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January 18, 2013

2012: A Game Changer for Luxury Goods

CA2_136x136Analyst Insight by Rob Walker, Contributing Analyst at Euromonitor International

The luxury goods industry lost some of its swagger in 2012. Having shown robust insulation from global economic volatility post-2008, cracks appeared in the form of profit warnings and investor jitters over softer growth in China. Some brands shifted upmarket to promote a more exclusive image, while others moved downmarket to cash in on trends in affordable luxury. Fuelling the strategic conundrums were issues of wholesale footprint, retail expansion and the extent to which brand ubiquity and discount activity threatened prestige heritage. Gone were the days when a luxury label was a shoe-in for success. 2012 was a year when luxury consumption culture rationalised, with consumers shifting into a more discerning gear.

Desire and exclusivity

Absolute luxury was one of the big winners in 2012. High-end fashion house Hermes International had a particularly strong year, culminating with a hike in its 2012 full-year earnings guidance. This was in contrast to the profit warnings issued by Burberry, Mulberry and Mercedes-Benz (Daimler), and to the cooling sales reported by leading luxury goods players Gucci (PPR), Louis Vuitton (LVMH), Richemont and Tiffany & Co.

The resilience of Hermes owed much to its commitment to exclusivity. Iconic Hermes handbags, such as the Birkin and Kelly, were hugely popular, yet the company resisted the temptation to ramp up production. In China, the waiting list to acquire Hermes handbags added to their desirability. By contrast, Louis Vuitton’s Speedy – once the most sought-after handbag among China’s high net worth women – lost some of its cachet due to growing retail ubiquity.

The risk versus the opportunity of retail expansion, especially in China, will be one of the critical strategic challenges of the year ahead. Gucci, for example, has expanded rapidly in China and, while the brand has shifted upmarket over the past three years, there are signs that the mushrooming visibility of Gucci in interior China has weakened its prestige value in Shanghai and Beijing. The brand’s Asia Pacific sales were up a modest 2% in the third quarter of the year, compared with growth of 14% in Western Europe and 11% in North America.

‘Flash’ fashion drives Prada

Prada was another big winner in 2012. Over the first three quarters of the year, the group’s revenues were up 35%, while net profit climbed 50%. Most strikingly, Prada reported a 32% revenue increase in Europe (at constant exchange rates), higher even than the 28% growth surge in emerging Asia. Prada also notched up growth of 16% in the US and 15% in Japan.

Prada’s results show that the luxury goods growth story is not all about emerging markets. China has become critical to the bottom line of many international luxury goods retailers and manufacturers; hence the widespread industry jitters when key players started to flag softening sales. But, Western Europe continued to present pockets of opportunity, not least from sales fuelled by international tourists, including the Chinese.

Prada opened more than 60 new stores over the year, and overall sales through its own stores were up 34% compared with wholesale growth of 6%. Growing retail ubiquity did not appear to dilute the heritage of the brand. Rather, a strategy of launching new styles and fashions for short periods of time – so-called ‘flash sales’ – helped create an image of exclusivity. We will see more of this type of selling in 2013 as brands look to promote an aura of ‘hard-to-get’.

Raising the retail innovation bar

Retail innovation was a key theme in 2012, with some companies prioritising premiumisation over unit expansion. LVMH, for example, opened its first Chinese maison in Shanghai. This super luxury store has invitation-only floors and sells ultra-premium one-offs. The objective is to re-energise the prestige appeal of Louis Vuitton among China’s wealthiest consumers.

Burberry’s new flagship on London’s Regent Street raised the bar on how to fuse bricks-&-mortar retailing with digital technology. It is a template for future Burberry stores, and is likely to be copied by other retailers going forward. Aside from its digital sophistication, the store promotes a more egalitarian retail environment than is normal in luxury goods (stores are often intimidating places to visit for consumers inexperienced in luxury goods shopping). The ‘come and hang out’ ethos of Burberry’s new store echoes the highly successful retail model of Apple.

Mulberry’s shift upmarket

Mulberry was arguably one of the losers of 2012, with pre-tax profits dropping 36% for the six months to the end of September, although there was a silver lining in an upbeat online performance. Mulberry has been positioning itself as a more upmarket luxury goods brand and, as a result, instigated a cull on wholesale accounts where discount activity was rife.

The reduction of Mulberry’s wholesale footprint has accelerated a momentum away from so-called affordable luxury, which has served the company well over recent years. The shift upmarket has also squeezed profit margins due to the use of higher quality materials and more sophisticated manufacturing.

The online challenge

Luxury goods retailers faced multiple challenges with e-commerce in 2012. On the one hand, digital technology was a means to attracting a wider consumer base. On the other, there was the risk of cannibalising bricks-&-mortar sales, encouraging discount activity and fuelling online counterfeits. It is estimated that 80% of brands sold online using the Hermes label were fakes, for example.

But, the internet – and the mobile internet in particular – is the fastest growing channel of retailing. Sales of smartphones and computer tablets have surged globally, and their heavier footprint is having a major impact on the way people shop. Mulberry’s e-commerce revenue climbed 44% for the six months to September, and tablets and mobile devices were identified as a key driver. Online sales now account for 9% of group sales.

Furthermore, the emerging middle class is increasingly internet savvy and, while mobile internet usage in markets such as China and Brazil has lagged behind advanced economies, the latest generation of tablets and smartphones is ushering in a new internet culture, with potentially far-reaching implications for the distribution of luxury goods. Luxury goods retailers will have to find ways of accessing the power of the internet in 2013, but digital strategies will need to be more innovative than in non-luxury goods sectors.

The next luxury frontier

Investment interest grew in Africa’s frontier markets in 2012 and the region is set to become a key battleground for the luxury goods industry. There is still plenty of risk, of course. Economic fundamentals might be stronger than a decade ago, but corruption, conflicts and instability are never far from the headlines, and are often enough to deter investors. On the flipside, the youthful demographics, maturing political infrastructure and abundant natural resources are fuelling a potential gold-rush climate.

Africa is some way behind emerging Asia Pacific and Latin America in terms of the size of its middle class, but the combination of rapidly growing economies and youthful populations auger well for the future. Equally, a spate of oil and gas discoveries – and the high probability of more to come, for example in Ghana (oil) and in Tanzania (gas) – could provide a get-rich-quick spawning ground for a new generation of high net worth individuals (HNWIs).

Sub-Saharan Africa is already on the cusp of a growth spurt in social classes A and B. In Kenya, for example, Social class A is forecast to grow by 28% to 2020. That is one of the highest projected growth rates in the world for A-class consumers. Social class A in China is forecast to grow 4% over the corresponding period, while in Russia it is forecast to contract 2%.

Going forward, we will see new momentum in retail real estate investment in Nairobi, fuelled in part by its potential candidacy for the 2024 Olympics. Garden City, a 32-acre mixed-use retail development will be the largest shopping mall in East Africa when it opens next year, for example. Its developer Actis built Nigeria’s first mall (The Palms) in 2006 and Ghana’s first A-grade mall (Acera) in 2008. This type of modern retail space will help luxury goods brands build new positions in what could become a major new growth engine.

 


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