Business | General
World's luxury goods industry struggles with big challenges
As demand tumbles across the globe due to the financial crisis, top-end brands are facing their biggest challenge in decades. Major manufacturers are saddled with stubbornly high costs, leaving little room for manoeuvre.
- Financial Times
- Published: 23:05 June 17, 2009
For years, equity analysts urged Johann Rupert to spin off tobacco and turn Richemont, the company he chairs and controls, into a 'pure play' luxury goods group.
In 2008, the independently-minded Rupert finally took heed and returned Richemont's stake in British American Tobacco (BAT) to shareholders, leaving his group focused on Cartier jewellery, Montblanc pens and much else.
Today, some of the same pundits are regretting the loss of those high and stable BAT dividends, as the world's luxury goods industry struggles with its biggest challenges in decades.
Demand has tumbled virtually across the globe with no clear sign of recovery. Manufacturers from LVMH Moet Hennessy Louis Vuitton, the world's biggest luxury goods group, to Italy's Bulgari, find themselves saddled with stubbornly high costs, leaving little room for manoeuvre.
Even beauty has proved vulnerable, contrary to the common claim, as figures for L'Oreal and others show.
On top of the market problems, the sector faces tough secular change. Globalisation has put a premium on size - but sheer mass risks diluting the exclusivity that is luxury groups' key feature.
The grim economic backdrop has also come just as some companies, notably in leather goods and fashion, face anxieties about ethics and environmentalism.
Advocates of sustainability have targeted groups using rare species and skins; parfumiers have to cater to growing interest in all things organic.
Ever fickle, luxury goods have turned near impossible to predict - as the irony of Richemont's restructuring demonstrates. So hard has it become to forecast the market that many top manufacturers have virtually given up.
"Visibility is non-existent," Norbert Platt, Richemont's chief executive, says.
The unpropitious circumstances have been reflected in grim results. Bulgari has incurred its first quarterly loss in 10 years.
Burberry, the UK fashion brand familiar for its distinctive plaid, last month reported its first full year loss. Richemont's sales in April, the first month of its new financial year, were down 19 per cent.
Tiffany's first-quarter sales and profits tumbled as expected. And last month, Christian Lacroix, one of the biggest names in French fashion, filed for protection from creditors.
With the scope for cost-cutting limited, brands have turned to 'cost containment'. Hiring has stopped, temporary labour contracts have been suspended and pay sometimes frozen. Store networks, particularly in the stricken US, have been pruned.
Richemont is closing 62 outlets, mainly in the US, while Burberry has taken heavy charges on the value of its Spanish stores. And everyone is looking to protect cash flow by reducing inventories and squeezing suppliers.
In an image-driven business, only marketing and advertising have escaped relatively unharmed, as manufacturers fear tarnishing their brands.
Reducing share of voice risks inflicting permanent damage in an industry where customer perceptions are vital. Manufacturing has also been protected - as far as possible - with fashion and watchmaking brands especially aware of the difficulties of replacing highly-trained seamstresses or watchmakers when the upturn comes.
How severely companies have reacted has depended on market factors and on owners' perceptions of the crisis, in an industry still dominated by individuals.
Richemont's Rupert has been among the hawks, warning of the sharpest downturn in 20 years. Francesco Trapani, chief executive of Bulgari, by contrast, said last month his group had registered a "clear sign of improvement" in April, both at its directly-operated stores and even in the tougher third-party distribution channel.
Burberry's Angela Ahrendts reinforced that message, noting recently that the recession was beginning to diminish. And Nicolas and Nick Hayek, the father and son team at Swatch Group, maintain the second half will bring a distinct improvement.
More objectively, Bain & Co, the management consultancy, believes the luxury goods market will shrink by 10 per cent this year, with the pain concentrated in the first half, following a flat 2008.
But some broader themes have emerged. Take geography. Those brands particularly exposed to the US have faced the biggest challenge, with Japan not far behind. Europe has been mixed, while Asia, notably China, has remained resilient. Bain expects only China and the Middle East to escape this year's contraction.
Robust Asian markets have tended to favour the larger groups, such as LVMH or PPR, owner of Gucci, with the broadest international networks and the resources to have invested heavily there.
"In the current context, we see emerging markets exposure to be the key factor limiting adverse trends in more mature markets," Luca Solca, luxury analyst at Sanford Bernstein, notes.
Products are the second key factor. Firm data is scarce, but many analysts argue that, in hard times for even the rich, cheaper items, such as shoes or handbags, hold up better than pricier ones.
"Gift giving will still go on in the sub $1,000 (Dh3,670) bracket, but not with watches costing $50,000 or more," Jon Cox, analyst at Kepler Capital Markets, says.
The breadth of a group's range also matters. Here, the evidence is not compelling - as the relative health of Hermes shows.
But most analysts say companies with products spanning price points are more protected than those, like the French silk and leatherware group, that are more tightly focused.
A broader portfolio means manufacturers can cater to consumers trading down, and can provide muscle with third-party wholesalers and retailers.
In a market where prominence has become more pertinent than ever, distribution has gained ground. Independent retailers, facing stretched credit lines, have destocked rapidly to preserve cash flow.
Luxury goods brands with a high proportion of directly operated stores, have enjoyed greater protection than those dependent on third parties.
"We continue to see risks associated with a high exposure to the wholesale network - channels must destock before a recovery in sales can occur," Louise Singlehurst of Morgan Stanley, says.
Having a portfolio of products, such as at LVMH, Richemont or PPR, has helped to spread risk. While financial flexibility may be more dependent on gearing than size, bigger groups can spread costs over much larger turnovers, enjoy greater potential for cost synergies, and more sway over suppliers.
With centralised treasury operations, the largest groups may also be better placed to withst and currency swings. And they may have deeper and better qualified management pools. Recent upheavals at Italy's Versace have spotlighted the potential for internal squabbling when times get tough.
Finally, the largest groups may be best placed to exploit opportunities from the tougher market. That means anything from negotiating better product positioning in stores to improved terms from media outlets or rental contracts from mall owners.
Ultimately, the biggest groups may also seize any rare chances for acquisitions in a still-fragmented industry. Richemont's Rupert has said none of the companies he covets is for sale.
But he - and others - have taken care to avoid mistakes of the previous downturn after 2001 by ensuring strong balance sheets. That not only reassures shareholders, but also provides the financial firepower to act should the chance arise.
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