The future of luxury goods: the Bain study (II)

This is the second of two posts on the latest Bain report on luxury goods.  Here’s a link to the first.

the recent past

If you were to characterize the dominant consumer of luxury goods over the past thirty years, the description would be:

–older

–female

–European or Japanese.

In all likelihood, she would have done the bulk of her spending in a department store.

That’s starting to change.

For a long time, Japan was considered the holy grail of luxury retailing.  A much larger segment of the population there than elsewhere was interested in luxury goods.  Customers wanted the highest quality (read: most expensive).  They purchased often and were relatively insensitive to price.  In fact, luxury retailers routinely set their Japanese retail prices 40% above the European level.

For some years, however, the Japanese luxury star has been waning.  Why?  The market may finally be saturated.  Twenty years of weak economic performance may have robbed consumers of the means to afford luxury goods.  Younger Japanese are clearly not interested in emulating their elders in this–or in much of anything else, for that matter.  In any event, Japanese luxury retailers, whose business was stagnating beforehand, were especially hard hit during the recession.  Business hasn’t been recovering, nor is it expected to.

Europe, although it declined less than the US in 2009, has been a laggard in recovery during 2010.  Damage from toxic financial instruments, questions about the stability of the EU and collective decision among countries to take the path of fiscal austerity as the road to recovery.

In the US, in contrast, the rebound has been surprisingly strong.

China‘s luxury goods consumption grew by 20% during the recession and has accelerated to what Bain estimates to be a 30% advance in 2010.

the new face of luxury…

…is:

–younger

–male

–Chinese.

He is more likely to shop in a brand-owned shop at home, or in Macau or Hong Kong.  That way he is assured the merchandise isn’t counterfeit.  He is, I think, more apt to travel to Europe than the US because the States makes it hard for him to get a visa.  But he’ll do luxury shopping while on vacation, since the prices are much lower.

elements of growth

outlet stores

Long a staple in the US, outlet stores have been expanding rapidly in Europe in recent years.  They’re just about to hit Asian shores as well.  Outlets sell three types of merchandise:

–overstocks,

–seconds and

–products made specifically to be sold in outlets, typically a lower standard of quality than the branded goods sold in front-line company shops or in department stores.

Bain estimates that outlet sales will be up by €2.2 billion ($3.1 billion) vs. 2008 results, at €8.2 billion ($11.5 billion), or just under 5% of total luxury sales.

online

Bain estimates that luxury sales on the internet are growing at about 20% a year.  The consultancy thinks online revenues will total €4.2 billion ($5.9 billion) in 2010, and will comprise about 2.5% of all luxury goods sales.

That’s €1.2 billion ($1.7 billion) ahead of the 2008 level.  The largest part of the increase from two years ago (€700 million) comes from off-price business done on “private sale” websites.  These sites–like Gilt Groupe, RueLaLa or Buy VIP–now account for 30% of online revenues, up from nothing three years ago.

company-owned stores

Distribution of global luxury goods is gradually shifting from indirect to company-owned stores.  Branded retail stores will likely account for 27% of total sales this year, up from 23% just two years ago–a result of increasing new store openings and same store sales growth that’s much faster than the department store channel’s.  At the very least, the luxury goods manufacturers are picking up the wholesale to retail markup–less their costs, of course.  And it’s possible that the larger number of sales locations is expanding the overall market, as well.

China

Bain puts China’s luxury goods purchases at €9.2 billion ($12.9 billion) for this year.  That’s €3.3 billion ($4.6 billion) more than in 2008.  Add €8.3 billion ($11.6 billion) from the combination of Hong Kong, Taiwan and Macau, and “Greater China” accounts for €17.5 billion in luxury sales.  That would be good for third place among individual countries, just a tad below Japan, whose luxury goods sales are projected to be unchanged at €18 billion ($25.2 billion) this year.

investment implications

Let’s assume that Bain is correct and that global luxury goods sales will equal the €167 billion achieved in 2008.

If Bain is correct on the breakout of sales, off-price revenue from internet (€.7 billion) and outlets (€2.2 billion) will have added €2.9 billion to the total.  China will have chipped in an extra €3.3 billion.  This implies that traditional luxury sales will have lost €6 billion+ over the two years.  That is in fact what Bain is forecasting, a loss of €2 billion each from Europe, the US and Japan.

Look at 2011 for a moment.  Bain thinks total luxury sales will be up by 3%-5% at around €175 billion, assuming exchange rates remain constant.  That’s €7 billion better than for 2010.  Let’s pencil in a gain of €2.2 billion for China and €1.6 billion for the combination of off-price internet and outlet sales.  That leaves €3.2 billion for traditional luxury sales, or a growth rate of about 2%.  Given the experience of 2010, one might guess that the US will be a little better than that and both Europe and Japan somewhat worse.

Any way you look at it, though, that’s not much to write home about.

What is a luxury goods manufacturer to do?

1.  China is the only growth game in town.

2.  As China is a male-skewed market, get more male–as LVMH has just done with Hermès.

3.  Move down market to benefit from outlet and possibly also on-line sales.  Neiman Marcus has recently announced a move like this with the creation of Last Call Studio.

4.  Continue to take the added risk of opening retail stores, in order to capture the wholesale to retail markup on products.

5.  Consolidate.

What about investors?

It strikes me that the American companies TIF (I own it) and COH are particularly well-placed.  Both are innovative marketers.  Their brands sell well in the Pacific, although both are burdened with Japanese exposure.  Their status as ersatz luxury brands in the eyes of Europeans works in their favor, both because this gives them extra flexibility and because Europeans seem willing to trade down from their traditional brands.  Hard on the ego, maybe, but not on the bottom line.

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