This year was supposed to be one of demand recovery for the luxury goods sector, yet with only a few months to go until the all-important festive season, it looks like another lost year. Cyclical factors have certainly not helped: tragic terrorist events impacting inbound tourism, stock market and currency volatility, and downside risks to GDP forecasts in the UK and Eurozone post-Brexit have further weakened European demand. Where emerging markets had previously offset sluggish European performance, they haven’t escaped the slump this time: depressed oil prices, tough economic conditions, the weakness of emerging market currencies against the dollar and less demand for lavish gift-giving in China, due to President Xi Jinping’s far-reaching crackdown on corruption, have exacerbated the malaise on a global scale.
However, structural factors seem to be the major drivers behind a third consecutive year of uninspiring results characterised by muted revenue growth, volatile demand patterns and margin pressures. This has left many senior luxury goods executives in doubt as to how to create future demand and prompted an unprecedented game of musical chairs across company boardrooms.
After an initial denial of the “new normal” financial situation that emerged after the crash of 2007-08, most luxury companies seem to have accepted the realities of stagnant demand and a potentially lower growth profile. The expression “new normal” should probably be avoided in any case, as it suggests the previous growth cycle of quasi-uninterrupted double-digit revenue growth over the past 15-20 years was “normal”. If GDP growth, wealth effects and demographics remain the key factors behind luxury consumption, demand grew exceptionally fast during this golden era — about 2.5 to three times real GDP growth — at a time of aggressive retail expansion, significant price inflation, the rise of a very brand-conscious emerging-markets’ middle class and a growing market in China amid a fast-growing economic boom driven by real estate and infrastructure investment.
Luxury brands have to think about how to attract and retain tomorrow's customers
Important structural changes have taken place in the luxury industry over the past few years, impacting demand and requiring companies to adapt. Lower barriers of entry into the luxury market, for instance, have allowed newer brands to establish themselves and led to a more competitive landscape. Examples include the emergence of niche brands in some of the historically high-growth, high-margin categories such as leather goods and watches, and the sustained global growth we are witnessing in experiential luxury, from fine dining to spas and boutique luxury travel.
Retail networks have also become saturated. After more than a decade of significant retail expansion in both developed and emerging markets, there are limited opportunities to add new space; on the contrary, downsizing has already begun and we are seeing, for the first time, store closures in Hong Kong and the smaller cities in mainland China.
Pricing power, a key component of growth, seems to be more challenging than ever for brands as the development of e-commerce has enabled greater price transparency. Currency volatility — in particular a weaker Euro — is only making the problem worse with the price gap for products across regions widening to unsustainably high levels. This provides consumers with greater buying and selling opportunities across regions and/or distribution channels, and facilitates the development of parallel markets (eg. China’s personal shopping daigou websites), ultimately damaging brand equity.
As a consequence of austerity across developed markets, “trading-down” shopping behaviour has also had adverse effects. Entry-level luxury price points and categories have outperformed expectations while high-income shoppers have been less ready to spend, raising the question of affordability after more than a decade of aggressive price inflation.
Luxury brands also have to think hard about how best to attract and retain tomorrow’s customer base: the millennial generation. Millennials are causing disruption in many respects: they are facing mass unemployment (in particular in Europe), they are more educated than their baby-boomer parents, often more discerning and politically and socially engaged. This underscores the need for brands to address questions of authenticity, provenance and sustainability. Millennials are also digitally enabled and more price-sensitive as they become fully aware of the industry’s pricing structure and often reject traditional pricing models, prioritising access over ownership.
Luxury companies have acknowledged the industry slowdown maybe more structural than cynical
The good news is that most luxury companies seem to have acknowledged that the industry slowdown might be more structural than cyclical and have started to adjust business models accordingly. As a start, many brands are taking a more effective approach to increase return on capital outlay. Some are working on enhancing the quality of the existing retail networks through store refurbishments, enlargements, relocations and closures, in the context of an overall reduction in planned capital expenditure. Many are also monitoring and reducing particular administrative, selling and distribution costs, although marketing expenses are still on the rise to support conversion. Leading luxury firms with diverse product portfolios and a global presence are also completely re-thinking pricing architecture in two ways: by reinforcing the product offering in higher-margin entry-level categories (small leather goods and footwear for example) and by reducing the relative pricing gap between regions, in particular on new, seasonal items.
Responding to millennial demands, brands are now looking at ways to increase customer engagement through more personalised customer service, bespoke events, data capture and analysis of customer relationship management tools and social and digital media. Greater focus on training, retention and compensation of sales and back-office personnel will nonetheless be key to maintaining an enhanced service. The industry is also waking up to the sensitive issue of sustainability; successful brands realise they are not just selling a story based on an aspirational lifestyle, but also on how and where the product has been made.
As Bob Dylan sang in 1964, “The times they are a-changin’.” Time will tell whether these actions will be sufficient for the luxury industry to return to a more appealing growth and margin trajectory. In any case, changing times represent a formidable opportunity for the luxury industry to reinvent itself and create the right conditions for future demand.