By  on August 15, 2011

The luxury Swiss watch industry is battling a double punch.

First, the Swiss franc has soared against the value of the euro and the dollar, increasing against the dollar by 12.9 percent in the last month alone. Second, the price of gold — a key material in many luxury watches — has skyrocketed as world stock markets have plummeted.

The strength of the Swiss franc is of more immediate concern for most watchmakers. The strong currency is likely to lead to price increases, although it’s too soon to know their extent — especially once the gold crisis enters the equation. The precious metal increased in value by 11.3 percent from July 12 to Aug. 12, climbing to a record high of $1,817 an ounce Aug. 11 and surpassing even platinum, historically the most expensive and coveted of the precious metals.

Talking about the strength of the franc, Monica Mailander Macaluso, vice chairman of Girard-Perregaux parent Sowind Group, said, “In the last two days, the situation really worsened, because we were mainly 1:1 with the euro and very close with the U.S. dollar — and a company like ours is established in Europe and also in the United States. In one year [the Swiss franc] increased 20 percent [in strength] — and for competitiveness, as you can imagine, this isn’t the best situation. If it lasts, it will really compromise the whole industry.”

Girard-Perregaux, in which PPR became the majority shareholder last month, already has increased prices by between 7 and 10 percent over the last year. Despite this, Macaluso said the company’s business for 2011 is “still very strong,” and numbers are approaching pre-2008 levels.

She maintains that the current strength of the franc affects everyone, but it might be a little more complicated for the Swiss watch industry — especially many of the high-end firms that produce and develop all components and movements in-house (Girard-Perregaux boasts upward of 100 variants of movements).

Then there is the issue of gold, which only adds to the pressure. Nearly 80 percent of 220-year-old Girard-Perregaux’s watch cages are comprised of gold and most of its customers, especially in the Far East, demand the metal.

Jean-Claude Biver, chief executive officer of Hublot, agreed gold is what the luxury watch consumer demands. The brand’s bestselling watch is the Big Bang gold ceramic style — a rose gold design with a black ceramic bezel that retails for $25,800.

In the past year, Biver said that Hublot’s prices have risen between 20 and 25 percent — yet the higher gold prices climb, the more gold watches Hublot sells. Biver contended that consumers are buying more gold timepieces than ever because they’re scared that in another four months the price of the watch will increase even more — and this fear has been a driving factor for sales. The rising price of gold only further reinforces the high-end consumers’ view that luxury watches are an investment.

But Biver admits he is a bit worried that he’s going to lose some of his margin when currencies such as the dollar or the euro become too weak.

“I can’t adjust my prices from one day to another. I must adjust progressively, step by step — but before I have made a full adjustment, I will have lost some margins because I can only adjust by 5 to 7 percent at a time, not 30 percent each day,” said Biver. “I will lose some, but we are ready to lose some margins because that’s life. If you aren’t ready to lose or gain margins, you can’t do business. Business isn’t stable, and sometimes margins are better, and then they are worse. We are used to that.”

His outlook today is as follows: the brand might have the best year in turnover to date, but might eventually suffer in terms of margins.

“Today the market might be in negative and people might think it’s the end of the world, but that’s not how it will be. The market will recuperate and the world will go on and the Swiss franc will weaken again,” Biver said. “I say, please don’t panic and lets see what will happen in the next 12 months. We have been in this watch industry for 450 years — not for 45 minutes. I am not too worried.”

Asked why his perspective on the impending currency and gold crunch is more upbeat than one would expect, his answer is simple: a monopoly on the sector. Since the Swiss watchmaking industry has no real competition in terms of luxury watches, every brand is facing the same issues. No low-cost competitor can break into the sector and steal market share.

His optimism is well founded. In June, Swiss watch sales rose 10.1 percent, to 1.58 billion Swiss francs, or $1.92 billion. Gold timepieces continued to lead the way, gaining 25.7 percent, with steel timepieces seeing a below-average increase. First-half sales increased 19.3 percent versus the same time last year, to 8.7 billion Swiss francs, or $10.34 billion. Dollar figures are converted at average exchange rates for the respective periods.

The increases continued a trend that has been seen since 2010 and come on top of difficult years for the industry as global demand plummeted in the Great Recession.

The rebound has benefited almost every company. First-half net profits of Swatch Group, Switzerland’s largest watch company that also controls production of many of the key components, increased 24.5 percent to 579 million Swiss francs, or $640.2 million, although the company warned the continued strength of the Swiss franc would hurt sales and profits in the second half.

“Continuing strong growth and the positive outlook in local currency will, however, be hampered by uncurbed speculation in the Swiss franc. This will further negatively impact sales growth as well as operating profit and net income,” the group stated.

The strength of the franc is of growing concern across all segments of Swiss industry. The Swiss government last week took the unusual steps of boosting liquidity in Swiss money markets, which caused the franc to slip back a bit, and also hinted that it might consider pegging the value of the franc to that of the euro. Over the last month, the Swiss franc has increased in value by 12 percent against the euro.

David Wu, a luxury goods and beauty research analyst at Telsey Advisory Group, said brands are dealing with the current situation by raising prices — speaking specifically to Compagnie Financière Richemont’s group of prestige watch companies, which include Cartier, Van Cleef & Arpels, Vacheron Constantin, Officine Panerai and Jaeger-LeCoultre. Like Patek Philippe and Girard-Perregaux, the Richemont brands raised prices in the midsingle-digit range between February and April to help offset the pressure from higher gold prices and the stronger Swiss franc, said Wu.

“These price increases aren’t enough to fully compensate for the rise in gold and the stronger Swiss franc. We do expect some pressure on the gross margin,” Wu said, but he noted that many of these brands might not see the magnitude of the effects until at least 12 months from now because if gold is purchased now, it won’t make it to the market until next year.

“At the high end, the consumer is more willing to take on higher prices,” Wu said. “In terms of demand elasticity, it’s a little more inelastic. They are more likely to accept higher prices versus the lower end consumer.”

After all, a 10 percent increase in the luxury watch sector is relative since many of these watches sell for more than $30,000 — and top brands like Patek Philippe or Girard-Perregaux are known for watches that contain highly complicated movements that can take years to craft and cost hundred of thousands of dollars. So it’s unlikely there will be too much price resistance for a luxury consumer who can afford to spend upwards of $100,000 on a timepiece.

According to Wu, gold and diamonds tend to represent about 30 percent of the costs of goods sold on Richemont’s watches — and in addition to raising prices, another way for these brands to mitigate price pressure could be by adjusting the product. When launching new products, Wu said many brands will use slightly less material to offset the rise in gold.

Again, those products are unlikely to be introduced until the next watch shows in Geneva and Basel in 2012. And the pressure could last until at least then. Patek Philippe’s U.S. president Larry Pettinelli believes the situation isn’t going away anytime soon, and is bracing himself for just that.

As a result, he said the brand had it’s second price increase this year. Prices went up 10 percent in February and another 7.5 percent in July — but this is unusual, as the company sometimes goes two to three years without adjusting prices.

Pettinelli’s main concern isn’t the short-term swing in the Swiss franc, which most definitely puts some margin pressure on the company, but taking the time to really figure out how long the situation will last and make cautious decisions with respect to pricing product.

He said the more-than-170-year-old, family-owned company will be careful about modifying prices for a third time this year.

“It’s much easier to go up than to ever go down in price. So when we move up, we move up very slowly and very cautiously,” Pettinelli said. “Frankly speaking, we don’t want to get caught where the dollar gets stronger and swings the other way and we’re overpriced.”

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