. However, for brands, they might appear as boutiques. These parallel traders have spent generations buying boutiques in Italy and use these boutiques to purchase from the brand.

Okay, so they own boutiques in Italy.

Yes.

And they use those boutiques they own. So, it's a Hong Kong company that owns a boutique in Italy and uses that boutique to access inventory from the brand.

I wouldn't say it's owned by a Hong Kong company because it's more of a family tree. For example, my grandfather is from Hong Kong. Typically, the biggest traders have a history where their grandfathers were already in this business in Hong Kong. Then their children and grandchildren expanded into Italy or Europe because they needed more products to support their sales. As brands started imposing stricter regulations, they considered whether buying from boutiques was acceptable, and most found it was fine. Some already have European passports or grew up in Europe and own local boutiques. So, you wouldn't typically find a boutique owned by a Hong Kong company.

It's just owned by a Hong Kong person in Italy.

Yes.

Okay, I understand. It's basically a family relationship. They might have a cousin in Hong Kong handling parallel trading, while someone in Italy is responsible for acquiring products through the boutique.

Yes, exactly. If you have siblings, one might be in Europe handling supply, while another is in Hong Kong managing sales.

Is it literally families?

Yes, they are literally families. The market is so profitable that even Daigou operations, which differ from larger traders mainly in size, can be run by just a few people. Even a Tier 3 Daigou group might only have five people and can still run a successful business, potentially buying a house after two years.

Just to clarify, when you say Daigou, you mean a Chinese national buying items in Italy from boutiques, similar to someone personally buying five bags and shirts to sell in China?

Let me explain. One of the top parallel traders in Hong Kong is family-owned. At the management level, they are all family. In Hong Kong, they have a team called the buying team.

They need a lot of products to sell, so their own boutique isn't enough to support themselves. They also need to place orders with all the boutiques they know in Europe or the States. This team usually consists of 20 to 30 people. Every day, boutiques release a stock list because they might receive a box from Prada, either for stock levels, previous orders, or restocks. Every morning, boutiques send a list of what they received the day before. The buying team in Hong Kong starts downloading orders directly, and everything needs to be closed within 24 hours or sometimes even within three hours. Yes, it's a bit messy, I know. But we can go further and then come back to this.

So this is the layer, right? You have the brand, different channels, direct and wholesale, and you have parallel traders, gray market traders, and Daigou in between that get products from either.

I can also buy from the showroom or directly from the brand if I have a suitable company structure. Some Daigou or gray market traders know they can't use a Hong Kong or Chinese company to buy from the showroom because the brand refuses. They might say, "No, I'm not selling to them because they claim to have a boutique, but they don't. They're the gray market, and I hate them." So some try to buy or set up a company in Africa or small countries to buy from the brand.

Really?

Yes.

The third layer is these distributors?

Yes.

Who are they typically? How would you describe them?

You mean how do you define them?

How do you describe them? The simplest way to ask is how would you describe those distributors?

I think distributors are the ones who sign a contract directly with the brand or showroom. They own a contract, which means they are regulated by the brand. Let me give you an example. There's a boutique, and you can find many of them across various regions. In every region, you can typically find companies that own their own multi-brand boutiques. At the same time, they might say, "I also run Burberry in southern Italy. I manage the Burberry shops there; I have 18 shops." I started my career working for one of them in Taiwan. They own a multi-brand boutique and also represent brands in the local market.

And they own the boutique where, in Italy?

They also help the brand run a Burberry or the brand boutique in the local market.

So, the boutique they own, was it in Italy or Taiwan?

This model is applied all over the world. It's the same everywhere. This was the Daigou market overview estimation I did in 2018. Considering the pandemic, if you calculate the overall changes from 2018 to now, I think it wouldn't have changed much. In 2018, the EU market size was about 42 billion renminbi. Specifically the luxury product market, was approximately 42 billion renminbi back in 2018. Then, boutiques directly run by the brand or where the brand gives rights to local distributors should account for 12 billion.

In the multi-brand sector, where they buy directly from the brand and typically have a mix of 100 to 300 brands, this accounts for about 24 billion renminbi. And there are two billion from outlets.

So in 2018, the European market for Daigou was 42 billion renminbi, of which 12 is mono-brand, 24 is multi-brand and two is outlet?

Let me explain how we work with brands. We also collaborate with VIPs, brand VIPs. For instance, I personally meet some VIPs from Louis Vuitton and Chanel. They are the top VIPs for regions like Milan or Northern Italy. We buy from them, or they sell to us.

Really? Is it more like seeing what the VIPs have, or do you chat with them before they go into the store and tell them what you want, and then they order it for you?

I think it's both. I'm not sure how they become VIPs, but when I see them, for example, a Louis Vuitton VIP, they are dressed head to toe in Louis Vuitton. Even their car is filled with Louis Vuitton accessories. I don't know if these are gifts or if they buy them. They also have small furniture items from Louis Vuitton. Some might be born wealthy or financially capable to be a Louis Vuitton VIP.

They start this business because it's a way to grow money. With brands like Louis Vuitton, we can't buy directly or through a middleman. We rely on Daigou or hire people to queue in front of the shop to buy items, or we purchase from VIPs. We buy from VIPs because they have previews at the start of the season and can order directly from the lookbook, not just from the shop.

So, for example, with Louis Vuitton, it's hard to get products directly, so you go through Daigou or buy from VIPs.

Yes, we have people queuing in front of the shop.

So your people actually buy from them in the store.

Yes.

That's very interesting. For example, I spoke with an Italian guy yesterday who worked at a boutique and sold a lot to China and Korea. He mentioned that many brands have restrictions in their wholesale contracts with boutiques. I'm curious about your experience with wholesale contracts, what the restrictions typically are, and any details about the contracts between boutiques and brands.

What do you want to know about the contract between brands and boutiques?

What is typically included in those contracts? What do they actually specify?

Normally, when a brand signs with a boutique, the contract includes several parts. One is the territory, another is pricing, and when you can start offering discounted prices. Some brands will require you to commit to purchasing a certain amount for the entire season, and you cannot exceed or fall short of that. They usually group the products into categories, such as trendy items, classic pieces, and runway showpieces. They will specify the percentage you must buy from each category. Bags typically sell the fastest, so everyone wants the best ones. However, brands will not allow the entire order to be bags. If you want to order bags, you also need to purchase a certain percentage of ready-to-wear items, and you cannot sell them below a specified discount price. The interesting part is that brands still cannot dictate where you can sell online.

That's interesting. For example, let's take Loro Piana. They might have a wholesale agreement with a boutique, stating you can sell in your physical store and on marketplaces, but not to the gray market. How common is that? To me, marketplaces and the gray market sound similar. I'd be curious to hear your thoughts.

You mean they can sell in the local market and on marketplaces?

Yes, for example, they can sell in their store and also on platforms like Cettire or Farfetch.

No, actually, only Farfetch has permission from brands directly. Farfetch's approach was quite challenging because they listed all their boutique partners on their website. As a result, brands started to block them, saying if you sell to Farfetch, we won't sell to you. Then Farfetch started working with brands to gain their trust.

Farfetch assured brands that they would not place them in undesirable situations. They promised to present them positively, and that's how they gained permission. Farfetch is the only one with such permission from brands. No other platform has it.

Yes, that makes sense. Just to quickly revisit the source of inventory for the gray markets. Which sources are you referring to? If you had to estimate in percentage terms, where does it come from? From boutiques in Italy, from distributors, from Daigou? How would you split that in terms of percentages?

Actually, let me rethink because the landscape has changed a lot. I would say between 60% to 70% comes from boutiques. And there are maybe 25% coming from the showroom.

So that gives us about 80% in total.

The rest comes from distributors.

And what about Daigou? Where do they fit?

If you want to include Daigou, let's redo it. In this case study from one of my companies, we asked two Daigou individuals where they get their products. The first one said boutiques, and the second one said brand shops and outlets. The first one operates with only two people helping him run between boutiques. His monthly transaction was six to seven million renminbi.

Let me see how much that is in dollars. You said six million renminbi?

Yes, six to seven million renminbi.

That's almost a million dollars.

They are a Tier 3 operation with only three people, reaching six to seven million renminbi. The profit for this tier is around 18%.

So, this Daigou, for example, is generating around $800,000, almost a million dollars, in revenue monthly with three people.

Yes, monthly.

So, a million a month of revenue with three people.

Yes, and 18% is pure profit.

So, back to where the inventory comes from. You say 60% to 70% is from boutiques, but that includes Daigou.

I would say I don't really categorize Daigou as a major group. If you're talking about marketplaces, they use APIs to connect directly with boutiques. We use Daigou because boutiques start to limit how much they sell on our marketplace. For example, if they have 100 Gucci bags, we want them all, of course. They know everyone wants them all, so they might only list 20 on our marketplace, another 20 on Farfetch, and another 20 on another platform. We have KPIs to meet, so we use Daigou to obtain more.

Let's get back to your list. There are three ways marketplaces work with them. The major one is API, then there's Futures Buy, and the third is On-stock Buy. You might already understand the pros and cons of these from the boutique side. The API is the major method used by marketplaces, but the downside is that the traffic they receive is becoming more expensive. Boutiques calculate this with platforms like Farfetch because Farfetch is the most mature one. Boutiques pay Farfetch a commission of 38% to 40%. They also face pressure from brands, so they don't list everything.

So, boutiques buy inventory to sell in their stores. In your experience, how much do boutiques actually sell in their physical stores, especially in Italy?

I've asked them before. They said around 30% to 40%. For mid-sized to small boutiques, it's worse. They sell over 80% on marketplaces and around 10% to 20% in their physical stores. This is why many boutiques are in debt and easily acquired by Chinese or Hong Kong entities because they can't sell enough.

Yes, exactly. I spoke with someone yesterday who worked for a boutique in Italy. He mentioned that only 10% of their sales were in their physical store. Around 30% to 35% were to Chinese and Korean boutiques.

No, that's too low. It's 60% to China.

And another 30% to 35% through marketplaces.

Most of their sales go to China.

Yes, he sold on Farfetch and Cettire and other usual platforms. So, you're saying that for Italian boutiques, 60% of their sales typically go to the gray market?

Yes, between 60% to 70% go to the gray market. For large-scale boutiques, that's the case. For smaller ones, you might see this screenshot as another case study from a boutique that owns many brands. They own 64 brands that actually sell. However, under these 64 brands, they have around 300 brands in total.

Only 64% of the brands sell. We categorize them as big, trendy, designer, and classic and premium. This is really significant, I would say, among the top five in Italy. That's how they sell. You can consider, for example, Gucci. During the pandemic, in 2019 or 2020, they had around 300 distributors, including boutiques and local distributors, in Italy.

In the first year of the pandemic, they said, "Oh, because of the pandemic, we don't have enough people to handle the product." They decided to streamline their partners in Italy, reducing from 300 to 180. By the second year, around 2022, it was about 120. By the end of 2022, many people told me it was only 40 boutiques that could really sell Gucci. So, going back to our discussion, if big brands only keep those who can sell, they are the only ones making a profit for the boutiques. Medium and smaller-sized boutiques lose these big brands and can only have medium to smaller-sized or less profitable ones. It's a bad cycle; they can't sell, and people don't want to have them on board because they lack big brands.

Does Gucci, for example, contract directly with gray market sellers? Do brands generally engage directly with the gray market instead of letting boutiques buy?

You mean if they try to manage the gray market?

Yes. Do they, for example, go to Cettire directly?

I would say yes and no. The "no" is the major part. If you want to say Cettire works with Gucci and they have an agreement, etc., no, it's a big no because the brand doesn't want damage. But on the other side, they might have seasonal sales or flash sales, like a three-day special marketing event with platforms like Farfetch or POIZON. These are significant for marketplaces to get brands on board. For these brands, the trend is to sell items that might need to go to the outlet.

On the other hand, those big brands all have outlets, right? They have outlets and also stock they think they cannot sell or is past the season. After this outlet or past season department, they will secretly work with the gray market. I have observed that some traders buy directly from Burberry and Coach for their past season products.

Referring to the 60% you mentioned going to the gray market, if I work at Gucci or any brand and I'm selling to an Italian boutique, it's obvious they're selling to the gray market. A boutique in a small Italian town can't sell that volume just from local customers. Is it reasonable to assume that, or do the boutiques tell them something else?

Yes, when you visit these big boutiques, you'll notice they often come from wealthy local families. They have the resources to buy and build extravagant boutiques. One boutique I admire is run by the grandchildren of the original owners. They bought a theater and transformed it into a boutique. It's amazing. Brands love having showpieces in iconic magazines like Vogue, and these boutiques serve as local magazines. They maintain local customer relations and brand image. For events or brand exposure, they rely on these boutiques. Financially, these boutiques from wealthy families have a wide range of resources. Dolce & Gabbana, for example, grew with the support of a few boutiques that placed large orders, helping them become a big brand.

But what if you're already a big brand, part of Kering or the LVMH group? Why would I sell to a boutique in Italy if I know that inventory might go to the gray market?

From a brand perspective, yes, I cannot allow anything to damage my brand value. However, people who work for brands have sales KPIs. Everyone has a KPI. That's how you manage your playlist nicely. Everyone knows this. If you ask someone working in a brand about a boutique, they might say, "I can't tell you because I work for a marketplace." They might not disclose everything, but they can share other insights, like the boutique's background, which can be very informative.

Yes, that makes sense. You mentioned there are key hubs and parts of the supplier network. What did you mean by that? Can we explore that further?

Are you referring to the key people in the supply network?

Yes, exactly. You mentioned key hubs in the supply web. Is that what we discussed earlier?

Yes, the Hong Kong parallel traders play a crucial role. They are very detailed about price changes. For example, if I am a Western parallel trader or marketplace and want to buy specific Gucci bags, boutiques might offer one price. However, Hong Kong traders might offer three different prices based on color popularity, with the best-selling color being more expensive.

Yes. Where do these Hong Kong parallel traders sell their products? Yes, they get products from Italy through family-owned boutiques. Once they have the products, who do they sell to?

They sell to other parallel traders, Daigou, and even some department stores in Asia. Asia is a big market. They also sell to marketplaces, but primarily to the top five biggest parallel traders.

Would it be possible to get the names of these top five traders?

I don't have specific names because they operate through many companies. You might know the person but not the company they use for billing. You might receive different billing addresses, but they all come from the same company.

So, these Hong Kong traders bought the product from Italy. Now they have the product in Hong Kong and they want to resell it to department stores and boutiques in Asia. Who are they mostly selling to?

Parallel traders. Let me think how to say this. These Hong Kong traders are family-run businesses over generations. Their hub is in Hong Kong, but their network is global.

It's not just about getting a product from Italy to Hong Kong. It's about getting a product in Italy and directly shipping it to the customer's location, which are other traders, maybe in America or elsewhere. Not every product goes back to Hong Kong.

So most of what they sell is to other traders instead of Chinese boutiques?

Yes, they are like a family in Hong Kong, but they have connections all over the world. Their business and customer list grow globally. They ship everywhere, and most of them are in the top five. It's like different layers. For example, I'm in Taipei, and Taiwan is not a big market for the gray market. I visited the biggest marketplaces in Taiwan and asked where they get their products from. They gave me names I didn't recognize, which seemed impossible because I know most people in this world. Then I found out they are the fifth layer from the top ones.

The fifth?

Yes, number five or six. They thought I knew nothing about them, but I know everyone at the top. How come I don't know? It's wrong, but they have so many layers. The top ones have deep roots in the brands and the original sources of the products.

I remember you mentioned sourcing products for Chinese marketplaces before moving to POIZON. At POIZON, you did it on a much bigger scale. What is the difference between sourcing for a smaller marketplace compared to POIZON?

Let's start with the company size. In previous companies, like Secoo, they had around 1,000 to 1,200 people when I joined. However, when I joined POIZON, they already had about 13,000 permanent contract employees, including all the outsourcing, like storage and shipping, the contractor part in China alone had 18,000 people. So, company-wise, it's already quite large. In terms of IT, they have 2,000 people, which is impressive. In terms of support and experience, they are much more advanced than my previous companies.

How large is POIZON in terms of revenue? Just to clarify, I've read a bit about POIZON. My understanding is they started with peer-to-peer, second-hand fashion, and are now sourcing directly in fashion. They initially focused on sneakers. How significant are they in the fashion industry in China? I know they're trying to expand. Could you provide some context about POIZON from your perspective? You likely know more than I do.

Before our conversation, I tried to access screenshots from presentations but couldn't find them. However, I can share my insights. POIZON started with shoes, like trainers and basketball trainers. I once discussed with finance about securing special trainers from Nike and Adidas in Europe. I asked how they source in China, and they said they buy from brands. I asked how they calculate, and they said by tons, by weight.

Really?

Yes. They calculate the price by weight, in tons, every month.

Wow, that's surprising.

Yes, I realized I joined a really large company. My overseas business was quite small compared to the local ones. When I joined, they had been trying to start the overseas business for two years with no results. They had 200 people in the overseas department but zero income. After I joined, suppliers started coming. In my first year, we generated about 280 million euros from zero. When I asked for more support from the company, they told me my part was too small and they wouldn't change the rules for me. I was like, okay, thanks.

So, regarding the overseas part, is that /280 million euros from selling luxury fashion to people outside of China or within China?

Are you referring to the actual customers?

Yes, the actual buyers purchasing through POIZON or Dewu.

It's a mix. In China, most of the trading team at POIZON comes from Alibaba, so POIZON is often called a mini Alibaba. They operate similarly, with suppliers in China and cross-border, which means they might be in Hong Kong or elsewhere outside of China but can still trade in renminbi, as well as overseas suppliers. So, there are three major types of suppliers.

Yes, that's about the suppliers, but what about the actual customers, the consumers?

Yes, over 98% are in China. They do try to sell overseas, but I don't see it happening significantly.

They announced about a year ago that they were starting to target markets outside of China and have hired people in the United States.

I know, I drafted the plan and strategy. Realistically, I think the number of actual overseas customers might be lower than 3%. If it's more than 3% or even more than 1%, it might be a B2B business. They source a marketplace and collect many products, but they can't sell everything. They sell some to other traders from the beginning.

What do you think makes the most sense to discuss next?

What I want to talk about is the work type because that's how marketplaces start to have more cash flow burdens. We mostly work with APIs, but APIs can only support daily operations and satisfy basic needs. The market is too competitive now. People want to ensure you have what you show because sometimes customers download orders for, say, Gucci bags, and the boutique says it's sold out and wasn't updated in time. Or the boutique doesn't want to sell because you buy at a low price. They have future buys and on-stock buys, which is the biggest part of the gray market.

Please explain what that means.

The futures buy is like, now it's December. I am supposed to download orders for next year's spring/summer. However, it's too late for that now. I should be downloading orders for next autumn/winter, for products that will arrive in September or from August. I've already received the spring/summer products. So, this is futures buying, where I buy for the future season.

Yes, so it's a kind of a pre-order, correct?

Yes, pre-order. Pre-orders actually take place mostly in the gray market because of all the Daigou or parallel traders and the buying offices. The biggest part comes from the parallel traders. What happens is when a boutique goes to the brand office to download an order, they are very strict. You need to download the order in their office. You can try to take product photos, but you can't take everything. You have to complete your order within their office and cannot take anything out. You can only amend it once or twice within one week. This is how Gucci tries to protect themselves from the gray market.

In 2021, I helped a parallel trader, and I think these companies are around Tier 2. I never worked with a Tier 1, but I worked with Tier 2. Tier 2 parallel traders get products from Hong Kong people and try to go to the brand showroom with boutiques. Let's say now it's 8PM my time, and only at least from 10PM we start to receive the lookbook spreadsheet from people in boutiques. I say, give me the answer within one hour or 30 minutes. That's the timeframe I need to download the order. Normally, for Gucci orders, it might go to a few million, two million, three million, or as much as I can have.

After 2022, we can only go with them in a showroom. The boutique and the top parallel traders will tell us, all these Daigou or those who have money to buy the pre-orders, will inform you about the percentage of different categories you can have. They'll ask for your budget and what kind of things you want, and they'll try to make it for you. But you can't really pick, so it's a surprise bag every time. This is the biggest part of the gray market, the pre-orders, and it takes about 65% of the gray market coming from pre-orders.

That's good to know. I don't think I knew that before. One thing you mentioned that was interesting was about a Tier 2 parallel trader. What does that mean?

You see this one; it's a square. You will see something like 100, 100 to 200, 200 to 500, 500 plus. This refers to the orders or the monthly transactions.

So it's basically about the size?

Initially, it was one million, then one million to two million, and two million to five million. But it has grown since 2018. By 2020, for Tier 2, they need to reach at least, let me think, at least 50 million renminbi as a basic requirement for this tier. Normally, they should ensure they fit between 50 million to 100 million renminbi in monthly transactions.

That's a lot.

Yes, that's a lot. But I have so few people, so you know how profitable it is.

Why do you think the gray market has grown so much over the last five to 10 years?

Because there's a profit. I forgot to mention. We have the cost, the wholesale price, and the retail price.

The markup from cost to wholesale price is something I'm not quite sure about, as I usually see the wholesale price. But from wholesale to retail price, the markup is defined by the country. Normally, it's between 2.8 to 3.6. So, if my wholesale price is 100, I can sell it for around 330 euros or pounds on average. The markup is significantly different, and within this markup, there are many opportunities for profit depending on who you work with and how you obtain your product.

Which sources of inventory are the cheapest for you?

Of course, those who work with pre-orders.

Pre-orders. What is a typical scenario? Let's say the boutique buys it wholesale for 100 from the brand, and you pre-order.

It depends on the category and brands. Sometimes the brand says you have to tag, so the boutique might say, "Okay, could you please join me to take this, to share this thing we know you might not be able to sell?" That part will be zero. I will buy it at the wholesale price, and the pre-order will be at the wholesale price. Sometimes, the particular item might be wholesale price plus 5, plus 8, plus 12, or plus 20. But basically, it's more like a financial share with them. So, the pre-order is the lowest price.

And what about on-stock?

Regarding on-stock, you can see it's cost plus and retail price minus. For very popular brands like Gucci, when we buy on-stock, it will be the retail price with a certain discount, normally 20% to 25% or even 30%. For some iconic brands that are not the top picks but are still popular and can sell, there will be a wholesale price plus 30%, 40%, or 25%, 22%. It really depends on who you talk with.

And what about the marketplace API?

It will be the retail price minus about 10%, 5%, 15%. For some really low-quality brands, it might be minus 20%.

When you say retail price, do you mean the retail price in Italy or the retail price in China?

The retail price in Italy. If I wanted the retail price in China, why would I work with a boutique?

Exactly, that's why I wanted to make sure. So it's the Italian retail price with a discount. Since in China it's more expensive anyway, there's still a margin to be made. Why are these boutiques taking the risk of ruining their relationships with brands?

One part is that they have been doing this for so many years, and brands try to tell them they cannot, but they gain so much profit from it. It's more like they are greedy. On the other hand, they have grown too big to lose this. Maybe after five years, your company already needs 80% of sales from the gray market. How do you manage that? You cannot afford to change that. You have so many people to support and have made so many promises to the brands. Many brands see you as a big player in the market and give you special privileges, like pre-orders earlier than others. How can you lose this?

Also, in the fashion industry, it's very human. Like, I work with you for many years, and we are super close friends. If you make a mistake, I can tolerate that. If it's a big mistake, I'll tell you not to do it, but I'll still help you. Only if it goes to the media or if it's too damaging will I send a lawyer's letter. Otherwise, it's fine. We grow up together.

That makes sense. How do the brands respond? Or maybe another way to ask the question is, how can brands actually stop the gray markets if they wanted to? Could they actually do it?

You mean if they want to?

Yes, for example, you mentioned LVMH is very hard to get products from, whereas Gucci seems very easy to find in a gray market. What could Gucci do? Let's say in five years the gray market is significantly reduced. How could brands stop their inventory from being in a gray market?

Another important point is when people buy products from the gray market or from us through the marketplaces, most of them take these items to the local brand boutique. They ask, "Hey, I have a problem with my bag, could you please check it for me?" They also use this method to verify if the product is genuine. What Kering and LVMH do is embed RFID chips within the product. If you try to remove them, it will damage the product because they are placed between the layers of leather, making them difficult to remove. They use this to track the product's origin. For instance, if a product is found in China but the chip shows it belongs to a boutique in Italy, they can trace it back and take action, like imposing fines.

All marketplaces are trying to figure out how to handle these chips. While you can't remove them, you can erase the information on them. In 2022, one major topic we focused on was how to erase the chips' data. This way, the chip remains, but no information can be retrieved from it. If nothing is found, brands won't claim ownership or provide customs services. This is a smart approach. Another strategy involves requiring weekly pictures from boutiques, showing their shop, window display, and storage levels. Brands like Italian ones even make surprise visits, informing boutiques in the morning that they're coming for a coffee. That's how Italians handle things with other Italians.

Have you seen examples of brands being aggressive after discovering a boutique is selling on the gray market or to China?

Coach is a good example, and also Prada. They were quite strict. They cut ties with many boutiques, keeping only three or four Italian ones to sell their products. They reorganized their boutiques, demanding proof of capability and reliability to sell their products.

So that means it's hard for products to end up on the gray market.

It's really difficult. Now, when we ask boutiques to provide their brand mix and stock levels, if they claim to have certain brands, we inquire about the seasons they have. If they can't provide the upcoming season's stock, we might not work with them or negotiate a lower commission.

Another thing I want to mention is what Chanel has been doing. They have adjusted their prices globally so that the price you pay in, say, Taiwan, isn't too different from what you pay in France. In 2016, the price difference between Europe and Asia was about 34%. By 2020, if you buy directly from a brand boutique or department stores, this difference has decreased to around 18% to 19%. If you get a department store VIP discount, you might already cover this difference.

Yes, that makes sense. What does that mean for the middlemen? It seems like they are facing challenges, right?

Middlemen who are experienced and have been in the market for a long time still work with boutiques because of their deep relationships.

They avoid being greedy, and if no accidents occur. By accidents, I mean real incidents. Many middlemen I know have faced tragedies that made them fear for their families. In Italy, I met at least three middlemen, big ones like Tier 2 or Tier 1 Daigou. Typically, they have large houses where they store expensive items, often in the basement, for easy sale and shipping. However, they sometimes face threats from locals or other Daigou traders who might use substances to incapacitate their families and steal their products. Some middlemen have had bad experiences, like when boutiques only accepted cash payments. They would arrive in a city, inform the boutique, and then, after checking into a hotel, find their car broken into and all the cash gone. The big middlemen who grow safely usually become part of the boutique circle.

These middlemen are either large enough to work with boutiques or choose to remain small, satisfied with their monthly transactions. Others work directly with brands or department stores. I've seen many middlemen grow by working not only with boutiques but also with department stores' VIP programs.

Another point I want to add is that in the luxury gray market, it's not just about ready-to-wear items, bags, or shoes, but also watches and jewelry.

Yes, I spoke with someone who was a Hong Kong trader in watches last week. It's very interesting. I'd even say it's more like the Wild West, with people trading more freely than even in the luxury market.

For some people, whether it's jewelry, watches, or ready-to-wear fashion, they will directly pay for the whole travel group. They contact a local travel agent in China, go to a small city, and ask who wants to go to Europe for free or at a basic price. The condition is that you can only have cabin luggage; your checked luggage belongs to me. They gather a group of people to go to Europe, either queue at LVMH, Louis Vuitton, or Chanel, or go directly to an outlet. Each suitcase can carry 23 kg of products to bring back to China.

What percentage do you think the gray market is as a percentage of the total luxury market in China? Let's say the total Chinese luxury market is 100. How big is the gray market compared to that?

I'm not quite sure of the current estimation, but from my experience, over 85% of luxury products in China come from the gray market.

So 85% of the products bought in China are from the gray market?

Yes, 85% to 90%, I would say.

So what's the other 10% or 15%?

Think about it. Most Chinese people buy luxury products from marketplaces like Alibaba, Jingdong, VIP.com, POIZON, Secoo, or directly from Daigou. How do these people get products from the gray market?

I see. That makes sense.

That makes sense. So the remaining 10% or 15% comes from company stores, brand stores, and potentially multi-brand boutiques. But I've heard that even multi-brand boutiques sometimes get their products from the gray market.

Yes, that's true. One of my experiences was when I worked for a showroom in the UK. My boss asked me to accompany her to visit boutiques in China on behalf of the brand. We visited around 12 cities in China. Some boutiques were so successful and beautiful. But my boss would ask, "Where did you get this product? I don't remember it being on our order list." It wasn't something I sold to you.

I remember that around 20% of boutiques we visited turned out to be storage locations. When we arrived at the address they provided, it was just storage. I asked my boss if she informed them about our visit. She said, "Oh no, I didn't tell them." I asked if she was sure it was the boutique address they gave us. She confirmed, and I realized it was just storage with no one there.

Yes, that's quite amusing, but it's just how things are sometimes. I've heard that many boutiques selling through marketplaces are worried about payment terms and how quickly they get paid due to cash flow issues. What have you observed about how payment terms have changed over time?

Between the marketplace and boutiques?

Yes, and the supplier, whether it's a parallel trader or a boutique.

When dealing with parallel traders, there's no flexibility with payment terms. They treat everyone the same. Give me money, I'll give you the product. So when a Chinese company works with these Hong Kong companies, they have to pay on time, otherwise they cut straight away. They don't care because I think marketplace is just a small piece for them. But when we work with a boutiques, with the showroom and with local distributors, it can be a bit different.

My first job in China was with Secoo. I asked about our agreement with suppliers, which stated that payments should be made within 30 days. Yet, more than 10 suppliers told me they had been waiting for payment for over six months. Secoo told me it was usual in China, but I realized afterward it wasn't. Regarding marketplaces, besides Alibaba and JD.com, which are FMCG marketplaces, luxury marketplaces often face cash flow problems. They rely on investor capital to grow rather than profit from consumers, as they are still expanding and need to pay bills. Balancing profit and cost is challenging, so they continue to depend on investor funding.

You can imagine that cash flow is really terrible. When you try to get money from investors, they'll ask, "What are you going to bring to me? What kind of new story or scale are you going to reach?" Marketplaces need to show what they are working on. The cash flow is just terrible.

Another thing I mentioned is the relationship between a boutique and the brands. They grow together and have a deep relationship. It's the same between marketplaces and boutiques. When I left Secoo, I still worked in this sector. Even when I was at POIZON, some boutiques told me that Secoo still owes them eight million euros. I asked if they still supply to them, and they said they just cut it last month. I wondered why they kept supplying when they weren't getting paid. They said that in the beginning, Secoo worked well, so they still kept hope.

Did POIZON make a profit, as far as you know? Were they profitable?

I think POIZON is still profitable. They have a stable foundation with runners and trading shoes, which is profitable for them. The challenge is selling globally. After marketplaces grow, their first challenge is the supply chain, and the next is their operation, like net profit rate. The recent challenge is going global because in China, people aren't buying as much, and second-hand might be better. Going global is difficult for Chinese marketplaces. That's why I never wanted to join Alibaba or JD.com; they are so stuck with Chinese logic.

In terms of cash flow, if I were Chinese and bought something on POIZON, like a Gucci bag, I'm paying them now. They get my money now and pay the boutique 30 days later. They have positive cash flow because of that, right? They don't need to pay the boutique until 30 days later, so it's not that bad. Have you seen many boutiques tell the marketplace to buy their inventory upfront? If a boutique in Italy is supplying, say, POIZON or Secoo, with all the history you just mentioned about people not being paid, have many boutiques told the marketplaces, "I need you to pay me now for the inventory I put on your website"?

Yes, a lot. But it's really difficult for a boutique to collect money because even if those companies, even those marketplaces, have a company in Italy, it's still a very small one because it's just a local office. So if they want to sue them, most boutiques already have debt, so they don't want to sue them. Also, the administration in Italy is just terrible. Another thing is, if I sue you, does that mean I also let the brands know I'm doing this?

Let's go back to pre-orders because that's quite an important part. Let's go through it. I'm the boutique, I go to the showroom, I see the products. I tell these parallel traders in Hong Kong, "These are the products you can buy." We agree on which products they buy and at what price. So when does the boutique pay the brand? And then when does the parallel trader pay the boutique?

You have to pay straight away. Pre-orders are the most critical topic in the gray market. You cannot joke with people in pre-orders. You will be cut off directly. Yes, so if you want to do pre-orders, tell me you have money. If you have no money, sorry, I'm not going to work with you. Just go with on-stock.

But what happens if I'm the boutique and I bought because you, as a parallel trader in Hong Kong, told me you had the money, but now I'm stuck with these Gucci bags from Gucci that I ordered because I thought I was going to sell them to you. But then you don't have the money and I'm stuck with the bags. So do you prepay? Does the Hong Kong parallel market prepay for the inventory, or how does that work?

Like today, if I am the parallel trader, I go with the boutique, then maybe I own 50% of this order. I need to pay this 50% on time.

So you're paying at the same time. Basically, you're paying the boutique so they can pay the brand. It's not like the boutique pays, and then you pay the boutique.

Yes, you have to pay me. Like tomorrow is my due time with Gucci. Give me the money now. Otherwise, no Gucci. I will never invite you again.

My last question is, with the market in China in luxury being as hard as it is today and not doing so well, how do you think that will affect the gray market? What will change because of that?

I think they just go to Southeast Asia.

Southeast Asia.

Yes, Southeast Asia. Let's try to sell to them. I think since two or three years ago, because Southeast Asia is growing while China is declining. So they go to Southeast Asia. I know some people also try to go to Africa, but Africa is quite challenging because you might also lose your life as well. So, yes, very few people go to Africa, but a lot of people go to Southeast Asia. And also Korea. Like since three years ago, boutiques started to ask me, like, "Hey, do you know anything about Korea?" We sell to them at a really good price, and they never argue with us or ask for the price back. They are really good customers and they buy so much. I was like, okay, it's something new to me.

That's what I heard too. Well, something similar. Yes. So, do you think the boutiques will sell to Southeast Asia, or do you think the Chinese people who are holding inventory will sell to Southeast Asia? Which did you mean?

Both. I think all of them are doing this because boutiques also receive on-stock orders from Daigou or from smaller traders. So the Southeast Asia market starts to go to them, but still not so much. And yes, the Chinese try everything to survive. So don't worry about them. I think most of the products either go to Southeast Asia or to North America, Canada, and America. And also where the Chinese are.

There was one thing that popped up that I thought about all of a sudden. Yes. So you said about 60% or 65% of the gray market is pre-orders? How much then is marketplace and Daigou and on-stock? I mean, how do you think about the other 35%?

Let's think about it from two sides. One side is the supply side, and one side is the marketplace side. So, marketplace, over 90% of the stock comes from API, which means on-stock; the API and also on-stock. It's so difficult to convince them to buy the pre-stock because they don't know which are going to sell.

Because the marketplace is not like a shop or not like this kind of generation, generations of Hong Kong traders buying office. They can expect what kind of things are going to sell. They can forecast what kind of things are going to sell. But the marketplace can't even tell you. We have so many detailed tools to tell you what kind of things are going to sell. But in luxury, no, none of them can.

Another thing I want to say is actually the gray market, most of the key players, they all have a gang background.

Gang background, what does that mean?

It's like the biggest boutique in Italy. They originally came from a mafia background. So, the biggest boutiques I work with in different countries either come from mafia backgrounds or have very strong political connections, which I feel is similar to mafia. I know some parallel traders who went to Eastern Europe before the war with Ukraine. Ukraine was a popular place for top players to get products because they were directly owned by the mafia. They would lock the shop entirely for you to get whatever you wanted and sell at almost wholesale prices because they wanted cash flow on their books.

And is it the Hong Kong people that have a background in politics and mafia or also Italy?

It's in Europe, and also in Southeast Asia. In these regions, most of the biggest boutiques have owners or backgrounds linked to the mafia.

This is fascinating. It's very, very interesting.

So, when you work with Daigou or parallel traders, some of them will tell you stories about someone knocking on their door in the middle of the night with a suitcase of cash, saying, "Here, two million euros, spend it." Then every week, they bring you more to spend.

It's a way to launder their money, right? I give you cash, you go to the store, you resell it, and suddenly, I can account for this.

Yes; I help you with your business and you help me launder my business?