PARIS — Antoine Colonna, luxury analyst at Merrill Lynch in Paris, has been fascinated with Japan since he started following the luxury goods sector 10 years ago. After all, the market is vital to the success of any luxury brand and the country remains a consumer paradise (even if its economy has been depressed for more than a decade.)

This story first appeared in the March 12, 2003 issue of WWD.  Subscribe Today.

But the Japanese market for luxury goods is changing rapidly — and not for the better, as Colonna outlines in a comprehensive new report. WWD sat down with him to talk about his findings:

WWD: How important are Japanese consumers for luxury products?

Colonna: Japan accounts for 24 percent of sales for the key luxury firms we cover, which include Bulgari, Gucci Group, Hermès, LVMH Moët Hennessy Louis Vuitton, Richemont, Swatch Group and Tod’s. Europe actually accounts for more, 38 percent of sales. But we estimate that Japanese travelers account on average for between 5 percent and 20 percent of sales of luxury goods outside of Japan, depending on the brand, city and product category. If you split sales by nationality rather than country or region, Japanese consumers appear to account for more than a third of total luxury sales.

WWD: What’s the biggest misconception about the market?

Colonna: That Japan is an ever-increasing market with superior margins for all players. In fact, the Japanese market is by far the most mature market for luxury labels in the world. The balance of power is already established in most segments.

WWD: Why do people think of Japan as a limitless market for luxury and fashion?

Colonna: People are misled by the good performance of a handful of brands in the past five years. Most of these brands are owned by listed companies and they communicate with the media more than the average. In reality, the majority of the other firms are logically penalized by the recession and have recorded lower growth rates in the period.

WWD: How much has the luxury business in Japan contracted?

Colonna: Contrary to popular perception, luxury consumption patterns of the Japanese are subject to the laws of economics. Since 1996, the Japanese luxury goods market for apparel and accessories has lost approximately a third of its value.

WWD: What’s the outlook for 2003?

Colonna: We expect the luxury market to be flat both in Japan and on a global basis: Merrill Lynch economists are anticipating for Japan, the U.S. and Europe gross domestic product (GDP) growth of, respectively, 0 percent, 2.3 percent and 1.2 percent, or 1.6 percent for all the G7 countries [the U.S., Japan, the U.K., Germany, France, Canada and Italy] for 2003. Analysts with sales growth estimates in the mid-single-digit range on a reported basis are in our view too optimistic given the likely significant negative currency impact on revenues this year.

WWD: If the overall luxury pie in Japan is shrinking, how do you account for the fantastic performance some companies report?

Colonna: This is because the market is still extremely fragmented but at the same time increasingly oligopolistic. The companies who dominate the market all show the same characteristics. First, they enjoy superior brand awareness-recognition and high intent-to-purchase figures. They’re known for being innovative. They have superior advertising power, and they appeal to a good balance of age groups. This is where the Japanese market does not defy gravity but accentuates the superiority of the leading brands. The European and U.S. markets are less mature.

WWD: Are the Japanese interested in all fashion brands?

Colonna: No, they’re mostly interested in the best brands in each product category. In our view, the true star brands on the market are Burberry, Cartier, Chanel, Hermès, Rolex and Louis Vuitton.

WWD: What about the wannabe stars. Do they have any chance?

Colonna: There are two types of wannabes in Japan: the ones that are already very strong in their home markets and backed by parent companies with deep pockets like Coach, Fendi, Montblanc, Tod’s, etc. — these ones should do very well in coming years, even if they are growing with a much easier comparison basis compared with star brands — and the ones that are very small in absolute terms and often with a limited financial surface and are looking at the Japanese market only as an additional source of growth.

WWD: Are high prices why Japanese buy so much fashion when they travel?

Colonna: Yes and no. Because of gift-giving practices and the fact that they still travel less than other nationalities given their income per capita, one could argue that they are just trying to take advantage of price differences when they travel. Frankly, we expect other Asians and Americans to take advantage of price differences as well going forward. We see this trend as a worldwide phenomenon whereby affluent U.S. citizens who travel a lot, for instance, will be more and more tempted to take advantage of price differentials on high price points going forward.

WWD: Is it true some Japanese will scrimp on necessities in order to buy more luxury goods?

Colonna: The middle class is increasingly suffering because of the rising unemployment. It has a strong tendency to carefully choose products. These consumers have been reevaluating brands with the recession. They look for real value, seek out quality items that last, have superior understanding of the value items and no longer accept goods of inferior rank after enjoying the taste of luxury. Whereas the traditional Japanese consumer demanded quality at any price, today’s customers are often more price sensitive than their Western counterparts, even if they are less willing to compromise quality for price. Among young Japanese, many purchase all necessities at 100 yen shops — the equivalent of North American dollar stores. They buy basic necessities there in order to devote the rest of their income to whatever they really like: electronics devices, restaurants and, of course, fashion.

WWD: What are “parasite singles,” and why are they so important to luxury companies?

Colonna: The “parasite single” syndrome has been an important growth driver for luxury goods companies in Japan since the mid-Nineties. The term refers to young men and women who live with their parents well into adulthood, enjoying a carefree and well-to-do life. The number of parasite singles today exceeds one out of 10 Japanese. Parents provide room and board, making whatever income these young people have almost entirely disposable. We estimate that these consumers account for as much as 30 percent to 40 percent of the most prestigious European brands’ sales in Japan. Remember, most Japanese do not own cars in major cities since public transport is easily available. Additionally, it is also important to dress up in the best possible style in Japan.

WWD: Is there anything else about the nature of Japan that drives luxury sales?

Colonna: Yes, we believe there’s a deeper motivation: hedonism. With the economic downturn and the progressive crumbling of traditional values like lifetime employment, jobs with predictable and timed promotions and stable families, many young Japanese are no longer willing to make the same sacrifices as their parents. They have a new way to see life and spend one’s money. Buying luxury goods is hedonistic consumption by excellence: the sole purpose of the expense being pleasure. Also important is the fact that 71 percent of households have no children, which stimulates luxury goods consumption, in the near term, anyway.

WWD: Where does the huge interest in luxury goods come from?

Colonna: There are economic, cultural-sociological and demographic arguments. Most luxury goods companies entered the luxury goods market during the Seventies and Eighties, two periods of tremendous growth and affluence for Japan. During these two decades, luxury firms also took advantage of three major positive trends. First, the Japanese elite have always demonstrated a strong knowledge and appreciation for fine craftsmanship. For example, Hermès has been supplying products to elite Japanese for about 100 years. Secondly, steady yen appreciation led to a boost to travel flows. There were 2.6 times more overseas travelers in 1990 than in 1980, which supported sales of European-U.S. luxury goods companies in Japan. Between 1970 and 1990, yen appreciation against the dollar averaged 5 percent per year. Finally, disposable income increased dramatically at a compound annual rate of 4.7 percent in the Seventies and 2.6 percent in the Eighties. The bubble economy and rising semiannual bonuses enabled Japanese consumers to spend a high proportion of their incomes on traveling and shopping.

WWD: Are some brands guilty of overexpanding in Japan?

Colonna: Definitely, even if this is a worldwide phenomenon, particularly on the retail front with “white elephant” stores. The problem in Japan is running costs can prove quickly higher than in other regions of the world and corresponding losses as well, even if rents are proportional to revenues. Frankly, I would say that virtually all the companies or at least some of their subsidiaries that we follow overexpanded in Japan in the past decade. Going forward, this is why the leading ones will continue to increase their market share.

WWD: Is there any new trend in how foreign brands manage their distribution in Japan?

Colonna: The Japanese department store channel has to reinvent itself, otherwise it will always give most of the retail margin to the directly operated stores of the star brands.

WWD: What’s your number-one piece of advice for a fashion company wanting to do business in Japan?

Colonna: No compromise on product quality and customer service, otherwise beware. Compromising on short-term retail expansion or product diversification is in my view understandable. But jeopardizing brand image in today’s environment is the worst thing to do given the increasing maturity of the luxury goods market.

Editor’s Note: This is the debut of Talking Points, a regular WWD Q&A feature.