By Miles Socha
with contributions from Samantha Conti
 on April 16, 2016

BRIC countries have cooled, tourists are skittish and currencies remain volatile.

This story first appeared in the April 13, 2016 issue of WWD. Subscribe Today.

And so it’s back to fundamentals for Europe’s big luxury players, adapting to a period of slower growth for the sector by intensifying sales density in existing stores, stealing market share from rivals, keeping costs carefully in check — and keeping an eye out for acquisition opportunities.

“When volatility and challenges increase in the business, everybody must go back to the basics,” said Armando Branchini, deputy chairman of Milan-based consultancy InterCorporate, forecasting that companies will become “more consumer-centric and more product-centric.”

“Luxury companies seem to have gradually evolved from a reaction of denial to a sort of acceptance of the new realities, namely a lower and more volatile growth profile,” noted Thomas Chauvet, luxury analyst at Citi. “On that basis, most have started to adjust their business models accordingly by reducing retail expansion, focusing on reducing discretionary expenses, thinking harder on global pricing strategy and returning cash to shareholders.”

Expectations for 2016 are modest — low single-digit organic growth — much like ho-hum 2015.

Chauvet cited evidence of a weak start to the year, with continued double-digit sales declines in Hong Kong and Macau, normalizing trends in Japan, further weakness in the U.S. and softer European tourism after the terrorist attacks and recent Chinese currency depreciation.

Other hurdles this year include the threat of further terrorist attacks, which is already scaring tourists away from the big shopping cities such as Paris and London; Britain’s vote on whether to leave the European Union, which is spooking investors and businesses; lackluster economic growth in Europe and the U.S., and low oil prices.

According to Branchini, the rash of designer changes at the top levels of luxury — Lanvin, Dior, Saint Laurent, Ermenegildo Zegna and Ferragamo among them — reflect a shift from easy growth in China to a tougher slog, compelling brands to become newly appealing to customers in more established luxury markets, including Millennials.

“Many companies need to find a way of revamping their product identity to hopefully enter a new phase of interest for the target clientele,” he explained.

Mario Ortelli, analyst at Bernstein, said the key is “product innovation” to stoke a brand’s desirability and win market share. This could require a retooling of the supply chain to build a more continuous product flow and encourage more frequent store visits. “When the market is booming, there is space for everyone. In a muted climate, we will have winners and losers.”

He projects that jewelry will be the fastest-growing category in 2016, followed by accessories, ready-to-wear, perfumes and cosmetics. Watches are still likely to struggle.

“To grow at faster rates, say 5 percent, companies have to either gain market share; be exposed to growth segments, such as digital players; trade in more resilient absolute luxury segments, such as Hermès or Brunello Cucinelli; lower beta categories, like perfumes and cosmetics; or execute well on turnaround efforts, like Gucci,” said Rogerio Fujimori, luxury analyst at RBC Europe Limited.

Analysts agreed that most brands will scale back store openings in favor of closing underperforming units, revamping plum ones — and maximizing sales per square foot.

“Burberry is a good example of a greater focus on retail productivity,” Fujimori said, noting tactics could include customer analytics, more targeted marketing, elevating customer service via training and multilingual staff, more personalization and bumping up the average spend. “The big challenge for big luxury brands is to have the right product at the right time at the right location, given rapidly shifting travel flows on the back of foreign exchange swings.”

It’s no wonder, then, that Yoox Net-a-porter Group just signed a deal with IBM aimed largely at improving customer service and deliveries. YNAP is looking to personalize customer and brand experiences; sharpen its customer insights, analytics and cognitive capabilities. “For me, one of the biggest enemies of customer experience is ‘out of stock,’ and we’re able to eliminate that by having the product at the right time for our customers,” said Alex Alexander, YNAP’s chief information officer, after the IBM news.

What can be done in-store? Ortelli said brands are likely to reallocate space within existing locations to exalt performing categories. It’s a way to tap into the demand of more aspirational consumers who travel abroad less than the more affluent and therefore buy more domestically.

The luxury market is not alone in suffering the chill winds of the macroeconomy. Lord Simon Wolfson, chief executive officer of British high street giant Next, said he fears this year could be the retailer’s toughest since 2008. The fashion sector overall, he pointed out, is suffering as consumers opt to spend on restaurants, travel and leisure.

As for the next potential El Dorado, Branchini said he’s bullish on Southeast Asia, noting there are some 600 million consumers across Singapore, Malaysia, the Philippines, Indonesia and neighboring countries — all with no visa requirements or travel restrictions.

Fujimori added that Mexico looks “OK,” while Japan and Australia are “pockets of strength today.”

Observers agreed the slow-growth climate, combined with the liquidity of most European countries, could lead to more acquisitions. Firms said to be in play include Balmain and Isabel Marant, while potential targets could include Missoni, Etro, Chopard, Audemars Piguet or even Ferragamo.

While margins are likely to come under pressure, brands would be wise to resist aggressive cost-cutting. “I would not expect a reduction in marketing as a percentage of sales as companies should focus on protecting long-term brand equity,” Fujimori said.

Analysts expect greater divergence in share-price performance. Citi’s top pick for the next 12 months is Kering. “It benefits from self-help and turnaround at Gucci, exceptional growth momentum at Saint Laurent and the smaller brands (Balenciaga, McQueen), potential simplification of the group structure with an exit strategy from Sports & Lifestyle, and attractive absolute and relative valuation,” Chauvet said.

HSBC has buy ratings on LVMH, Richemont and Moncler and forecasts that the “sector should see lower but healthier growth.” It’s also more hopeful for the second half, noting in a recent report that travel flows could pick up, equity markets should stabilize, allowing growth to resume.

China, it said, “is paradoxically the only [place] where trends are accelerating.…With the U.S. being expensive, parts of Europe perceived by some as unsafe, and Hong Kong dull, mainlanders who may want to go to Seoul, Tokyo, Bangkok or Australia — the hot destinations today — may also opt to stay at home.”