the trouble(s) with the luxury goods industry

For most of the past quarter-century, the publicly traded luxury goods industry, both companies based in the EU and in the US, has been a source of almost continual outperformance.

the old pattern

Its appeal rested (and I do mean the past tense) on two major trends:

–the gradual aging of the working population in the US and EU.  A twenty- or thirty-something in either area typically aspires to own a work wardrobe, a car and a house.  A forty- or fifty-something, in contrast, wants to own jewelry and a vacation house, and to go on a cruise.

So the rising affluence of older workers in the US and Europe has meant increasing demand for luxury goods.

–growth in Japan and the development of capitalism in China, beginning with Deng’s turn away from Mao in the late 1970s.  Again, increasing affluence has sparked higher demand for globally recognized luxury goods.  In addition, in China “gifts” (read: bribes) of luxury goods have long greased the wheels of bureaucratic approval of new projects–until the ongoing anti-corruption crackdown there began a few years ago, that is.

What has been less well understood is that the unit profits from selling a given luxury good in either China or Japan has been much, much higher than elsewhere (double would be my first approximation).  This means that if Japan/China accounted for 25% of a company’s sales (and a sales figure would typically be all a luxury goods firm would announce), they would represent half the company’s profits.

the new

–the rise of Millennials (the suit, car, house people) in the US and EU and the gradual retirement–and loss of income–of Boomers are putting a crimp in demand for luxury goods in these areas.

–luxury goods sales in Japan have hit a brick wall in recent years.  This is partly demographics, partly the immense loss in purchasing power that the Abenomics-induced depreciation of the yen has caused.

–the China case is a little more complicated.  The main reason for the falloff in Western luxury goods sales there is, of course, the anti-corruption campaign.  But even before this, there was a clear trend of high-end consumers in China away from foreign luxury brands and toward domestic ones.   It also seems to me that years of economic stagnation in the EU have further undermined the image of European brands as cultural symbols of power and influence.  So my guess is that even as/when the anti-corruption campaign runs its course, the bounceback of traditional European luxury goods sales will be muted.

my bottom line

Studying stock performance patterns of the past twenty or thirty years suggests that major selloffs of luxury goods stocks are always buying opportunities.  I don’t think this will be the case any longer.   This is not to say the stocks won’t go up in market rallies.  They likely will.  Bur they won’t be leaders.   And the best-known names will lag firms that primarily serve Millennials, as well as companies that tap into growing consumption in China.

5 responses

  1. isn’t the issue that the idea of a “luxury good” has evolved as well — and I’m not sure the “luxury good industry” has dealt with that. Shoes, watches, and handbags aren’t necessarily the best luxury items.

    Apple devices, to a large extent, are luxury products. So is organic kale. So was Lululemon.

    (sure lower price points but didn’t Tiffany’s make a lot of money at the under $100 segment)

    Tory Burch dating the head of LVMH to me is a sign of that time.

    • Thanks for your comment. You’re absolutely correct. There are certainly generational changes in what constitutes luxury. In addition, the luxury market in most parts of the world is driven by purchases for women. In China, however, purchases for men are more important. You’re also correct that Tiffany has been able to maintain a powerful position in the $10,000+ jewelry market, while selling $200- items labelled with the same brand. TIF is uniquely able to do so, though. Every other company I know that has tried to move its brand name down-market has destroyed its up-market presence in doing so.

      • Ralph Lauren is another company that seems to be able to compete at all price points — they are struggling as well but I think it more about how tired the brand looks now rather than being dragged down.

        I was reading about Tommy Hilfiger and that they made all their money out of Asia for the past 10 years. So you can move it around as well.

        Lulu is a great example of a company that has destroyed it brand by going downmarket. They changed the sizing around — my GF is now a 1 there was previously a 6.

    • Thanks for your question. Selling prices in China or Japan for luxury goods have tended to be very much higher than elsewhere for identical merchandise. +40% would be a standard markup amount. Also, although the transaction might take place in Tokyo, for tax purposes the sale would likely be recorded in Hong Kong–where the corporate tax rate for foreign companies is zero.

      An example: an item sold at retail in the US for $100 might generate pre-tax profit of $50 and after-tax profit of $32.50. The same item might go for $140 in China/Japan, generating pre- and post-tax profit of $90.

      In addition, at least in Japan, local partners might absorb surprisingly large amounts of a luxury firm’s sales and general costs, enough to raise profits by, say, another 10%.

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