China’s Daigou Shopping Model

China’s new e-commerce law, which took effect January 1, 2019, threatens to upend the entire daigou business model. As we’ve written previouslydaigou are individual shoppers who purchase goods overseas and then bring them back to China in their luggage for resale in China. Yearly estimates of the value of goods brought into China this way ranges from about $6 billion to upwards of $100 billion.

The new e-commerce law requires anyone who sells products online to (1) register in China and in the country where they purchase goods and (2) pay all required taxes. If the law is strictly implemented and enforced, this would be the end of daigou, because the vast majority of daigou sales are online, and with few exceptions, the daigou business model requires tax evasion.

Most of the articles about daigou refer to their wares as grey market goods. This is, at best, misleading. The term “grey market” suggests the existence of a legal loophole or ambiguity. But China’s rules on import tariffs, sales tax, and consumption taxes are quite clear: if you import goods into China, they are subject to tariffs. If you resell goods in China, they are subject to tax. If daigou paid the proper duties and taxes, they would have no business because they could not compete on price with legitimate importers. The major exception would be for goods that were difficult or impossible to buy directly in China.

It’s true that from a trademark standpoint, China has no per se prohibition on parallel imports. See China Trademarks: Counterfeit Goods and Parallel Imports. But this is irrelevant to the question of tax fraud and, as we noted previously:

China has attempted to crack down on illegal grey market importation through a number of means, including (1) higher taxes on goods brought in by travelers as part of their luggage, (2) lower taxes on goods imported through legitimate channels; and (3) increased penalties for those caught falsifying customs declarations.

Will China’s new attempt be more successful? Early indications are that it has teeth. Customs officials began cracking down on the import side last fall with enhanced inspections of luggage at airports. Rumors began flying on social media, and then, after LVMH informed investors of such inspections in a conference call last October, luxury goods companies’ stock prices slumped across the board, falling somewhere between 3 and 10 percent later that day.

Many daigou are already migrating away from “classic” e-commerce and into social media or instant messaging, where they describe their products using code words. You would think this, plus the increased scrutiny at the border, would marginalize daigou as a viable sales option – if you make something difficult enough, only the true believers will remain. But I have learned not to be surprised by the ability of Chinese entrepreneurs (and consumers) to turn on a dime in response to changing market/regulatory conditions – to say nothing of their willingness to ignore tax laws.

It may be more difficult for luxury brands to adapt. I had previously posited that although manufacturers might not be concerned about relying on daigou sales, they should be.

It boggles the mind why any company – let alone a major luxury brand – would have a market entry plan dependent on third parties successfully committing tax evasion, but that’s exactly what some brands did, and now they’re scrambling to put together a “real” China strategy. Just for the record, my law firm’s international e-commerce lawyers have always advised against relying on this strategy.

Meanwhile, the trade war lurks as subtext. Right now products brought in by daigou are unofficial in every sense. If they are reported and taxed, then China would reduce its trade imbalance AND increase tax revenues. Easier said than done, even in China. But the trend is clear.