SOUTH KOREA.  The South Korean duty free market posted a +20.7% sales increase last year to a record US$12.8 billion despite a collapse in Chinese tourism from March 2017.

The figures, released this week by the Korean Duty Free Association and expertly analysed by Mirae Asset Daewoo (see chart below), fly in the face of a seemingly catastrophic -49.1% fall in Chinese arrivals through to November last year. The tourism slump resulted from a row between China and South Korea over the latter’s deployment of US anti-missile system THAAD.

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Packing up in duty free for the holiday
I watched as some of the world’s most illustrious beauty brands were stripped out of their packaging and stuffed into this young woman’s holdalls. Doesn’t do much for the selective distribution argument does it?

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Sales to foreigners rose sharply to US$10.6 billion despite a -26.8% drop in foreign customers compared to 2016 (see chart below).

“They generated +23.8% more revenues, implying a huge pick-up in average spend per person (ASP) from foreign customers (+69% year-on-year),” noted Mirae Asset Daewoo Equity Analyst (cosmetics, household goods, duty free shops) Regina Hahm.

That surging per person spend was driven by the daigou (shuttle trader) phenomenon that reached new, often frenzied heights last year (see analysis below).

The ASP from foreigners rocketed from US$369 in 2016 to US$624 last year, while Korean ASP increased marginally by +2.1% to US$109.

“Koreans also contributed to a healthy growth of +12.9% year-on-year, which reflects Koreans’ exceptionally strong spending in duty free,” said Ms Hahm. “We are not seeing such a strong trend in any other retail channels except for online.”

Despite a -28.6% drop in foreign shoppers at South Korean duty free stores, a +69% surge in their average spend drove a +23.8% hike in sales [Source: Mirae Asset Daewoo; Korean Duty Free Association]

[The seemingly anomalous rise in duty free sales to foreigners last year was due to the surge in daigou (shuttle trader) sales. The latest edition of The Moodie e-Zine examined that phenomenon in words and a compelling short video filmed at Busan Gimhae Airport. Click on image to enlarge.]

The influence of daigou shopping was confirmed by a Korea Customs Office spokesman, who told Yonhap News Agency: “Despite the plunge in Chinese tourist arrivals, small-scale Chinese traders have been driving duty-free sales growth.”

These (usually) Chinese ‘shoppers’ travel to South Korea to purchase products for resale in China. However, while benefiting the top line, the daigou business has severely eroded retailer profitablity due to surging commissions to travel agencies specialising in this market. An oversupply of duty free stores (thanks to the former government allowing a proliferation of downtown licences) has added to retailers’ woes.

More positively, the growth in top-line revenues last year, driven by the daigou phenomenon, confirms that Korean items (particularly skincare) remain in high demand in China – THAAD or no THAAD.

Yonhap News cites a Korea Customs Service spokesman, who attributes the Korean duty free results to the growth of daigou shopping

Earlier this month, Incheon International Airport also posted all-time high annual duty free sales of US$2.1 billion in 2017, a +4.1% rise over 2016. As a result, Incheon regained its place as the number one airport for duty free sales worldwide. The airport said its spending mix is much less dependent on Chinese travellers compared with downtown retailers.

Incheon Airport is less reliant on Chinese spend than downtown retailers, a balancing factor that helped drive record duty free sales of US$2.1 billion in 2017

Is the worst over?

November saw a slight easing of the slump in Chinese arrivals amid an apparent resolution to the THAAD dispute (-41.1%), according to Korea Tourism Organization. For the first 11 months, Chinese visitors accounted for 31.4% of all foreign arrivals in South Korea, down from 46.8% in 2016.

If conventional Chinese tourism does bounce back in 2018 and the daigou business continues to grow, it promises to be a very interesting year for Korean duty free. , However, whether daigou sales are ultimately good for the business is a highly debatable question. Different brands have sharply differing attitudes to this business, with some luxury houses believing it is short-sighted and damaging, both to duty free and to the China market. Plenty of others, though, especially in beauty, are happy to accept the immediate rewards.

The November arrivals still don’t make pretty reading but the worst appears to be over for Chinese tourism to South Korea. Source: Korea Tourism Organization