MILAN — Short-term pain for long-term gain.
This was the general view taken by analysts following Prada SpA’s decision on Tuesday to further cut back its wholesale network.
This is an “additional near-term headwind” for the group, said Rogerio Fujimori at RBC Europe Limited. “While clearly positive for long-term brand equity/exclusivity, this decision should weigh on sales performance this year (along with its previous decision to remove end-of-season markdowns) and drive another leg of consensus downgrades for Prada Group.”
Fujimori also believes the move is “consistent with Prada’s aim to enhance brand desirability by cutting exposure to gray market risks and adapting to ongoing consumer shift to e-tailers.”
Equita analyst Paola Carboni said Prada’s move was “commendable” and, while determining a contraction in revenues in the short term, it will “in particular reduc[e] the parallel market to the advantage of the image and positioning of the brand.”
In the long term, the reduction could be offset by “an increase in business through e-tailers, even though the switch will not be immediate,” continued Carboni. “The numbers could suffer a bit especially in Italy and Europe in the short term. To be honest, I did not expect this because Prada gradually set in motion the selective wholesale strategy years ago and I did not foresee such a sudden and drastic approach, but better to have chosen to accelerate the process, it’s consistent also with the work that they are doing on discounts (reducing discounts in their own stores), always with the goal to strengthen the brand.”
One luxury observer, who requested anonymity, also commented on the cut, envisioning a deeper reduction than expected.
The Italian luxury group said on Tuesday that, given “the growing complexity and fragmentation of the wholesale market,” it plans to rationalize its network of independent partners, but did not provide details in terms of numbers or locations.
The decision aims to “ensure greater consistency in pricing policies across retail and digital channels.” It is also seen as a means to further grow the group’s brands in the long term.
A company spokeswoman said that the move will help Prada be “more transparent” with its customers in terms of pricing, have greater control over its distribution and further raise the image of its brands. It is understood it will mainly impact the group’s core leather goods category, which last year accounted for 57 percent of sales.
Armando Branchini, deputy chairman of Milan-based consultancy InterCorporate, believes Prada’s “priority is to have a direct line with its end consumer. This is strategic.” Prada would rather “give up on some business but control distribution and commercial image, optimizing the value chain and the industrial and commercial margins.”
In March, reporting the group’s 2018 financial figures, chief executive officer Patrizio Bertelli emphasized the decision to end markdowns starting in 2019, after gradually reducing them in 2018.
“This has already impacted results and I believe it will utterly strengthen the brand image and guarantee higher margins, yielding results in the medium term,” he said in a conference call with analysts at the time.
For the full year, Prada reported a 17.6 percent decline in net profits, which fell to 205 million euros, on the back of revenues that were up 3 percent to 3.14 billion euros.
In 2018, the retail channel was up 4 percent to 2.53 billion euros, or 7 percent at constant exchange, accounting for 82 percent of total revenues, and it was driven by full-price sales. On the other hand, the wholesale channel was flat with revenues of 566 million euros. Fujimori wrote in the RBC note that Italy and Europe accounted for 50 percent of the wholesale channel.
RBC forecasts a 7.5 percent drop in wholesale revenues at constant exchange rates in the full 2019 year and a 2 percent growth in retail, “held back by lower markdowns and resulting in flat sales on an organic basis and a 2 percent growth on a reported basis, expecting an operating profit of 315 million euros in 2019.” Fujimori also suggested “significant long-term margin recovery potential when we consider the strength of the Prada brand.”
Gian Luca Pacini, equity analyst, branded goods at Intesa SanPaolo, said Prada had been focusing on increasing its retail sales for some years now, aiming at “a distribution entirely under control, like Hermès and Louis Vuitton.”
Since Prada’s initial public offering in 2011, the company has opened many stores, reaching 620 units in 2016 compared with 388 in 2011 and then slowing down in 2017, with five additional doors, and nine in 2018, observed Pacini. “Closing wholesale doors in the cities where you open your stores allows to ease a change in distribution channels,” he said. “In the past few years, traffic has diminished also in directly operated stores and so closing accounts that do not respect the qualitative standards and that perhaps face financial problems and delay payments helps limit the damages.”
Also, the online channel creates “an additional need for price homogeneity.” Brands will have to “continue to tackle the problem of parallel sales and to limit out-of-control discounts, and, for this reason, control over the distribution network will be increasingly more strategic for the luxury world,” concluded Pacini.
Bertelli in the past has been vocal about his company’s efforts to fight unauthorized reselling by selectively weeding out its wholesale accounts and relying on its own retail network to protect the brand. “With regard to wholesale, we have to know that many of these wholesale people in the European market are in it to go for parallel sales, and so they just create some confusion on the international market,” he said back in 2015.
Armando Mammina, owner of consultancy Retablo Milano, said parallel reselling of merchandise that is in season is a reflection of the appeal of a brand, its positioning and expansion. “It is the litmus test of the success of a label,” he said, noting that “uncertainties related to positioning and pricing” are more easily linked to the wholesale channel, and that he has seen brands in the luxury range pay increased attention to their own retail and online channels.
The subject of the gray market remains sort of taboo and trying to shed some light on the trade of authentic goods — not counterfeited — through unofficial or unauthorized distribution channels is generally met with some resistance. Although gray market trading may be shady, it is not illegal. Perhaps the issue highlights the hurdles companies face in controlling such distribution — or, at times, their silent acceptance of a means to boost margins and dispose of unsold goods (although that’s a suggestion that is firmly objected to by most observers of the luxury industry and its main players).
One luxury observer said luxury firms “go to great lengths to preserve their brands’ exclusivity, by even destroying merchandise that has not been sold.”
A Milan-based fashion consultant said there is “some ambivalence” and reluctance to talk about the issue of the gray market as luxury executives “have now become increasingly less tolerant” than before, and are more attentive and proactive in limiting the damage caused by the circulation of unauthorized goods — despite the easy money.
“We must fight the gray market because it disturbs the order of our distribution strategies, it creates problems of control and pricing,” said one luxury executive. “There is only one way to take action: rigorously control whom we sell to and to whom our authorized distributors sell to.”
At the same time, “it is necessary to cooperate with wholesalers, avoiding the imposition of a minimum order that is not proportioned to the store because whatever is not sold will end up in the gray market channel.”
The executive conceded that it is legitimate and understandable for a company to be demanding, expecting orders to better “represent the brand and the way the product is presented in a multibrand” store, but this could lead to excessive orders and eventually parallel sales. The executive said the gray market particularly feeds on accessories and watches from “brands with a very strong desirability, and a very high international notoriety.”
A direct network helps to control the gray market, which in the automotive category affects new models and new cars, while in fashion it applies to end-of–season goods, too, and in those countries where the price differential is significant. The gray market disturbs the official price and observers note that globalization and online sales have made the issue even more relevant now.
It is understood brands don’t want to reduce the margins of their own distribution chain and are turning more and more to pure Internet resellers, from Yoox and Net-a-porter to Vente-Privee, and to their investments in their own e-stores.
“The Internet has changed the rules, it’s transparent, not gray, it feeds the market in a parallel way and fuels international sales,” said one luxury observer, who also said that “very often companies that are not in the high-end range of the market and that don’t have their own retail network, as in watches, computers, or eyewear, for example, face more problems with the gray market, as they cannot control prices. The Internet has made reselling less expensive compared to the past, when one had to physically travel and visit stores and showrooms.”
One fashion veteran, who has worked in the commercial offices of several top Italian brands and manufacturing companies, said gray market sales began in Japan in the Eighties, when firms relied on big trading companies or middlemen, with prices more than doubling at retail.
“This opened enormous room for a parallel market for those customers that did not have the possibility to buy at such steep prices,” said the source.
At the time, companies were not that structured and business was booming, with stores perhaps having a mere 5 percent in remainders. The source singled out the Giorgio Armani company and its senior manager at the time, Pino Brusone, for its structured organization. “Brusone would analyze every single client, working with that client in defining its potential and putting a limit to the purchases. All brands were doubling sales at the time. Armani had a lesser growth in percentage but was solid as a rock, aiming at real exclusivity. Armani and Brusone removed that middleman, the agent, so that clients would meet with the sales personnel directly and were given guidelines to respect the brand’s style.”
A number of companies today have taken charge and are able to track the merchandise through new technology to tackle the growing problem of the sale of counterfeit goods and unauthorized distribution and selling. Products carry a unique identification code that enables consumers to verify their authenticity and the related point of sale anywhere in the world by checking on the Internet.
Also, the Chinese government has been cracking down on illegally operating resellers of goods, the daigous, while price differentials globally have been reduced.
On Tuesday, Prada shares closed down 1.89 percent to 23.30 Hong Kong dollars on the Hong Kong Stock Exchange.