In the wake of the Brexit vote, the U.K. economy wavered due to investor panic and a severe drop in the British pound. In October 2016, the pound fell to its lowest rate against the U.S. dollar since 1985, almost 20 percent since the EU referendum.
As a result of currency fluctuations, the U.K. has become one of the least expensive luxury markets in the world. A majority of luxury goods are now cheaper in the U.K. than anywhere else, leading to a shift in tourist spending power to the country. British luxury fashion house, Burberry, reported a 40 percent increase in U.K. sales in the quarter ending December 31, 2016. The immediate effects of Brexit have clearly been beneficial to the luxury brand’s topline. However, if manufacturing and shipping costs are mainly in foreign currency, the increase in sales may not be enough to offset these higher costs.
It will become increasingly difficult to analyze the trends in the U.K. luxury industry and whether the upturn in the market is a result of organic growth or the “Brexit effect.”
The results of the EU referendum have led to a surge of tourists flocking to the U.K. The latest statistics from VisitBritain show a growth in inbound visits during 2017 of 8 percent and visitor spend of 9 percent. Moreover, for the first quarter of 2017, visitors from North America increased by 16 percent and 27 percent from China. Some large U.S. luxury brands rely on foreign shoppers for a significant portion of their sales. Historically, travelers have purchased luxury goods in the U.S., as goods were traditionally cheaper here.
The Brexit effect is already putting additional pressure on U.S. luxury brands’ earnings. Those with a strong U.K. presence may experience an approximately 10 to 15 percent decrease in consolidated sales value. This earnings decrease may put pressure on other markets, such as Europe or China, to reduce the gap.
For U.S. luxury companies with a strong international presence, determining the impact of Brexit on worldwide sales will be a challenge. The industry already faces domestic concerns with the ongoing decline in mall traffic and the shift of consumer spending to online platforms.
In its latest 10k filing, Tiffany & Co. disclosed that “A continued strengthening of the U.S. dollar against foreign currencies would require the company to raise its retail prices in order to maintain its worldwide relative pricing structure.” Traditionally, slumps in exchange rates trigger companies to reassess the retail price of goods in foreign markets to avoid large fluctuations in consolidated reported sales.
Sharp drops in exchange rates increase the risk of goods entering the grey market — the trade of authentic goods through distribution channels unintended by the original manufacturer. There is an incentive to buy goods in a cheaper market and resell them in countries where the retail price is higher, resulting in lower profits for the original manufacturer.
Monitoring the grey market can be challenging. Companies must have the ability to trace the location where each of their products originally entered the marketplace. This can be both expensive and difficult to manage. For a business-to-consumer model, grey-market goods are more easily identifiable, as each point of sale location belongs to the company, whereas in a business-to-business model, there are multiple parties in the distribution chain which can affect the brand’s visibility of the market price.
The grey market can damage both price positioning and a brand’s reputation. A traditional way to protect a brand against the grey market has been to realign retail prices worldwide to discourage these practices.
The obvious resolution for the worldwide luxury market is to increase prices in U.K. boutiques to restore market norms in consumer purchasing and maintain profit levels worldwide. Brands such as Russian jeweler Fabergé and Swiss watchmaker Rolex have already increased their retail prices in Britain by 10 percent. Companies must be mindful that the price increase remains within a reasonable corridor and does not fall outside their current transfer pricing structure. If the price increase in the U.K. is too high, U.K. customers may be alienated.
Historically, price repositioning to control the grey market has proved successful. In 2014, some products in Chanel boutiques in Europe were 40 percent cheaper than in China. In May 2015, Chanel announced the objective to maintain worldwide prices not fluctuating more than 10 percent above and below the global Euro benchmark. As a result, Chanel lowered its prices in China by 20 percent, and reported in May 2016 that despite its challenges in China’s luxury industry, Chanel was seeing signs of success against the grey market in China.
Luxury brands need to continue developing their global-pricing strategy to minimize the effects of Brexit on the brand, its consumers and relationships with its trading partners.
It is clear that Brexit’s impact on the global luxury market will continue to evolve over the next few years. In the U.S., there have been recent discussions on potential renegotiation of current trade agreements, as well as consideration of border taxes on imports, which were eventually shelved ahead of the release of the tax reform plan. In this context, luxury companies’ global pricing strategies will prove valuable to manage the level of uncertainty in the market.
Caroline Brown is audit manager at Mazars USA LLP.