I was recently browsing the 2009 annual accounts of Giorgio Armani S.p.A., exercising those dusty MBA skills, when something in the data jumped out at me.
Maybe it is not obvious to the casual observer, but for a business guy like me a couple of numbers leapt off the page and deserved some more analysis – those relating to the cost of making the goods Armani sells, the raw materials and services.
These high level numbers, which seem to equal 56% of revenue, need a little more interpretation, as they include things like advertising, travel and sales commissions, which throw off a direct comparison with other companies:-
When you dig further into the footnotes on COGS to break this down, and do a like-for-like analysis with a similar company, those numbers really are a very high percentage of the cost base of Armani – 42% of revenues in fact, exactly 50% higher than the percentage cost of Prada, for example, whose COGS are 28% of revenues.
What does this mean? Well, because we look at in common size (percentage), terms, it is clear that Giorgio Armani is either overpaying his suppliers, or making clothing with vastly superior raw materials, at least compared to Prada.
The numbers above and the breakdown below (page 114 in the footnotes) show that Giorgio Armani pays about 30% of revenues for just raw materials alone, and then pays another 12% of revenues on outsourced production services and related costs.
That amounts to 42% of revenues on making the goods. In contrast, Prada pays a total 28% of revenues for raw materials and the same categories of production-related services combined.
This implies that Giorgio Armani is making clothing from better – or at least much more expensive – raw materials, and then spending even more money to have them produced. And in absolute terms, with a business that has €1B lower revenues than Prada, Armani still pays 87% of the absolute COGS that Prada does (€638M vs. €728M).
This naturally has impact on the bottom, profit line. Giorgio Armani makes a pre-tax profit that recently has been in the neighbourhood of 9%, compared again to Prada pre-tax figures of 24%, almost three times higher. If things were in proportion, Armani would pay just €436M for COGS, potentially pushing another €202M to the bottom line, and their pre-tax percentage profit would be very similar to Prada.
As an investor this means I would be buying Prada shares. As a potential Giorgio Armani acquirer like Bernard Arnault I would be basing an acquisition price on today’s profit numbers while secretly licking my lips thinking about cost improvement opportunities. I wonder if this is one reason why Giorgio Armani is reticent to sell? Does he fear that the acquirer will seek to cut costs and impact the quality of his products?
As a customer I am quietly very happy that although Giorgio Armani charges me a lot, the money is going into product quality, not his pocket. Whether by design or by chance, Armani sacrifices profit to make better products. And I can literally feel the difference, as a future story about Louis Vuitton will reveal.