retail-world



Walking in the death zone: how aggressive discounting is threatening the watch industry

Español
November 2015


The watch industry’s slowdown has trapped many brands in a dilemma: price rebates are supposed to motivate consumer demand and boost sales. Yet aggressive price incentives put gross and profit margins under pressure. In the death zone of continuous discounting many brands risk being wiped out. The air is getting thinner.

TOUGH TIMES AND WEAK OUTLOOK

The recent news has not been encouraging. For September, the Federation of the Swiss Watch Industry reports a year-to-date decline in wristwatch exports of 2.4% in value and 0.8% in units. Though the contraction seems to be moderate, compared to the industry’s compounded annual growth rate (CAGR) of 6% for all exports from 2000 to 2014, and 13% for timepieces above a per-piece export value of CHF 3,000, the numbers are dramatic. With its excess capacity the industry is increasingly struggling to respond to the challenges. And the outlook for 2016 promises little relief. The Bridge To Luxury estimates next year’s growth at a maximum of 1–3%, which would correspond, at best, to the 2014 results. In comparison, TBTL expects the luxury industry as a whole to perform at a 4–6% rate next year.

MULTIPLE EXTERNAL CHALLENGES

Obviously, China’s modest economic growth has surprised and impacted the watch industry. And so have the anticorruption measures implemented by the Chinese government. The Greece crisis has paralysed local demand in many European countries – growth here is mainly based on tourist shopping in the major metropolises. Volatile currency exchange rates have added to worrying exogenous factors – a case in point is the Swiss National Bank’s decision to free the franc against the euro. The internet continues to affect the industry: it gives consumers new power over brands by providing quality information about product pricing and availability.

THE INDUSTRY PARTLY TO BLAME

Yet, however great the temptation to blame external causes for the current difficult situation, which is unlikely to change any time soon, the industry has to ask itself why it is under pressure. The correlation between economic growth and demand for watches is not a new phenomenon. Consumers need to be in a good mood to purchase watches, which is the case if the overall economic frame is positive. It’s just common sense. The same applies to the influence of currency exchange rates on the business. To believe that the Swiss franc and euro would remain perpetually pegged at a 1.2:1 ratio was naïve, and reveals a general industry characteristic: business planning often seems to be based on a simple extrapolation of a favourable past, while potentially negative impacts are glossed over. This leads to aggressive growth targets resulting in capacities and distribution structures exceeding consumer demand. It also points to a disregard for economic cycles, crises and major events that do happen quite often if one just recalls some of the incidents of the last 15 years: 9/11, SARS, Lehman, Greece, Ukraine etc. The industry was slow to anticipate the importance of the internet, and has again been slow to anticipate the impact of the smartwatch. It is a conservative industry in which innovation is generally confined to movements and designs in the constrained universe of a classical steel or gold case. Excluding the big groups, with diminishing sales many small and medium-sized brands face increasing cash flow and funding problems, because they have failed to put anything aside for a rainy day.

DISCOUNTING AS THE SOLUTION?

In reaction to a challenging environment the industry is largely responding in two classic ways: cost-cutting and price reductions along the distribution chain. Both approaches are legitimate, however they are not without risk to the brand’s image. In general, streamlining expenditure in times of crisis starts with marketing. It is a fair assumption that the smaller the company, the more hazardous the effect of a reduced brand presence in the marketplace. Big brands maintain recognition and recall values at higher levels due to their bigger budgets, in both relative and absolute terms. Even if the effects are not felt before, once the markets rebound the consequences will be driven home as bigger brands enjoy stronger growth rates, resulting once again in a larger market share. Vicious cycles such as this can also be observed with regard to pricing. Currently, in the high-end timepiece market, collectors are offered discounts on a broad scale, at a rate of a borderline insane 30–50% knock-down on the net retail price. In their urgent need for cash flow, brands try to bypass retailers, distributors and agents and connect directly to the final customers – or the grey market. Given their commissions of 2–5%, many of these players are ready to sell anything to anyone. Sometimes it’s good to remember some basic arithmetic. For example, a brand that previously generated a gross margin of 50%, if it introduces a 10% price rebate, will have to pump up its sales by 25% to achieve the same profit as before. Is this realistic? The discounting will destroy a lot of long-term trust in the market. And most important: the customer will have learnt the lesson that brands are not as sacred as they seemed. A once highly respected luxury and prestige object is turned into a commodity. Cynically, one could add that at least the pricing of the Apple Watch is consistent.

SOME OPTIONS

The current crisis triggered by China’s loss of economic momentum is speeding up the process of restructuring in the industry that was delayed and masked by the last decade’s boom in Asia. Sadly, brands, especially those of smaller and medium size, will either silently disappear, or eventually find out that even quite public efforts to attract investors or new owners will be in vain, or will only happen at the expense of high write-offs of assets and brand goodwill.

In the future, the industry needs to take a more cautious and humble attitude. Business plans that define at least a five-year horizon, and which factor in at least one major crisis, are an absolute necessity. New attitude, old-school financial planning. Yes, even the venerable watch industry could face the threat of new competition. As a consequence, innovation needs to be understood in a broader sense. The vast healthcare industry, for instance, offers many possible opportunities for new partnerships and pioneering watch-based products. The Lehman crisis showed that watch enthusiasts under time pressure to sell their collections were able to regain 50% of the purchase price for some brands, while others fetched just 10%. Long-term, branding is king. The stronger the brand, the greater the power to withstand the temptation of heavy price discounts in troubled times. But branding is a complex strategic and creative effort that demands patience – and investment.

Vertical integration grants control of the distribution chain – and therefore of unwanted grey markets and discounting. However, here again, long-term business plans should anticipate downturns. As embarrassing as it may be, some brands nowadays would be happy to close down some of their expensive monobrand boutiques in Hong Kong, if only their rental contracts permitted (see our Retail Map, page 68). In this context, sensitive multi-channel management helps. Those who follow the rule “one channel, one offering” are better prepared to flush out a dysfunctional distribution network.

International market research on competitors’ pricing, along with monitoring of global currency developments (again linked to business and scenario planning) should be a matter of course. Hedging, while a complicated instrument in itself, may soften currency risks. Obviously, the better the company’s funding, the easier it is to weather the storms. If marketing budgets really are to be cut, it should be done where the effects on strategic brand as well as customer and retailer relationships are the least hurt. How big does a booth at an intra-industry fair really have to be to make an impression? On an organisational level it is important to control local business units that may be tempted to secretly compromise on pricing. Here, it is possible to define sales managers’ contracts such that they focus on healthy gross margins rather than rapid sales growth.

One of today’s management tasks is to consider business exit scenarios in a timely fashion. Over recent years it has proved increasingly difficult to identify investors. The search should start as early as possible – and in many cases the process itself gives owners and senior management a valuable learning experience in terms of the true market value of the company and its brands. There are no easy and very few short term solutions to the current situation. However, the old saying will unfortunately prove correct: “Those who resist change will be changed.” At some point, restructuring will take place. Professional brands try to lead the process consciously and in advance. For the others, the air is indeed getting thinner.

Source: Europa Star November 2015 Magazine Issue