Hainan has grown to become one of the largest luxury travel retail markets globally, rivalling South Korea for the number one position, and dwarfing Hong Kong and other destinations.This spectacular growth has happened as a result of the mainland China government’s resolve to build Hainan as a major Chinese travel destination, driving massive infrastructure investment and creating a uniquely favourable tax environment. The Covid crisis was a powerful catalyst to accelerate Hainan’s growth, as the island became the only destination where Chinese people could travel for most of the past three years. Hainan luxury travel retail sales grew from around US$2 billion in 2019 to $8 billion in 2021.  During Covid, most key Asian travel retail markets experienced steep declines in spending – Hainan was the exception. As a result, major global luxury brands have jumped on the Hainan bandwagon, seeing a huge growth opportunity for their business. Hainan is also a great marketing hub for brands to build awareness and acquire new customers from all over China. During Covid, Hainan became a lifesaver for brands to sell big volumes of products that could not be sold in other channels affected by travel shut-down elsewhere. But coming out of Covid, there was a big question mark over whether Hainan would continue to grow at the same pace, with concerns about ongoing travel to the island and the nature of this traffic. Would Chinese tourists continue to come to Hainan when they have other options? Would high spenders shift back to international destinations? Would travel retail spending in Hainan come down when other travel destinations start to recover?After a drop in sales in 2022 largely caused by China lockdowns, the numbers for the first quarter of this year numbers – which surpassed the first quarter of 2021 – came as a relief.But then Hainan’s growth again stalled in the second quarter, raising new questions and concerns about the extent to which brands should bet on Hainan: The Hainan dilemma. Our firm, OC&C Strategy Consultants, has been exploring this dilemma over several client engagements and research projects recently, and formed the following conclusions:The 2023 Q2 slowdown could be seen as a short-term “normalisation” with the slow-down of China’s economy probably an underlying factor, with falling consumer confidence dampening spending. The Daigou bubble burstsThat said, the bulk of the recent decline is probably tied to the burst of the Daigou “bubble”: Around 40 per cent of Hainan’s duty-free business last year, according to our estimates, was driven by Daigou resellers taking advantage of huge discounting offered by travel retail operators during the Covid crisis. Since then, three factors have led to the dramatic decline of Daigou’s share:The Chinese Government has started to crackdown on Daigou excesses. Creating a favourable environment for the development of Hainan is an important objective but it cannot result in damaging business and, more importantly, tax revenue from domestic sales in the rest of China.Travel retail operators are realising that their business with “industrial Daigou” (done with deep rebates to large organised entities that are reselling throughout China in C2C online platforms) is not very profitable and would rather bank on the revival of the legitimate tourist business.Brands are getting their act together after their excesses of the Covid period, during which some of them became overly dependent on Daigou volume at huge discounts in Hainan and Korea. Some short-term rebalancing of inbound traffic flows may also have affected Hainan, with some of the higher-income travellers shifting back to international destinations, although this probably had a relatively small-scale impact. Given flight capacity and visa constraints slowing down international travel, this may have resulted in a higher mix of lower-tier city visitors who have less spending power.Brands – particularly those in the beauty sector – don’t need to use Hainan as a “clearance” channel as much as they used to during Covid when Hainan had become the only place where they could sell large volumes of products that they could not sell elsewhere. Many brands are now in the process of “cleaning up the mess” of discount excesses that they fell into during Covid.The case for Hainan growth moving forwardThere is a strong case for continued steady growth in Hainan. Firstly, the fundamentals of Hainan’s attractiveness as a travel and shopping destination are solid. Because Hainan is a domestic destination, Chinese people don’t need a passport to visit the island. Hainan’s visitor pool is therefore much bigger than the 10 per cent or so of the Chinese population that hold a passport. The Chinese government has also created unique tax conditions for Hainan visitors, with a duty-free spending limit by trip extended to RMB100,000 (about US$14,000), no duty-free spending limit on single items, and the possibility to shop duty-free online with home delivery for up to 180 days after returning home from Hainan.  Secondly, the ongoing investment in tourism and shopping infrastructure is massive. China’s leading travel retail company CDFG is leading the charge, controlling about 80 per cent of the duty-free mall capacity in Sanya, Haikou and Bo’ao. Competitors – including DFS, HTDF, CNSC and Wanfujing – have also built large, high-quality duty-free malls, hoping to grab a share of Hainan visitors’ wallet.Beyond that, China’s vision for Hainan is much bigger than building a ‘Chinese Hawaii’. Massive investment is planned not only to continue to expand hotel and entertainment capacity (such as an e-sports theme park and a tropical opera house) but also commercial and industrial infrastructure. The plan is to create a fully-fledged free-trade port by 2035.Hainan’s 2025 “seal-off” will be a big milestone, at which time the entire Hainan territory will become duty-free, therefore competing more extensively with Hong Kong, its new status facilitating the expansion of shopping options throughout the island.Another factor in Hainan’s future growth is that higher-income residents in China’s northern regions are increasingly looking for a warmer climate heaven during the tough winter months and we should expect a growing flow of Chinese people choosing Hainan as their home when they retire, making Hainan a “Chinese Florida” – in doing so, creating a new powerful source of business on the island.Finally, as the Hainan economy expands – not just in tourism activities, but increasingly in non-tourism activities as well – the local resident population will start to become wealthier and provide a much bigger source of business in addition to inbound visitors.So, all in all, there are many reasons to be quite bullish on the future of Hainan. What about the rest of Asia?So what are the implications for other travel retail destinations in Asia? South Korea’s travel retail market is taking a big hit, estimated to be down by around 30 per cent since its peak of about $10 billion in 2019, due to the increased competition from Hainan and a crackdown on Chinese Daigou by the Korean government. A big part of the Korean travel retail market decline was driven by Chinese corporate Daigous which have started to shift to Hainan. Korean travel retail operators had become very dependent on these Daigous during Covid, giving them huge rebates. They also realised that the Daigou business was not sufficiently profitable and they are rebalancing their business toward a more genuine and more profitable traveller mix.The Hong Kong travel retail market’s short-term growth has been driven by the rebound of inbound Chinese visitors but with an increased share of day trips from the Greater Bay Area. Hong Kong is still regarded as Asia’s ‘shopping paradise’ for the quality and variety of its shopping experiences – travel retail accounts for only a small percentage of total retail and the entire territory is “duty-free” – but it is increasingly challenged by Hainan. However, even when Hainan becomes entirely duty-free, it will take a while for the island to build the same level of richness in retail, restaurant and cultural experiences that Hong Kong is renowned for offering.Macau’s short-term growth is also being driven by the rebound of Chinese travellers, but its longer-term prospects are affected by the negative impact of China’s government policy to restrict casino-bound junkets, which means that the Macau visitor mix is evolving towards less high-spend high rollers and more towards middle-income families.The Hainan boom is reshuffling the cards among major Chinese traveller destinations, creating an urgency for travel and leisure, luxury goods and other retail players to rethink the role of each destination in their regional strategies.It is also an important trigger for local governments to re-evaluate the strengths and weaknesses of their value proposition as a destination for Chinese visitors in the context of growing competition from Hainan.This story first appeared in the September 2023 issue of Inside Retail Asia magazine.