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Hanwha’s retreat shows difficulties in duty-free

Licenses are no longer guaranteed cash cows as competition builds
May 03,2019
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Duty-free shops were once considered golden geese, but Hanwha’s decision Tuesday to close its duty-free business highlights overly heated competition within the industry.

Three years ago, Hanwha acquired the five-year right to operate a city duty-free shop, one of seven lucky newcomers to the industry including Shinsegae, Doota, Hana Tour and HDC Shilla.

In December 2015, the group opened Hanwha Galleria Timeworld, which runs Hanwha Duty Free, in the iconic 63 Square skyscraper in Yeongdeungpo District, western Seoul. It still has a year remaining on its license, but Hanwha will shut it on Sept. 30 - not surprising since it has run losses totaling more than 100 billion won ($89.7 million).

Back in 2015, when the government renewed city duty-free shop licenses for the first time in 15 years, Korea was enjoying rapid growth in the duty-free industry thanks to hordes of tourists from China.

The number of city duty-free shops in Seoul - meaning shops in downtown areas rather than airports - increased from six to 13 that year.

Among the newcomers, Shinsegae Duty Free and HDC Shilla Duty Free have managed to find grooves. The rest are not in a good shape.

Hana Tour’s SM Duty Free in central Seoul shrunk its six-story shop to just two, while Doota Duty Free, also in central Seoul, shrunk its operating hours from 13 and a half hours a day to just 10 and a half.

The major reason for Hanwha’s failure is its poor location, according to Seo Yong-gu, a professor teaching business at Sookmyung Women’s University.

“First off, there are hardly any tourist attractions near the 63 Building,” said Seo. “Secondly, despite its success in the department store business [Hanwha Galleria], operating department stores and duty-free shops are completely different.”

Operating duty-free shops requires heavy initial investments to purchase all the luxury inventory, Seo said.

“So companies with deeper pockets are able to secure a larger number of brands and goods, and thereby, are able to secure price competitiveness. Duty-free is an industry with a high entry barrier, and smaller companies can hardly succeed in this business,” said Seo.

“For a duty-free operator to succeed, it needs to secure diverse and unique brands as well as a network to be able to secure foreign tourists,” said Kim Nam-jo, a professor teaching division of tourism at Hanyang University. “Embedding a strong brand value is also crucial. Smaller duty-free shops, therefore, have a lower chance to succeed in this industry.”

But duty-free operators also found themselves blindsided by geopolitics.

A major problem was China’s retaliation against Korea for the deployment of the U.S.-led Terminal High Altitude Area Defense (Thaad) anti-missile system in 2017.

Beijing pulled the plug on Chinese tour groups traveling to Korea. The number of Chinese tourists fell by nearly 60 percent at the height of tensions after Beijing banned the tours in 2017.

Beijing has yet to lift the ban entirely. Industry insiders hope for some alleviation in June, when Chinese President Xi Jinping will reportedly visit Korea.

Following the ban, individual shoppers, nicknamed daigou, started dominating Korea’s duty-free sales. They purchase great amounts of luxury goods and cosmetics in Korea to resell on their return home. They have become the main source of income for duty-free operators in Korea, accounting for up to 70 percent of their sales.

But profitability has narrowed because of the increased competition to entice daigou shoppers. Commissions have to be paid to agencies that manage daigou shoppers to get them into the shop and discounts offered to get them to spend.

Commissions are said to eat up around 7 percent of a duty-free operator’s entire sales.

From 2016 through last year, the duty-free market in Korea continued to grow: by 33.5 percent in 2016, 17.9 percent in 2017 and 31 percent in 2018. According to the Korea Customs Service, the size of the duty-free market in Korea stood at 18.96 trillion won last year.

“Even though sales have grown, our operating profit has retreated,” said a source in the industry. “We have to provide commissions and also provide large discounts. The discounts grow, in fact, the more the shoppers spend.”

In fact, some say Korea’s duty-free industry is ripe for some changes that a shake-up may bring about.

“There is no such thing as sales commission offered by any duty-free shops around the world, except in Korea ,” said Seo. “It shows the distortion of the industry that developed in the country following the rapid growth of the industry.”

BY JIN MIN-JI [jin.minji@joongang.co.kr]