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Antoine Colonna

Antoine Colonna is the head of Merrill Lynch’s Luxury Goods Equity Research team. He joined Merrill Lynch in 1999 from Crédit Lyonnais, where he held a similar position for eight years. Antoine and his team were named #3 in Institutional Investor’s Global Equity Research on the sector this year and #2 for the second consecutive year as best analyst on Reuters’ European Survey on Textile & Apparel.

The luxury goods sector

Introduction

The world luxury goods market is estimated to be worth $68bn in the broad sense, including wines and spirits selling at about $20 per bottle, with the market growing at an annual rate of 8%-12%. The sector is expected to continue growing at rates in excess of GNP in most developed nations in the foreseeable future, provided that no major world conflict reduces consumer confidence and air travel.

Ready-to-wear designer clothing is the largest segment (26%), followed by Leather & Accessories (17%), Wines & Spirits (15%), Cosmetics (12%), Fragrances (12%), Watches (9%), Jewellery (5%) and Tableware (4%). Geographically, the industry is now quite well balanced between the different continents: North America 30%, Asia 36% and Europe 34%.

1. Note the strong correlation between global GDP growth and sales for the luxury goods sector.

The dynamics of the luxury goods sector are strongly correlated to the macro-economic environment. 1999 was marked by a stronger than expected rebound of Asian economies (excluding Japan) and by vigorous growth in the US. The millennium effect also boosted demand especially in segments like jewellery, watches and tableware. Equity markets exert a strong influence on the fortunes of the sector, especially in the US.

2. Value for money has always been important.

The purchase of luxury goods is often associated with the desire for higher social and/or economic status. This may well be one of the motives, but ironically customers are also motivated to buy luxury goods because they feel that they offer value for money.

Many of the brands that are seen as fashion or status icons - for example Hermes leather goods, Louis Vuitton luggage, and even Chanel’s classic designs - built their reputations by offering value for money. Their high quality seemed to justify their comparatively high price. Looking forward, consumers will continue to pay very high prices for quality and for top design, but will disregard brands that cannot fulfil these criteria.

3. Value for money is becoming more important.

Capacity to provide goods that seem to offer value for money will be a crucial factor in determining likely levels of profitability. Some segments of the industry - for example, watches and leather goods - are much more profitable than others. Because most of the established luxury brand companies are likely to move into these highly profitable areas, customers should have a plethora of choice - and will opt for the brand which seems to offer the best quality and value for money.

4. Consolidation is inevitable.

The luxury goods market is extremely fragmented and there is powerful pressure for consolidation. The biggest companies in the sector will reinforce their market share significantly in the coming years, both through organic and external growth.

Unlike other consumer goods, it is difficult - near impossible - to replicate the established success of a luxury brand, so companies that want to establish a presence in a segment quickly have little choice but to buy their way in. Vertical integration both downstream into retail and upstream into manufacturing also enables groups to capture larger margins and exercise more precise management of the brand.

5. Control over distribution is a major factor in competitive advantage.

Over the past few years, distribution control and its corollary - ‘measured product scarcity’ - have progressively emerged as the key factors for success within the industry. There is a clear correlation between the performance of the most successful brands (Vuitton, Cartier, Gucci, Prada, etc.) and the degree of control they exercise over their boutiques, stores, franchises and wholesale accounts.

The benefits of strong distribution are not only in making sure the products reach the right market, but also in protecting the value of the brand and the pricing policy.

6. Traditionally high levels of profitability may come under pressure.

One of the features that singles out the luxury goods industry from other consumer businesses is the high level of profitability that most of its segments enjoy. Over the next five years, margins could come under pressure as established companies penetrate all segments and tempt younger and less well-established companies to overspend to improve their brand awareness.

Having said that, a number of companies have scope for better margins as free cashflow is often used to buy out franchisees, and the ongoing consolidation allows multi-brand conglomerates to jump-start cross-selling initiatives. This should help margins or at least balance out the possible pressure coming from higher levels of marketing spending.

7. Japanese consumers are key.

The industry’s largest single geographic market is Asia, and more specifically Japan. The Japanese are the largest single body of luxury goods consumers. Sales in Japan account for an estimated 20% of total sales.

If it is assumed that Japanese people travelling abroad buy about 40% of the luxury goods sold in Europe then sales - and a similar level of profits - to Japanese consumers worldwide account for a more sizeable 32%-35% share of the total. Moreover, Japanese customers may account for up to 60% of the total market for certain goods and even more for certain markets (Hawaii, Guam, Saipan). While Japan represents the single largest market in Asia, markets in other countries, such as Korea, Taiwan and China, are growing rapidly.

8. The internet poses challenges to brand management.

Luxury goods’ distribution is based on service, product scarcity and brand awareness. E-Commerce is based on price rebates, order fulfilment and volumes. For luxury goods companies, therefore, the internet will be a test in terms of increasing brand awareness while refraining from brand dilution.

Brands characterised by tightly-held distribution are well placed to control the consumer experience and be profitable online in the medium term. In absolute terms, the so-called ‘low touch’ product categories (ready-to-wear, basic accessories, perfumes/cosmetics, wines and spirits) are likely to sell better than ‘high touch’ ones (shoes, high jewellery).

‘Stocks that lead the rally to the top in late stages of bull markets aren’t likely to lead the rally off the bottom in late stages of bear markets. Newer, smaller, and faster-growing companies rise to the top.’

John Rothchild