LUXURY
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S
N
Professor Sonia Marciano
Spring 2011
1
Value Creation by Luxury Firms Has Distinct
Features…
Total Economic Value Created
Buyer
Surplus
Producer
Surplus
Drivers of WTP:
 Quality & style
 Variety & availability of complementary items
 Perhaps most critical are many unquantifiable features
such as exclusivity, “affiliation”, authenticity, how
“classic”, how “trendy”
Price:
 Quantity does increases as price decreases – but
can diminish WTP
Cost:
 Net efficiency gains are valuable but are challenged by:
- Increased monitoring costs
- Preference for the “western made” moniker
• Risk to WTP if increase volume
2
Luxury is Distinct from Other Markets:
• Customer relies on signals rather than
direct observation
• Short term gains often create longer term
liabilities
• Efficiency gains are difficult. Also,
“negative network effects” make these
gains less valuable.
3
Objective of the Luxury Brand is
“Endogenous” Demand
• Endogenous vs. Exogenous
Demand
• Revenues without discounting
4
Airlines Don’t Populate Lists of “Best Brands”
• The travel “vertical” includes the:
– Ride to the airport
– Airport location
– Airport operations
• Airlines responded to low profitability by:
– Outsourcing call centers
– Outsourcing maintenance
– Outsourcing food and other services
• Consequently, airlines typically do not control
much of what affects a flier’s experience.
5
The Airline Story is Analogous to a Luxury Maker
Dependent on Retail Channels Run By Others
• The misalignment between luxury brands and
retail was made clear by Saks’ “nuclear”
discounting in the fall of 2008
– Saks did not anticipate that sales would soften by the
summer of 2008
– Saks went with 70% off rather than risk inventory
accumulation
– Some smaller luxury brands were left with negative
returns
– Luxury brands with their own retail operations were in
an additional pickle as their own stores had to match
Saks’ prices.
6
Some Retail Figures
• Recent returns (rough net income/sales):
–
–
–
–
–
Saks: 1-2%
Nordstrom: 5-6%
Walmart: 5-6%
Gap: 12-14%
Lulu Lemon: 17-19%
• Gross margins are in the 40% range, but net of fixed
operating costs (rent, labor, warehouses,
transportation, etc.), most returns are in the single
digits.
• Turnover (roughly):
–
–
–
–
Saks: 2.5
Macy’s: 3.0
Nordstrom: 6.0
Walmart: 8.9
7
Retail Economics
• Retailers are the re-real estate business --“rents”
are driven by:
– Margins
– Turnover
• Relatively more of their costs are fixed:
– During “good” times, retailers can hold out for
margins and so are aligned with luxury brands
– During “bad” times, retailers may drive turnover
through discounting
• Demand for retail services is relatively exogenous:
– Generally, less customer intimacy with retailers
– Discounting is “quick fix”
8
Key Insights
• Retailers often generate negative externalities on luxury brands
– Saks
– Nordstrom
• How might some brands respond?
– Do their own forecasting! Brands should not be complicit with
retailers being their own (and the brand’s) worst enemy.
– Determine HOW each potential retail “partner” drives turnover -ways to drive turnover including discounting, product mix, location,
operations, forecasting, sales service, etc. Some ways hurt luxury
brands more than others – some may actually be good luxury
brands.
– Don’t think of a “store within a store” as an easy fix:
• Fees are correlated with the “rent” the retailer is earning on its
shelf space
• Retailers see these deals as a “twin edged sword” as this set up
doesn’t leverage their talent, confuses shoppers and reduces
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the retailers operating flexibility.
Integration into Retail Appears
Effective for Larger Players
• LVMH controls around 60 brands
• Operates 2,400 stores
• Arnault family controls 63% of LVMH’s voting
rights
• LVMH uses its reach and concentrated control
to impose discipline on LVMH’s operations.
10
China is Currently LV’s Biggest Market
Where…
• 26 cities have populations in excess of 8
million.
• 93 cities have populations in excess of 5
million.
• 177 cities have populations in excess of 3
million.
In contrast, 35 cities in Europe have populations
in excess of 1 million.
11
LV Doesn’t Economize on Rent or Use the Brand
to Secure a Discount on a Lesser Location
No and
No!
12
LV Chooses the Developer and the Mall
Operator Very Carefully
LV wants to control the look, feel, smell, etc. of
the environment of their stores. Avoids “short
term” wins that could diminish the brand.
13
LV generates Endogenous Demand by Reinforcing Their
Background and Heritage and by Building a
Relationship with Customers
LV sticks with classic
rather than trendy
merchandise—next
best thing to
predicting demand.
14
LV Doesn’t Have a Sense of Humor
About Infringement
15
Preserving WTP in China …
• Harder than in ROW due to
– Culture of bargaining and value seeking
– Government restrictions on luxury advertising
– Challenge in finding brand appropriate, detail oriented
salespeople – 1/1000 make the LV cut.
• LVMH is dominating China (40% share) through its
highly vertically integrated structure.
– Design (France)
– Production(France/US)
– Retail (Ubiquitous)
Notable for their
considered choices.
• LVMH is aggressive about preventing and litigating
IP and copyright infringement
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In Sum
• Like airlines, luxury brands risk WTP through outsourcing
activities and JVs
– The value of luxury brands is impacted by the actions of
other players in their ecosystem.
– Luxury brands need to manage to the externalities.
• It is difficult to amortize the cost of vertical integration
over a few brands, hence, the industry may further
consolidate.
– Interesting that LVMH has taken about a 30% stake in Hermes
(Hermes is resisting).
– LVMH has relatively efficient assets and capabilities with
global reach that would provide leverage for Hermes.
– Hermes, of course, employs highly skilled talent and
craftspeople, has a few hundred retail stores and is a very
exclusive brand with some iconic items. It either cannot
drive more sales on its own or it knows better!
17