Luxury Consumption

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Demand for luxury goods can be seen as a bellweather of burgeoning economies, as wealthy population segments consume more leather goods, clothes, watches, liquor and other high-end goods during boom times. The epicenter of this industry is in Europe, where companies such as LVMH, Swatch and Hermes have established dominant portfolios of luxury goods in a largely consolidated market. However, some of the most interesting regions of luxury consumption are Japan and China:

  • Japan consumes luxury goods twice as much per capita compared to the U.S.; luxury goods consumption in this country is largely unaffected by recession, as evidenced by strong demand during the prolonged economic slowdown recently
  • China is playing an increasingly important role in both outsourcing manufacturing for many luxury goods companies as well as end consumption. If its economy continues to grow at a double digit rate, China will drive a large portion of the growth in the industry. Luxury companies are rushing to establish a foothold in this market, which is not currently dominated by any particular brands

Those seeking to ride the trend of luxury consumption in the U.S. may be best suited investing in U.S.-based "near luxury" companies such as Polo Ralph Lauren (RL) and Tiffany (TIF) or looking at luxury retailers based in the U.S., including Nordstrom, Macy's Bloomingdale's and Saks (SKS).

Consolidating Brands & Diversifying Products

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The Swatch Group owns the Omega brand among many others

The biggest luxury houses own a portfolio of various brands across different luxury categories such as clothing, jewelry, watches, handbags, shoes and even wine and liquors. The table below shows the spread of products offered by several key luxury goods companies (biggest product categories in grey, where information is available).

It should be noted that leather goods and ready-to-wear clothes typically garner the highest operating margins among these categories. For example, LVMH, the largest and most diversified luxury goods manufacturer, generated operating margins of about 30% in these categories compared to 10% and under for its other products. Wines, spirits and liquors are also a high operating margin (30%+) category; LVMH is the only company of those mentioned in this article with substantial holdings in alcohol.

  • LVMH is the most highly diversified luxury goods company in the world, generating over 3 times the revenue (15B Euro) of its next closest competitor. LVMH is an acronym of three key brands (Louis Vuitton Moet Hennessy), but the company is the steward of over 50 various brands:
    • 13 apparel and leather goods brands, including Louis Vuitton, Fendi, Donna Karan
    • 20 wines and spirits, including Domaine Chandon, Veuve Cliquot, Moet & Chandon
    • 10 perfumes, including Christian Dior
    • 7 watches and jewelry, including Tag Heuer
    • 6 retail brands, including Sephora
  • The Swatch Group, the world's largest watch manufacturer, is a unique case study. It is one of the few companies that have successfully expanded vertically across different price segments rather than horizontally across different luxury product categories. It sells watches ranging from the very expensive (i.e., Omega watches start around $1,500) to the inexpensive namesake Swatch brand (<$100). Their horizontal strategy involves expansion across related electrical systems--many of which involve quartz and battery technologies--rather than other luxury goods categories. Watches generate approximately 75% of overall revenues and operating profits.
  • Hermes is an exception to the brand consolidation trend. The company generates nearly all of its sales (95%+) from its namesake brand. Hermes has acquired companies at a slower rate than other luxury goods houses; acquisitions are targeted to fill out product offerings (e.g., crystal ware) and often re-branded as Hermes.

Image: Luxury_Companies_by_Products.jpg

LVMH Richemont (Cartier) The Swatch Group Gucci Group Valentino Hermes Hugo Boss Bulgari
Revenue (Euro, B) 15.3 4.3 3.0* 2.1 2.0 1.5 1.5 1.0
Operating EBIT Margin 20% 17% 19% 29% 12% 26% 12% 16%

*Based on CHF to Euro exchange rate in May 2007

Directly Operated Stores

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Louis Vuitton store, Hong Kong

Directly operated stores (DOS) helps to increase margins in times of rapid growth and high demand and increase the market presence of key brands. However, in times of slower sales, the fixed cost of stores can drag down financial performance.

  • LVMH is the clear leader in directly operated stores with approximately 350 retail outlets
  • The second tier is very competitive, and a handful luxury brands--including Gucci, Dior, Hermes, and Cartier--are bunched around 100-200 stores each
  • LVMH, Tiffany, Dior and Hermes all sell at least two-thirds of their main brands in directly operated stores
  • On the other end of the spectrum, Swatch and Hugo Boss sell the majority of their products (90%+) wholesale

Outsourcing Manufacturing

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This made-to-order handbag is crafted with diamonds and alligator skin. The price: a mere $148,000

Luxury retailers are increasingly shifting manufacturing to cheaper labor regions such as China. While such outsourcing activities generate short-term cost savings to operating margins, these activities may have a particular effect of de-valuing the brand. Burberry suffered from negative publicity when it announced a relocation of polo shirt making operations from a British factory to one in China. Public image is crucial the the success of luxury goods companies, as consumers pay a large premium for brand.

One extreme example of controlled in-house production is Hermes' handcrafting of its leather goods by highly skilled craftsmen. This slower manufacturing process often results in waiting periods for many of the brand's leather goods; but as is the case for many scarce products, Hermes enjoys up to 40% price premium on these goods over similar brands. One of their legendary items, the Birkin bag, takes five weeks to craft and prices start around $6,000, sometimes reaching into six figures (i.e., the latter being made with alligator skin and diamonds). The waiting period for this item is over two years.

  • Mostly in-house production: Swatch (Switzerland) and Valentino (Italy) manufacture nearly all of their products in their respective countries, in-house. Hermes, LVMH produce the vast majority of the products in house (70%+).
  • Mostly outsourced: On the other end of the spectrum, Burberry, Bulgari and Gucci produce less than one-third of their products in-house.

Asian Appetite for Luxury

Virtually all large luxury goods makers hail from Europe, and while Europeans and Americans consume a large portion of luxury goods, some of the most compelling opportunities recently seem to be emerging from the emerging markets of Asia, particularly China and India. Furthermore, the Japanese obsession with luxury must never be forgotten.


The Japanese market has demonstrated a near insatiable appetite for luxury items, and leading luxury goods companies responded by flooding the market with branded boutiques (i.e., DOS) in recent years. Japan consumes about 25% of luxury goods--the same as Americans and Europeans each; as a point of relative comparison, Japan's population is about 125 million and the U.S. is around 300 million, meaning that Japan consumes luxury goods at about twice the average rate as Americans. One stunning fact is that nearly half of all Japanese women over the age of 20 own a Louis Vuitton handbag and over 90% of all Japanese women own at least one Louis Vuitton item

Many luxury companies have scrambled to establish a foothold in a luxury crazed market that was largely immune to the recent lengthy economic recession. The market is fairly mature, however, and luxury companies are all fighting for a piece of a fairly saturated pie.

Hermes and Bulgari have high exposure to Japan, with about 30% of all product sales coming from that country. Louis Vuitton (the brand) has one of the highest exposures at 33%, but its parent company, LVMH, generates only 15% of overall revenue from Japan due to its vast brand and product diversification. The average exposure to Japan's luxury goods economy is about 20% for other luxury houses.


Unlike the Louis Vuitton phenomenon in Japan, no brand or luxury company dominates the luxury fashion sector in China. One reason is that the luxury goods industry is in its nascent stages and currently, relatively fewer Chinese consumers can afford luxury items.

The attractiveness of the Chinese market is two-fold. First, the potential market is very large. The country currently consumes 10-15% of the world's luxury goods production, and if the economy continues to boom at a double digit clip and wealthy population segments grow, demand for luxury fashion goods could skyrocket. Compounding this effect is that the Internet, travel and marketing have accelerated the embrace of different cultures, especially European in regards to luxury goods. Second, no company has established a dominant brand in the region; brands are especially important given consumers’ loyalty to certain designers and labels. Luxury fashion companies may reap large dividends from early market penetration.

  • China is one of the largest markets for many of Swatch's brands. The company produces 4 of the top 7 selling brands in China, including the top overall luxury watch brand, Omega, which sources about one-quarter of all sales in the country. China generates about 10% of overall revenues for the company. The 2008 Olympics in Beijing may prove to be a boon to their business, as Swatch has been designated an official timekeeper for those games.

High Correlation with Economic Growth

Luxury goods are cyclical and correlate with GDP in specific regions, often exaggerating the up- and down-swings; in boom times, consumers' demand tends to grow faster than the growth of economies (as measured by GDP). On the flipside, slowdowns can cause sales to retreat rapidly, as consumers buy fewer high-priced luxury goods. In addition to GDP swings, regional economies can drive a disproportionate amount of growth; in China and to a lesser extent, Russia, a small but growing segment of the population is becoming very wealthy and driving a large portion of demand for luxury items. Some interesting items of note:

  • Japan is a notable exception to this rule, as seen in its continued demand for luxury items despite its prolonged recession. Companies with greater exposure to Japan may experience steadier results in the case of a worldwide economic slowdown.
  • Hermes has focused on steadier, organic growth and tends to be less cyclical than its competition; nearly 50% of its sales comes from "evergreen" items that the company offers year after year (this also makes them less vulnerable to fashion trends). However, the company benefits less from burgeoning economies and tends to underperform its peers during times of rapid industry growth.

High-End American Retailers

While it may be difficult to invest in European-based companies, Nordstrom (JWN) and Saks (SKS) are high-end department stores based in the U.S. that sell a wide variety of luxury items, including most of the top European brands. Macy's Bloomingdale's division is a luxury department store retailer aimed at a slightly younger, sportswear-oriented crowd. These retailers benefit from an increase in luxury consumption, though they are competitive to luxury manufacturers' own directly operated stores.

The “Near-Luxury” Opportunity

True luxury goods are aspirational products few people can afford. Many companies such as Tiffany, Abercrombie & Fitch and Ralph Lauren depend heavily on the "near-luxury" market, which provide branded goods more accessible to the masses (i.e., at lower price points). Near-luxury companies, like luxury goods companies, tend to track with economic growth (i.e., GDP) but are more volatile. Wealthy consumers are more likely to continue buying high-priced goods--but in fewer quantities--than middle class consumers are likely to continue buying near-luxury items, which are affected by lower-priced substitutions. Several important companies in this space include Ralph Lauren, Coach and Tiffany, all of which experiences significant (>60%) gains in stock price over the past 12 months.


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