10 Thoughts on the Luxury Industry 💎
Status-shopping, European exception and perspectives
Hi there, this is Younes!
I recently left my position as CFO & Director at the investment firm The Family, and am taking the time-off opportunity to write about topics I haven’t talked about while figuring out my next full-time gig.
As a refresher, Chasing Paper is a newsletter giving my perspectives on finance, strategy, tech & innovation - and how they interact.
I previously shared 10 Thoughts on the Gaming Industry. Today, I’m doing the same with Luxury as a target industry. With Bernard Arnault (Chairman and CEO of LVMH) recently crossing the mark to become the richest person in the world, diving into the luxury goods market is a source of valuable insights on how to hold steady in crisis time.
Warning: this is a long post.
Enjoy, and subscribe if you haven’t!
My interest in the luxury industry has grown over the years. While as a teenager I was a mere aspiring customer, I realized in grad school that the prospect of working in the industry was tantalizing to many and started wrapping my head around it by reading CEO profiles.
With the years passing and my disposable income growing, I started to enjoy luxury experiences (for me, it’s fine dining) and reflecting more and more on the drivers and dynamics of this one-of-a-kind industry.
More recently, my wife-to-be became a concierge, working in one of the most exclusive hotels of the world. That was another insight into the industry, from the employee perspective this time.
The 10 thoughts below are personal views developed over the years.
I couldn’t think of anything screaming luxury more than James Bond in a neat suit in front of an immaculate racy sports car
Clientele
1/ Shopping for Status
Growing up, I was always a massive fan of Italian supercars: marvels of automotive design, with incredible performances, sleek curves and bold colors. I regarded the ownership of one as a token of life achievement: ‘when I’m rich, I’ll get an apple-green Lamborghini’ (sic).
While I did snap out of it - admittedly not entirely - for a number of reasons (including but not limited to: learning about asset depreciation, living in a car-banned city-center, crypto bros, Andrew Tate), I think it’s a relatable experience and a good introduction to the main driver of the luxury market: desirability.
Whether your kick is clothing, jewels, bags, watches, spirits, dining, hotel leisure, cars, boats, planes, art, real estate: the luxury market has something for everyone to crave and lust for.
Arguably one of the best articles I’ve ever read about tech is Eugene Wei’s Status as a Service (do yourself a favor and read it). Eugene’s article also offers incredible insight into human nature:
“Let's begin with two principles:
People are status-seeking monkeys*
People seek out the most efficient path to maximizing social capital”
The analysis that follows is breathtaking, unraveling how social capital (where we stand on the status ladder) is much harder to grasp than financial capital, yet how the former serves as a proxy indicator of the latter. Ergo, the more social capital you have, the likelier you are to own high financial capital.
My first observation, as for the luxury industry, is that many believe that the opposite is true. While people seek status, displaying financial capital appears as the most efficient path to maximizing their social capital.
And what better way to display financial capital than to carry a Chanel bag, wear a Patek Philippe, drive a Bentley, smoke a Cohiba, own a Mondrian or live in a secluded mansion?
Of course, the argument can be made that those are all fine pursuits for genuine amateurs: if you truly enjoy leatherwork, watchmaking, automotive engineering, cigars, art or real estate (respectively) then you would aim for artifacts like these. The point is that the two are non-exclusive: true amateurs and ‘wannabes’ alike display financial capital when purchasing luxury goods.
As such, luxury goods customers are shopping for status, and luxury industry players are purveyors of one of the most sought after resources on Earth: status. Better yet, readily-available status.
That fact alone explains why luxury is such a good business, especially in times where status (whether in the form of likes, followers, retweets, views, dollars or votes) are increasingly considered important.
2/ A bottomless market
Another reason that makes the bull case for the luxury industry so compelling is that it is a virtually bottomless market.
I actually realized this upon reading XAnge’s Cyril Bertrand excellent article on his investment thesis upon investing in LeCollectionist back in 2017.
Cyril says:
“I often have to remind myself that luxury is not a niche. True luxury — as a market, not as a branding strategy — does not show off on the Champs Elysées. It is a discrete, demanding, disciplined segment, much, much deeper than we spontaneously think.”
Inarguably, luxury is a spectrum: there is little to no commonalities between the teenage US buyer of the lowest priced Balenciaga bag and a South Asian tycoon lavishly spending $100k+ on hotel stays on a regular basis.
Arguably, however, both ends of the spectrum add to the industry profitability: low(er) margin, high volume luxury goods at one end ; very-high margin, low volume at the other - but more on that later. The industry indeed serves a large type of customers, from the highest brackets of middle classes (HENRY: high-earning, not rich yet) to HNWI and UHNWI ([ultra] high net worth individuals).
In all cases, though, the pricing elasticity is huge: buying appetite is of course a function of price, but with a <1 coefficient (i.e the breaking point for a single purchase is reached slower as price increases).
Considering the range of the consumer base, their very elastic buying appetite, the virtually infinite buying power at the richer end of the spectrum, the regions who just “recently” started to consume luxury goods and crave for it (esp. China, Middle East, Russia), and the number of different categories (clothing, jewels, watches, spirits, dining, hotels, cars, yachts, PJs, art, real estate) – the luxury industry is indeed seated on a growing pot of gold, as even the most niche products can very well tap into immense addressable markets.
3/ Now you see me, now you don’t
Something quite puzzling about the luxury market is how ubiquitous it is - with ad billboards and shops in city centers, malls, social media, airports, etc. - and yet remains exclusive and very high-end.
My take is that most of the market is actually hidden in plain sight, with the more confidential and exclusive experiences accessible only to the highest spending consumer segments and the entry level made as visible as possible.
Indeed: you will see prospective customers line up on the Champs-Élysées (likely tourists) in front of the Louis Vuitton boutique to buy a bag or a pair of shoes (which is a droplet in the brand’s sales: LV just had a booming year, topping €20bn in revenue), while more elite purchasers spend (much) more but have the boutique privatized and/or a personal shopper and/or have items delivered directly to their hotel or pied-à-terre.
We mentioned just earlier the different luxury consumer types: from high-earning upper middle class individuals (HENRYs) to really ultra high net worth individuals (UHNWIs). Inarguably, the marketing strategies that brands need to deploy to target those different segments are in essence very distinct, as are the revenue and profitability breakdowns for those market segments.
Some brands, however, are cleverly playing across categories. Paris Society is a French hospitality group offering some of the most currently sought-after restaurants, clubs and events in France (Paris, the Riviera and the Alps). Recently acquired for a whopping €330m by the Accor hotel group, Paris Society has built a recipe that’s quite unlike the others in the market: exceptional and iconic venues that appeal to locals and tourists alike, quality cuisine but no emphasis on sophisticated menus and dishes, and make everything Instagrammable.
Interestingly, all categories of luxury consumers are heavily satisfied with the concept: very-high spenders see it as casual but chic, far from the bling they’re used to (“understated sophistication”), while the venues are aspirational for many entry-level consumers. The concept will be rolled out internationally thanks to Accor’s international leverage, and surely will find resonance.
Business dynamics
4/ A European exception?
Can you think of five luxury brands? Okay? Go!
Out of those five, how many were not European? Maybe you thought of Tiffany’s, Marc Jacobs, Fenty Beauty, Supreme (🇺🇸), Comme des Garçons, Yohji Yamamoto (🇯🇵), or even De Beers (🇿🇦).
More likely, your suggestions were French 🇫🇷 (Dior, Chanel, Yves Saint-Laurent, Hermès, Balmain, Céline, Louis Vuitton, Givenchy, Louboutin, Lanvin, L’Oréal), Italian 🇮🇹 (Gucci, Prada, Versace, Bulgari, Ferrari, Lamborghini, Dolce & Gabbana, Valentino, Armani, Loro Piana, Off-White), British 🇬🇧(Bentley, Rolls-Royce, Stella McCartney, Vivienne Westwood, Burberry, Alexander McQueen), Swiss 🇨🇭(Rolex, Tag Heuer, Hublot, Patek Philippe, Audemars Piguet, Vacheron Constantin), German 🇩🇪(Rimowa, Porsche, Mercedes, Maybach), or Spanish 🇪🇸 (Balenciaga, Loewe, Massimo Dutti, Manolo Blahnik).
As a long observer of the European tech market, and European industries in general, I have to admit that there are many industries were local European players appear to compete on the sidelines, while the US and Asian competitors fight for the lion’s share.
The luxury market is very distinct to that regards, with the top brands mostly being originated in Europe, as is also the case for the leading conglomerates (LVMH, Kering, Richemont, EssilorLuxottica, L’Oréal, Hermès - with the notable exceptions of Estée Lauder and Chow Tai Fook).
Lake Como, a European landmark and go-to destination for worldwide luxury consumers
The prevalence of European luxury brands, including the more recent ones (Off-White, Margiela) stems from historical consumer perception that these countries produce luxury goods of superior quality and have precision craftsmanship. Indeed, having been involved earlier in leatherwork, watchmaking, engine building ; having developed hospitality arts, and having colonized a sizeable portion of the world to secure access to the most sought-after resources, European countries had a head start in the luxury market, that they retained through efficient industrialization and transfer of skills, but also a lot of marketing: it’s not as good if it’s not from Europe (which by the way makes for hilarious memes 👇)
Champagne is a protected designation of origin and is only called champagne if it comes from the Champagne region of France, otherwise it has to be called sparkling wine, which infuriates many people on Twitter.
This concept, the provenance paradox, dictates that a product's country of origin establishes its authenticity and quality. Consumers associate certain geographies with the best products, such as French wine, Italian sports cars, and Swiss watches. Products from other countries, especially developing markets, are perceived as less authentic and even if they are of the same quality, less desirable.
With desirability being of the utmost importance for luxury brands as we established, it’s no surprise that European brands and groups have retained their importance in the market.
5/ A steadily lucrative market
If you’re any interested in annual financial reports (which, if you’re reading a newsletter initially designed for CFOs and finance professionals, I assume you are at least a little bit), then I suggest you have a look at LVMH’s 2022 financial performance document.
A caveat before diving in: obviously, the group has its own strengths and weaknesses, but its size and scope make it in my opinion a good enough proxy for the entire industry. However, things that are said below might not apply to independent brands, who will have different challenges (procurement, production, overheads, marketing, etc.).
In the report, several of the revenue and profit breakdowns are very interesting, including the ones by regions, currencies and categories. More interesting are the operating totals for the entire group: 68% gross margin and 26.6% operating margin on a €79.2bn revenue.
A few remarks here:
One could think that luxury goods, only sourcing and using quality materials (whether it’s leather, grapes, cashmere wool, tobacco leaves or precious stones) and requiring precise craftsmanship would have low gross margins. That’s not the case: gross margin stands very high (with high variance across categories to be noted). That’s also an advantage of conglomerates over small, independent brands.
Conversely, one could think that luxury conglomerates got so rich by industrializing production processes and decreasing procurement costs while increasing retail prices. Again, not really the case, since production costs account for a significant portion (around ⅓) of revenue - factoring in raw materials, design and craft. The “you’re paying an x00% premium just because Gucci is written on the T-shirt” argument does not stand, overall.
Looking at both points above, I realized that a long-held thought of mine about the luxury market is disputable. I always thought that there was an immense discrepancy between perceived quality and actual quality in luxury goods. As such, marketing stunts would create a desire bias for goods that overall aren’t that well produced. Conversely, at the other end of the spectrum, going the extra-mile to create a really unique experience for the most demanding customers would kill profit margins. While naturally we do not have access to an itemized profit breakdown by SKU, and I imagine well that each individual brand has its cash cow products and its lower margin, higher prestige ones ; the result is well-balanced at group level. Having a brand and product portfolio surely helps mitigating both effects.
Final remark, marketing and selling expenses are the main cost element in the income statement, at ~35% of revenue. Designing and producing luxury goods is costly, but even costlier is the art of making them desirable, as we shall see in the next section.
6/ Stargazing distribution
There is too much to say about luxury marketing to fit in a single article. However, one aspect I find rather interesting is how the status appeal we mentioned in the first section is reinforced or even sometimes created by savvy marketing.
One example of that is endorsement deals: you have probably seen countless billboards with a singer or actress in a panoramic scenery trying to sell perfumes.
Perfume licensing deals are indeed an alluring prospect for celebrities, who are typically awarded a royalty of 5-10% of the sales, along with mouthwatering upfront payments for lending their name.
But there’s even more in it for the brands: celebrities are often involved in luxury marketing because of their popularity and influence over consumer behavior. People are drawn to their lifestyle and image, and associate that with the products they endorse. If you’re a status shop, displaying high-status individuals who endorse your products is quite obvious as a marketing strategy.
A few remarks:
Some brands, Hermès for instance, are reluctant for their own reasons to rely on celebrity advertisement deals. Is that to say that they can spare celebrity endorsement or references? Well, not really. Hermès’ iconic bag is the Birkin, literally named after actress Jane Birkin. What’s more, even though it does not rely on KOLs (key opinion leaders) to sell its products, Hermès produces the exact same effect by having celebrities, millionaires and other high-status individuals wait and crave for their products. It makes their brand even more unique: wanted by those who have it all. As a side-note, Birkin bags have shown a steady 14% YoY increase in value over the past three decades, making them one of the best alternative asset class there is.
Some other brands, mostly upmarket ones (Boss, Calvin Klein) but also some brands geared towards discount consumers (CVS, Walmart, etc.) also use the same branding tactics and obtain celebrity endorsements. The strategy is effective, still consumers know what brands are considered luxury due to craftsmanship, exclusivity, heritage, price and other elements.
Luxury brands increasingly rely on influencers as the content creator space matures and allows them to turn eyeballs into dollars. For instance, Dior’s partnership with French influencer Léna Mahfouf had a media impact value (the sales impact of placement, endorsement and other social media campaigns for a single media) of $4.72m in 2021.
In any case, luxury brands are champions at creating masterful marketing buzz and receiving endorsements of household or up-and-coming celebrities is a definite trick up their sleeves to continue enticing consumers of all ages, genders and regions.
As Bernard Arnault put it himself: the luxury business is difficult because “you need to create desires for things that no one really needs”. Showcasing a galaxy of stars definitely helps.
7/ The talent war
One aspect we haven’t discussed yet is how all luxury brands, small and large, all emerge from a determined Creative and Artistic endeavor.
In general, luxury brand identities are defined by their founders (think Chanel or Yves Saint-Laurent), who give it a clear DNA. From there on, the brand is put in motion and reinvents itself through the work of creative designers who embrace the brand history and are able to express it with their own eye and renew the brand expression.
It’s all about individual talent and risk-taking. Finding or hiring a Karl Lagerfeld (Chanel), John Galliano (Dior), a Virgil Abloh (Louis Vuitton) or an Olivier Rousteing (Balmain) is a quintessential task for all brands, who are also putting the crown jewel at risk every time a new Artistic Director is hired.
As with all markets where individual talent is in very high demand and very short supply, there is a continual mercato (transfer market) for talent. This is true for fashion, but also restaurants, events, and other forms of luxury goods and/or services.
Gary Cruz, Master Watchmaker for Audemars-Piguet
Yet, besides the essential role of Artistic Directors, Designers, Chefs and Architects are also countless jobs that the industry requires in order to maintain its prestige: haute couture workshop fairies, leatherworkers, shoemakers, watchmakers, craftswomen, concierges, tailors, sommeliers, maîtres d’hôtel, etc. Luxury groups invest a great deal of money into the hiring, training and retention of these qualified workers who are also essential to the quality of product/service.
It should also be noted that the industry also hires a great number of less qualified workers: kitchen helps, clerks, busboys, dishwashers, petites mains, etc. who do not benefit from the same prestige, yet also suffer the extremely demanding environmental pressure. As an employee in the industry, you are supposed to deliver the best only, which has many pitfalls.
René Redzepi, the Chef of the now-closed-once-best-restaurant-in-the-world Noma, puts it this way: “fine dining, like diamonds, ballet and other elite pursuits, often has abuse built into it.”
8/ Conglomerates and independent brands
Caravaggio’s David & Goliath. The smaller one doesn’t always win, though.
M&A activity in the luxury space has grown continuously over the past few years.
Under increased competition, consumer behavior changes and the need for scale and efficiency, large conglomerates (Kering, LVMH, Richemont, Estée Lauder, L’Oréal, EssilorLuxottica, Chow Tai Fook, etc.) have grown ever bigger in the past years through a trailblazing acquisition spree.
Indeed, pressure is increasing for individual, independent brands: expanding their reach to new regions or customer segments, increasing market share or launching new product lines are all very costly endeavors in the presence of behemoths in the market. Consolidation has allowed luxury brands to scale and improve distribution, pool resources, share expertise and reduce costs, which improves competitiveness - and makes the acquirer ever profitable with a portfolio of balanced brands.
The question is: can individual brands resist the movement?
Some have: Hermès, Ferrari or Rolex remain independent to this day. Yet for them, the key to remaining independent lies in the mythical character that they have for consumers: legacy is a great help.
For newer brands, the question remains. There is no definitive answer to this question, but I believe in a few assets that independent brands have over large conglomerates that they can strategically leverage to their advantage:
Creativity: as we mentioned in the previous section, creativity and talent are the centerpiece of luxury brands. Designers who build their own brands can be radically experimental and entirely expressive of their identity, which can gain foothold rapidly and win over some consumers.
Risk-taking: similarly, independent brands can take more risks in their marketing approach, distribution techniques, etc. They do not have to be ubiquitous, rather they can try to gain momentum and market shares in specific, niche markets.
Adaptability to trends: while consumer behaviors change (m-commerce, live purchases on TikTok, carbon neutrality, etc.), smaller brands have larger avenues to experiment and cater to these new consumption patterns
Innovation: finally, independent brands can also incorporate tech and innovations more easily into their product offerings, whether it’s on the product itself (e.g 3D-printed dresses) or in the way it is marketed, distributed or sold (e.g virtual showrooms, VR catwalks, etc.).
While they don’t have the scale, resources or cost advantages, smaller brands can count on some strengths that are core competitive advantages in the luxury market: a flair for design, innovation, risk-taking and limitless creativity.
It will be very interesting to see how the market plays out in the next few years.
My take is that a few brands might slip to the crack and make it to a worldwide scale without being absorbed by larger conglomerates, but that this will be the minority. Large luxury groups will continue to expand their portfolio of brands and grow externally through M&A, raking in more and more revenue and profits.
Conveniently, time for us to move to the perspectives for the luxury industry.
Perspectives
9/ Tech & Luxury : friends or foes?
The luxury industry, like all others, has not been spared by the need to implement digital innovations into its operations. All core functions, product and supply chain management operations, distribution channels have digitized and will continue to overcome silos and challenges linked to digital transformation.
That is not the point here: obviously being able to sell on mobile, through influencer social media, to model new products through digital tools, to adapt wrist bands to digital watches, etc. are things that luxury brands need to do in order to cater to changing consumer needs.
What I would like to talk about is that luxury and tech seem to have a love/hate relationship. They could pair very well, yet they tend to stay apart.
Indeed, luxury has an intrinsic attachment to tradition and legacy ; yet it is also the domain of pure creativity and innovation - making it an interesting object for tech.
For instance, there is no such thing as luxury software. Sure, there is expensive software (think anything B2B that very few large customers badly need), but there’s no status or desirability elements attached to it. No one will tell you “oh my god, I am so jealous of your new Tidal/Netflix/Slack subscription”. The one example I thought of was the infamous ‘I am Rich’ app that debuted with the first iPhone at a $999.9 price and that did nothing but signal you had bought it. Pure status.
Yet, as SaaS develops, you could think of alternative strategies to increase MRR whereby number of seats is limited and ARPU (average revenue per user) is much higher, and you rely on user FOMO to acquire more customers. Companies like Superhuman have used this strategy with great success when launching.
At my previous firm, we used to say that tech is the perfect tool to provide luxury-like experience at scale. Indeed, tech allows to personalize services or products offered to each individual users, based on feedback or usage data and/or selected preferences. But is it really luxury if it reaches scale? Doesn’t luxury imply some form of scarcity? And isn’t that intrinsically incompatible with technology revenue models (increasing returns to scale)?
Apple might be the one brand that has a foot in both markets. It builds technology products and markets them like luxury. Yet its products are hardware, physical ones. One could argue that iOS user experience is high-end, hardly that it is luxurious.
The Merge sold for $91.8m
One of the recent innovations that could reconcile the scarcity of luxury and the scalability of technology are NFTs (Non Fungible Tokens). In the past years, pictures of monkeys have sold for millions of dollars as if they were an original Van Gogh. While the raving about NFTs has virtually stopped with the slowdown of the overall cryptocurrency market, the concept itself could help implement luxury-like concepts into digital products.
Arguable, to say the least: while Alexandre Arnault (heir to LVMH) is the proud owner of a CryptoPunk, his father Bernard has taken a jab at competitor Gucci for selling virtual sneakers: “we’re in the real world selling real products”.
10/ The future of luxury
Wrapping up, I’d like to talk about the future of the industry - not by stating possible truths (my crystal ball is broken these days), but by raising a few key questions that will surely determine how the space will move going forward.
Is status-shopping going anywhere?
Is it likely that in the next few years, the human desire for personal recognition and ego boost will fade away?
While my opinion is that society seems to be going in the opposite direction (with likes, views, clicks, etc. becoming a norm), we might reach times where more pressing needs in the Maslow pyramid need to be addressed first due to ecological or societal reasons.
However, I still think that even if constraints appear (consumption, energy, etc.), inequalities will rise and allow a smaller group of individuals to access more demanded luxury products (artificially scarcitized).
Overall, I think that looking for status is inherently human and that luxury is a mean to that end - an efficient one at that as it offers Status-as-a-Service.
Can luxury goods become digital, and if so are luxury brands equipped to pre-empt the move?
I’ll leave that one as an open question - my thoughts are in the previous section.
What effect will recession have on the luxury market?
This one is more current than the previous ones. While stock markets are plummeting and inflation is increasing, what can we expect from luxury consumers?
On one end of the spectrum, will consumers save more money? Channel their disposable income to more pressing needs? Or will they invest in alternative, “safe” investments (as we saw, luxury handbags are among these).
Overall, the pandemic has benefitted luxury brands and the rapid expansion of the customer base (especially driven by Asia and younger consumers) could be partially offset by a decline in revenue per consumer while recession lasts.
Yet, luxury conglomerates have had exceptional results in 2022, have profitability levels that make them geared to face the long winter and can count on customer segments that recession does not really affect.
Having written this long-a** article and raised those questions, I have to admit that I am very long luxury. Happy to have a chat about it if you disagree or would like to dive in a particular topic more specifically - as you’d have noted, my guilty pleasure is a gourmet meal, so you know where to invite me ;)
Until next time,
Younes
Amazing blog and phenomenal writing. It was truly informative, thank you for putting all the effort that you did in writing this exceptional blog!