Lvmh in the Recession the Substance of Style

http//www. economist. com/node/14447276 LVMH in the recession The substance of style The worlds biggest luxury-goods radical is benefiting from a flight to quality, nonwithstanding the recession is also prompting questions slightly the companys pretension and balance Sep 17th 2009 Paris from the print edition * * Bloomberg THERE ar four main(prenominal) elements to our business modelproduct, distri moreover whenion, communication and price, explains an decision straighten outr at LVMH, the worlds largest luxury-goods group. Our job is to do such(prenominal) a antic job on the first three that concourse forget all in all about the fourth. For decades LVMHs formula has worked similar a spell seduced by beautiful status-symbols, perfect shops and clever advertising, millions of people charter swooned forgetfully towards the firms bullion registers. At Louis Vuitton, LVMHs star company, the models pricing power has yielded consistent profit margins of around 40-45%, the amplyest of any luxury-goods brand. These days customers argon finding it far harder to forget about price. The seriously rich, of course, are still spending freely. hardly much of the industrys speedy growth in the past decade came from middle-class people, often buying on credit or on the thorn of rising house prices. According to Luca Solca of Bernstein Research, 60% of the luxury marketplace is now establish on subscribe to from aspirational customers earlier than from the wealthy elite. The recession has quickly reversed the trend to trade up, and people are delaying expensive purchases. Bain & Company, a consulting firm, expects the industrys sales to fall by a tenth in 2009, to 153 one thousand thousand ($225 billion).Some executives even expect a lasting shift in customers preferences, towards discretion and value. Bernard Arnault, chairman and chief executive of LVMH, believes that the whole industry needs to rebrand itself. The word luxury suggests triviality and s ho kick upstairsg off, and the time for all that has gone, he says. Brands which sold blingy easy-to- carry products, milking old names, he says, will fare particularly badly in the freshly environment. LVMH, by contrast, has never taken such an approach, he says, preferably emphasising quality, innovation and creativity.To underline these values, the group is going back to basics in its daily operations. Before the crisis, we were putting a lot of energy into beautiful stores, solely now we care a bit less about expanding our network and even more about design and price, says an executive. A few years past, for instance, at the height of the boom, one LVMH brand was putting diamonds all over its watches, so that it was al approximately difficult to tell the time. Now we are getting back to what truly matters, which is nice movements and design, he says.For whatsoever luxury firms, the recessions performances take for already been brutal. Private-equity firms and other outsid e investors which step on it into the industry at its peak accommodate suffered most. At the top of the market this industry was perceived as easy by outsiders, says Mr Arnault. You borrowed 80% of a targets asking price and hired a good designer, but the strategy has not been successful in several cases. Lenders to Valentino, an Italian fashion house, are reportedly assay to renegotiate its debt. Permira, a private-equity group, bought the firm in 2007 in a deal valuing it at 5. billion. Permira has since written land its equity investment of about 900m by more than half. Prada Holding, through which Miuccia Prada and her husband control Prada Group, another Italian house, recently domiciliateructured its loans in station to defer payment to banks. Prada Group has denied that there are talks to read in a minority shareholder. Two particularly weak firms, Christian Lacroix, a Paris-based ready-to-wear and haute couture enunciate which used to be part of LVMH, and Escada, a German maker of luxury womenswear, filed for bankruptcy earlier this year.Amid this turmoil, LVMH is perform intercoursely well (see chart 1). It has benefited from an established pattern in the luxury industry when people have less, they spend what they do have on the best quality. Shoppers are going for fewer, classic itemsone Burberry raincoat, rather than three designer dresses, or a single Kelly bag by Hermes, a French luxury-goods group, instead of four bags from various lesser designers. For this reason, says Yves Carcelle, chief executive of Louis Vuitton and president of fashion and leather goods for LVMH, Vuitton always gains market share in crises. As reliable and sturdy as one of its own handbags, therefore, Vuitton is carrying LVMH fairly well through the recession. In the first half of 2009 the groups revenues were about the same as a year before, though earnings were 12% lower. Two divisionswine and spirits, and watches and jewellerywere the worst impact their rev enues each cast by 17% and their profits by 41% and 73% respectively (see chart 2). Rapid de-stocking by retailers exacerbated the effect of falling demand.But the falls were offset by Vuitton, where revenue rose by a double-digit percentage, registering gains in each market. It is incredible that in a downturn the consumer still buys so galore(postnominal) Louis Vuitton bags, but she or he does, says Melanie Flouquet, luxury-goods analyst at JPMorgan in Paris. Vuittons performance, and the overall robustness of LVMH, a global conglomerate with more than 50 brands and revenues of 17. 2 billion in 2008, should allow it to take advantage of its competitors weakness in the recession. In the next few years we expect several failures in the industry and good opportunities to acquire assets at good-natured prices, says Mr Arnault. Shareholders in the firm are particularly preoccupied by what he index buy and dole out in the next few years. What explains Vuittons resilience? Beneath the gloss of advertising campaigns, catwalk shows and each seasons fleeting trends, Vuitton brings a machine-like discipline to the selling of fancy leather goods and fashion. It is the only leather-goods firm, for instance, which never puts its products on sale at a discount.It destroys stock instead, keeping a c recede eye on the isotropy it ends up scrapping (which it calls the destruction margin). In 2005, when Maurizio Borletti, owner of several prominent part stores in Italy and France, was preparing for the sacrificeing of a refurbished La Rinascente department store in Milan, he recalls, the Vuitton people built a scale model of the building in their offices to understand customer flows and get the best positioning. In this theyre the most professional in the industry, he says.Unlike most other luxury marques, Vuitton never gives licences to outside firms, to avoid brand degradation. Its factories use techniques from other industries, notably carmaking, to repel costs d own ruthlessly and to allow teams of workers to be switched from one product to another as demand dictates. It has adopted methods of quality control, too one quality supervisor came from Valeo, a French auto-parts supplier. The result is permanent utility, beyond show, which is valuable in difficult times. Owning shops gives Vuitton control over levels of stock, demonstration and pricing.It was not therefore affected by the panicked price-slashing of up to 80% by Ameri crumb luxury department stores in the sew together to Christmas last yeara catastrophe for others in the industry, according to Mr Arnault. Although other LVMH divisions have been hit by outside retailers de-stocking during the crisis, Vuitton has managed its own inventory, with no competition for space from other brands. With a global network, says Mr Carcelle, the firm can move poorly selling stock to shops where it has performed better. The luxury of diversityVuittons ability to offset the steep falls in other divisions shows the value of the diversified conglomerate model in luxury goods. Richemont, the industrys second-largest company, has a less vary portfolio and greater exposure to watches and jewellery, demand for which has been especially weak. According to a recent trading statement, its sales fell by 16% in the five months to the end of August. A group structure also yields nest egg when negotiating deals for advertising space, property and credit-card fees. It helps to have a specialist beauty retailer, Sephora, and a chain of airport shops, DFS, to sell perfumes and cosmetics.When Vuitton develops watches, say, it can call on the talents of TAG Heuer. But LVMHs breadth also comes in for criticism. Although there is undoubtedly value in some diversification, some people ask whether 50-odd brands under one roof are too many. Vuitton, for instance, would doubtless like to see disposals of weaker brands as a result of the crisis, and a greater preoccupancy of resources on the g roups key businesses. The groups executives devote the bulk of their attention to the most important of these Louis Vuitton, Moet Hennessy in drinks, TAG Heuer in watches, Christian Dior in perfumes and cosmetics, Sephora and DFS.The group has many smaller businesses, and these get much less attention in such a big group. LVMH does not disclose financial figures for individual brands, but at its presentation of first-half results the groups finance music director replied to an analyst asking about fashion and leather-goods that a handful had lost bullion somewhere. There is speculation that Celine, a ready-to-wear clothing and accessories label, Kenzo, a fashion brand which analysts have long suggested LVMH dispose of, or Loewe, a Spanish leather-goods brand which has so far failed o win much of a following outside Spain and japan, are among the less profitable. Nevertheless, the group can use the might of Vuitton to support its smaller, upcoming brands. A department store, for in stance, may be asked to take Loewe or Celine in order to get Vuitton. That often frustrates people at Vuitton, however, who would prefer to use the power of the brand for its own benefit, says a person who knows the company well. Theyve never heard of another of LVMHs brands saying, Either give this to Vuitton or I wont come, he says.Apart from the synergy in watch design, Vuitton does not find that it benefits much from the rest of the group. The reason why LVMH has many small brands which arent quite making it, says another person familiar with the company, is that Mr Arnault is an optimist who believes that every property can at some point be turned around. That can pay off some years ago Mr Arnault halted the imminent sale of a make-up line. Thanks to the distribution muscle of Sephora, it has since turned into a bestseller in America.Investors, however, are nevertheless wary of what they see as Mr Arnaults tendency to collect brands. The crisis has also underlined the fact that Vuitton dominates the groups results. Were it not for Vuitton, estimates one analyst, LVMHs sales would have fallen by 3% in the first half of 2009 and profits would have plunged by 40%. In normal times Vuitton contributes about half of the groups profits, and most of the rest comes from Moet Hennessy. In the first half of this year, however, Vuitton contributed an estimated 70% of profit.That leads some people to question whether LVMH is overly dependent on the leather-goods firm. You can argue that theres nothing as good as Vuitton in LVMHs portfolio, says Pierre Mallevays of Savigny Partners, who was formerly director of encyclopaedisms at LVMH, but that simply states the fact that LVs business model is the gold standard of luxury brands no other brand in the world compares to it. The biggest risk to LVMH is Vuitton, argues Ms Flouquet, since it accounts for such a big proportion of profits the company depends on it, she says.The risk to Vuitton, in turn, is that it could fall out of fashion or lose its exclusivity in the eyes of consumers. So far there is no sign of fatigue with the brand. LVMHs senior managers have devised ways to refresh it. In the late 1990s, for example, Mr Arnault saw that there was a risk that as a maker of leather goods alone, Vuitton could be perceived as boring. In 1997 he hired Marc Jacobs, then a relatively unknown designer, to design a fashion line. The aim was to generate seasonal buzz and embrace coverage.Vuittons senior executives at the time were against the idea, fearing that adding fashion could undermine a timeless image, but Mr Arnaults move prove successful. To avoid overexposure of its signature Monogram print, Vuitton has taken care to develop a wide range of products and other patterns. We maturation the number of product lines and we are careful to have several different colours and shapes, says Mr Arnault. Thus Vuitton sells more or less priced handbagsthe smallest Speedy Bag costs 430 in Parisbut also wild ly expensive tailor-make luggage, reinforcing its exclusive image.Another effective tactic is to make limited-edition handbags which are hard to get hold of. Five or so years ago Vuitton depended to a large degree on one market, Japan. Most Japanese women owned at least one Vuitton productand hence provided a large proportion of Vuittons profits, which worry analysts at the time. Yet the Japanese market for luxury goods was souring. Spending on such items in Japan has fallen sharply since the end of 2005, according to a recent report by McKinsey, a consulting firm. unfledged women are more individualistic than their mothers, and are seeking out lesser-known brands. You used to see thousands of Vuitton bags coming at you in the Ginza shopping district but far fewer now, says Radha Chadha, author of a book, The Cult of the sumptuosity Brand Inside Asias Love Affair with Luxury. That reliance on one country is no longer so marked (see chart 3). Fortunately, Vuitton has since rapidl y established a strong position in what it hopes will become another Japan China. The Chinese consumer is in a love affair with the Vuitton brand, says Ms Flouquet. According to LVMH, in the first half of 2009 sales to Chinese people (at home and travelling) made up 18% of Vuittons revenue.Despite widespread concerns about counterfeiting in the country, the Chinese are now Vuittons biggest customer base later the Japanese. The key to the firms success, says Mr Arnault, has been approaching the market exactly as if it were a developed market. We treat the Chinese customer as being very sophisticated. Many competitors, by contrast, have at times lowered their standards for shops in China, he says, using inferior furniture or positioning their stores poorly. Going into new markets and developing new product lines will enable Vuitton o continue producing double-digit growth for years to come, says Mr Carcelle. On every get out to mainland Chinahe makes five or six a yearhe tries to d iscover a new city and meet its mayor. Mr Carcelle is also tackling other new frontiers in October he will open a shop in Sukhbaatar Square in Ulan Bator. Already if you go to an upmarket disco in Ulan Bator you will see a significant number of our bags, he says. Vuittons expansion into China, Mongolia and new product lines such as watches and shoes, suggest that the leather-goods firm will continue to be LVMHs main source of growth.However, it also operator that the group may become more rather than less reliant on Vuitton. In theory, the final result could lie in strengthening some of LVMHs smaller names, such as Fendi, a fashion and leather-goods brand. But buying a big, established, global brand with potential for growth could be both a fast and a surer route. Or maybe that oneImagineChina A new collection? Analysts and bankers are convinced that Mr Arnault wants to buy the Hermes Group, a producer of leather goods and fashion which matches Vuitton for quality and design.Beca use Hermes is run so conservatively, says an investment banker who knows LVMH well, it is only a tooshie of the size that it could be. Mr Arnault would grow it while preserving its values, he says. Earlier this year, there were rumours that LVMH would sell Moet Hennessy to Diageo, the worlds biggest spirits group, which already owns 34% of the business. Such a sale could raise money to buy Hermes. Mr Arnault, however, refuses to be drawn into commenting. For the moment, such an acquisition is impossible, since the family which controls Hermes does not want to sell, and the firm is strongly defended against takeover.Nevertheless, says the banker, the family which controls it has several branches, all with different views. Its a pressure cooker and some day it will blow up, he says. Chanel, another closely held global luxury brand, could also make a desirable target for LVMH. Some people recommend a merger with Richemont, which, Mr Solca argues, would address LVMHs relative weakness in watches and jewellery. Any such deals, or selling Moet Hennessy, would radically change the balance of the group. I would be surprised if LVMH sold Moet Hennessy. The business has high margins, high ashflow and it is well managed, says Ms Flouquet. They would probably only sell it if they had a large deal ahead. Shareholders are nervous that LVMH will pay too high a price for a large acquisition. For this reason the groups valuation may not fully devise its performance during the crisis. Such concerns are not likely to deter Mr Arnault, who has demonstrated his confidence in LVMHs prospects in luxury by raising his stake in the group over time he owns 47%. If LVMH does go shopping, it will probably behave like one of its best customers with price in mind, but willing to spend on enduring prestige.