Pricing Luxury: LVMH in 'Old' Europe, 'New' China

Having several friends and relatives working in the industry--female and male, mind you--I've taken a keen interest in luxury goods as an exemplar of globalization's dynamics. Not only do leading luxury firms have global reach and name recognition, but they also have to deal with variations in culture, custom and differences in various nations' economic performance (among other things). Thus I found Dana Thomas' book-long rant about the commodification of luxury products fascinating even if it was more a lament concerning how most luxury goods were no longer handcrafted in traditional fashion hotbeds alike France and Italy but mass-produced in plebeian places such as China. While I normally couldn't care less about where something is made provided the quality is the same, these considerations do matter when snob appeal forms part of your product's unique selling proposition.

Anyway, the geographical concern we have today is not where these luxury products are made but where they are sold. Specifically, we are talking about the world's biggest luxury goods group Louis Vuitton Moet Hennessy (LVMH) whose name derives from the combination of legendary leather goods maker Louis Vuitton, champagne house Moet & Chandon and cognac house Hennessy.

In the past, LVMH has priced similar goods significantly higher in Asia than in Europe. Aside from encouraging luxury buyers in the Asia-Pacific to come and visit France to buy their luxury goods, doing so also acknowledged that European buyers were--how should I put it--less able to buy costly trinkets and baublets. Especially now that Europe is under strain due to the existential crisis of the EU, buyers in France have been few and far between even after accounting for tourists from abroad. (As an aside, when I visited these shops in the 90s, they had a lot of Nihonggo-fluent salespersons to attend to Japanese buyers. On more recent visits though there seem to be more Mandarin-speaking salespersons.)

The conundrum here is a variation on the paradox of thrift. While raising prices elsewhere may boost LVMH revenues, they may depress the French economy as a whole given that shopping is one of the primary reasons Asian tourists come to France. That is, LVMH pricing not only has effects on the firm's bottom line but on tourism to France in general. From Bloomberg:

Chinese tourists traveling to Europe to take advantage of savings as much as 50 percent on designer clothes and accessories are finding fewer bargains. LVMH Moet Hennessy Louis Vuitton and its peers are raising prices to make up for lost business in China and lower profitability outside the country, even if it puts items like 2,270-euro ($3,000) Lockit handbags further out of reach for Europeans whose disposable incomes are shrinking amid austerity.

“You cannot continue to sustain the existing price gaps that have been a mainstay of the luxury goods industry for the past 20 or 25 years,” said Luca Solca, global head of European equities at CA Cheuvreux, in an interview. “What we expect luxury-goods companies to have to do is progressively close the pricing gap and, more likely than not, this is going to come from stepping up prices outside of Asia.”

With China expected to account for a third of luxury sector expansion this year, weakening revenue growth there is a risk to earnings even as the value of sales in yuan rises with currency moves. Earnings before interest and tax as a percentage of luxury sales is 40 percent in China compared to 25 percent in Europe, largely because of lower rents, Solca estimates.

Tourists, mainly from Asia, account for between 35 percent and 60 percent of luxury sales in Europe, according to HSBC analyst Antoine Belge. At Paris-based Louis Vuitton, currency shifts widened the price differential between mainland China and France to as much as 47 percent in the first quarter [via a strengthening yuan and a weakening euro], spurring more Chinese to shop abroad, according to LVMH Finance Director Jean-Jacques Guiony.

While the premium propped up flagging local demand in Europe, it came at the expense of sales in the world’s second-largest economy, he said on a conference call last month. “This will continue to be a feature of the industry this year unless the group rebalances pricing to discourage parallel imports,” said Barclays Capital analyst Julian Easthope... 

Given that other luxury brands are following LVMH's lead by jacking up prices elsewhere, PRC buyers who used to go abroad to take advantage of "arbitrage" opportunities may find it becoming less and less attractive to do so:

Lower prices are the main reason wealthy repeat Chinese travelers buy abroad, Sfez said. That doesn’t mean they scrimp. Chinese visitors reported spending an average of 11,000 euros on shopping per trip to Europe, Hong Kong or Singapore, according to a recent Global Blue survey. “Shopping is their preferred activity at destination,” Sfez said in response to e-mailed questions.

Sales to Asian tourists will rise by a mid-teens percentage this year in the region compared to a mid-single digit decline for local customers [penny-pinched Europeans, mon ami], Belge estimates. Sales of high-end goods may climb 10 percent in 2012, half last year’s rate, and 9 percent in 2013, he said. Vuitton, which raised prices 2.5 percent to 3 percent in Europe in the first quarter, hasn’t decided how it will adjust its pricing structure further, Guiony said. He doesn’t expect the shift in business from China to Europe to be permanent.

Luxury companies risk hurting local European demand or damping other tourist spending in the region if they raise prices too much, said Armando Branchini, founder of Milan-based luxury consultant Intercorporate. Still, a progressive increase is needed and austerity measures are likely to be main obstacle to consumption in the region, Solca said. 

In case you're wondering, while luxury brands do milk the Chinese market or what it' worth, you also need to account as well for relatively high duties on such products: 

Lowering prices in China isn’t an alternative and won’t be until Chinese authorities cut import duties, PPR SA (PP) Deputy CEO Jean-Francois Palus told analysts last month. As China cuts taxes on consumer goods this year, Branchini said he expects the duty on luxury goods eventually to reach between 10 percent and 12 percent compared with 17 percent currently. 

Very interesting stuff, and I should have more to say about luxury in general and LVMH in particular in the very near future.