SEA CHANGE IN LUXURY
THE LIMITS OF THE LUXURY MARKET’S RESILIENCY WERE PUT TO THE TEST IN 2001. COMPANY RESULTS REFLECTED THAT PRESSURE, BUT LONG-STANDING STRATEGIES HARDLY BUDGED.

Byline: Dana Telsey

Prior to 2001, conventional wisdom suggested that the luxury goods industry was more insulated from broader economic volatility since wealthy people generally remain that way in good times and bad. Since the wealth among the world’s richest people continues to become more concentrated and the number of high-net-worth individuals expanded an impressive 22 percent in 1999-2000, the target luxury goods customer base is seemingly much stronger today than it has been in the past.
In the second half of 2001, one of the most geopolitically charged and macroeconomically challenging periods in history, luxury sales were no longer achieving the robust sales gains that they had enjoyed during the first half of the year. We attribute the marked slowdown to two factors: the effect of a sluggish global economy (and of pronounced weakness in the U.S. in particular) and to the tragic events of Sept. 11, which impaired the “feel-good” factor that is critical to luxury goods sales. To be fair, many luxury goods companies were still able to post stronger sales gains than their more accessibly priced counterparts during 2001, but not on the same scale they did in 2000.
Sept. 11 was a shock to the world, and had an immediate negative impact on the share prices and sales results of luxury goods companies worldwide. Since the market losses have largely been regained, company executives, investors and consumers alike are left wondering about how the future will unfold. Travel and tourism are important drivers of luxury goods sales, and can account for as much as 30 percent of a luxury brand’s revenues. We estimate that Japanese travelers alone account for 10 to 15 percent of total industry sales. With major luxury goods outposts in the U.S. and Europe feeling the pinch, restoring consumer confidence in the safety of travel and tourism is critical to the future sales and earnings prospects of luxury goods companies.
In the aftermath of Sept. 11, many industry observers believe that the desire to spend on discretionary items in the face of such mass destruction and loss has been squelched. On the other hand, many believe that the escapism, fantasy and indulgence that luxury goods offer are precisely what people need in times of such distress. We have seen indications of both: Sales of luxury goods have languished in the U.S. post-Sept. 11, although sales trends for the hottest brands, such as Yves Saint Laurent Rive Gauche and Christian Dior, continue to achieve stupendous gains — in the six weeks ended March 16, YSL’s sales were 218 percent higher than the year-earlier period.
What we find particularly interesting about luxury goods sales during 2001 are the different trends that emerged across brands. Those positioned at the highest end of the market — Brioni, Bulgari and Hermes among them — demonstrated the most top-line resilience during the second half of 2001. In fact, Bulgari’s jewelry sales expanded 19 percent during the second half of 2001, which comes on top of 31 percent growth in the second half of 2000, and compares with total second-half 2001 sales growth of .8 percent. (Bulgari’s average jewelry price point is $4,000.)
Brands such as Gucci and Tiffany, which have become more accessible to a broader customer base over the past few years, have clearly seen their more aspirational customers take a breather, as evidenced by dramatic second-half sales declines. Tiffany’s average transaction size fell during the fourth quarter of last year, an increase in customer traffic in its stores outside of New York notwithstanding. While Gucci claims to have maintained its average transaction size during the latter part of 2001, fewer customers are shopping the brand. Product-wise, fragrance sales at Bulgari and Hermes posted healthy sales gains during the second half of last year, indicating that more economically sensitive customers are perhaps still interested in luxury brands, albeit at lower price points.
In the past, the geographic diversity of luxury goods companies has acted as a hedge to being overly reliant on any one country or region of the world. We estimate that Europe accounts for one-third of industry sales, and Asia and North America represent nearly 45 percent and 20 percent, respectively. With global economies so tightly linked today, the mid-2000 softness in the U.S. was soon felt in other key luxury goods markets such as Europe and Japan. Although Coach’s sales held up well, companies with the most exposure in the U.S., such as Tiffany and Gucci, found their sales hit hardest (although sales of Coach merchandise remained strong). After Sept. 11, luxury flagship stores located in key European tourist destinations began to see their sales challenged by the lack of American and Japanese tourists.
Despite the top-line challenges faced by luxury goods companies, luxury brands, which include heritage and prestige among their most precious assets, aren’t likely to begin to lower prices to generate more sales. In fact, YSL spent most of 2001 eliminating points of sale in order to elevate the profile of the brand among the most discerning consumers. Maintaining brand strength by continued investment in product development, superior craftsmanship and creativity are paramount to the long-term success of a luxury brand. While advertising and communications are areas where companies can trim costs easily, most luxury goods companies, such as Tiffany and LVMH, aren’t likely to go that route. Bulgari, on the other hand, does plan to reduce its advertising expenditure to between 8 and 9 percent of sales during 2002, which is down considerably from its historic level of about 12 to 13 percent. To be fair, Bulgari has needed to support its entry into many new markets in the past, and now appears to be focusing more on brand maintenance.
The growth initiatives that the luxury goods companies have undertaken over the last few years — such as broadening their product assortments, extending their price ranges, and expanding their geographic presence — have made strategic sense and position them for greater, and more sustainable, long-term earnings growth. The development of global, directly operated store networks allows luxury goods companies to maintain sales growth in an environment where travel and tourism have been curtailed significantly. In addition, many companies are seeing operational improvement that should lead to higher profit margins.
Whether it is gross margin expansion through internally manufactured merchandise (as at Gucci and Tiffany), or advertising and rental expense leverage achieved across a portfolio of brands, many luxury goods companies boast strong fundamentals for their core brands. For example, the Gucci brand was able to achieve 350 basis points of operating margin improvement in the face of a meager 1.4 percent sales gain during 2001, largely through continued improvement in operating efficiency thanks to lower costs and increased vertical integration.
Luxury goods companies have learned from past challenging times. The development of Asian-Pacific directly operated store networks is the result of a decline in tourism that was experienced during the 1997-1998 Asian financial crisis. Today, luxury goods sales gains in Asia, and in Japan in particular, are among the strongest given the falloff in leisure travel. The Gucci brand’s Japanese retail sales advanced an astounding 20.7 percent during the fourth quarter of last year, reflecting a decline in Japanese tourism and, as a result, more local buying. During the fourth quarter of last year, Tiffany’s Japanese sales rose 5 percent in constant currency, fueled by an increase in the number of units sold and a slight increase in the average transaction size. Sales outside of Tokyo were stronger than sales in Tokyo, a phenomenon that we believe reflects the benefit of developing a local customer in secondary markets.
The second half of 2001 began a frightening new age in world politics, but it also marked the dawn of a new era for luxury goods companies. After a few years of tremendous consolidation activity, the leading luxury goods companies — such as Gucci Group, LVMH, Prada and Richemont — are focusing more on organic growth and cleaning house during 2002. For example, recent top-line challenges have incited LVMH to take decisive measures to reduce the operating costs at its Selective Retailing Division, and at its tourist-dependent DFS business in particular. LVMH has stated its intention to focus more intently on its star brands in its core luxury business and, as such, reduced its ownership stakes in noncore businesses such as Philips, de Pury & Luxembourg and Pommery champagne. Prada has also disposed of its interests in the Byblos and Fendi brands.
We remain optimistic about the long-term health of the luxury goods business, but sales and earnings will likely remain challenging over the near term. The benefit of a renewed focus on improving core businesses will take time to be realized. It is our impression that although sales trends are showing signs of improvement, they remain weak. Most luxury goods companies are up against strong sales gains that were achieved during the first half of 2001. North American luxury goods sales will likely be down throughout the first half of this year, European sales could be somewhat lackluster due to the absence of Japanese and American tourists, and Japanese sales will likely remain strong. Since 2002 is shaping up to be a transitional year, we believe that the sector as a whole will emerge stronger and more profitable in 2003.

Dana Telsey is senior managing director of Bear, Stearns & Co. with responsibility for coverage of specialty stores and luxury goods. She joined Bear, Stearns in 1994 following positions with C.J. Lawrence and, earlier in her career, Baron Capital. Guest Spot will be a regular feature of The WWD Business Review.

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