Maria Meita: Is the Luxury Playbook Broken?

In the know with Bernstein Research Welcome to In the Know with Bernstein Research. In this series we discuss investment controversies together with what is top of mind and in the news with Bernstein's research analysts who are In the Know. Our disclosures can be found at the end of this and every episode. I am Patrick Robinson from Bernstein's London office. During this episode of is the Luxury Playbook Broken. We are joined by Maria Meiter, a luxury goods analyst at Bernstein in London to discuss the rise and fall of the luxury empire. What happened before, through and after Covid? Why does the industry hold such a draw for investors and their products for consumers? We'll also touch on possible winners and why they have a chance as well as what we might see from the industry in the short to medium term. So, hey Maria, thanks for joining us today. It's a pleasure to be here Patrick. So the luxury goods sector had an astonishing run up to 2023, but since then it's stumbled badly. What's gone wrong? So the luxury industry has been going through a perfect storm of macro weakness, negative price elasticity and the lack of newness. If we take it from the top, macro weakness is pretty self explanatory, but to be more specific to the industry, you have the Chinese customer on the back foot and that's particularly painful because they represent 90% of the growth pre-COVID and that's 90% of the growth. Then you have the US and European customer confidence, that's quite low, as a result of high inflation, high interest rates and also on uncertain job market. The war is in the Middle East that also affecting confidence and to top it all off, you have Trump in the US and the volatility of his presidency as well as the term negotiations. You have pricing where over the past 50 years or so, the luxury goods industry has been increasing price between 5% and 7% on average, that's about two times the broader CPI index, but between 2020 and 2023, they increase prices by 35%. And that's on a like for like basis, that's not even including mix, and that's on average. So if you look at Chanel, they increase prices at 60% like for like and your has increased prices at about 50% like for like. And this price increases were not even on sort of a Montenegam or an improvement in quality basis or even a new creative director setting a new aesthetic tone, it was on the same products. And that's because there was an innovation deficit in the industry and that brings me to my third point, dream COVID, brands became a bit complacent because you had all these customers sitting at home who could not spend on experiential luxury, think restaurants or hotels and they're spending on luxury goods, regardless of pricing and innovation. And that has sort of ended, customers are back out traveling and going to restaurants. So they started pushing back on the luxury goods industry. And in particular, the aspirational customers started pushing back because they have a smaller discretionary wallet to spend and they're choosing experiential versus products. That pricing is absolutely astonishing. Have you mentioned aspirational customers there? Should we be thinking about the customers in different categories of spending power? Absolutely. And there are two sort of main diverging customer profiles in the industry. On one hand, you have the aspirational customer I mentioned earlier. There the customers have been priced out by the industry over the past three years. There are also the customers that are more sensitive to macroeconomic weaknesses or macroeconomic movements in general. And we know there's a very strong correlation between their spending on luxury goods and GDP growth, for example. And we also have data showing that 50 million customers have come out of the luxury industry over the past two years. And these are the aspirational customers. And the most affected by these exodus have been the mega brands. Because if you think of an aspirational customer as the customer who buys once or twice a year, maybe once every two years, they usually focus on the entry level products, think of wallet or a key chain, but they focus their spending on the mega brands at top of mine brands. That's Chanel. That's Dior. That's Louis Vuitton. And it had these brands really affected. So Dior we estimate was down, double digits last year, Chanel was down for a percent last year. And these brands were actually considered untouchable because they're just growing, growing, growing. At the other end of the spectrum, you have the high-knit work client. These are the clients who spend at least 50,000 years a year on luxury goods, high-knit works are known as people with assets, liquid assets above one million dollars. And they've only become more important for the industry, think about 10 years ago, they represent about 12% of the industry in terms of sales, whereas today they're closer to 25% of the industry. So obviously brands went after this, this growing customer cohort. And in 2020, there are news that Chanel or Gucci would be opening VIP only stores. Again, it's a good strategy because the high-knit work individual customer is more resilient. They're less affected by macroeconomic weaknesses, that doesn't mean they're completely immune to it. I mean, they're just affected by asset prices rather than GDP growth thing, stock market or real estate, but they are overall more resilient. However, if you price out all your aspirational customers, which is what most brands have been doing for the past two years, you have a problem because they're still about a quarter of your sales, and that's why we're seeing so much weakness in the industry. Okay, so as the market becomes trickier for luxury goods companies, who are the winners lolly to be? So until now, we've seen a couple of different categories of winners, and Hermes is probably in a category on its own. It's considered the most resilient luxury brand in our coverage. That's because it has very high deserved ability. It acts on a volume restraint basis, and it also has weightless for its most popular products. That's the Kelly bag, the Birkin, the Constance, for example. So they can manage growth quite well. Then we also have the jewelry brands. These are because one jewelry is considered more of an investment than a handbag or a ready-to-wear item, but also because they became relatively cheaper to leather goods, for example. Today you can buy a Cartier Love Bangal, who actually two Cartier Love Bangal's for the price of one Chanel bag, almost. The bag, I'm sure. And that equation was actually reversed five years ago, let's say. So as a result, you have companies like Richmond or Laupou Gold in China doing quite well. Then you have accessible luxury brands, who are just benefiting from this down-training of aspirational customers, think Ralph Lauren or Coach. And finally you have quite luxury brands, which I'm sure you've heard about. These are the brands that traditionally focus more on the high-nate word individual customer, the Laura Pianas and the Coutineries of the world. I have heard of them, but not being a high-net worth individual myself. So let's talk about Coutineria a little bit. Why is Coutineria working? Coutineria is the closest to a cult that the industry has. You know, it's Coutineria, you don't really buy the product. You buy a place in a community that's built up on Solomail and cashmere and humanistic capitalism. If you want the ultimate, if you know, you know brand, it has no logo, it has no bestseller, it has no entry price point item. In fact, you need to sort of buy the whole look in order to look Coutineria. And that gives them sort of lowers the risk of brand fatigue to virtually zero. And it also lowers the aspiration exposure to virtually zero. And then what they've done is they focus exclusively on the top and client, which gives them pricing power. So the average price of Coutineria is between 1.5 to 2,000 euros on average and also resilience amid economic downturns. And we've seen, you know, the sector this year is estimated to be flatish in terms of growth whereas Coutineria is growing at 10%. So they've done quite well for themselves. So one of the things about the industry that I struggled to get my head around is this marriage of heritage and mueness that you mentioned earlier. So does Coutineria need to balance selling by the millions and scarcity or how do they marry ubiquity profits and brand awareness? So that's a cash Patrick. They don't need to sell exclusivity by the million. They only need to sell exclusivity to 500,000 clients, which the company claim are their, you know, their clients today. And to put it in a context, that's only 2% of the high net worth individuals of the world. And high net worth individuals are those people with liquid assets above 1 million dollars. And this very narrow focus on high net worth individuals turns their scale disadvantage into an advantage. We all know luxury kids is a business where scale matters and take marketing, for example. Their marketing budget is only 1% of LVMH's marketing budget. But they can stretch that quite well because they organize this very intimate story of events of about 100 to 200 people where they immerse their clients into the brand's philosophy. So for example, they organize golf tournaments in terrain, private dinners at the Casa Coutineria members clubs, and they invite people to sell mail, which is their company headquarters in Ombria, where clients get to to assemble, you know, Coutineria's own wine or their homemade olive oil. And again, that really gives loyalty to the brand. And what's really, really smart about these events is that they're also creating impedes for clients to buy either before or after the event, but I do it before the event because it's a bit of a full bar trial, but the Coutineria event restition now rates. I can imagine. I had heard about Ferrari doing like similar sorts of events at Marinello. And even though I am yet to receive this kind of invite, I do hear podcast host is the road to riches, so fingers crossed. So given this world is way out of my wheelhouse, I'm going to ask a few questions I've always wanted to know about the sector, is the star designer still relevant? That's actually a really good question. And you're not only on asking it. I think a lot of people in the industry are debating this quite actively. In my opinion, it depends on the type of brand. So if you take let it get brands, for example, creative director is less relevant there. You would struggle to probably name the Louis Vuitton creative director or their most creative director. Most people would. And that's because their growth and, you know, their sales are driven by the classics. They're driven by the monogram product in Louis Vuitton, they're driven by the Kelly or the Birkin at Hermes, for example. And that's not to say, you know, it's the same item again and again, there's innovation there. And there's collaboration, think of Takashi Murakami for Louis Vuitton, but you only need a creative director or star designer to start those. Whereas if you think of ready-to-wear brands, they do need a creative director to set the aesthetic tone, their heritage is probably not strong enough to be adapted to the side guys by itself. So you need a creative director, comes up with a vision, they set up usually in the cultural show and it flows down all the way to anything from, you know, perfumals or beauty ads. And those are the Gucci, the Dure, the Pradas of the World. But even there you have exceptions and the exception there would be again, cutinnelly because they are ready to wear, 85% of their sales come from ready to wear, but they don't have one star designer. They have a team of 60 designers who are led by Brunello Guccinelly and his daughters. But aesthetically, the products are based around Solomere, so around the Italian countryside, colors and textures and atmosphere. And even in terms of innovation, the innovation is not reinventing the wheel every season. It's very much an incremental innovation, I think, a one-inch longer braiser or a different tone blue shirt. You've talked about the importance of a high net worth of the IP events, the IP stores. How about sales relationship? Do relationship managers get poached? Yeah, yes, and relationship managers are very, very important. Actually, this is a very high part of the industry, where the top 5% of customers are coming for 40% of sales. So you need that personal touch because at the end of the day, these people can afford anything they want. There's not that much difference between the products from one brand to the other. They should really think about it. What makes the difference is that that person likes touch the unique experience, the meeting with the creative director, the invite to the exclusive launch event. And that's what actually builds loyalty to the brand. And the sales assistants or the relationship managers are really pivotal in bringing, especially the high net worth individual back to the brand. During COVID, they became more important also for the more aspirational customers, because it was the only way to really communicate to your customer. But it's truly at the VIP level where it makes a difference. And you have brands like Bruno Cuccinelli, for example, where the CRM department actually responds directly to the CEO just to show you how important this part of their business is for them. And yes, they do get poached from what I understand, especially high jewelry sales assistants are quite valuable, because their clients do spend upwards to a million dollars for one piece. So when they do move from brand to brand, they take the book or their clients with them. So they're quite a hot commodity in the industry. OK, maybe we should rethink the podcast idea then and go and become sales assistants. Now I'm aware Cuccinelli have a sale, and the reason I know they have a sale is I had a colleague who used to go every time to the shop on Bond Street, but one year he went to meet some clients after dinner and left his entire hall in a taxi on the way home and lost it. So that's how I know Cuccinelli have a sale. But not all of these luxury goods companies do. So how can discounting affect the brand? So I think again, Cuccinelli is an outlier here. And the only reason they get away with discounts is because, well, actually, there's two reasons they get away with discounts, firstly, because they have no logos, as I mentioned before. So the risk of ubiquity is much less. Even if everyone around you was wearing Cuccinelli, it's quite hard for you to tell. And second, it's very unlikely everyone around you would be wearing Cuccinelli because they have such a narrow client base. Their client base is usually more interested in that those exclusive events rather than scavenging the internet for the best discounts, that's something that aspirational customers do. So there's very little overlap between their target customers right there, the high net worth individual customers, and the people who are actually buying those items on a discount and looking for them. And that being said, the luxury industry works on perceived value and exclusivity. So you don't really pay ten times production price for the product itself. You pay for what it stands for for what it represents for yourself and for those around you. So that's usually status, but also now more than ever, the values that the company stands for. For example, Cuccinelli, they're known for paying their workers two times a regional average and a lot of people want to show their investing in their artisan well-being, especially after the scandals you've seen in a drawer or a piano. But if you see products at discounts, if you see products in outlets, if you see products all around you in the tube in the morning, for example, they lose that shine and they lose the aspirational quality of them. And that's why the best in class brands, again, excluding vanilla Cuccinelli, they have no discounts. You know, Chanel Hermès, Louis Vuitton, Dior in order to maintain that high brand equity. In fact, the first action a brand takes when you most elevate itself is to cut off discounts. For example, Zenia recently, three years ago, they decided they wanted to increase their brand equity. They want to be known as a more exclusive brand. They cut out discounts in store and I dare say they've been doing quite well for themselves since. They must have stock left over at the end of each season. What do they actually do with it? Legally, they're not allowed to sit down fire anymore because that's what they used to do back in the day. So what you have is a lot of friends and family discounts. So a lot of their employees get to buy items at 70-80% discount, which is great. So if you're thinking about a new career path, that could be another option. So the joke about whether the French Revolution was a success, well, it's too soon to tell, likewise with the luxury sector over the past 10 years. So probably too soon to tell if we've seen the best luxury, but I'd be interested in your thoughts on what's next for the market. We're going through an unprecedented time in luxury today. I don't remember a time when you had over 10 different creative debuts coming up in the next year at the top luxury brands. You have Jonathan Andersen, your Mathieu-Blesie Chanel, themnagosiah Gucci and so on and so forth. And there's going to be a lot of marketing going to advertise these turn-arounds. So everyone will be able to see them on bus stops or in magazines or over social media. And that's going to bring the excitement back to luxury and it's going to solve that and a newness issue as mentioned in the beginning, but it's also a bit of a risk for the quite luxury brands if you want. There's a risk that the fashion cycle turns from minimalist to maximalist again. Then you also have a correction in terms of pricing. Brands are correcting pricing in terms of mix. As I mentioned, there's going to be new collections coming up, but they already started introducing more affordable products to welcome those aspirational customers back into the mix. For example, it was very hard for you to find a leather goods bag under the 4K mark at the top brands over the past two years or so. Whereas today, Louis Vuitton, they are selling a never-full tote. That's reversible. So you get two bags for the price of one. No, actually, they're also selling a pouch with that reversible tote. So you get three bags for the price of 2,500 euros. Another bargain. And that's a step in the right direction. And finally, Joey Brands, the brands that have been benefiting from what's been going on in the rest of the sectors, they're now actually taking the relate to increasing prices faster around mincegal digit percentage to try to compensate for the rising gold price. So we may actually see a rotation out of our luxury names into higher beta stuff luxury names when it comes to market dynamics. I want to just pick you up on a couple of points you've made there, which might be industry, but for someone like me. So a maximalist fashion cycle. Is that what we might imagine you see on an outrageous fashion walk? So that's what we've seen between 2015 and 2019, partly because of the rise of social media. That's the logo heavy, very colorful, very outer pieces that, again, show very well on social media. It's easy to identify them. It's very easy to differentiate among brands and customers as a result, but that during economic downturns, like you've seen after COVID, are considered a bit, you know, too much inappropriate, et cetera. So if the new creative directors show optimism for the future and the markets and the economy, et cetera, then they're going to bring back the color and, you know, the volume and the texture into fashion, basically. And then just talking about texture there, you talked about hard luxury and soft luxury. Is that the physical touch of it? It's the way we differentiate between jewelry and watch brands, that are hard luxury brands, and ready to wear brands, which are the soft luxury brands, if not. Okay. And then one final thing, dare I mention AI here, this strikes me as a very personalized analogue of business, relationships, people, hard products. Are there any ways that companies can benefit? Patrick, the luxury industry is not known for being a first mover when it comes to new technology. I mean, I'm not really sure we'll be in terms of e-commerce if he wasn't for COVID to speed things up. But there are certain ways where I do believe the luxury industry is already using AI. And that's mainly operational, inventory management or demand forecasting. So they get to sort of sell the right products to the right people at the right time. Also we spoke about client relationship management, like you said, personalization AI is very helpful in terms of that when it comes to product recommendation or tailored services. But also models, and that's probably the more controversial use of AI. A lot of smaller brands have started using AI models for e-commerce purposes, for example, as a result of cost management. But we've also started seeing it in a tutorial or rather advertising. So Vogue July actually had an AI model in its pages and it created an uproar in the industry and the media because of all the ethical and moral implications of that, if you want. Okay. Well, that's a good place to leave it. I think. Thank you very much, your time, Maria. Thank you, Patrick. You've been listening to In the Know with Bernstein Research. If you enjoyed this episode, don't forget to like and subscribe. In the know with Bernstein Research. If you do not have access to Bernstein's research, you can find it at Bernsteinresearch.com where you can also find important disclosures that we encourage you to review. Bernstein has no obligation to provide any updates or changes at any time in the future. All references and/or market forecasts are correct at the date of recording. The views and opinions expressed in this podcast are those of the presenter and may not be the same as the views of Bernstein or its affiliates. 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