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12: Financial and HR Management of a Luxury Company

Luxury brands distinguish themselves through the products and their reputations - but having a superlative product and a distinguished reputation is the result of operational excellence that is impacted by the way in which the company operates - and in that sense a firm must consider even internal decisions in light of the impact they have on the brand. Two areas of specific interest are the management of finances and human resources.

Financial issues in luxury companies

The strength of a brand is often measured by its financial value, which is tremendous for luxury brands. The authors provide a list of brand values, which seem to focus on the value of premium rather than luxury brands.

(EN: Toyota, Mercedes, and BMW are all in the top twenty, and all valued at about $30 billion, even though the two premium brands sell far fewer vehicles. However, further down the list is Porsche and Nissan, both valued at around $5 billion, in spite of the fact that Nissan sells 4 million cars a year and Porsche sells only 100,000 - and nor far behind is Ferrari, with a brand value of around $4 billion and annual sales of less than 10,000 vehicles.)

Luxury brands fare well in this kind of analysis because the estimation of brand equity considers the price of a branded product against a generic, which is significant for luxury brands.

In general, luxury businesses are much smaller in size, but have tremendous gross margins - though admittedly they have high production costs and overhead that is divided among a smaller number of units sold, so their net profit is not quite so extreme and many run at very narrow profits, even taking losses for a number of years.

The strategy of a luxury brand is to remain small and produce an expensive product, whereas the strategy of a mass market brand is to sell as much as possible, as cheaply as possible, which has a profound impact upon the entire business enterprise.

Luxury and profitability

Luxury can be extremely profitable under certain conditions. However, be careful to avoid the assumption that a high gross margin guarantees a high profit, as this is not so: luxury also has very high operating expenses.

High expenses in production are not to be reduced, for a couple of reasons: first, lowering expenses tends to lower quality and result in a product that has a high price but low quality, which is inauthentic. Also, low production costs make a product highly profitable to counterfeit.

Some general observations on the profitability of brands:

• The most focused luxury brands maintain a net profit rate of 35% constantly sustained for 20 or more years
• More diversified luxury brands can sustain a net profit of 25% to 25%
• Fashion brands the "flirt with luxury" undergo tremendous variances in profit or loss according to their standing at any given point in time.
• Luxury brands that are at the upper end but are too expensive to find a significant client base (such as Rolls Royce) are generally not very profitable

Another list of bullet-points is provided to explain the reason that luxury should be highly profitable:

• Revenue is proof of the brand's success - clients knowingly pay a high price because they feel the brand to merit it
• Because overhead costs of production and marketing are very high, a luxury brand must have a high margin
• The brand's ability to tolerate faltering profitability indicates the dedication of the firm and shareholders to achieving the dream of luxury, and putting standards before profits.
• However, if the profit margin is low and the firm is financially shaky, there is the perception that it will cede to financial concerns and compromise their standards

And yet more bullets, this time about the rules that must be followed to achieve and sustain high profitability:

• Remain concentrated on the core line and extend in a conservative and controlled manner
• Consider the morale of consumers and employees alike in any prospect of growth or diversification
• Control stockholder peevishness and keep them focused on the long-term goals of the brand rather than the short-term financial performance of the firm
• Resist the allure of generating greater profits by appealing to more customers or serving the fickleness of fashion
• Continue to invest strongly in the brand, maintaining its prestige.
• Avoid extravagant expenses for the mere sake of ostentation. Significant costs are expected, but not wasted.
• Be profitable in the core product before attempting to diversify

The profitability of luxury brands is described as a "virtuous spiral": a strong product leads to increased demand, which leads to increased production, which leads to economies of scale, which leads to increased gross margin, which facilitates marketing, which leads to increased demand, etc.

Globalizing

There are many skilled artisans who produce extremely good products that never grow beyond a single shop that serves local clientele: there simply is not enough demand in their area to enable them to grow their operations. To become financially successful, the brand must draw customers from outside its geographic market.

This was first accomplished by drawing customers from the rural provinces to travel to towns to purchase goods that could not be produced in the outlying areas, and drawing customers from towns to larger cities to produce goods that could not be produced in the towns. As well as drawing customers from other nations. This is still done today - consider that foreign customers make up over 90% of the clients of French luxury houses.

Today, globalization does not involve drawing the client to a business so much as bringing business to the client - from the gypsy caravan to the establishment of trade routes and distribution through permanent stores. This has enabled luxury brands to avoid relocating production to reduce costs, which is destructive to the brand.

Luxury, volume and profitability

Economies of scale drive profitability, but the degree and manner to which they are pursued must be carefully managed to preserve the esteem of a luxury product. To make the product too cheap, and to sell to too many people, negates the luxury status.

It is still possible for luxury firms to enjoy economies of scale, but to a more modest degree, by maintaining a high price and high product quality while reaching out to more customers, provided they are luxury class.

Investment in advertising stimulates demand, and gathers the greatest return on investment when production can be ramped up to fully satisfy the increase in demand. Shortcuts are taken, quality is diminished, work is done sloppily, all of which are poisonous to luxury. Where this occurs, luxury should not increase volume, but price.

There is a "swing thresholds" of volume at which it is more profitable to invest in communication than in cost reduction. At this point, more units may be sold, but the brand must concentrate on maintaining quality while increasing its production.

There is a separate "saturation threshold" after which increasing sales would diminish the esteem of the brand. At this point, the logic of volume has reached its limit and pursuing it further would reduce the exclusivity of the product. The authors suggest that this is the way in which Mercedes fell from grace.

In addition to a high gross margin, luxury brands also historically have a very high price-earnings ratio, which is attributed to four reasons:

1. A luxury brand is sheltered from competition and can maintain a high price for its goods without diminishing demand.
2. Communication by the brand is a long-term investment rather than a short-term expense: advertising for a luxury brand in the present year creates demand far into the future.
3. Few investors can resist the temptation to have a luxury brand in their portfolio, which effectively creates a higher demand for their stock, which bloats its price.
4. Many decision makers in financial firms are affluent individuals who are "secretly in love" with luxury brands.

Managing the human capital in luxury

Luxury companies have very specific and demanding needs for personnel. It has been discussed that luxury reflects humanity, and reflects the very best in humanity. In both production and sales, luxury requires a high degree of professionalism, talent, creativity, and attention to detail. To compromise on people is no less devastating than to compromise on materials and manufacturing.

Luxury is 'left-brain and right-brain'

The authors speak in general terms of the right/left brain dichotomy. They see left-brain as the demesne of industry and right-brain as the demesne of art, and that firms generally fall into sterile inefficiency or frivolous creativity almost exclusively.

A few examples are cited of luxury brands that flourished as the result of the partnership between two leaders - one of whom had creative vision, the other the discipline to make it a reality.

Luxury brands that are all analytics and no creativity may succeed, but not as luxury brands: they belong to the mass market and produce mundane goods with great efficiency. Luxury brands that are all creativity and no analytics tend to fail in the market, and their producers become artists who produce works of inspiration that are not popular enough to be viable as products.

A luxury company is a team

Following this logic, the author suggests that success in luxury requires a team of three distinct talents: artists, craftsmen, and managers.

The "artists" are men of great vision and very little common sense. They understand what is necessary to design a product that is awe-inspiring, but not how to make it or how to sell it.

The "craftsmen" are men who are supremely competent at making things. They are specialists in the hands-on skills of mass-production, but do not have the creative vision to design a product nor the sense of how it sell it.

The "managers: are men who are excellent at business, who can find a buyer for the things designed by artists and manufactured by craftsmen - but who themselves are incapable of artistry or craftsmanship.

Success is achieved when the three work in concert, each contributing his expertise and refraining from interfering with the work of the others.

Stability is critical

Stability of workforce is extremely important to a luxury brand. Traditionally, employees spent their entire career in a single firm, learning not only the tasks but the culture of the organization, and becoming a fully sorting member of the brand.

This has changed much in the mass-market products, in which the workforce is fluid, and a worker scarcely has time to learn the basic skills to do a task before he is reassigned, laid off, or leaves for better treatment elsewhere. Such a workforce does not understand the culture, not does it care to support it.

From an industry perspective, the skills and knowledge travel with workers from one firm to another and firms are eager to learn and implement the practices of their competitors, resulting in degradation of quality and commoditization of product. This is entirely unacceptable to luxury.

As an example, consider that luxury perfumes maintain consistency by having a "house nose," that ensures the product retains its distinctive scent. The "nose" is not merely a quality control checkpoint, but something that every employee develops ... but cannot develop if the workforce is in constant upheaval.

Beyond consistency in individual employees, luxury also depends on consistency and stability in the interaction among team members, which requires stability not only of the workforce, but stability of individuals in their roles.

The 'inverted pyramid' of human resources management

Luxury recognizes that the most important people in sustaining the brand to the customers are the workers: those who make the product and those who interact with the customers on the front lines. All other employees are in place to support these critical roles.

The notion of grass-roots management has received attention in various firms - but it is only lip service. Leaders and management may claim to value the input of the workers, but their day-to-day conduct is more in the nature of giving orders than providing support, and they treat their workers with little respect for their expertise.

This is one of the reasons that luxury management is very difficult - genuinely practicing the inverted pyramid approach is very difficult for managers who are used to receiving deference and holding unquestioned power over drudges - it requires a level of humility and hard work to which they are unaccustomed.

There is also a caution about prima donna employees who wish to be "stars" of the brand and outshine their colleagues. This approach, which is all too common in the fashion industry, also squelches morale and prevents the development of company-wide expertise.

Luxury Groups

A relatively recent phenomenon in the luxury business is the emergency of luxury groups - LVMH, PPR, Richemont, and the like - but the word "luxury" is used indiscriminately when these groups are formed: they are conglomerates of brands, some of which are luxury, others of which are not.

The authors distinguish two types of groups - the first follows a genuine luxury strategy, and the second does not, though they may operate partially in the luxury market. For example, PPR group manages the Gucci brand as well as Puma, a middle-market tennis shoe. However, this does not disqualify their luxury brands, as the individual brands do not take on the identity of the conglomerate, and it does not necessarily manage all of its brands in the same way: the luxury brands may follow luxury strategy, whereas the premium brands do not.

The independent management of luxury brands is essential to maintaining their prestige - synergies may be exploited, but in general the headquarters does not impose itself on the brand. For example, the LVMH group still manages its brands (Vuitton, Moet, Hennessy and others) as if they were independent companies, and their sole reason for conjoining into a conglomerate was protection against corporate raiders. The headquarters consists of a very small financial team that manages finances and investor relations but does not interfere with the management of manufacturing or marketing of the brands.

Luxury groups: brand portfolios or brand bouquets?

In traditional businesses, a corporation seeks to manage its portfolio of brands to a given purpose: it may have several brands to cover various market segments. In luxury, it is more a bouquet, a collection of beautiful objects without an identifiable practical goal.

As a result, there are often few synergies within a luxury group - each brand stands on its own merit, and the operations are not integrated except for superficial administrative duties such as finances and human resources. That is, the stems are arranged in a vase, but no attempt is made to hybridize them.

Type 1 luxury groups

The type-one luxury group, which manages multiple luxury brands and does not maintain any premium or mass-market brand, follows the bouquet model, and serious mistakes have been made in attempting to leverage synergies. Some examples:

• BMW owns Rolls-Royce, which has been very awkward because the RR people do not respect the BMW people, much in the way that a prince does not associate with a merchant, even though the merchant may be wealthier and more successful.
• Hermes attempted to augment the value of Leica by manufacturing leather cases - totally ignoring that Leica cameras are favored for their technical superiority, and no one buys a Leica for its case.
• Sometimes a luxury brand is simply too small to be bothered with, which is the reason LVMH divested itself of Christian Lacroix after 20 years of attempting to build the brand
• In other instances, there is simply no respect for a brand - such as when PPR purchased Yves Saint Laurent and used it as a cash cow, destroying the reputation of a once-luxury brand

While the authors cannot provide a specific example, they are also decidedly against the use of CRM software to leverage the affinity of one brand to cajole the customer into purchasing other brands in a luxury group. CRM is superficial and automated, which immediately voids the quality and intimacy of the relationship between a luxury brand and its customers.

Type 2 luxury groups

The type-two group, which blends luxury and non-luxury brands, does provide better opportunities for leveraging synergies, though always at the risk of defiling their luxury brands. In general, the premium brands can feed off of the luxury brand, but the luxury brand risks being compromised if it feeds from premium brands.

There can be operational synergies created by lending some of the expertise and capabilities of the luxury brand to premium brands in the same group.

• Research and development is an excellent example, in which an innovation that does not contribute to the success of a luxury product can be handed off to a premium brand.
• The manufacturing operations of a luxury brand can be used to fabricate components for a premium brand, provided that this is done with excess capacity and does not draw resources away from the luxury brand.
• In the same way, the knowledge and expertise in back-office operations can be lent to a premium brand, with the same provision that it does not sap or distract resources from supporting luxury brands
• Relationships with suppliers and distributors of luxury may also be extended to help along premium brands.
• The premium brand can feed off the fringes of the luxury brand's market: prospects who desire but cannot afford the luxury brand can be ushered into the premium
• Premium brands can also consume what would otherwise be waste. For example, materials that are rather good, but not quite good enough for the luxury line, may be handed down to the premium brand.
• Likewise, employees who are highly talented, but not at the very top of their profession, can be handed off from a luxury brand to a premium one, or the premium brand can be used as a training grounds for those who may eventually prove themselves capable of managing a luxury brand