Tiffany Eats Chow Tai Fook's Breakfast

The Hong Kong jeweler has bulked up in small-town China just as consumers are heading overseas.

Think Tiffany's third-quarter results were bad? Take a look at Chow Tai Fook, the world's largest publicly traded jewelry chain. Net income fell 42 percent in the first half, the Hong Kong company reported Tuesday. With more than seven times as many outlets, Chow Tai Fook has been trailing its New York peer in terms of operating income all year.

Diamond in the Rough

Jewelers' U.S. dollar operating income, trailing 12 months

Source: Company reports, Bloomberg data

To add insult to injury, the main bright spot in Tiffany's results Tuesday was a place where Chow Tai Fook should be cleaning up: Asia. Sales from Japanese stores rose 34 percent in the quarter once the impact of currency movements was stripped out. Chinese tourists accounted for a significant slice of the growth, Tiffany's vice-president of investor relations, Mark Aaron, said on an investor call after the announcement.

There's probably as much serendipity as strategy in this outcome. Japan hasn't traditionally been a big market for Chinese tourists thanks to the frosty relations between the two countries. The reversal of that trend this year probably owes a lot to Middle East Respiratory Syndrome driving mainland holidaymakers away from Korea, Tiffany President Frederic Cumenal said at an investor conference in September.

Chow Tai Fook, on the other hand, doesn't have the excuse of accident. The Hong Kong company has an explicit strategy to shift its sales toward China's provincial and sub-provincial capitals known as Tier 2 and Tier 3 cities. It opened its first Tier 3 outlet back in 2000, and its ``direct, deep and strategic'' access to an expanding middle class in small-town China was an important part of the pitch for its 2011 initial public offering. Over the past four years, the company has added 543 point-of-sale outlets in Tier 2 and Tier 3 cities, compared with 37 in Tier 1 cities such as Beijing and Shanghai and 43 outside of mainland China:

Building in the Bottom Tiers

Chow Tai Fook net jewelry store additions, by region

Source: Company reports

Note: 161 stores in tier 3 cities and 4 in tier 1 cities were reclassified to tier 2 cities during the March 2014 half-year; numbers have been adjusted to reflect this

The logic of this drive has been about branding and long-term positioning: By turning up early in small Chinese cities, Chow Tai Fook gains a first-mover advantage and wins the lasting loyalty of an increasingly affluent public.

That's a compelling narrative, but it has to contend with the fact that Chinese goods don't have a particularly good reputation among Chinese shoppers. Locally bought products are frequently associated with poor quality and counterfeiting, problems that are rife in the jewelry trade. Within the luxury segment, spending via daigou -- informal traders who buy products overseas and send them back to China to escape import duties and ensure authenticity
-- is equivalent to about 50 percent of sales from mainland stores, according to Bain & Co. Lao Feng Xiang, a jeweler controlled by Shanghai's municipal government, has been opening more outlets in Hong Kong precisely to drag up the reputation of its mainland stores by association.

Chow Tai Fook's push into deepest China also sucks up management energy that could be better spent closer to home. The company is promising to cut the pace of new store openings to 60 this year, down from a long-term target of 150 to 200 a year. This is a step in the right direction: Until last year's acquisition of diamond company Hearts on Fire, about 90 percent of Chow Tai Fook's long-term assets were in mainland China, despite the region only generating about half of group operating income. Sales per store in the mainland are yet to rise to one-tenth of their level elsewhere:

Home Ground Advantage

Sales per store at Chow Tai Fook points of sale

Source: Company reports

For Tiffany, on the other hand, the export of China's consumer dollar provides an opening. About 70 percent of luxury spending by Chinese shoppers occurs overseas, according to Bain. Moreover, the spending is higher the further afield you go: Mainland tourists spend about $2,500 a head in the U.S. and Europe, more than double the level in Hong Kong, according to a September report by Fung Business Intelligence Centre and China Luxury Advisors. In Japan and Korea, the spend averages $2,270 a head and $1,922 a head, respectively.

Global companies typically lament the difficulties of gaining a foothold in the Middle Kingdom. On this occasion, the Chinese market is coming to them instead.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

    To contact the author of this story:
    David Fickling in Sydney at

    To contact the editor responsible for this story:
    Matthew Brooker at

    Before it's here, it's on the Bloomberg Terminal.