[At a Crossroads: Duty-Free] Post-COVID Era, the Taigong Dilemma

Increasing Dependence on Daigou Sales... Overheated Competition in Customer Referral Fees
Criticism of Daigou Resale, Vicious Cycle of Luxury Brand Store Closures in City Centers
Mid- to Long-Term Structural Transformation Requires Time and Self-Regulation Efforts
Entering Incheon Airport Market in Unprepared State Poses 'Crisis'

The domestic duty-free industry is engulfed in great concern as it approaches next week's bidding for the ‘Incheon International Airport 10-year Duty-Free Operator’ contract, which is set to shake up the industrial landscape. After enduring the long COVID-19 tunnel and entering the endemic era (periodic outbreaks of infectious diseases), those hopeful for an industry recovery are now facing a signal of change with the emergence of a wildcard: the global No.1 operator, China’s state-owned duty-free group (CDFG). If CDFG is selected as the operator, it would mean that a massive Chinese state-owned enterprise would gain a bloodless entry into the symbolic gateway of Korea, Incheon Airport, absorbing Chinese customers who are key to the domestic duty-free business and expanding its footprint into downtown stores, thereby growing its presence in the domestic duty-free market. While it is not unusual for overseas duty-free operators to participate in global airport competitive bids, the intense tension stems from structural problems within the domestic duty-free industry. The industry’s reliance on Chinese ‘daigou’ (personal shoppers) was re-highlighted amid the major changes in the global duty-free business caused by COVID-19, and as luxury brands withdraw from Korean downtown stores criticizing this sales method, we examine the current situation and solutions surrounding the unprepared entry of China’s No.1 operator amid unresolved structural issues.

According to the Korea Duty Free Association, last year’s domestic duty-free annual sales amounted to KRW 17.8164 trillion. Although the skies gradually reopened in the endemic era and many foreigners visiting Seoul’s Myeongdong and Samseong-dong for tourism or business were noticeable, the annual duty-free sales did not surpass the previous year’s level (KRW 17.8334 trillion). This was only 71.7% of the 2019 sales before the COVID-19 outbreak (KRW 24.8586 trillion).

Daigou Sales Share Is Absolute... Limits of Self-Regulation on Customer Referral Fees

Domestic duty-free annual sales, which had slipped to KRW 15.5052 trillion in 2020 due to the direct impact of COVID-19, slightly recovered in 2021 and maintained a similar level last year. The industry attributes this to China’s ‘zero-COVID’ policy. China’s continued lockdowns restricted cross-border movement, leading to a decrease in daigou sales as well.

After the THAAD (Terminal High Altitude Area Defense) incident, as Chinese travel to Korea sharply declined, the duty-free industry entered into contracts where travel agencies would send daigou shoppers to duty-free stores and pay a portion of daigou sales as customer referral fees. During the COVID-19 period, with a sharp drop in domestic and international travelers, the domestic duty-free industry’s dependence on daigou increased, at times exceeding 90% of total sales. The cutthroat competition over referral fees to retain these customers escalated to a self-destructive level. Amid worsening business conditions and the entry of latecomers, daigou referral fee rates soared from the mid-10% range before COVID-19 to the high 40% range at one point.

According to the office of Hong Seong-guk, a member of the Democratic Party, referral fees paid by domestic duty-free stores in 2021 reached KRW 3.8745 trillion, accounting for 21.7% of total sales. This was a sharp increase from 5.30% in 2019, just before COVID-19. It is expected that last year’s figure exceeded KRW 4 trillion. Hotel Shilla disclosed that its brokerage fees from Q1 to Q3 last year amounted to KRW 1.04526 trillion, already surpassing the 2021 annual fee (KRW 1.0628 trillion). Considering that about 90% of brokerage fees are daigou referral fees, it is anticipated that the industry-wide referral fees also surged significantly this year.

With overheated competition, the Korea Customs Service launched a public-private consultative body for the duty-free industry to mediate, and the industry is also preparing self-help measures. Since the beginning of this year, despite accepting sales declines, efforts have been made to reduce excessive referral fees to improve profitability. The referral fee rate, which recently dropped to the 30% range, is expected by the industry to fall to the 20% range by the end of this year. However, if this relies solely on industry self-regulation, aggressive fee setting could return at any time depending on circumstances. Ultimately, unless the fundamental sales structure, which is overwhelmingly dependent on daigou, changes, transformation will be difficult. The Korea Duty Free Association has already started a survey this month on the current status and methods of referral fee payments by each company to prepare countermeasures.

Daigou Resale Quality Not Maintained... Luxury Brands Leaving Korean Downtown Stores

Duty-free stores, which circulate business through economies of scale based on their location and brands, place great importance on which brands they attract and where they operate. This helps them break into new business areas and gain leverage in negotiations with new brands. For this reason, recent global luxury brands’ policies to restrict sales channels are bad news for domestic duty-free operators. Here again, the concentration of daigou sales is cited as the cause.

Luxury brands, having passed through the era of liquidity caused by COVID-19 and seeing an increase in potential customers with purchasing power, are adopting policies to restrict sales channels to enhance product value and scarcity. They are critical of daigou buying large quantities of products at domestic duty-free stores and reselling them in China. A representative brand is Louis Vuitton. Louis Vuitton has announced plans to focus on airport duty-free operations and has withdrawn from Lotte Duty Free Busan and Jeju, and Shilla Duty Free Jeju, gradually ceasing operations in domestic downtown stores.

In the endemic era with the resumption of overseas travel, whether duty-free operators can secure luxury brand presence is expected to become even more important. This will also significantly impact domestic duty-free stores’ overseas expansion efforts to diversify sales channels. An industry insider said, "We are working on measures to diversify domestic duty-free customers after the endemic, but this must coincide with the cooling down of overheated daigou referral fee competition and other cost issues. For structural change, the industry must unite in the mid-to-long term, but it is not easy." He added, "We are also striving to strengthen overseas markets, but that too requires time."

This content was produced with the assistance of AI translation services.