Double-digit falls in demand for luxury and premium goods and services mean a diminished future and a new reality for many companies
THE HARDER they come, the harder they fall, one and all. The decade of decadence, of affordable luxury and premium everything, from expensive spirits to fashion label clothes and first-class air travel, is over.
It was, of course, an illusion to imagine that the business cycle had gone away in historically cyclical industries such as airlines and luxury goods. But the years of expansion carried on long enough, with only a brief interruption in 2001, that a lot of people came to think so.
They have changed their minds. Virgin Atlantic expects to lose money in this financial year. Giancarlo di Risio, chief executive of Versace, is to step down after falling out with the family amid a 13 per cent fall in revenues in the first quarter.
Double-digit falls in demand for luxury and premium goods and services are common in recessions, but this hangover is especially sharp. Big airlines suffered a 35-40 per cent fall in revenues from international first- and business-class passengers in the year to March.
So what should such industries do when faced with a slump in consumer demand?
The textbook answer is to cut costs, curb output and do everything possible to adjust – apart from slashing prices.
“You must accept that you will sell less, but the biggest mistake is to cut prices across the board and ruin your brands. People are not refusing to buy because prices are too high, but because they are frightened and are hoarding money,” says Hermann Simon, chairman of Simon-Kucher, a pricing consultancy.
There is logic to what Mr Simon says. Even for non-premium industries, it takes three to five years to get consumers to pay the full price again once you have started discounting. As for luxury goods, price-cutting rips apart the industry’s artfully constructed image.
Discounting can exact a terrible price, as the imminent bankruptcy of General Motors shows. The company was the king of cheap finance and price-discounting even in the good times; it was left with thin to non-existent margins, having put its brands through the crusher.
But the reality for many companies (happily for consumers) is that they have no choice. Luxury and premium brands have grown so much – and reached so far into the mass market – that their owners cannot choose from a menu of cutting costs, output or prices. All are required.
British Airways, which was slower than Virgin to hedge fuel prices and discount business-class fares across the Atlantic, made a pretax loss of £401m (€456m) for the year to March and is now grounding 16 aircraft, talking ominously about the elimination of first-class seats on additions to its fleet and squeezing staff costs.
That is still not enough. The problem with just trimming output and costs in an industry with severe over-capacity – and there are a lot of those around – is that it does not stop rivals from price-cutting as well. BA is now offering two-for-one deals on business-class fares and online upgrades to economy fares.
Luxury companies have always tried to control distribution channels and limit output by selling through branded stores and cracking down on the grey market, but the profusion in the past few years of new labels and prêt-à-porter versions of established brands makes it tough.
Few of them control distribution channels sufficiently to stop others discounting on their behalf. Luxury fashion labels found this out to their horror last December when Saks Fifth Avenue, the New York store, slashed prices and was promptly followed by Barneys New York.
The premium vodka market in the US, where literally hundreds of pricey labels have sprung up to challenge Absolut and Grey Goose, is trapped in such a squeeze. People are trading down from “ultra-premium” bottles in shops, and bars are slipping cheaper spirits into cocktails.
“People do not want to admit that they cannot afford to buy Grey Goose, so they say they have found a new vodka that happens to be cheaper,” says Chester Brandes, president of Imperial Brands, which imports Sobieski, a Polish vodka.
Amid the price carnage, the best that many premium and luxury goods companies can do is to cut prices in as canny a fashion as possible. Instead of openly knocking down prices for everything they sell, they must find ways to do so both discreetly and discretely.
“Almost every industry has excess capacity, so now is the time to apply pricing and promotional science,” says Michael Silverstein, a senior partner of the Boston Consulting Group and author of Trading Up, a 2003 book about how US consumers were spending more on luxury. He says that companies should aim promotions at existing customers whom they know wait for sales. “Get them into stores now because you know you will have to mark down eventually.”
Mr Simon prefers two-for-one offers and discounts-in-kind to price-cutting, arguing that it absorbs excess capacity and is better for margins. It also limits the tarnishing of brands at the bottom of the cycle.
These are smart tactics, but they do not obviate the problem – an excess supply of premium and luxury goods compared with long-term demand. Even when corporate demand for business-class air travel returns, the artificial wealth created by the credit bubble will not accompany it.
Facing a diminished future, it makes sense to act as airlines such as British Airways and Virgin Atlantic are doing: reducing everything to find a new floor, from operating capacity and staff costs to prices. It would be preferable to avoid the last, but obstinacy is not a virtue.
– Copyright The Financial TimesLimited 2009
