Developing Luxury Brands Within Luxury ... - The Luxury Strategy

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Developing Luxury Brands Within Luxury Groups – Synergies Without Dilution? The recent acquisition of the famous luxury jeweler Bulgari by the world’s leading luxury conglomerate LVMH foretells a wave of consolidations. In order to grow, many family-owned luxury brands will join existing conglomerates or form new groups. This article explores the value created by the corporate level of luxury groups. Their level of integration is usually moderate, reflecting a balance between the search for synergies and the preservation of the autonomy of luxury brands that is essential for sustaining their symbolic power. VINCENT IJAOUANE | JEAN-NOEL KAPFERER

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n most industries, concentration has been a long-standing trend, with major groups leading in each sector. The benefits of size (“big is beautiful”) are well known. The luxury industry, although attached to images of independent family brands, is no longer an exception. LVMH originated in 1987 from the merger of a leather company with a cognac and champagne house and is now home to more than 60 brands. More recently, PPR, originally a wood and retail conglomerate, added a luxury arm with the purchase of the Gucci Group, with the ambitious goal of making it the world’s number two luxury group. Richemont (Cartier), the Swatch Group or Ralph Lauren are other famous groups. 24

The recent wave of acquisitions has been driven by the desire of many well-known family companies to give up their autonomy and by the search for synergies. But some voices have expressed doubts about the validity of such concentration. Rigby et al. (2006) argued that “the usual benefits of being big – leverage with suppliers, shared marketing and administrative expenses, and high-volume, strategic customers – just do not seem to apply for most multibrand luxury players”. They added some disturbing facts. In the luxury industry, single-brand companies actually grew 60% faster from 1994 to 2004 as compared to brands owned by multibrand conglomerates, without showing weaker Marketing Review St. Gallen

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Developing Luxury Brands Within Luxury Groups – Synergies Without Dilution?

profitability (Rigby et al. 2006). Also, it has been speculated that luxury brands could be in danger when integrated with and managed by non-luxury groups (e.g., Jaguar and Ford) (Kapferer/ Bastien 2009). But why should luxury groups be a special case? Because, in contrast to FMCG (fast moving consumer goods) brands (Kapferer 2012), the brand equity of luxury brands depends on their high symbolic power. Whenever a change of ownership takes place, there is a risk that stakeholders will lose confidence in the sustained authenticity and inherited culture of the brand. As luxury groups have transformed into listed companies, they have come under growing pressure to exhibit growth while simultaneously maintaining their high brand equity. However, the feelings of privilege that they create are threatened by the pressure to increase penetration, diffusion, trading down, and the introduction of so-called “accessible luxury” options (Kapferer/Bastien

2009). De Sole, former CEO of the Gucci Group (Galbraith 2001), put it bluntly: “When you are a public company and you want to continue to create value for your shareholder, you have no choice. You cannot go downmarket because of the effect on margins and profitability.”

Theoretical Background: How Groups Create Value In the luxury business, unlike in other sectors, groups cannot be based only on cost reduction motives. If they were, how would they create value? A review of diversification theory reveals that the performance of multi-business firms is related to their capacity to generate a corporate effect rather than industry or business effects (Brush et al. 1999; Rumelt 1991). The corporate effect can be defined as value creation at the corporate level, which corresponds to both the vertical relationships between the corporate center and

Fig. 1 Typology of Synergies Within Luxury Groups

Resources Manufacturing Sourcing Purchasing

Loan conditions Productive functions

Currency hedging Financing

Emplacements

Financial synergies

Bargaining Power

Legal structures

Market Power synergies

Wholesalers Space Purchase

Lobbying

R&D

Retailing

Pooling of resources (Economies of scope)

Logistics Warehousing

Luxury expertise

After-Sales service

Support functions (Central & Regional)

Management of Talents Legal (IP..)

Efficiency synergies (Hard synergies)

Marketing Media Buying

Luxury branding Brand Tumover

Corporate Capabilities

Corporate effect

Human Resources IT and ERP

Fashion magazines

Financial Corporate Assistance Services

Real Estate

Tax Insurance

Back office Utilization of best practices to improve cost efficiency

Operational synergies

Transfer of know-how

Raw material Technology, component or product

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Access to scarce resources

Organizational Design Best Practice Sharing Staffing of key people

Transfer of know-how

Luxury market trends

Communication/Media

Corporate initiatives

Brand Streching International expansion

Corporate synergies

Growth synergies (Soft synergies)

Corporate Control & Planning Corporate development

Formulation of Strategy Control of Performance M&A JV

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the businesses and the horizontal relationships between the businesses (Knoll 2008). Search for synergies is another goal of groups. Synergy means that the combined return of two or more units together is greater than the sum of the returns of each unit individually. Usually the study of synergies has been limited to efficiency-focused synergies or hard synergies (economies of scope). Following Knoll, we integrate it into a more global theoretical framework defining operative synergies, market power synergies, financial synergies and corporate management synergies, which are derived from leveraging operative, market power, financial, and corporate management resources, respectively, across the businesses (see figure 1).

Research Objectives and Methodology A brand joining a group has to add value to the group. Reciprocally, the group has to add value to the brand. But what is the reality of this parenting advantage with which luxury groups are said to endow their brands? As Moore and Birtwistle (2005) put it: “Little, if any consideration has been given to how luxury brand conglomerates secure what Goold et al. (1994, p. 13) described as ‘parenting advantage’ – those strategies, structures and processes whereby the ‘parent works through its businesses to create value’.” For them, luxury brand development and sharing of group resources are the main sources of parenting advantage that luxury groups can create. Is this really the case?

To answer this question, we conducted a comparative/collective case study. As mentioned above, three major conglomerates dominate the luxury sector: LVMH, PPR-Gucci and RichemontCartier. All of them are multi-business firms (MBF) in the sense that they own different brands and offer a very diverse group of products within the luxury industry – fashion & leather goods, watches & jewelry, fragrances & cosmetics, pens, wines & spirits, etc. These MBF were selected because they are representative of luxury conglomerates. Fifteen interviewees were selected following a competence and relevance criterion. We met with at least two interviewees from all three companies investigated in the collective case study, including the Chief Financial Officer of each one. Semi-structured and open-ended interviews were used.

Findings of the Transversal Analysis Operative Synergies The first finding is that in the luxury sector operative synergies are not as important as they are in other consumer goods industries. However, we found that efficiencies and growth synergies do exist and contribute to the corporate effect. We furthermore found that efficiency synergies, by which value is created through economies of scope, result from the pooling of common resources. These can be divided into two distinct forms: resources required for production and resources related to support activities.

Fig. 2 How Luxury Groups Create Added Value Fashion

Leather Goods

Timepieces

Jewelry

Fragrances Spirits & Cosmetics

Overall

Pooling of Resources Manufacturing for Productive FuncPurchasing tions Sourcing R&D Pooling of Resources Logistics for Support FuncWarehousing tions After-Sales Service Human Resources IT and ERP Marketing Media Buying Real Estate Back Office Transfer of Know-How Best Practices Efficiency Synergies

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In the luxury industry, support activities can usually be pooled without much concern, but pooling production activities is a different matter entirely. As we have shown (Kapferer/Bastien 2009), this is due to the nature of luxury, and specifically to the importance of having a distinct brand identity. For a luxury brand, integrating production with that of other brands could potentially damage its image as well as its integrity in the minds of its customers. However, we found that, depending on the product category, numerous domains can generate efficiency synergies, e.g., R&D in fragrances, purchasing in leather, sourcing and manufacturing in watches (see figure 2). The synergies regarding support activities are much more obvious and generalized across all investigated companies and businesses. These synergies are simply derived from the possibility to share costs in functions that are not intrinsic to the luxury product. Throughout the luxury industry they are systematically present at two different levels:

» The performance of multi-business firms is related to their capacity to generate a corporate effect rather than industry or business effects. « ■ Centralized support functions (for operations impacting the whole brand) operated as shared centralized services. ■ Regional support functions (for operations impacting the brand in a specific area) operated as support platforms. The latter represent an opportunity for brands to successfully combine the efficiency of centralization with the need for local responsiveness. Efficiencies in regional support functions are primarily derived from logistics (including cross-docking), warehousing, human resources, IT, and media buying. Distribution and delivery are often centralized within timepiece brands. Similarly, in spirits brands the distribution is fully integrated. The use of common regional warehousing platforms has been generalized across different product categories. For timepiece brands, the pooling of after-sales services is a major source of synergy, as these brands utilize common regional technical centers to ensure after-sales service. However, there are a few functions or shared services that generate synergies that are not always pooled, depending on the level of integration. Real estate (store development), IT and ERP, regional marketing (especially for timepieces), media buying, human resources, and diverse back-office operations are generally organized on a product category basis. Within operative synergies, the boundary between efficiency synergies and growth synergies is vague. This is illustrated by the transfer of know-how, which generates both efficiency synergies and Marketing Review St. Gallen

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growth synergies. On the one hand, transfer of know-how allows the brands to share best practices that help reduce various costs (of manufacturing, contract manufacturing, licensing, processes, etc.). On the other hand, it also results in other opportunities, such as allowing brands to extend their existing product offering. A good example of this are timepieces that are offered by fashion brands (Tag Heuer and Louis Vuitton, Boucheron and Gucci, Richemont and Ralph Lauren). Furthermore, transfer of know-how can enable brands to expand more easily and rapidly in new markets, due to the existing knowledge and stakeholder relationships in local luxury markets established by those brands in the portfolio that already operate there (e.g., LVMH’s access to the US fragrances market thanks to Bliss, Hard Candy, Urban and Decay). Finally, brands can exchange information about market trends across different businesses and thus adapt in a better way to current demand or simply develop an enhanced vision of the luxury market. Through the present multiple case study we uncovered another major source of cross-business growth synergies in addition to the transfer of know-how: access to scarce resources, which can be divided into access to raw materials, such as precious stones, specific fabrics or grapes (e.g., through the purchase of wine domains), and access to specific technology, components or products (taking the watches industry as an example, e.g., Gucci Group’s stake in the Sowind Group with the Girard-Perregaux and Jean Richard brands and their purchase of Sergio Rossi and its manufacturing plant, or LVMH’s purchase of Roger Dubuis and its manufacturing capacity). Joint development platforms are relatively insignificant for luxury brands. This kind of synergy is often seen in highly technological products, whereas in the luxury industry the dream function is often superior to the utility function; thus, these products are more about creativity and affection than about innovation and perfection (Kapferer/Bastien 2009). Finally, it should be noted that typical soft synergy opportunities (e.g., cross-selling, lead-sharing, cross-business bundling) as well as joint marketing activities (e.g., joint image campaigns, joint customer loyalty programs) and extended umbrella brands are not relevant or highly marginal in the luxury industry, due to the specific relationship to its customers and the fact that sales and merchandising teams are kept autonomous. However, the pooling of after-sales services is a major source of synergy in the watches business. Two important domains in which non-luxury groups usually realize synergies are not relevant in the luxury industry: creation and distribution. In luxury, exclusive distribution is the ideal for selling the singularity of the brand experience. Creation and distribution are usually not organized to create synergies, because the risks generated (e.g., value destruction by damaging the brand equity of each luxury brand) are too high. Only the Poltrona Frau Group created its own multi-brand flagship stores in the BRIC countries to break even faster. There are also a few functions or shared services that generate synergies that are not always pooled, depending on the level of integration: real estate (store development), marketing and diverse back-office operations. 27

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Market Power Synergies When Knoll (2008) proposed his classification of cross-business synergies, he acknowledged that, in the face of limited empirical evidence, market power synergies might be speculative because of national anti-trust laws that increasingly hinder and jeopardize the legal realisation of market power synergies. We agree on this word of caution, as in our specific case market power synergies have proven not to meaningfully contribute to the corporate effect. However, we also suggest two additional reasons why their realization is difficult in the luxury industry: First, in the luxury industry companies do not compete against each other in the same manner in which firms compete in other consumer goods industries. Second, most conglomerates do not wish to impose their newly bred brands on their business partners (e.g. wholesalers) and thus do not leverage their existing “market share”. This is due to the fact that the long-term risks of damaging the star brands are quite high, both in terms of image and in terms of the conglomerate’s power, which is directly harmed if the brands pushed forward do not perform. However, we also identified two distinctive opportunities for value creation. First, luxury malls are multiplying throughout the BRIC countries. No luxury mall can be established without LVMH. With their portfolio of 60 brands, LVMH alone can start a luxury mall and make it grow. Second, these conglomerates have one or several leading brands within their portfolio which give them bargaining power vis-à-vis their different stakeholders, such as wholesalers, department store or mall managers (for the choice of the best location), journalists (fashion or luxury magazines), and regarding media space purchase.

Financial Synergies This point is often ignored yet matters substantially. Our study shows that all luxury conglomerates have implemented a pooling of financing resources. This means that the brands no longer have to negotiate their credit lines on their own, but rather receive funds according to a budget approved by both the brand and the corporate level. This gives the brand easier access to credit, which can be very important considering that brands in ramp-up often find it difficult to acquire the financial resources that they need to expand and reach their very high break-even point. Moreover, brands in conglomerates are granted much better conditions for loans, as the parent often has a better risk profile, since it is more diversified and larger. Finally, some conglomerates are cash rich and often only need to use debt to raise their leverage and the return to their shareholders. We also identified the possibility for brands in conglomerates to protect themselves from currency fluctuations by pooling currency hedging at the corporate level. Doing so allows the brands to fully concentrate on their operational management and remain confident that their performance will not be greatly endangered by currency fluctuations. 28

Eventually, thanks to a legal integration of local affiliates into the legal entities of the parent company and other sophisticated legal schemes, the brands can optimize their legal structure.

Corporate Management Synergies Corporate management synergies are often neglected in synergy studies, but our study shows that they are of prime importance, at least in the luxury industry. Corporate synergies are derived from corporate capabilities, corporate initiatives, corporate planning and control, and corporate development. In the luxury industry, corporate parents create value for brands by bringing specific expertise in distribution (e.g., shop experience, selective distribution, internet distribution), licensing and market intelligence. Conglomerates often have particular knowledge and proficiency in luxury branding (i.e., in helping brands to position themselves as true luxury brands). Every so often they also have demonstrated a significant ability to turn ailing brands around by change management. Last but not least, the management of talents seems to be a significant lever of value creation among multibrand companies. Groups have been leveraging the potential of their talents across brands by offering them attractive career paths. Luxury groups offer many more talent development opportunities than do most single brand companies. Indirectly, these HR strategies help attract, motivate and retain the best talents in the luxury groups. This is a major difference between conglomerates and family-owned companies. We found that corporate centers can, in addition, generate value in HR executive management by first allowing operational top management to share high-level best practices and ideas through internal universities (e.g., LVMH House in London) and by employing them strategically at key positions across the different brands. These key managers represent a very scarce resource, as they need three complementary skills or competences that are fairly exceptional: a thorough understanding of the product, excellent commercial and financial skills, and the ability to manage the creative leader(s) of the brand.

Implications for Growing Luxury Brands Within Groups Synergies in luxury groups are not so much about costs. Given the industry’s high margins, cost reduction logic is not needed and cannot be achieved at any price. Every search for synergy must be conducted carefully so as not to harm the brand. Usually, synergy is a word that is badly connoted from the employees’ point of view, but in the luxury industry it is the managers who have to be careful with regard to the realization of synergies, always remaining aware of the potential drawbacks of such synergies. All activities in contact with the end customer have limited synergy potential and this is confirmed by the fact that all brands are expanding their directly operated network. Production, however, seems to follow a different logic. While production used to be fully autonomous, this might change and become dependent on customer perceptions. Marketing Review St. Gallen

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Regarding the governance debate between autonomy and centralization, we believe that with respect to the identity, culture and strategy of each brand, an organization by business branches can provide a powerful infrastructure and deliver shared resources to the brands of the division, especially the weakest or smallest. Each entity (also called Maison) acts as a virtual company with its own CEO and its own head creative designer, both having a real “brand custodianship”. The difficulty comes in finding the right balance between the search for synergies and the autonomy of the brands. We would like to warn corporate managers that cross-business synergies should be implemented carefully and that “the more synergies the better” is a very dangerous point of view. Luxury brands’ symbolic capital is fragile. It is essential for them to maintain their roots and their freedom within a framework. If too many synergies are realized, brands tend to underperform, as sharing resources can reduce their sense of accountability. However, entrusting full profit and loss responsibility to brands driven by corporate objectives jeopardizes coordination and collaboration mechanisms. Finally, we would like to draw corporate managers’ attention to human capital and knowledge management (including the sharing of best practices), two undisputable strengths that groups should cultivate so as to outperform their peers on a long-term basis.

Galbraith, R. (2001): Multibrands: A Lucrative Strategy for the Luxury Italian Fashion, http://www.nytimes.com/2001/03/02/news/02iht-rbrand.t. html?pagewanted=all (Accessed: 27.10.2011). Goold, M./Campbell, A./Alexander, M. (1994): The New Strategic Brand Management, New York. Kapferer, J.-N. (2012): The New Strategic Brand Management, 5th edition, London. Kapferer, J.-N./Bastien, V. (2009): The Luxury Strategy: Break the Rules of Marketing to Build Luxury Brands, London. Knoll, S. (2008): Cross-Business Synergies: A Typology of Cross-business Synergies and a Midrange Theory of Continuous Growth Synergy Realization, Wiesbaden. Moore, C.M./Birtwistle, G. (2005): The Nature of Parenting Advantage in Luxury Fashion Retailing – the Case of Gucci Group NV, in: International Journal of Retail and Distribution Management, 33, 4, pp. 256-270. Rigby, D./D’Arpizio, C./Kamel, M.-A. (2006): How More Can Be Better, http:// www.ft.com/intl/cms/s/0/4f86d8ec-f42f-11da-9dab-0000779e2340. html#axzz1c0U1IMgK (Accessed: 27.10.2011). Rumelt, R. (1991): How Much Does Industry Matter?, in: Strategic Management Journal, 12, 3, pp. 167-185.

The Authors Vincent Ijaouane Investment Manager at Agora Fund LP in Geneva, Switzerland E-Mail: [email protected]

Jean-Noel Kapferer, MBA, PhD References

Brush,T./Bromiley, P./Hendrickx, M. (1999): The Relative Influence of Industry and Corporation on Business Segment Performance, in: Strategic Management Journal, 20, 6, pp. 519-548.


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Professor at HEC Paris and Pernod-Ricard Chair on the Management of Prestige Brands in Paris, France E-Mail: [email protected]

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