The domestic duty-free industry leader, Lotte Duty Free, is expected to end its nearly two-year deficit in the first quarter of this year. The primary background for this is the cessation of transactions with "daigong" (Chinese buying agents).
Daigong used to hold a dominant position as a major customer responsible for a large part of the domestic duty-free industry's sales, but it has contributed to deteriorating the revenue of companies by taking excessive commissions.
The domestic duty-free industry, led by Lotte Duty Free, is reducing its reliance on daigong. The results are showing signs of improvement in revenue.
◇ China’s daigong sees increased value amid THAAD and COVID-19
According to related industry sources on the 8th, daigong (代工) is a compound of "代" meaning "to represent" and "工" meaning "artisan," referring to a "proxy purchaser." Generally, it describes individuals or groups who purchase goods overseas, including Korea, and resell them in mainland China for a profit.
Daigong first emerged in the mid-to-late 2000s. At that time, as the demand for overseas luxury goods in China surged, a method of purchasing expensive brands without taxes and delivering them emerged. This purchasing style quickly spread, driven by the increase in direct flights, eased visa regulations, and favorable exchange rates. Subsequently, in the early to mid-2010s, as the Chinese government implemented strict anti-corruption policies aimed at regulating luxury goods, daigong also became popular as a means to circumvent luxury purchases.
Daigong brings products purchased at Korean duty-free shops into mainland China and distributes them through personal WeChat stores or social networking services (SNS), generating price discrepancies. From the duty-free shops' perspective, there was an advantage of being able to easily increase sales volume through them and manage store inventory more easily.
Beginning around 2015, major duty-free shops such as Lotte, Shilla, and Shinsegae actively sought to attract daigong. In this process, companies invested efforts to secure customers, even paying a form of rebate called transaction fees.
Initially, the transaction fees were structured so that the duty-free shops paid a portion of the revenue generated from tourists brought in by travel agencies or guides. However, after the pandemic limited the entry of foreign nationals and led to a decline in revenue, the system was altered to pay commissions to individual daigong. The transaction fees, which were in the range of 10%, surged to 30-40% following the THAAD (Terminal High Altitude Area Defense) incident in 2017 and the COVID-19 pandemic in 2020.
However, with tourism halted during the pandemic, the business structure of the domestic duty-free industry, which had relied on daigong, began to falter. The main consumer group for duty-free shops, Chinese group tourists, who typically have a high spending per capita, stopped coming, while fixed costs like rent for stores at airports continued to accrue. Duty-free companies raised the transaction fees they paid to daigong by up to 50% to protect their revenue, but this resulted in worsening profitability.
An industry insider noted, "From the perspective of duty-free shops, if the sales scale is insufficient, there are constraints in product orders and other areas, meaning that during the pandemic, when tourists disappeared, there was a competitive race to excessively raise transaction fees for daigong."
In fact, the transaction fees, which were 967.2 billion won in 2016, soared to 1.3181 trillion won in 2018, and in 2021, they skyrocketed to 3.8748 trillion won, more than quadrupling. In 2022, they increased by about double to 7.1526 trillion won. Considering the total sales of domestic duty-free stores was approximately 17.8 trillion won that same year, 40% of total sales ended up in the pockets of daigong.
◇ The duty-free industry in crisis shifts focus to revenue and parts ways with daigong
Even in 2023, after the end of the COVID-19 pandemic and the resumption of overseas tourism, the number of Chinese tourists visiting Korea has not recovered. The ongoing economic slump in China and the Chinese government fostering its own duty-free market have contributed to consumption being diverted to local duty-free shops. According to the Korea Tourism Organization, the number of Chinese tourists, which nearly reached 8 million in 2016, dropped to around 4.6 million in 2023, nearly halving.
Sensing the crisis, the duty-free industry agreed to gradually reduce transaction fees starting in January 2023, but losses continued. Last year, the operating losses of the four major domestic duty-free companies (Lotte, Shilla, Hyundai, and Shinsegae) reached about 280 billion won. Leading the way to resolve the situation was Lotte Duty Free, the industry leader in terms of sales, which announced at the end of last year that it would completely cease transactions with daigong.
Thanks to this decision, Lotte Duty Free is expected to return to profitability in the first quarter of this year, putting an end to seven consecutive quarters of losses after the second quarter of 2023. Of course, a significant drop in sales is likely inevitable.
Other companies are also beginning to reduce their reliance on daigong. Hyundai Duty Free decided to close its Dongdaemun store, which mostly relied on daigong revenue, starting this August, and plans to reduce the floor area of its Trade Center store. Earlier, Shinsegae Duty Free also closed its Busan store, which was a downtown duty-free shop, at the beginning of this year. These companies are undergoing significant restructuring measures, including voluntary retirement.
The industry is evaluating that a seismic shift is happening in the long-standing dominant-subordinate relationship between daigong and the duty-free industry. An industry insider stated, "Led by Lotte Duty Free, other companies are joining in reducing their reliance on daigong, and are restructuring their businesses to prioritize securing profitability rather than chasing after sales."
Lee Jin-hyeop, a researcher at Hanwha Investment & Securities, stated, "As the number of clients decreases, daigong must meet the level of profitability desired by duty-free shops to secure inventory. The situation is changing so that duty-free shops can secure a negotiating advantage. An increase in negotiating power will lead to improved profitability."