Luxury, Munich and the Global Recession

It is often said that the luxury industry is immune from recession; the wealthy will keep shopping no matter what the macroeconomic environment.

And there is some truth to that – not complete, but a strong element. Recent newspaper reports are rife with big upticks for the major brands, despite continuing global economic woe.

As witness I present to you a couple of recent developments in downtown Munich.

It’s well understood locally that Munich itself is almost recession-proof; economic downturns seem to skirt past this city, which is fundamentally very wealthy and enjoys a tax-base supported by successful local family-run businesses – like BMW.

Firing the starting gun for expansion is Louis Vuitton, moving from a smaller store on Maximilianstrasse to a massive new “maison” nearby, the Residenzpost, in the heart of historic Munich.

DSC04729

This location used to be just slightly more utilitarian – it was a Deutsche Post office until a couple of years ago, before the entire block underwent a very expensive renovation/gentrification.

This store is now a world-class LVMH expansion, with three enormous floors featuring pretty much every LV product known to mankind. There is even an LV promo video for the new store. And even at 10:05 AM on a Monday morning there were quite a few people shopping.

This move changes the dynamic of the nearby shopping district immensely. Perhaps not by coincidence, Prada, situated literally just across the street, has decided the time to expand is exactly now, and I would not be surprised to see a few other expansions, refurbishments or relocations in the near future. Belstaff (which is, in my opinion, one of the most unlikely luxury brands ever; when I was young Belstaff was what bikers bought when they couldn’t afford leathers) already opened a brand new store nearby.

DSC04727

But beyond the local environment, this is a telltale of the continuing global success of luxury brands, even the smaller ones in the PPR Group (now called Kering) like Stella McCartney and newly acquired Christopher Kane, about whom I will write a dedicated story later, and Giorgio Armani is no exception.

Globally the tide is lifting all luxury brands. When will it end?

A mistake and a lesson at Louis Vuitton

A few weeks ago I had a sudden rush of blood to the head and bought what seemed like a very nice jersey from Louis Vuitton, costing about US$930. It had a small LV logo on the neck, but for Vuitton it was quite discreet.

DSC03786

But on reflection I decided it was a mistake. After returning home I tried it on a couple more times, and realized that as nice as it was, it didn’t fit the style and direction of the wardrobe I am building.

I therefore decided to return the item – and in doing so discovered LV’s returns policy: no refunds.

Credit notes? Yes.

But refunds? No.

And that policy is clearly written both on the receipt and below the cash register, so you have very little wiggle room if all you can say is “I changed my mind” – which is all I personally had to say.

Firstly I find this interesting, as this policy partially explains Vuitton’s continually stellar and growing revenue numbers – they don’t have refunds, so cash in the bank is cash that stays in the bank, and goods go back on the shelf; other stores do return for refund, although they don’t have to do so, at least under EU law.

Secondly it is a tiny bit annoying, mainly because I blindly spent nearly $1000 without thinking about it more carefully and sticking to rules I defined publicly some time ago.

Lessons learned:-

  1. Stick to Giorgio Armani for clothes, and Prada for shoes, just like you said you would.
  2. Don’t buy anything else from Louis Vuitton unless absolutely sure you want it.

I have since used a large chunk of the credit note to buy a nice shawl as a gift for my mother-in-law, who was very happy to have it. I consider that a save.

Giorgio Armani’s €202M Sacrifice

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.

Airports, Giorgio Armani and Jennifer Ohlsson

I travel quite a bit on business each year, and have noticed that although you can regularly find Hermes, Bulgari, and Gucci, there are pretty much no Giorgio Armani boutiques at airports around the world. Maybe I just haven’t spotted one yet, but if there isn’t one at Tokyo, London, Munich or Paris, I would be surprised if they were elsewhere.

You do often however see Emporio, as well as the cosmetics as a store-in-store. In fact it seems like there is a deliberate focus on opening these second-tier stores in airports, with new openings in Dubai, Hong Kong, Singapore, Sydney, London and Paris, amongst several others.

I am drifting through the verdant English countryside today, wondering about why this would be a corporate policy. Why does it make more sense to offer the mid-level brands rather than the black label?

Is there a cost-effectiveness issue with airport stores? If so, why do the other brands – especially Hermes – find it profitable? Hermes must be choosing a high price/low volume strategy, but it seems like Armani, by focussing on EA, goes for a higher volume/lower price approach. That would be an interesting choice; most MBA courses will help you understand that lowering price has a disproportionate impact on volume required to hit the same profitability.

Maybe it is to protect exclusivity? This makes more sense for the Giorgio Armani brand – some airports are pretty utilitarian places. But again why doesn’t Hermes reach the same conclusion?

Perhaps it is a stock vs. time issue; they cannot keep enough stock on hand to satisfy the wide range of demands from impulse airport shoppers, who have just a few minutes to spend browsing. This could be possible, but does it sound plausible? Not really.

Or maybe they simple want to cluster their boutiques – all 75 of them – in high density repeat-business areas, rather than catching transient business.

I am still not sure. Given the intense airport investment in other sub-brands, it’s clearly a strategic choice by Armani management. But the core of the logic escapes me, as I have seen with my own eyes that there are potential customers passing through. Today I queued at immigration behind a supermodel called Jennifer Ohlsson, carrying a red Chanel wallet and wearing clothes that looked too well cut to be anything other than the best labels. Surely travelling clientele like that would be solid targets for the big brands?

Whatever the reason, sometimes with an hour to kill at an airport I would like to visit a GA boutique and cannot. It is a conundrum.