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    Luxury retailers: Readjusting the business model in the midst of a global crisis


    A recent research report by Verdict Research, part of the , finds that the global downturn has brought about a major reversal in the fortunes of the sector, shattered some cherished myths and radically changed the rules of the game. Verdict predicts that a significantly different luxury retail sector will emerge at the end of this crisis.

    A major reversal
    The synchronised downturn in the EU, the threat of a second lost decade in Japan and the difficulty in negotiating the in the US have altered the rules of the luxury retail game globally. The global downturn has affected the fortunes and real incomes of the global elites from Russia to China to the West, has curbed global travel levels (which is very important in the sector as a sales generator in particular from airport locations) and perhaps most significantly has fundamentally changed the consumer attitudes of the mass market. Generally speaking, an era of consumer frugality has set in and has left its mark on the luxury sector and the widening of the consumer target group to the mass market has halted. In short bling, which characterised the Noughties, is out and considerate consumption with a focus on quality and perhaps understatement rather than fashionability is in. We can say, the change in external circumstances has once again demonstrated the cyclical nature of the luxury business globally. Contrary to what has often been claimed luxury by any means is certainly not immune to crises.

    Currency fluctuations
    Another direct consequence of the financial turmoil has been extreme currency volatility. For the vertically integrated luxury players this has turned into a major issue as luxury is one of the few industries where products are manufactured in Europe at large and sold to the rest of the world. So far currency exchange rate fluctuations have meant, that apart from the rising gold and diamond prices, the upward pressure on prices has been immense. Especially outside the eurozone, home to the majority of the luxury industry, retail sales prices need to be adjusted upwards to make up for the shortfall in depreciations. However, raising prices in a recession is very difficult to carry off even for a luxury business, especially for those ranges targeted at the mass market and in particular in relatively new and poor markets in the Middle East and emerging Asia (including India).

    Emerging markets – not so decoupled after all
    In recent years emerging markets have been crucial as a sales driver for the luxury industry and luxury retailers flocked to the Middle East (Dubai), Russia and emerging Asia. This has also come to an end. Decoupling clearly was a myth and the global meltdown has led to a sharp correction in economic performance of emerging markets. Sales across the region have felt the impact acutely. Moreover, going forward, we expect a consumer attitude change in emerging economies, as consumer behaviour usually follows trends set in the west. As considerate luxury consumption becomes the watchword in the west, frugality will also be the major theme in emerging markets and ostentatious showing off will be a thing of the not too distant past.

    Focus on the major markets, as sales declines have become inevitable
    For luxury retailers the game now is almost exclusively about traditional core markets, the EU, the US and Japan and complete focus is required. This warning comes against the backdrop that research forecasts a six per cent decline in global luxury expenditure in € terms to €211bn in 2009, predicting that the global industry is headed for one of the worst years on record. In particular Japan (-14.6%) and the US (-12.1%) will see sharp declines in sales growth. For revenue, cash flow and profit generation and protection it is vital that the domestic houses of the luxury dynasties are in order. Some luxury businesses are highly geared and covenants need to be honoured – and only if domestic performance is assured can luxury businesses finance further expansion abroad.

    Where to cut costs
    In the midst of the crisis it is vital to reengineer the business model and to relentlessly focus on driving sales and cutting costs. Cost cutting measures will include the renegotiation of leases, reducing advertising in a very careful manner, so that the brand does not drop off the radar, some short timing at the back end in manufacturing, cutting any underperforming sub brands and most radically mothballing store expansion programmes.

    Where to drive sales
    The other tactical response in combination with a cost cutting initiative is to aggressively drive sales growth. As the department store sector in many markets shows signs of implosion, we would advise luxury retailers to go fishing where the fish are. The new opportunity lies in shopping centres. Especially in the EU this sales location has mostly been ignored as it was assumed that luxury retailing needs to be as exclusive as possible and boutique based. However London’s Westfield shows a viable alternative and could act as a template for other centres across the EU. In the US and many emerging markets shopping centres are already locations of choice for luxury retailers. For those with the necessary cash reserves, the current climate spells a golden opportunity to snap up cheap (sometimes even rare, exclusive) retail locations, as the real estate market is bottoming out.

    Other sales driving campaigns could revolve around careful diversification into new sectors such as tourism and wellness and renewed licensing activity. Crucially, luxury retailers need to make sure their sales staff are sufficiently incentivized to maintain service levels, as the luxury proposition needs to be maintained at all costs. Moreover, luxury is probably one of the only industries