Zara's Biggest Flagship in China Was in Chengdu. Why Did It Close?

Zara's pause on new stores and H&M's aggressive expansion send the same signal: the good years of opening stores on the back of the department-store bubble are over.

On February 7, at No. 31 Zongfu Road in Chengdu's Chunxi Road shopping district, the Zara once billed as its "largest flagship store in China and first image store" closed its doors.

The store ran to 3,000 square meters and sat inside Lesen Department Store. When it opened six years ago, it took the space Louis Vuitton and Dior had occupied, spreading across the first three floors, and was announced as the first flagship in Greater China built to Zara's "new, more design-led image." Local coverage at the time described Lesen Department Store pinning on it the hope of turning from "high-end luxury" into a "trend-led department store." The Zara logo at the entrance was even bigger than the Lesen Shopping Center sign itself.

Now the display windows have been stripped bare, with a single notice pasted up: the store is closed, please shop at the Ito-Yokado or Taikoo Li Zara stores.

It's Not That Zara Is Doing Badly

Read on its own, the news invites the thought that Zara's sales must be sliding. The store that shut was no ordinary outlet, after all, but a former image store.

Look at the financial reports, though, and you find that over the past year Zara's parent company, Inditex, has not taken the hit that luxury brands or traditional teen apparel chains have. As of July 31 last year, Inditex's total sales were about €10.5 billion, up 11% year on year, with net profit of €1.26 billion; Zara accounted for 66.5% of sales.

Zara's rethink of its retail channels is not news either. From last March it had already begun slowing the pace of store openings, cutting its planned annual increase in store floor space from 8%-10% to 6%-8%, because part of its sales had moved online, where "the average order value on the official website has passed that of the physical stores." In an official statement, Zara said new stores would now mean "flagships in prime locations, like the three-floor standalone store in Manhattan's SoHo."

Wall Street analysts largely approved of the shift. Bernstein banking analyst Jamie Merriman told Reuters: "Inditex is now clearly able to grow its market share in a more e-commerce-driven, less capital-intensive way."

In China the shift came earlier still. In 2014 Inditex opened an official flagship store on Tmall to push online sales. In August 2015 the group said that once its store count in Greater China passed 500 it would slow the pace of opening new stores, because "in the early period we moved into shopping malls too eagerly; the next job is to open flagship stores in key cities." In the first quarter of that year, Inditex opened only 8 new stores in China, against 44 in the first quarter of 2014.

So Why Close a Store That Opened With So Much Noise?

Lesen Department Store was founded in 2010. Zongfu Road, where it stands, runs along the northern edge of Chengdu's Chunxi Road shopping district and is regarded as a cluster for high-end brands. Next door is the five-star Crowne Plaza, and nearby sit Wangfujing Department Store, Pacific Department Store, Times Parkson, and old chains such as Japan's Ito-Yokado and Isetan.

But to people in Chengdu, No. 31 Zongfu Road was never prime shopping ground. It has even been nicknamed the "mall Bermuda Triangle." Before Lesen arrived, the Sichuan department store brand Hezheng Parkson and the well-known Japanese chain Seibu Department Store each ran there, neither for long. Seibu in particular once stood alongside department stores like Meimei Licheng and Renhe Chuntian, and brought Chengdu high-end brands including Louis Vuitton, Dior, Dickson Watch & Jewellery, Longchamp and CK — and lasted only three years.

One big problem is the dated building itself. In an interview with Tianfu Morning Post, Ran Lichun, president of the Sichuan Chain Commerce Association and secretary-general of the Sichuan Commercial Real Estate Alliance, said that "the design of this property doesn't fit what a modern department store needs; businesses have kept moving in only because of the location." The five-story building presents a frontage on Zongfu Road just 4 meters wide, yet runs 154 meters deep, with low ceilings and elevators tucked out of sight. Some residents say, "I get lost every time I go — the layout is too complicated."

Another problem is that Lesen Department Store sits at the out-of-the-way northern end of the old Chunxi Road district, yet pays rent no lower than the center. In 2011 rents near Zongfu Road ran to at least 300 yuan per square meter a month, which over 3,000 square meters meant at least 1 million yuan a month. Li He, 28, from Chengdu, told QDaily: "Lesen Department Store is on the north corner of the Chunxi Road district. To get there from Chunxi Road you have to take either the pedestrian bridge or the underpass — it's a bit far. Between the malls in the Chunxi Road district itself it's all shopping streets, hardly any cars, easy to walk."

When He Yulan, chairwoman of Lesen Department Store Co., bought No. 31 Zongfu Road and the neighboring Dongfeng Shopping Mall in 2010, she meant to carry on Seibu's high-end positioning, knocking the two properties together into a single luxury mall of more than 30,000 square meters. But after Louis Vuitton, Dior, Versace and others closed and pulled out, saying the space was "too small to meet the needs of business expansion," she began to see the problem with the building, and decided to bring in Zara as the starting point for turning the department store toward fashion.

At the opening ceremony she told Tianfu Morning Post, confidently, that the new customers would be the white-collar workers packed into the office towers around it. "This is a good site, with steady daily foot traffic of 80,000 — an excellent commercial location. The Zara flagship leases only three floors of Lesen Department Store; we plan to convert the remaining floors into offices, and then bring in more high-street brands like H&M, C&A and Uniqlo, and make this a high-street fashion district."

The advertising value of that foot traffic was another point raised at the time, by the ad industry's Yang Jian: "By our estimate, an outdoor billboard that size in a spot like this would cost at least 4 million yuan a year."

That was exactly what Zara needed in 2011. It had been in China only four years and was in a hurry to cover 60 key first- and second-tier cities and build its name. Chinese commercial real estate was booming at the same moment: some 400 new department stores opened across the country that year. Riding the wave, Zara went through its fastest growth since entering China, opening 156 stores — more than the 119 it had accumulated since 2006. Yet in Chengdu, seen as the commercial hub of the southwest and a city with real spending power, Zara had only two small stores before 2011, in Ito-Yokado and Kaidan.

It is easy to imagine how tempting Lesen Department Store must have looked, offering 3,000 square meters in the high-end Chunxi Road district. And how badly a traditional department store with a narrow product mix and an urgent need to change needed Zara to pull in newer, livelier shoppers.

But the market today is nothing like the market then. In 2015, IFS and Sino-Ocean Taikoo Li — on the eastern side of the Chunxi Road district, built as a new kind of experiential street — became Chengdu's new commercial landmarks. That April, Zara, among the first tenants, opened a three-floor standalone flagship at Taikoo Li, claimed as the largest, newest and best-stocked in the Asia-Pacific. If you haven't forgotten, that is precisely what was described above: "flagships in prime locations, like the three-floor standalone store in Manhattan's SoHo."

Which left three Zaras within a ten-minute walk of one another in the Chunxi Road district: the Ito-Yokado store, the Sino-Ocean Taikoo Li store and the Zongfu Road store. Sun Daidai, who works in Chengdu, told QDaily, "The whole Chunxi Road area is malls — you can browse there for ages, and Zara is everywhere anyway, so there's no reason to make a special trip."

Plenty of brands have moved too. Last year Gucci closed its store at the Renhe Chuntian department store on People's East Road and opened a new image store at Sino-Ocean Taikoo Li; the fast-fashion brand Gap closed its store on the Chunxi Road pedestrian street.

"IFS and Taikoo Li really did have a big effect — foot traffic here has dropped at least 50%. People head straight for the shopping centers now, they don't walk the streets," Du Bin, general manager of leasing services at RET, told QDaily. "Old department stores not being big enough is a common problem. Shopping centers now are big and handsome, anyone shopping with a purpose goes there, brands choose to open there — it has taken at least 30% off old department stores' sales. The Lesen Zara was not the best choice for shoppers or for the store."

Over the past five years Lesen also failed to land the other fast-fashion brands it had counted on. Zara stood alone. For many shoppers it loomed larger than Lesen Department Store itself. "I've never heard of Lesen Department Store, but I've heard of the Zara on Zongfu Road — my impression is that store never has many people in it," Qu Xiaohui, 24, told QDaily. BEE, who grew up in Chengdu, hasn't been to Zongfu Road in years and still thought "the first floor of Lesen is Louis Vuitton and Dior."

Rents on Zongfu Road, meanwhile, kept climbing — by Du Bin's figures, to 25 to 40 yuan per square meter a day — and the floor space still couldn't match the Taikoo Li district. Lesen paid nearly 300 million yuan in 2010 for the Chengdu Dongfeng Commercial Plaza at No. 29 Zongfu Road, expanding into the 32,000-square-meter Lesen Shopping Center, but that is thin next to IFS's 200,000 square meters and Sino-Ocean Taikoo Li's 114,000.

For Zara, which runs a short, fast supply chain and sells on thin margins in volume, the choice of site is fatal. As we analyzed in an earlier article, it has no concept of a city transfer hub; goods ship straight to the scattered points of its retail network. Even with rent subsidies from landlords, stores with piled-up inventory and sales that miss their targets have to close to stop the bleeding.

Looking back at the Lesen store on Chengdu's Zongfu Road that has just shut, it counts as one of the clearest cases of what Zara called "moving into shopping malls too eagerly in the early period."

Lesen Department Store Won't Be the Only One

On Shanghai's Huaihai Road you can find much the same story.

In 2007, Huashi Plaza on middle Huaihai Road, trying to break out of the traditional department store layout, cleared the cosmetics, footwear and womenswear counters off its first two floors and leased the space to two fast-fashion brands, Zara and UR, while the third, fourth and fifth floors kept their menswear, youth sportswear and dining.

According to a Labor Daily report from the time, Huashi Plaza had tried offices, restaurants and nightclubs, and never traded well. "The main problem was a big flower bed that used to stand between Huaihai Road and the building, cutting it off from the flow of shoppers. The mall removed the flower bed, but the plaza was still underused." After years of vacancy, Huashi was bought outright by the Dutch fund ING in 2005 and converted into a shopping experience center in 2007.

But fast fashion is plainly no longer commercial real estate's cure-all. In 2006 a Zara had already opened at Shanghai Times Square, 2 kilometers from Huashi. Then new-style shopping centers such as K11 and iapm opened one after another on middle Huaihai Road and drew off crowds of their own.

We asked five white-collar workers in Shanghai, picked at random, who like to shop in their spare time. Only one had been to Huashi, and she went for the children's wear brand Mothercare rather than Zara (she didn't know Mothercare has since moved out too). Asked which Zara in Shanghai they most like to visit, these people in their twenties and thirties named Grand Gateway, Super Brand Mall, the Nanjing West Road store and the Nanjing East Road store — all averaging more than 3,000 square meters. Their reasons: "close to home or the office," or "a big space, fewer people, a better experience."

The Huashi Zara, barely refurbished since it opened in 2007, is only about 1,000 square meters, which leaves much of the new season with nowhere to hang. In 2014, probably under pressure to turn a profit, Huashi Plaza simply converted everything above the second floor into a business center, letting as much as 60% of its floor area as offices.

Du Bin reckons that among Zara's flagship stores in central Shanghai, the Huashi Plaza store probably ranks near the bottom on sales. "If iapm had a Zara, the Huashi store certainly couldn't survive. Zara's lease at Huashi Plaza is nearly up, too, and whether they renew is an open question."

Lesen and Huashi both show that in this new round of change in commercial real estate, the fast-fashion chains have choices to make as well. As we analyzed in last week's article on H&M, Euromonitor puts the compound annual growth rate of China's apparel retail market between 2016 and 2020 at only 6.3%, far below the 15% for Chinese womenswear and 8% to 10% for menswear that A.T. Kearney forecast in 2013 for 2012 to 2016. Over the same stretch, the compound annual growth rate of the US apparel market is expected to shrink to 2.7%.

Beyond slowing demand, the commercial real estate that fast fashion leans on has, after years of aggressive building, begun to show regional bubbles. In 2013, investment in developing commercial retail space in China rose 28.28% year on year, yet vacancy rates at shopping centers in cities such as Chongqing, Shenyang and Qingdao reached 15% to 20%.

Look at where Zara's Chinese stores are today and the new shopping centers dominate. According to 2013 figures from CBRE's research arm, Wanda Plaza locations accounted for 54% of that year's 192 stores. CapitaLand's Raffles City and COFCO Property's Joy City were also favored.

And although Zara has been planning since 2013 to push down into third- and fourth-tier cities, as much as 85% of its stores are still in first- and second-tier ones. Which means that besides picking its "flagship stores in key cities" carefully as it moves down the tiers, Zara will also clear out stores in first- and second-tier cities from the past few years whose locations no longer make sense and whose per-store profits are no better than passable. And the department stores that survived the last round of reinvention by leaning on fast fashion will have to find a new way to reach the next generation of shoppers.

To quote Zara's reply to Sichuan News Network: "In certain cases we choose to adjust the location of a store; this is normal business practice."

Having opened stores on the back of the department-store bubble, fast fashion is bound to enter a period of adjustment. The closing of what was once its largest image flagship is one piece of the evidence.

Cover image and images in this article: Winshang, China Textile Network