You have to feel sorry for the big luxury brands. Encouraged by years of explosive growth and projections of China becoming the world's largest luxury market, they expanded like crazy, opening dozens of new outlets every year and ever-larger flagship stores. And then in late 2012, President Xi Jinping launched his much-publicised crackdown on 'excess'. Ever since, China's luxury industry has been in a flat spin, dazed and confused, lacking clear direction. Is this the end of the 'Golden handbag'?

The past two years have been a hard landing for luxe. Every brand that rode the rocket of 'official gifting' has come down just as hard. The luxury watch business – which dropped 25% immediately after Xi Jinping's speech – is today 95% smaller than the pre-2012 heyday levels. The Macau watch fair was cancelled due to 'low interest'.

High-end liquor has also been decimated. Baijiu, the strong-tasting Chinese white spirit, once a favourite gifting item, has seen sales drop by two-thirds. Even foreign spirit houses, such as Diageo, that are much smaller in volume, are off 25%.

And after years of 'can't-build-them-fast-enough' market demand, Maserati and other luxury car brands have said that sales are now flat. The days of seeing pink Hello Kitty Porsches may be sadly coming to an end, just when I was beginning to appreciate them.

This is a big twist in the China fairytale. China's luxury brands have had to shift from bedazzling the new wealthy with big bling, and then suddenly… the Chinese don't want to look 'flashy' any more, for fear of ending up a target of the luxe purge.

And what is making the whole saga so interesting to observe is knowing that the core desire for 'bling' among the top end hasn't gone anywhere. It lies buried, hibernating, waiting to re-emerge. Having said that, some of it may have gone to Singapore. The guys running the Singapore Luxury Yacht conference said that one of the reasons why they held the event there and not in Shanghai was so that the superwealthy could go to a place where they could publicly, fully, loudly enjoy their boats, away from the gaze of the CCCP (Central Committee of the Communist Party of China).

Mega-wealth aside, the most strategic challenge is that the buyer has changed. With government-gifting under the squeeze, the next most important target audience is the 300 million or so 'middle class' who are enthusiastic to display their luxury taste, but are much more price-sensitive. And this is driving them out of the country for their luxury purchases – so much so that three out of every four luxury items purchased by the Chinese doesn't happen in China. Which also means that the fancy luxury malls are mostly empty ones, which doesn't feel so special.

Luxury brands need new strategies for China. In the recent past, it was about scale. Louis Vuitton and others were in a retail land grab. The bigger and brighter the better. Mass brand recognition helping the perceived value of the gift in the eyes of the recipient. Now, luxury brands are hastily retooling. Their buyer is the user and the experience is now more important than ever. We can see this with the Johnnie Walker House in Shanghai. Part-museum, part-lounge, all luxe. You come away with the story behind the man, behind the bottle. And Montblanc and Gucci (who have perhaps experienced the worst decline) have both opened cafés in a move to rebuild their relationship with a younger, more progressive customer.

But the biggest daily reminder is their attitude towards digital. Luxury brands – always defined by exclusivity – saw digital as anathema to their very essence. The way that digital democratises and makes like-for-like product comparisons easy can commoditise luxury brands and rob them of the magic. Burberry deserves the credit here in being the first major brand to prove this wrong. Not only did it embrace WeChat, it launched its branded Tmall store a year ago and following it have been Estée Lauder, Hugo Boss, Lancôme and others earlier this year.

Although one yellow brick road has been closed off in China, this is putting the focus back on the real consumer. And in surprising and delighting them and the digital platforms in which they reside, luxury brands have nothing to fear and everything to gain.