Understanding the (true) luxury industry
Understanding the (true) luxury industry
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Hi reader,
Chit Chat Money released a couple of days ago a podcast episode where Sleepwell Capital and I discussed the luxury industry. You can listen to it below:
It takes some time to prepare a transcript because it has to be reviewed quite thoroughly, but I took the time to do it because I thought it might be useful for you.
We go over a wide variety of topics such as…
What's a luxury company?
How do they solve the growth vs exclusivity dilemma?
What separates Hermes/Rolex/Ferrari from the rest?
Why is luxury Lindy?
How should luxury businesses distribute their products? Why has $FTCH not worked?
Will $RH successfully make the transition?
Importance of being privately owned in the luxury industry
Pros and cons of standalone vs group companies. $LVMH vs $RMS
Potential risks for the company
I think it was a great episode and should be very useful as an industry primer. The main pain point I always come against when analyzing a new company is finding a comprehensive report on the industry, which will most likely drive a good chunk of the investment returns.
Hope you find value in this and if you do be sure to subscribe to this blog or to become a paying subscriber of Best Anchor Stocks, where I cover these topics much more in detail.
You can also find Sleepwell’s work in his substack
and you can also find Chit Chat Money’s work in their substackThe transcript starts below! Have a great one! 👇🏻
Brett (Chit Chat Money): Welcome to Chit Chat Money. My name is Brett Schaffer and I am without Ryan Henderson today. Unfortunately, he had to work during this interview. However, we have two very special guests, recurring guests that have been on this podcast, I think three or four times each. It is Sleepwell Capital and Leandro from Best Anchor Stocks, and we are doing a sector overview on luxury companies. We hit a lot on Hermes, we hit a lot on Rolex, I should say both these. Guests have substacks and newsletters that have covered companies that we discussed on the show before, and we will link to that in the show notes.
Before we get into it, I should say, if you want more access, more written content, all that good stuff, subscribe to our free newsletter, the Chit Chat Money newsletter, in our show notes. We'll have possibly a transcript on this episode, we'll see, and we also have what we're trying out is three follow up questions with our two guests to cover a little bit more on the luxury sector.
Before we get into it, let me hit a special disclosure for our guest Sleepwell Capital. Disclosure, the opinions of our guest Sleepwell Capital are not investment advice. The guests and associates of Sleepwell actively invest in securities. They may have long or short positions in any companies discussed, which are subject to change at any time without notice.
All right, before we get into it, if you have, if you like this show, if you like listening to this stuff, we'd recommend following both of these guests, and if you want to support the show, the best and easiest way to do that is to give us a five star review on either Apple or Spotify. Okay, I think that covers it.
Let's get to our luxury overview with Sleepwell Capital and Leandro from Best Anchor Stocks.
Brett (Chit Chat Money): All right. Welcome. We are on our Thursday interview episode on Chitchat Money and we're doing one of our...we've done maybe three or four of these now. It's what we're calling maybe a sector overview and we're talking luxury today and luckily we have two great guests. We have Leandro from Best Anchor Stocks and Sleepwell Capital.
So guys Welcome back on the show. Everyone seems to love your appearances here. I think it's both third or fourth time. So this is going to be a great conversation.
Sleepwell Capital: Thank you. Excited.
Leandro: Thank you. Me too. I've honestly lost count of the times I've come.
Brett (Chit Chat Money): Yeah. So the listeners like it and we enjoy talking with you guys as well.
But we're going to be talking luxury today. It is a well known sector, I guess. Everyone is sort of aware of these brands, but there's a lot of intricacies. There's a lot of uniqueness to this industry that makes it different than others. So let's start things out. I guess maybe we'll just alternate with some of the questions here.
We can start with Leandro on the first one and then Sleep can follow it up. What is a luxury company? What are its main characteristics?
Leandro: I'd say that a luxury company is a company that follows a luxury strategy. I know that that won't clarify much the definition for many people, but it's important to understand that regular companies sell products and luxury companies sell much more than a product.
So there you can see the difference. For example, a premium company will sell a quality good, but quality is already a given in luxury. And it's the status symbol one achieves with a luxury product. And also it's the dreams that it evokes. So I think it's more about intangibles because you can find quality in another product, but you can find intangibles more in luxury products.
I know Sleepwell has a good framework to classify a luxury company.
Sleepwell Capital: Yeah, no, that's a great explanation. And just to add on to that a couple of things. I think it's it's helpful to think when we talk about luxury sort of more broadly as a total sector...it's basically a spectrum, right?
And Brunello Cucinelli has this way of separating the different types of luxury into basically three types. So if you think about a pyramid, basically on the top, you have the true or absolute luxury brands. And I think that's what we're going to be actually focusing on today.
And then below that you have what we can call aspirational luxury, which are basically companies that are trying to get to the top. But as we will get into, it's incredibly hard to get there. And then at the bottom, we'll call these accessible luxury brands. Okay. So I think something that is pretty unique to this industry as well is that basically every company that operates in the industry will tell you that they're a luxury company, but you kind of have to do your own work to figure out which ones are the true luxury brands.
And that's where I think, this definition actually comes from...from the Rolex piece that I put out a couple of months ago, which we can link to, it's kind of a framework to filter out those that are not real luxury companies and really make sure that you're looking at a true luxury company, right?
So the first one is an obsession with high quality and craftsmanship. A lot of this, I mean, the high quality part is almost a given. Obviously, you know, the product has to be really well made. The design has to be almost instantly, you know, recognizable. But a lot of this also has to do with the story that consumers kind of fall in love with and that's in many cases what they end up buying. And we'll talk about, you know, how you achieve this because it takes arguably decades to get to that place, right?
The second characteristic is that it has to be exclusive and scarce. And what this means basically is that the products are exclusive, right? You know, actually pretty hard to get your hands into...many times there are wait lists for for a lot of these products. Consumers will actually have to make an effort to get their hands on them. So that that's another important characteristic.
And the third one is that these products have to evoke a certain status when you own them and that's...you know, wealth is obviously one of them, but that's not necessarily the only one... you know, you can also, you know, be expressing things like you have a refined taste or an appreciation for culture or history, or, I mean, if you're more specifically talking about watches you can signal that you're super enthusiastic about watches and that you're a watch collector.
I mean, there's certain watches that if you were to wear them, nobody would recognize them, except if you were like a sort of a true watch enthusiast, if that makes sense. And then there's also these, you know, there's this aspect where there's many cases where consumers will be buying these products to, you know, to celebrate special occasions, right? It could be retirement, it could be your first child, so there's a lot of you know...that's kind of the psychology that that goes that goes behind it.
So those are are the three main characteristics when we're looking at these companies. And I think something else that's important to note is that the strategies that these companies use to get to this place are very different to sort of traditional business one on one strategies.
And in many cases, it's very counterintuitive too, right? I mean, the most basic principle of all of these companies is that you always have to sell less than what is being demanded, right? And so that's obviously completely opposite to what your basic economics supply and demand curve will teach you. But we'll get into some the examples of how they achieve this and why that is right.
Leandro: I think what Sleepwell just said is really interesting because, in essence, a luxury product makes no economic sense. Like a Veblen good makes no economic sense. Having a higher price product that as price goes up exclusivity goes up and then the desire for that for that product goes up, but, and that's why luxury is so special because you cannot apply the same strategy to luxury than to another sector because it makes no economic sense. So, obviously, you cannot follow the same path as you would with a product that does make economic sense.
Brett (Chit Chat Money): Right. And yeah, for the listeners this stuff can be counterintuitive as someone who studied it a little bit, there's still a lot of confusion I think out there. So we're going to go through plenty examples. And we're also going to talk about specific advertising strategies and all the pricing dynamics that go with these companies.
But first, we're going to go through 3 examples, Rolex, Hermes, Ferrari. 1st one is Rolex, what separates them from other watchmakers?
Sleepwell Capital: Yeah, sure. And maybe I think it's helpful to give a little bit of context of just...well, what is known as the Swiss watch industry, because that's technically the market that we look at when we're talking about these watchmakers.
Basically it's, you know, around a 20 billion Swiss franc industry. Rolex has 30% market share, which is kind of crazy if you think about it, right? That's more than the next five companies combined.
And when we talk about the sort of the true luxury companies within the Swiss watch market, in most cases, you're referring to what are known as the big three, which are Rolex, Patek Philippe, and Audemars Piguet, okay? Also known as AP. Now, in terms of Rolex, you know, like, just really quick history...I mean, it's been around for 120 years. It was founded in 1905. It wasn't actually always a luxury company which I think is also important to keep in mind because you can actually sort of move up in this pyramid, but it takes a very very long time, right?
So If we look at Rolex today and what makes them different to the sort of the lower end watchmakers, you can think of these as basically, you know Tissot obviously, Swatch is really low in the in the sort of in that pyramid, but even other brands like Tag Heuer, for example, which a lot of people might recognize...Rolex kind of stands on its own when you compare it to many of these other brands.
And just, you know, just by going back to that framework that I was talking about before, we can basically talk about each and how Rolex sort of really exemplifies each of those characteristics, right? So in the first one, which is quality, you know Rolex is really well known to have this sort of almost an irrational obsession with quality and what they call the perpetual pursuit of excellence, right? They take this to an extreme, right? So they're for example, they're fully vertically integrated I mean, when it comes to producing their cases of their watches and the materials they own, I mean, they own their own foundry, right? So they make their own steel, they make their own gold. The quality control that the watches go into is also pretty, pretty extreme. I mean, they have a machine that opens and closes the clasp of the watch a thousand times per minute. The waterproof tests are also kind of taken to the extreme.
Basically all of this is to say that, because they've worked so hard at this and also telling the story to the consumers, one of the reasons that people will buy Rolex is that you basically have a lifetime guarantee that, when you buy the watch, you can pretty much, you know, give it to your son in 50 years, and that it's going to be working pretty much fine, right? Now, the watches need to be serviced every couple of years and whatnot, but in general, these are extremely high quality products, right?
On the second characteristic that I had talked about, the exclusivity and scarcity of the product. I mean, the simplest way to give an example of this is that you can go into any Rolex authorized dealers, and just to be clear that the only places where you can buy a Rolex retail are authorized dealers, right? There's many secondhand places that Rolex basically doesn't control because that's the secondary market, which we'll talk about. But if you go to any authorized dealer and you ask them, you know, what do you have in stock? 95% of the time they will tell you they have no product basically. And this shows you that how hard it is to actually get a product. You have to actually, you know, talk to this to the salesperson and tell them why you're interested in buying a Rolex which model you're interested in buying and then...there's this whole concept of what is, quote unquote, known as a waitlist. And then you kind of have to go back and check in every couple of months with the salesperson to see what the status is and if they got the watch. And obviously it varies a lot by models. There's models that are, you know, almost impossible to get unless you've bought like 10 watches from this retailer, etc. But again, it's just...it's very hard to get your hands on this product sort of from the retail level.
And then finally, on the, you know, the status aspect, which is the third characteristic...you know, it goes back to this idea I was talking about how long it's taking them to get to this place. They've worked on cultivating their image and reputation, which is basically, you know, what... excellence and timelessness are kind of what they're what they're known for, right? And they've built this for the last 100 years, right? And this basically means that the clients end up being, you know, kind of obsessively and fanatical about the brand.
Obviously, you have the collector community, which are, you know, in many ways, they're kind of the best marketing and advertising that the brands have because they'll, you know, they're the most sort of excited about the product. And then you have things like the partnerships that they've built over time, you know...they're very selective with who they partner with.
And the sports, you know, tennis and golf are the sort of the two most well known, which they've partnered with for 50 years plus. I mean, Federer in tennis has been an ambassador for a long time. Jack Nicklaus in golf, Tiger Woods, of course, so these are, you know, the things that they do and they may sound simple, but they're also, you know, they're incredibly targeted and almost repetitive because if you go back, you know, to the 1990s, you'll see them talking about the exact same thing they're talking about today, right?
It's just to kind of ingrain this whole idea in the consumers mind as much as possible.
Brett (Chit Chat Money): Okay, and as a second example, and I hope I'm saying this right. This shows how little I know about this market...it's Hermes, correct? Am I saying that correct? I should have figured this out before.
Leandro: Yeah. I think a French citizen would be proud.
Brett (Chit Chat Money): Okay. Good. Good. Cause everyone in the United States says Hermes.
So, second example is going to be Hermes. What separates them from other leather goods and fashion brands?
Leandro: I'd say it's a tough question to answer because there are lots of things. I think it's important first to understand that the true luxury companies don't really compete against each other.
So if you ask Brunello Cucinelli if Hermès strategy influences their strategy, they'll probably answer "no", and the same goes for other luxury companies. I mean, Hermes' management always gets the same question like..."but your peers this or your peers have done that", and they always say that, obviously, that doesn't influence what they do because they are running their business and not the industry. They are not subject to any overall industry strategy. And if the answer to that question is a "yes", then it's highly likely you are looking at fashion and not at luxury per se. So that's the first thing.
I think this stems from the fact that a luxury customer doesn't necessarily face a choice between one or the other, it's more one and the other. So a customer from Ferrari probably owns a Birkin and probably owns a Rolex. And going also to what Sleepwell was talking about Rolex, probably someone who owns a Patek also owns a Rolex I mean, they don't face a choice as a normal consumer. I think there's one place where true luxury companies do compete and that's real estate because I think we'll maybe touch on this later on, but flagship stores are one method that these companies have to advertise.
If you go to Amsterdam and you see the store that Hermes has set up there, it's not a store that you need to know what Hermes is to go... like if you're walking on the street, you'll look at it because they have glass bricks and they are made by hand, each one of those bricks. So that's one way they have to advertise and obviously the best real estate is very limited in supply. So when a new country is starting to emerge, and now this is the case of India, a lot of the luxury companies will go and try to grab the best real estate, so that will be very expensive. And it's also competition, not only from two luxury companies, but also from other brands. I mean, Inditex will open a Zara store in the best locations in the city and that's not luxury, but they have the money to open that store.
So as I understand the question is more what differentiates true luxury companies from the rest, or what I think you referred to as "the pack". So the most important differentiator, and I think Sleepwell also touched on this is history or what these companies call the heritage.
Hermes was founded more than 180 years ago and this obviously has built throughout the decades a reputation of quality that customers trust. Time is probably the highest barrier, or the most significant barrier to entry in the luxury space. And it's not only time. Also, as Sleepwell said, It's a lot of time of doing things right, which probably is the most difficult thing there is because it's not like I open a brand today, I wait two centuries and I have my luxury company. No, you have to open your brand, then do everything right during 200 years and then you have your luxury company. So it's a pretty significant barrier.
I think the other differentiating factor for true luxury companies is that these are typically family owned and operated, so that enables long term thinking. This is probably the most important element of a luxury strategy because you cannot implement a luxury strategy if you are short term oriented and obviously fashion brands that are publicly traded and are not under the control of one owner, it's more likely that they're going to succumb to investor pressure.
And this is kind of very Hermes specific, but I think Hermes' management is the only one I have seen directly quote the terminal rate in an earnings call, like saying we know what that our valuation depends on the terminal rate and we're doing all that's possible to preserve this terminal rate. I'm quite sure that if Rolex, maybe it was publicly traded, you would hear similar things in the earnings call. But Hermes, right now, is the only company that I can think of that has quoted that.
I think another very important thing that separates luxury from non-luxury is that they are true to their roots. So Hermes produces 80%+ of their products by hand in France and other companies that were previously considered luxury, and you can think here about Prada...Prada went to manufacture products in China thinking that that would enable them to connect better with the Chinese customer, but obviously a Chinese customer is not buying Hermes because they are manufacturing in China. They are buying Hermes because they are manufacturing in France and they want a French-made product. So I think delocalization is typically a symptom of inability to raise margin by raising prices. When you have to raise margins by focusing on your cost structure then you are more or less implying that you cannot raise margins by focusing on your price, which obviously shows that maybe you don't have such a pricing power.
The other one obviously is...and this is very, very specific in the leather industry. I think Hermes has an advantage in the leather industry due to its origins. Hermes started, manufacturing or making...I prefer to say making actually because manufacturing seems like it's automated and it's made by hand. The company started making horse accessories in the 19th century. So obviously, these were all leather accessories, so that gives them a credibility with leather that maybe other companies don't have.
And then the last thing I'd say is that luxury companies have a hyper personalized treatment for VIP customers. I mean, with Hermes, you can feel like a normal customer...you go into the store, you buy an accessory and you leave, but you can also be a VIP customer and they do whatever you want them to do. I mean, if you have a house and you ask Hermes for advice to maybe put on the furniture, the leather you want to put, maybe your sofa, they'll do everything for you and they'll charge you for it... or whatever you want that Birkin that is tailor made for maybe some clothes that you have, they'll do that for you. So I think that's very important because there are a lot of companies that self-denominate as luxury don't have the ability to do this type of personalization because they are selling a lot of volume.
So I'd say those are some of the things that make Hermes different from non luxury companies and also what makes it shine inside the true luxury companies. I think Hermes is one of the best examples of what true luxury is.
Brett (Chit Chat Money): All right. And another public company that a lot of people will consider luxury, and I think maybe everyone will consider luxury is Ferrari, a very interesting company with probably, you know similar heritage type stuff. They have the unique Formula 1 advertising, but anything as we maybe try to reinforce these examples here, any, you know, notes from Ferrari you guys have for these.
Sleepwell Capital: I think Ferrari is is is a fascinating case study because if you look back at the IPO, so it used to be owned by Fiat, and it IPOd, it was a couple of years ago, I think, yeah, like seven, eight years ago or something. But basically...there wasn't actually like a consensus that this was a luxury company. Now it's clear because we know where it trades at.
And, you know, we've seen the track record, et cetera. But, when they were doing the road show, people were, you know, the analysts were comparing it to the sort of the traditional automakers, and maybe they were, you know, talking more about some of the higher end automakers, you know, Lexus and whatnot.
But, at the time, the late CEO from Fiat, who's legendary, Sergio Marchionne, he was saying, "no, you guys are all wrong, this should be comped to Hermes", and people were laughing at him. So it's pretty interesting because people really didn't understand the company and the earnings power that it would have. And obviously now with the benefit of hindsight and how the market reacted, we know, but it's very clear just by looking at their margins, and their, you know...if you look at the average selling price of a Ferrari, you know, you're talking about $300,000+, right?
And again, going back to those three characteristics that I was talking about, I mean, good luck buying a new Ferrari like it's impossible, right? Much harder than a Rolex. I mean, you have to basically be a collector of classic cars, specifically Ferrari and and there's basically a short list of of people that the company is in close touch with and they'll invite you to their headquarters if you want to try some of these cars and whatnot. So there's a very exclusive club that you have to, you know, get access to and be part of.
And just looking also at what some of these classic cars trade at, and we'll talk more about the secondary prices dynamics in a little bit, but, it's very clear that this is a true luxury company, right?
Leandro: I think what's funny, quote unquote "funny", about Ferrari is that when it started trading, people comped it against premium car brands. And now that it's clear that Ferrari is a luxury brand, people are comping like premium brands to Ferrari, which obviously they are not. And this is happening a lot with Porsche, for example. I think Porsche is a great premium brand, but Porsche cannot be comped with Ferrari because it's not the same obviously. You can go and buy a Porsche and I have explained it that maybe it's a very simple example, but if I'm in Madrid, I see a Porsche every day, for sure, or probably several, but I see a Ferrari once every three months, or once every four months.
So obviously, that already shows you the exclusivity between one brand and the other.
Sleepwell Capital: Yeah, I think...and Aston Martin, I think, was kind of similar at one point. Porsche is actually another interesting one because it's, I mean, I actually think...and that's the thing about luxury too, like there can be a lot of disagreements between what's luxury and what not. But I know for a fact that there are certain Porsche models that are very, very, very hard to get, but also they've diluted the brand over, over the years with entry, more like sort of entry level and accessible models. And, you know, the SUV, obviously, I mean the Macan, for example, and these other sort of crossover SUVs there, you see them everywhere. And they're much easier to get, even if they're priced, you know, sort of pretty expensive compared to regular cars.
But, yeah, again, just speaks to the fact of you know, the strategies...like you can take a sort of a high end luxury company, but if you start overproducing or making too many accessible products you can get to a point where the brand overall gets diluted.
Brett (Chit Chat Money): Yeah. And that leads to the next topic, which is if you're one of these companies and say you want to grow your business. I know one of the classic examples would be Louis Vuitton. How do you retain the allure of being luxury while trying to appeal to maybe more customers? Because I think one of the problems people have and one of the frictions is you don't want to see too many people wearing it. Just like you mentioned with Porsche.
I think one example that comes to mind from me just, you know, walking around in my personal life is Gucci. That's one I think I've read that people are concerned about. So what are you guys thoughts on that? How do you successfully make this transition?
Leandro: Yeah, I think there are two angles to this question. So when you talk about growth, you can talk about pricing and then growth from volume. In pricing, actually, luxury is the perfect model to grow in pricing because, and this is obviously counterintuitive, but it's what a Veblen good is: higher prices lead to higher exclusivity and higher demand. So I recall reading an interview by Ferrari's chief marketing officer and he claimed that Ferrari was quote unquote "forced" to raise prices annually because their customers were getting richer, and obviously if they didn't raise the price of the Ferrari, then the Ferrari was less exclusive for that customer. So they are forced to raise prices.
And then the problem probably comes from growth in volume, obviously, because that's the example that you discussed. I think luxury brands have been able to circumvent, like to manage through this problem through the years, and they have used different strategies. I think we've talked here about Hermes and Ferrari. For example, Hermes, yes, they will sell accessories to the middle class, but they have retained exclusivity in several iconic products and also across their VIP customers. So if you want a Birkin or a Kelly, it's not as easy to get a Birkin as to get a Hermes tie. So they have managed to retain exclusivity through several iconic products. Another good example is obviously Ferrari, because to growing volume, the company has said, "okay, we understand that we need to grow the company, so we'll, instead of launching, let's say 20 percent more Ferraris of this model, we'll launch more models."
So when you buy, for example, the new Purosangue, the SUV, you'll still own one of "x" Purosanges. Like, there'll be, I'm going to make up a number here, there'll be 10,000 or 2,000, and you'll own one. And we'll sell more volume of another model, but you still have an exclusive product, because we're not going to make more.
And I think it's interesting because luxury brands have always had this problem of growth versus exclusivity dilemma, but I think we might be operating in kind of a new paradigm where the brand can be reinforced by high penetration. I mean, I think some years ago, around 50% of office women in Japan owned a Louis Vuitton bag. So 50% of all office women in Japan own a Louis Vuitton bag. That's a crazy stat. So obviously people started to buy them just as a sign of status. Like I cannot be left out, but they still consider in Japan that Louis Vuitton is a luxury product. And I think it's more a question, and I'll let Sleepwell chime in here, of the demand and supply equation.
Normally, what Sleepwell commented at the start, the normal economic theory will say, well, if you have this demand, try to bring supply where it meets demand. And that's your sweet spot because you're able to sell as much as you have. Well, in luxury, the question is, can I grow while still undersupplying the market? And, if you grow while that equation holds where your supply is significantly lower than demand, then you'll retain exclusivity. If you grow by closing that gap, then you have a problem as a luxury company.
Sleepwell Capital: No, that's a great point. I mean, you have to strike that balance. And whenever you are growing production to meet the, you know, sort of increasing demand, you have to make sure that you're also, you know, investing in growing that demand at least as fast as that production.
And obviously it's very hard to measure what the demand is, but the best brands have to be really good at understanding how much their product is being demanded, right? There's a great quote from, you know, "The luxury Strategy", which is kind of the go to book for the luxury industry that says...
A luxury brand must have far more people who know it and dream it than people who buy it.
And that, again, goes back to that, you know, selling less than what is demanded, but I think that's a very nice way to put it and, you know, similar to what Leandro was saying in Japan and women in the office. I mean, if you go, I don't know the stat, but if you go to Wall Street, or whatever, midtown Manhattan, like, you'll see a ton of people wearing Submariners, right, like just the most popular Rolex model. And again, that doesn't mean that it's like accessible to everyone. It's just kind of an impressive feat that Rolex has achieved. Because, in fact, that's the people that you see that have been able to get one, but there's, you know, multiples more that are that are trying to get one and they basically can't, right?
So that's really what makes it all the more impressive. And I think it's also important to talk about the advertising strategies here, because, again, this is another part where you have to sort of flip the traditional school of thought when it comes to selling, right?
If you look at any advertisement from, you know, from Hermes, from Rolex, Ferrari, Patek Philippe, they're never going to be selling you something based on their characteristics or like telling you this is better than the competition are. Like, for example, in the traditional car world it's very, you know, it's very typical to talk about the technology that the car has or the zero to 60 acceleration or this Toyota is safer than this other car... Luxury brands will never do that because they live in their own little world and they're never going to be comparing themselves to to anybody else, right? It's sort of this very exclusive universe with an exclusive storytelling aspect that is very unique to them.
And again, goes back to what Leandro mentioned that they're not like directly competing with each other, right? They live, they almost live on their own little market if you want to think about it that way, I think one of the best advertising campaigns in the watch world, which is pretty well known is from Patek Philippe, right? And it shows, you know, sort of a guy in his, you know, in his mid fifties sitting next to his son who maybe is like 10 years old or something. And, you know, he looks like a successful businessman or whatever. But he's wearing a Patek Philippe, and then in the bottom, it says:
You never really own a Patek Philippe, you merely look after it for the next generation.
And that's just like genius, right? Obviously, but it speaks to how these brands are trying to sell to you, right? They're actually like telling you a story, right? They're telling you that this is going to last you multiple lifetimes, right? And they're selling you a dream, basically. Because a lot of people that are going to see this advertisement are probably never going to own a Patek Philippe, but that's kind of the point, right?
Brett (Chit Chat Money): Yeah, you're not going to see a QR code on a luxury advertisement. I think maybe to hone it on something because it can get confusing. So you mentioned the Rolex example, they love focusing on their golf and tennis personalities and the specific tournament tournaments, Wimbledon, the Masters Tournament, but you're not going to see a Rolex advertisement, I don't think. I guess I watch a lot of my local baseball team at my, on my local baseball team or at the local baseball stadium.
So why is that? Why do they choose these specific distribution points? Like are they, do they just have to be very specific and saying, look, tennis has this kind of luxury appeal, Wimbledon, you know, Wimbledon, the U. S. Open, stuff like that. How do they choose where to advertise?
Sleepwell Capital: Yeah no, I think you kind of hinted on it. I think it has to do with the crowds that these kind of sports attract right? Like if you go to Wimbledon or the US Open, it's a very different event than to go into a baseball game right? It's a lot more formal people dressed up for it, it's full of celebrities and golf is the same right? So they really want to be associated with, you know, certain sports and and activities that resonate with their image, right?
And their image and their sort of their main ideas, right? I mean, another thing that they've done, for example, is Rolex has been associated with, you know, scuba diving and sort of like deep sea exploration for a long time because they make these watches that can go, you know, to 30,000 feet underwater. So for example, when James Cameron built his own, you know, submarine and went down to the to the Mariana Trench, which is the deepest point in the ocean, Rolex gave him a deep sea challenger, which is the model that goes to the to the highest depths in the world, and he basically put it like right outside the submarine, and it went down with him all the way to the bottom and then came back.
It was like, just like a PR stunt right and it worked really well and James Cameron is a huge Rolex fan and he's an ambassador, right? So they just try to find, you know, sports and activities that really match with their image basically.
Leandro: I'll comment here one thing related to advertising because it's interesting because you can basically differentiate between aspirational luxury and true luxury just by looking at logo size.
So if you see a product with a huge logo, then you can question if that is really exclusive because they are...I mean, and there are surveys and studies around this, the more exclusive a product is, the smaller the logo the customers want. So I don't think luxury is about regular people knowing you are wearing a Birkin, it's about affluent, like, very rich people recognizing it without needing to see a brand.
I mean, if you wear a Birkin and you go to a place where you see a lot of people from the upper high classes, then they'll basically know that you're wearing a Birkin. They don't need to see the Hermes logo and the Birkin has like Hermes written on it, but it's so, so small that you can not even appreciate it.
Brett (Chit Chat Money): All right. We've talked a little bit about pricing but I'm just going to open it up to you guys. The pricing dynamics of luxury are quite interesting. As you guys say, quite attractive. So let's hit all these things. Pricing power, you know, and I think the key one is why higher prices doesn't necessarily equal luxury.
You can't just say this coffee cup is going to be a million dollars. No, it's not. It's a luxury product.
Sleepwell Capital: Yeah. And Leandro kind of touched on this in how Hermes thinks about it, but it's pretty much, you know, it's for these true luxury companies, it's a very similar strategy, right? It's raising price like clockwork. There's a great chart that I put out in a tweet a month ago or so that basically tracks the prices of the best selling Rolex models going back to like, you know, the 1970s. And you can pretty much see that it's compounded at like, 7% per year.
That's kind of what they've done, which is pretty incredible when you when you think about it. I mean, to have that kind of pricing power. The other thing that I think is very important and one of the most obvious tells that a company is not luxury is that none of these companies will ever discount, never. Like you'll never see any of their products going on sale 15% whatever Black Friday like that's a huge red flag for any of these companies.
And if we think about, you know, the concept of having a product price that at a certain level versus other products. I mean, that doesn't necessarily make it luxury. Prices is just one part of the of the equation. In isolation I don't think it really means anything. It has to be accompanied with all these other things that we're touching upon, right? And I mean, I think we're going to talk about why other companies that people might think are luxury, but really aren't as examples.
But just to give up like a quick one, like you can buy an Apple Mac Pro for like $20,000 if you like fully custom it. But that doesn't mean you're buying luxury, right? So that again, just because you're selling something that's super expensive doesn't make it luxury.
Leandro: I think that how I would describe it is that high prices... the ability to set a high price is a consequence of being a luxury brand, but it's not an enabler.
Just because you're charging a high price, you're not going to become a luxury brand. But if you're a luxury brand, you have the ability to do so because there's much more in luxury and we went over this at the beginning of the episode, there's much more than price. There's heritage, there's the intangibles. You cannot simply attain all of those characteristics by setting a high price.
And I'll give here the example of Hermes, because Hermes has a pretty special pricing strategy in the luxury world. So the other, well, the other day, a couple of months ago, I did a survey on Twitter, well, now X, where I asked, "what do you think is the price compounded annual growth rate for Hermes' pricing from 2018 to 2020?"
Obviously you receive the answers that you're expecting, like, "closer to high single digit or low double digit", Well, the answer is 1% because Hermes' prices are raised only when production costs rise. And you might think, well, that's stupid. Well, you can think that way, but they are thinking about the terminal value.
And they know that if they continue growing without needing to turn on the pricing lever, then they'll have that pricing reserved for the terminal years, which is what they care about. And it's crazy because if you get the resale value, and we can talk about this now, the resale value of a Birkin, the average, I'll say it's like 2x or 2.5x. Obviously this is an average, you have Birkins that go from basically the same price as the retail price and others that are much, much more expensive. But if you get these prices and then you make some calculations, you get to the fact that Hermes could increase the price of the Birkin by 3% every year for 30 years and they will still be pricing retail below resale. And that for me is incredible. And they have raised the price of the Birkin and the Kelly for an average of 4% per year over the last five decades. And when you start to read these stats is when you start to understand why these companies trade at the valuations that they trade, right? Because obviously this is some special pricing power.
Not many companies have the ability to raise prices one year 7% and still be as exclusive as they were last year. I don't know if you want to in the topic of secondary market values, if you want to touch on Rolex.
Sleepwell Capital: Yeah, no, that's a great point. And it's the same, you know, with the watchmakers, right? And basically looking at Rolex, Patek Philippe and AP, which is one of the three that we mentioned... the average, you know, the average secondary market prices versus retail is somewhere around that, right?
It's around double, depending on different models, but, that is such a great barometer to kind of see the health of a brand, and a very honestly, a very easy way to determine if a company is a true luxury company or not. I mean, I know a lot of people that like to argue that that Omega is the same as Rolex. But if you look at where Omega Watches on the secondary market trade at it's nowhere near that right, which means that obviously you can just go into an Omega store and buy pretty much any Omega that you want without really having to wait anything. I mean, there's always all these brands always have like very limited edition models and whatnot, but just generally on the most popular models, you can just walk in and and and buy them, right?
So again, it's just a really good reflection of the brand's health and there's you know, there's different ways of thinking of kind of where's the sweet spot. Should it really be trading that much higher? And then COVID obviously had all these sorts of implications where people started buying watches to flip them and thought they were going to keep going up and whatever.
But the fact is, even though the prices have come down a lot in the last, you know, nine months or so, it's still healthily above retail.
Brett (Chit Chat Money): Does this kind of connect to an example I've heard before where I think it was with Ferrari where people talk about customers wanting the price to rise, but they have to have a balancing act of maybe not fulfilling all of that, where they have to keep.
Does that make sense? Or does that connect in any way to across all these companies?
Leandro: I think that the resale value, the secondary market value is the limit where you can technically take your price because that's the price that the market is telling you "at this price is where we can equal demand and supply."
So you have to stay under that because if not, you're obviously supplying the market. And I think there are different strategies for the secondary market. For example, you mentioned Ferrari. Ferrari, actually tracks the secondary market because they know that if Ferraris retain their value in the secondary market, then they'll have a lot of repeat purchases by customers. Maybe a customer that has owned a Ferrari for three years will sell the Ferrari in the second hand market and will buy a new one.
But then you have Hermes, which is not really a fan of the secondary market and actually will blacklist a customer if they buy a Birkin and automatically sell it on the secondary market, because they want the Birkins to be reserved for the clients that actually want to have the Birkin forever.
So I think it's kind of a limit and some of them track it and some of them track it less, but for investors or for people interested in the industry, it's one, for me, it's one of the most important indicators of, like Sleepwell said the health of a brand.
Sleepwell Capital: And it's also in the consumer's brands. And I mean, I've talked to a lot of watch collectors and not everybody thinks this way, but a lot of them care about this secondary value because if you're going to go...if you're like a huge Rolex collector and you buy, you know, whatever, three, four Rolexes per year and you're buying this like limited edition piece for $200,000, like, at least there's some comfort in knowing that if you really need to sell that in whatever, in five years, because you ran into some financial trouble or whatever, you're probably going to get a lot more than that, right, or at the very least, you're going to get, you know, somewhere around that right. So because they're spending so much money on these, you know, collectibles and they just end up being almost like pieces of art.
Leandro: Ferrari is actually an interesting case because the chief marketing officer, I don't know if it's the current one or one that was in the past of Ferrari, previously worked at Barilla, the pasta company. Well, the food company, but mostly famous for the pasta. And he said that he had to completely change his way of seeing the relationship with customers, because when he was at Ferrari, when Ferrari launched an exclusive model, that was not a product that they were selling; that was a gift for the best customers.
Okay. Yes. The car is $1 million, but I'm making you a gift because you know that when you buy this car and this car arrives at your driveway, this car is going to be worth four or five million because you're one of the 100 people that have this car. And that's kind of also counterintuitive.
It's very special and especially in the car market, right? Because when you buy a new car and you open the door and turn the engine for the first time, that car automatically is worth like 20 percent less.
Sleepwell Capital: Yeah, at least.
Brett (Chit Chat Money): Yeah. Not a bad business model. Not a bad business model. All right. Let's talk distribution.
Uh, how do they. You know, get the products out to customers. How does a customer come in contact with the brand? You guys mentioned the flagship stores. I think people are well aware of those, you know, 5th Avenue, stuff like that. So how does this work? What, what, you know, what do they do differently than everyone else?
Sleepwell Capital: Yeah, I think... So it's very important for these brands to control the retail aspect of the selling process, because it's, you know, sort of personalized to the customers that, you don't want to be outsourcing that. And again, you have these in both in Hermes and Rolex, you have these issues where there's people that might be wanting to buy a Rolex and then they'll just flip it, which is an ongoing problem.
So you really need to have control of that selling aspect, right? And another part of luxury businesses that is misunderstood and sort of counterintuitive is that the selling is pretty much flipped on its head. Like there's no sales people in the store trying to sell you something. It's actually the opposite. You're almost trying to convince the salesperson that you're worthy of buying this product, which is insane, but that's literally how it works. Now maybe I'll let Leandro talk about what specifically about Hermes and and how that compares to maybe other of the, you know, leather goods and fashion brands.
And then I'll talk about Rolex because Rolex is an interesting example here that is actually live because they don't own the retailers, but they actually have started making moves to do this. So I'll pass it on to Leandro and then we'll talk about it.
Leandro: Well, I think as we've discussed throughout the episode, this is very similar...the strategy is very similar across luxury companies because they are actually following the luxury strategy. So if you're a luxury company, you have to own your distribution. That's it. That's like a rule because you have to own the experience, the customer experience. That's one of the intangibles that you get with a luxury brand.
The fact that you go to the store and it's like an event... when you buy from Hermes, a Birkin, they'll take you to the back of the store. They'll come with a Birkin, they'll serve you cake, they'll serve you whatever you want to drink. I mean, it's like an event. And I think this is in fact... that they want this to be so personalized one of the facts that has made these companies so reluctant to sell online, right? I mean, during COVID they had no other choice and they started selling. But these companies won't sell all the products in their website. You cannot buy a Birkin from Hermes in their website. Well, you cannot even buy it in a store. You have to go onto a list and then you'll go to the back of the store and you'll see the Birkin, but you won't see them before.
And I think Sleepwell referred to "The luxury strategy", which is from Kapferer. That is one of the most well known writers on luxury and a great strategist. And he said something that is very simple to understand, but that is so powerful. He said that the internet was built for the masses and luxury is opposite to the masses. So obviously it's very difficult to have a luxury strategy in the internet because it's contradictory and I think that's very important, although I would say, and obviously Rolex is an example of this and then I'll pass it on to Sleepwell that there are certain categories where you do sell through wholesale and that it will be probably perfumes, you also have sometimes jewelry and you also have watches and those three, these companies tend to sell through wholesale. And it's also a very good way of attracting new consumers to the brand. But if they want more products, then they'll have to go to Hermes to buy it.
Sleepwell Capital: Yeah, so on Rolex specifically, I think it's very interesting what's happening now because I mentioned that Rolex is pretty much fully vertically integrated. But if you look at that entire chain, the only place or part that they don't control is the selling aspect, which again is extremely important. Now, Rolex has a very strict vetting process in terms of who can become an authorized dealer for them. And, and it's, you know, they have to follow a long list of rules in terms of location and how the store has to look and feel and training for the employees, et cetera.
But again, they don't actually own that. They don't control that. So they've done as much as they can to keep that, you know, as highest quality as possible, but in the last, I think it was two or three months ago, they actually came out with an announcement that they're buying Bucherer, which also owns Tourneau.
If you live in New York City or one of these major U. S. cities, you'll recognize that watch store. And it was the first time ever that Rolex has gotten into the retail business, right? So obviously the watch world was pretty shocked to see this news. But again, if you think about their strategy and what they've done over the years, it's not all that surprising, right?
So now the question is, what are they going to do next? Because Bucherer and their stores, they sell all sorts of different brands, right? So now Rolex is essentially going to be selling, you know, Omega and IWC and even Patek Philippe in these stores, but we need to see what's going to happen going forward because there's going to be this tension with the other authorized dealers that they don't own. There's actually a public company traded in the UK, Watches of Switzerland, which is another very large distributor of Rolex, but it's multi brand. So we'll have to see how Rolex goes about this.
But my sense is they're probably going to start allocating more and more watches to their own stores and, you know, there's been a pattern of them, closing stores down to just kind of reduce the footprint footprint, again, just be more exclusive, really evoke that status that they're aiming for, that these things are hard to get.
So yeah, it'll be just interesting to watch all that unfold and where it lands. Audemars Piguet, which I mentioned before, they actually, they're going full on with a DTC strategy and they're basically rolling out their own boutiques and taking inventory out of all the other sort of multi brand authorized dealers.
Brett (Chit Chat Money): Now. This is kind of a timely one, but Farfetch was a good example, I think, of the distribution stuff. They've had quite a bit of issues, if you see that stock price, and there's been some news. I don't have the details, so maybe you guys can explain if it's relevant. But what happened there? Why, why was it not like following this luxury strategy?
Sleepwell Capital: Yeah, I mean, we could make a whole other podcast about this. Essentially, one of the main problems that Farfetch has, and to be clear, Farfetch is not luxury, right? Farfetch is a marketplace, right? They will, you know tell their investors they're exposed to the luxury industry, etc.
But one of the biggest problems that they have very much related to this topic of going wholesale versus going DTC is that by definition, the best luxury brands are never going to sell there, right? So you will never find Hermes selling there, a Louis Vuitton, a Rolex. To be clear, you know, they sell secondhand goods, so you can you can find used Rolexes and whatnot, which obviously the brands don't control, but the the point is that they basically end up with all these other brands that are essentially aspirational luxury brands. So you're talking just different economics.
And that's, I mean, that's one of the issues, right? There's a whole other bunch of issues they ran into. They thought they were going to grow a lot faster than they actually did. And the COVID pulled forward. And then, you know, bloated cost space, et cetera. But yeah, I think Farfetch is just, it's an interesting example of should there be or should there not be a scaled luxury marketplace and it's still kind of, you know, the question is still unanswered. We'll have to see what happens with the company, but so far it hasn't been successful, or at least not in a sustainable level.
Leandro: And I looked at Farfetch a long, long time ago, but what did not convince me and still doesn't convince me even today is that I think it's the right business model, but in maybe in the wrong industry, because if you strive to be a marketplace, a marketplace for true luxury, you're obviously not going to be able to do that. Then you'll go to aspirational luxury, and then that space is going to be much more competitive.
So for me, it's much easier for Zalando to go to the aspirational luxury space than it will ever be for Farfetch to ever go to true luxury. And I get the argument of, yeah, but they had, I don't even know if they have this still, but they have a Farfetch Platform Solutions, right? That they are trying to sell to other companies so that they can manage their online strategy while retaining their brand.
But I mean, Hermes has operating margins in the thirties. I don't think that they need to outsource any of this. They have enough money to control everything if they want. And one of the elements of the luxury strategy is to obviously own all your supply chain or try to own as much of it because you can then work on sustainability, you're not going to get disruptions. So for me, I don't know much about the company, but it doesn't seem the right business model considering the kind of sellers that there are in the luxury industry.
Brett (Chit Chat Money): Okay. Now this is a fun one. Leandro, I've heard you talk about this before, write about this before. Why is luxury considered lindy?
And for anyone that doesn't know, maybe explain what the lindy effect is.
Leandro: Okay. So, the lindy effect in short is basically that the past matters. So if you've been a company that's been alive or have has survived 80 years, then it's more probable that they'll survive the next 80, than a company that maybe it's newer. And that goes against maybe the diminishing returns or against capitalism, even because people think that when a company has been living for a long time, then they'll eventually face one of the most significant risk for any established company, which is complacency. And at the end they'll fall and they'll get disrupted. So that's capitalism. But Lindy demonstrates that there are companies that continue to do well. And maybe that's because of their past. And I think luxury is a perfect example of this effect. I think the question has two angles to it. So one, we could look at the past. And the other one is if we look at the future.
So if we look at the past, I think it's evident that luxury is intrinsically linked to human nature. It's obviously tough to put an exact, an exact date to the start of the luxury...to luxury as an industry, but, in ancient Egypt, that's around 5,000 years ago, and even before that, you already saw how luxury products were used by certain individuals as a status symbol. And we humans are social animals, and in society, obviously, there are going to be classes and people trying to be above others.
I think the relatively recent rise of social media is just A perfect example of this. I mean, everyone wants to appear in their Instagram that they have the best life and luxury is a way for them to also say, "Hey, look, I'm richer than you are." Or, "I am in the upper class while you're in the low class." And I think that if you look at the past, I mean, 5,000 years is a lot of years. So they have gone through a lot of pandemics, a lot of world wars. The industry has, has gone through everything that they can go through and it's still alive and growing. So obviously that demonstrates some Lindy-like characteristics.
And then I think in here, I will also comment that luxury has gotten some criticism about what it can do to inequality. I think it's a fair criticism. I don't remember who said it, but I think as investors we should try to invest in the world that we live in, and not in the world that we want to live in. And obviously, there's going to be classes. It's very nice of people to say "no, but there should not be like inequality." But inequality is something that will always be present in society. It's not something that we can fix.
So would the world be better without luxury? Well, it's a strange question because I'd say that I don't know. One of the reasons why China opened up to luxury is because they wanted people to strive to get better. So the rationale is that money obviously doesn't fall off trees. So having a society divided by status is positive so that people can strive to get to the next level. I mean, it's better to have people striving to be in the upper class than giving them no incentive whatsoever to abandon the lower class and luxury was seen like a tool to do this.
And now from the point of view of the future, I would say luxury is clearly Lindy and we've talked about, we've talked about this because history or time is the most significant barrier to entry. So this means that as more time passes, the entry barriers are getting larger. So it's very difficult for a company to go against Hermes and it's 186 years of history. But what would happen In another 120 years when Hermes is 300 years old? An aspiring luxury company needs to then overcome 300 years of history not 180. So I think it's the perfect example of lindy. And with this i'm not trying to say that Hermes will live on forever obviously. Any company can be mismanaged and Hermes can.
And I think one company you commented before... Gucci, I think Gucci has lost some of its luxury equity that it had in the past. And that's because it has not been managed exactly with the luxury strategy, but the good thing or what I would say is a good news for Gucci is that it's still remains top of mind as a luxury brand for many consumers, so they don't have to strive to... like, it's not going to be as hard for them to get to that level as for an aspiring luxury that was never true luxury.
Sleepwell Capital: Yeah, and I will add something else to that. To kind of take it to the next level, because you talked about the concept being Lindy and then the companies, but what makes it even, even more interesting is that the products and the models that these companies are selling, which are their most coveted and best selling products, they've been around for decades, right?
Like if you look at, The Rolex sub, which is sort of the quintessential, you know, if you think about a Rolex, that's literally what comes to people's minds and everybody recognizes it. I mean, that's been around since, you know, since 1953, right? And since then there's been, you know, hundreds if not thousands of brands that have copied that exact design and try to replicate it.
And obviously it hasn't worked, right? And if you look at the first submariner, and you look at the one that just came out last year, they're a little different, but the design is pretty much the same. They'll make these little small adjustments and whatnot, but these companies won't change the models.
And I can guarantee you that in 50 years, the Rolex lineup will be exactly the same, that they'll still be selling the sub mariner. And it's just, again, just to go back to the concept of the moat, it's just incredibly, incredibly hard to replicate that, right? It takes so much time, which is why these businesses are valued where they are, right?
Leandro: Yeah. I actually have a perfect quote for what Sleepwell just described and it's from Kapferer. And Kapferer says that Luxury does not aim to become a bestseller, but rather a long seller.
I think this is a key difference between luxury companies and premium companies or fashion brands.
Brett (Chit Chat Money): Yeah, that's a great way to put it. Now, we have maybe, I guess we're going to transition into some companies that aren't luxury or we're going to do maybe just a little separate topic here. Uh, it's going to be perfect for, as we were joking before about the breakout, uh, little video on Twitter because a lot of people love these brands and love these stocks.
But I have four examples here, Apple, Tesla, American Express, Nike. Good brands, all these stocks, I think have done phenomenally over the last few decades, or maybe shorter for some of the cases. Why are these companies premium, but not luxury? Because this is one of those examples of people I've heard all the time call Apple a luxury product, but I think you guys would argue that that's an incorrect way to put it.
Sleepwell Capital: Yeah. I mean, if we haven't answered that by now, we haven't done a good job. I think it's pretty clear, right? Like, it goes back to those characteristics that we were talking about. And in this case, the one that stands out the most, it's that these products are not scare, they're not exclusive, right? TLike, everybody who wants to buy an iPhone, unless, you know, you're in some sort of, you know, if you live in extreme poverty or something, you won't be able to afford it, but anyone that buys an iPhone, you know, we'll be able to buy an iPhone and Apple is basically producing as many iPhones as they can sell, right?
That's just the very, by definition, that's exactly what they're doing. So even though it's a premium product and that's exactly what these companies are, they sell premium products, right? They're, you know, they're higher quality and they perform better than some of their competitors, et cetera.
But, again, they're not scarce, they're easy to get. You go to the store, you buy them. You can order them online, you can, you know, you customize them, whatever. And they also change a lot, right? Like Apple will keep changing the iPhone, and the iPhone is not Lindy either. Like if we go back to that concept, I mean, who knows what that's going to be like in 30 years, right?
Leandro: And I think, I mean, these companies have made some of what we can call luxury sins. So Tesla has discounted cars. That's a sin in the luxury industry. Then if I right now, and I don't know if you're a shareholder Brett, but if I right now call American express and tell them I want to stop my subscription, I know that I'm going to get probably a better offer for my subscription. And a luxury company would tell you okay, go ahead. I mean you can leave as a customer, I don't care. So I think they obviously don't follow the luxury strategy.
I would say that Apple has done quite a good job being perceived as luxury even though it's not luxury, but people do see it like if it's following kind of a luxury strategy and I think that the the brands in the luxury industry also know that Apple has something between premium and their luxury, their type of luxury.
I mean, Hermes has some products for an iWatch and they have an association with Apple. So they obviously feel that by partnering with Apple, they are not destroying equity, whereas maybe partnering with other companies, they might feel that they are destroying equity. And I think it's incredible how Apple has managed to sell at the same time, more volume, but being perceived as luxury, even though it isn't luxury.
Brett (Chit Chat Money): Yeah, it's interesting how they do their advertising where it's not exactly luxury where they do talk about I mean I'm sure we've all seen that advertisement this year about titanium, which seems to just be endless. But in some ways they just do some of that aspirational stuff where they're not actually talking about the product I think maybe moat of some of these true luxury companies where I believe in that Rolex Business breakdown episode.
They talked about how when Apple watch and the smartwatches entered the market, it crushed fossil watch, which was, I think it's fossil, uh, which is maybe a premium brand, but Rolex has still maintained its dominance.
Sleepwell Capital: Yeah, absolutely. So that's actually a great point. And I mean, just like you said, like when the Apple Watch came out, everything in the I think it was a sub $500 segment just got crushed, right? Because that's basically where the pricing of the Apple Watch was. But if you look at whatever $3,000 plus, like that basically was untouched because you're just buying a completely different product. Nobody says "I want to buy a watch and I'm not sure if I want an Apple watch or a Rolex."
Like that's just, nobody does that, right? It's just two completely different products.
Leandro: And, and I think that out of like the people I know who own an iWatch, like 80% percent also own a Rolex and they will not give one for the other. I mean, this is going back to the fact that you're going to buy a Rolex, even if you buy another watch, because the Rolex is THE watch is not any watch.
Sleepwell Capital: Yeah, I will say interestingly about Amex, now that we talked about it a little bit, the Black Card is probably considered luxury. They follow a good strategy, because it's really hard to get, you don't even know how to get it, and there's, you know, it's scarce, I mean it's got like this little mystery to it when people, you know, pull it up and whatever.
But I just think that's actually kind of interesting.
Brett (Chit Chat Money): Yeah, they are a unique company for sure. Now, for an investor perspective, I think a lot of people listening are like, Okay, well, there's some of these well known brands, but you know, what could be? And Ferrari is probably One of those once in a generational opportunities of a luxury company trading and not a luxury earnings multiple.
Um, you know, are there any of those other companies out there? And I think one management team that would be on the table would be arguing about this constantly, that they are trying to be one of these brands and maybe are trying to, as they say, climb the luxury mountain. It's our reach for my Restoration Hardware.
Curious you guys, have thoughts here. If you've looked at them closely, I know Sleepwell, you have. Are they, can they make this climb? Is it impossible? Or, you know, it's an interesting case study for sure.
Sleepwell Capital: Yeah. I mean, it's definitely one of the most polarizing stocks out there. It's incredible how extreme either one way or the other people's views are.
I think it's an incredible case study to watch. And obviously, you know, Gary is quite a character and the earnings calls are super entertaining. I mean, on the one hand, Gary recognizes how hard it is to make that transition. I think they are doing quite a few things right. You know, especially on the way that they sell their products and sort of the merchandising and upgrading from the legacy stores to the galleries.
I mean, every time a new gallery opens up, it creates like a huge splash and people love to go to the stores. They're, you know, they've started building restaurants and hotels and all this like ecosystem around it. You know, the design has gotten a lot better, a lot more refined, a lot more modern.
So there's, you know, there's things that they've done right. And again, not to look at pricing in isolation, but also they've seemed to have shown that they have some pricing power in there as they've launched newer collections. Where I think I disagree with Gary is in a couple of places in their strategy.
I think the products are changing too much, and we talked about sort of the most important best selling products of these companies have to be around for a really long time, you know, the Birkin bags of the world, the Submariners, you know, Porsche 911 has been around for a really long time. I think it's Ferrari's case is probably the same.
Furniture is complicated, right? And it's different and they have to kind of keep on changing it. Actually their best selling product is called the cloud, which is a sofa that's like incredibly comfortable, and they're de emphasizing that, for example. If I were Gary, I would be doubling down on that and just like keep, you know, keep pushing that maybe change it a little bit, but maintain the same concept.
I think on the quality side, they've also cut some corners. And again, as we've said that sort of craftsmanship, not outsourcing your manufacturing, etc. Um, You know, if ideally this stuff would have to be handmade and have like a whole story behind it of where it was made and by who and whatever. So, all of that, I think it's important. And then on the advertising side, they don't do any advertising, which, you know, I'm not entirely sure whether that's correct or not. Each company will have their own way to kind of go about that. Obviously, you know, we know, I mean, Rolex and the other watch brands, they advertise as well as Hermes, but for example, Ferrari doesn't advertise. They spent zero dollars in advertising. Their main sort of marketing channel is, is Formula One and like sort of the races and events like that. So, I mean, I think it's going to be very interesting to follow, and I mean, for anybody that's interested in the luxury space, I think it's kind of a must to at least get a little, a better sense of what's going on in RH and see how that whole thing unfolds.
Brett (Chit Chat Money): One, uh, one follow up here. And I think. Maybe you guys can correct me if I'm wrong here, but it seems like you guys are saying with these luxury companies, the heritage is not even necessarily with the company, but it can be with a specific product like the Birkin bag or with Louis Vuitton. It's the, the travel, uh, case, I forget the exact term they have for it, but is that What you're saying RH might be making a mistake in is not having the specific product that has, say, a multi decade history that, well, they have to kind of build up over time, but is, uh,
Leandro: I would say one stems from the other, right? I mean, Hermes is much older than the Birkin, but the Birkin has been so successful because Hermes has been known for almost two centuries making leather goods.
Sleepwell Capital: Yeah, yeah, exactly. And another thing about RH is they have way too many products like SKUs to be considered luxury. The real luxury companies usually only have a handful of models.
Um, so if they were really serious about it, they would just like, you know, and it's again, it's hard because furniture is such a unique category and there's arguably not really any high end like real luxury furniture company. So it's all kind of up in the air to see how it goes, but it seems to me that that they also have like way too many collections and it would be probably smarter to just concentrate in a couple of their best selling products and really work to build on you know, on some story behind it and how it gets made, who designed it, and stuff like that, but they don't seem to be doing that.
And again, you can just walk in and buy any of this stuff, right? It's not, I mean, some of it might be backorder or whatever, but it's not, they're not hard to get.
Leandro: And I would also add that the products are, I mean, they have models that have been around for decades, but the products are not static.
I mean, you can see Hermes, they have 16 segments, and some of those have come in the last 10 years. The thing is that having such a brand equity allows you to bring a new segment and automatically your customers will have the same feeling as with your other segments because you have all that history behind you.
Brett (Chit Chat Money): That's a great point. All right. We're wrapping up ish here. I don't know. It's just, uh, kind of long for any of the listeners, but I think there's plenty to learn from this and it's such an interesting industry. Um, one thing that is unique, I guess, is there's a lot of private companies here, a lot of family on staff.
So what is the advantage of being private versus public? And what's the difference or maybe the advantage of being a standalone versus a part of a, as they always like to call themselves groups, but basically a conglomerate. I think the key example here would be Hermes versus LVMH.
Sleepwell Capital: Yeah, so interestingly, in the watch world, the true luxury watch companies are privately owned, right?
Rolex, Patek Philippe and, AP. Rolex interestingly is owned by a foundation, so it's technically operated as a non profit and, or I guess all the excess profits go to the foundation, which then are used for philanthropic uses and whatnot, but I think there's a huge advantage, for these companies to be private.
Mainly because you don't have to respond to any sort of shareholders, right? And, if you're public, in many cases, you'll have shareholders that are pressuring you to meet your guidance or, you know, achieve a certain level of EPS growth or whatever. And just, you know, Rolex doesn't have that problem.
Like, who knows how that stock would have reacted when they made this huge, splashy acquisition of Bucherer in the last few months, and they can just focus on the next 50 years. Literally, they don't have to worry about the next quarter or even the next two years like that's it just doesn't matter for them. So I think that's a huge advantage when it comes, to you know being public versus being private and just the very own nature of a luxury company and how it should be managed really lends itself well to having that really, really long term mindset.
And there's obviously very successful public companies on the luxury space and Leandro will talk about them. But in the case of the watch industry, yeah, I mean, you have Swatch, which owns a bunch of brands that is public, Omega being sort of the best one. And it's of in the top three of the largest Swiss Swiss brands.
And then, arguably, Richemont, which is a competitor to LVMH, one of the big groups, they actually have a pretty good watch portfolio. But it gets lost inside all the other stuff, right? They own Cartier as well and a couple of other fashion brands, but they have a pretty decent watch portfolio, which, interestingly enough, it's better than LVMH's.
And I think LVMH has talked about their interest in sort of growing their watch exposure because their brands aren't really that good. So, yeah, I'll pass it on to Leandro to talk more about the groups.
Leandro: Yeah, I think just to comment on this, I think the luxury companies that are publicly traded, they are basically all privately owned and operated. I mean, it's like they just are publicly traded to make a favor to shareholders who want to own them. But in Hermes, 70% is in the hands of the family. So, obviously, they're not going to succumb to investor pressure. And I know this is going to be a bit...a strange example. But if Hermes wasn't entirely family owned right now, probably they'd have a good shareholder base who thinks long term and I think you can also see this in companies such as Constellation Software, right? I mean, they have such trust behind them that they can run as they can be in the publicly traded but run almost privately because people trust so much what they are doing. But obviously it's better to have a controlling ownership just in case.
And as as for the standalone versus the group companies I think you said the best example Brett, which is Hermes versus LVMH.
I think both models can be successful and this is evident because LVMH has been extremely successful and Hermes has been extremely successful too. I think the success of LVMH, actually Sleepwell commented on this several months back, I don't know if on Twitter or on an article, has been demonstrating that they can be a very good owner of luxury brands. When a luxury owner wants to sell, they know that not every conglomerate is made for them because they don't follow the luxury strategy. And, Arnold was very intelligent in telling them, "look, this is going to be a house where you're going to be treated as a luxury company". So then that sets up, like a lot of the pipeline is strong for LVMH, but I think it's going to be very, very tough for other conglomerates to compete against LVMH, right? Because they have the reputation, they have all the means to do it. So why should I sell to Kering as a luxury company and not to LVMH? I mean, I think that's very important and people don't appreciate that Kering is going to be left probably with brands that are not so luxury because they don't have the history of being such a good conglomerate as LVMH.
I mean, there's a clear drawback to conglomerates in the luxury space. Sleepwell touched on this a few moments ago and is that you are going to dilute your best brands. I mean, that's going to happen because you cannot...but it's the same as having a portfolio when you invest, right? If you have 10 companies and you start to add more companies, then you're obviously diluting the quality of your first 10 holdings.
And, for example, in LVMH, you have Dior. Dior for me is true luxury. I mean, they are a very good luxury brand. Very strong in the leather space. But then you have Sephora. I mean, it's like two worlds, two different worlds. Then you also have...LVMH also has Spirits. Which okay, they can be considered luxury in some cases, but spirits is a very marketing intensive industry so that's not very appealing from a luxury perspective and I think it can work but it has that drawback.
And then you also have drawbacks in the stand alone model. And one of the things that people say is the main drawback to being a stand alone company is the reputational issues. Because if you have a reputational issue, it's going to affect the whole brand. Whereas if LVMH has a reputational issue in one of its brands, then probably they can contain it better, So that it doesn't spill to the to the rest of the brands. But I mean I'm a bit skeptical that that's really a drawback because I think it will take a lot of reputational issues to bring down a brand such as Hermes. I mean Hermes has has had scandals with crocodile skin in the past and nothing happened, basically. They just fixed it and moved forward.
And I mean, Ferrari, they have...their marketing is Formula One, and they are getting beaten by an energy drinks company. That's like huge for them reputationally, but it has to be a sustained period of Red Bull winning against Ferrari, or maybe Red Bull becoming the best team in Formula One, because Ferrari is still the best team in the history of the sport. And then if they retain that, then it's going to be tough to bring it down, but I think both can work. I personally think that if you're a standalone company, then you can focus all your efforts on building one brand equity. And that's also very appealing because then you can open another category. And it's what I commented on before Hermes started selling furniture. That segment automatically has the brand equity of another segment. And that's for me, that's very powerful.
Brett (Chit Chat Money): Okay, let's zoom in on today. What are maybe the growth opportunities and the state of the industry? I know at least people, some people are concerned about Asia Pacific, specifically China, a very important market, but maybe that's incorrect.
What do you guys thoughts on where we sit today in the next few years?
Sleepwell Capital: In terms of the state of the market, at least from the perspective of the watch world, and I think that it's pretty clear across the entire luxury space. What we're seeing in the second half of this year is basically a normalization in the growth.
COVID proved to be an incredible period for basically all luxury brands. So, I think we're, you know, they're still growing pretty, pretty nicely, not to the extent that they were before. But we're also starting to see some divergence between what we consider the true luxury brands versus the aspirational luxury brands.
So, you know, within watches, the big three that we've been talking about, they're still doing well. They have long wait lists. So, if for whatever reason, consumers start, you know, saying that they may not be as interested in this watch and they pass on it, you know, the retailer would just go down the list and call the next person up and it most likely will get sold pretty quickly, right?
So these companies are still probably growing in the double digits, while the rest of the industry is basically flat to down. I mean, Richemont, which I mentioned has a diversified portfolio of watch brands, some very, very respected, other ones are a little more, you know, lower end, but they reported basically low single digit sales. I think it was up 3% in the quarter.
Again, that's very different to what a Rolex and particularly, we don't know the exact numbers because these numbers aren't public, but Morgan Stanley comes up with some estimates and and yeah, they're just basically the top end of the pyramid is outperforming sort of the lower end if that makes sense.
Leandro: And I think it's key to read the earnings calls of true luxury companies, because you do get a sense that the management teams of the true luxury business have complete control of what's going on their business. I mean, your know, you go through a recession and they can tell you next year will grow and they'll grow. And when you read about aspirational luxury. The feeling is more that yes, they do have control, but that they are more subject to what the economy wants to do. And in luxury, it's just basically we'll do this next quarter and you will know, or we'll do this next year and you can count on that. They'll do it because they are basically in control.
And this is thanks to what we talked before, it's about the pricing, because if you control pricing and you still can price below the demand, then you basically control your growth rate. Another interesting thing is that you mentioned that China is the biggest market for luxury and that's obviously true, but if you look at the income statements of these companies, of the luxury companies, maybe I think Hermes has like 46% coming from, I don't know actually if it's Asia or China alone, but well, the exposure is much, much larger than that. I mean, if I go to the Hermes store in Madrid, like 80% of the people will be Chinese. So the exposure to the Chinese customer is very, very high, even if they report like, "no, in France, we sold". Yeah, but in France, the people that are buying are mostly Asians. So you're depending a lot of on the Asian population.
People think that we have seen a pull forward during the pandemic, because obviously you had Hermes growing at above 20% and, to some extent, I do agree. I don't think Hermes wants to grow 20% every year and I don't think that's the objective. They will always tell you in the last two decades, we've grown 8, 10%. And that's what you should have as your benchmark. And I don't think that the market has understood that this is sustainable either. I mean, these companies are trading at multiples similar to what they were before the pandemic or maybe slightly higher, but not double higher like pricing a double of the growth rate in just three years. And these companies know that they have to retain exclusivity above all costs. And if that means growing slower, they'll do it. And this goes back to being privately owned.
You can do that because you are privately owned. If you are publicly owned and you've set your expectations up 20%, then you know that if you don't beat that or at least meet that, then you're going to have a very tough time.
Brett (Chit Chat Money): All right. Last question. We try to do a sort of devil's advocate to end it. I mean, this is clearly an attractive industry, but from your guys's point of view, to people that follow the industry closely, why would it be say smaller or why would anything, you know, what could hurt this industry over the next 10, 20 years compared to today?
Sleepwell Capital: I mean, honestly, the only thing that I can think of is, you know, some extreme event, you know, kind of unforeseen that causes sort of the upper to middle class to lose a ton of earning power in the next 10 to 20 years, or maybe, you know, we have seen this trend of the rise of the super rich in the last, you know, a couple decades, there's every year, there's more and more billionaires or whatever, if that reverses, you know, obviously, you know, that's very bad for the industry.
For any of these companies that we talked about specifically, there's always the risk that they become complacent and sort of stop staying true to this luxury strategy. Yeah, this path that they've taken on for so many years and start, you know, diluting the brand and maybe having too many products or selling, you know, selling too much of it, etc.
So obviously that's always a risk with these companies and you just got to be cognizant of what they're doing to really build and maintain the status that they have.
Leandro: I think that if you look back 10 years ago, and well, or maybe 15 years ago, and you look back at the global financial crisis, and you see that true luxury companies growing through the global financial crisis, that's obviously a good benchmark to look at.
You also have to take into account that these companies are much more exposed to the middle class today. I mean, they have a huge accessory businesses, so that is more exposed to a recession. But then I was someone who thought this way, but then the other day in the earnings call by Hermes, management actually said that the proportion of sales coming from VIP customers has not changed as much. So these companies have have grown... they won't tell you a number, but they'll tell you like our VIP proportion of customers is pretty similar to what it has been in the past. So then, when you see that, you start to think, Okay, that's, that's actually impressive that they have managed to grow so much while having a similar amount of VIP customers.
I would also say that maybe regulation can be seen as a risk, especially as what we're seeing...I don't want to get political here, but when you see the governments that are advancing in the world and everything, regulation will always be an issue. Because, going back to what I said earlier, luxury in some cases is seen as creating inequality and maybe governments want to tackle that, but then at the same time, I see the Chinese government, which is obviously a communist country and they were the ones that said, "okay, open the doors. Here's luxury and try to get that because that's the way to grow." So if China has done that, I honestly have a tough time seeing how other countries will regulate luxury.
So, yeah,I think I have talked with Sleepwell about this, that when people talk about the luxury market, you'll search, "luxury market size" and you'll get a size that is not representative of the true luxury companies. I mean, you'll get a lot of premium brands in there. So maybe if you look in 10 years and we've had an economic crisis and the market is not where it is today, I'm pretty sure that will be due to the premium brands and not the true luxury brands. I have a lot of trouble seeing why true luxury is not bigger 10 years from now or 20 years from now than it is today.
Brett (Chit Chat Money): All right. I think that's going to do it. Thank you to both of you for joining today. As we wrap up, where can listeners and investors find more of your work?
Sleepwell Capital: Well, I'm on Twitter as SleepwellCap. And I also have a substack where I post, you know, whatever I'm interested in at the moment. Not very, not very often, but every, I try to do every couple of months, so feel free to take a look and we can link to that Rolex piece, which is relevant to the conversation as well.
Brett (Chit Chat Money): Yeah. I would say, yeah, I was about to mention, we will link to that Rolex piece and we'll link to a lot of the stuff we've talked about, including that luxury strategy book that's so important, but Leandro, where can people find you?
Leandro: On Twitter also, at Invesquotes and also on Seeking Alpha, an investment research service called Best Anchor Stocks. So I would say those two are the best sources.
Brett (Chit Chat Money): All right, that's going to do it everyone. I'm going to try to do the disclosure because Ryan usually does it.
Impressive! This article really delves deep. It seems the trend is shifting away from boasting and more towards personalization and discreetly indulging oneself. Such an intriguing perspective!
What is really interesting is what the future generations will make out of these brands. Some studies suggest that millennials are generally more interested in experiences rather than material possessions, which could lead to a shift away from luxury products. However, at the same time, many millennials are also highly focused on personal branding and status, which could lead to a continued interest in luxury products. Ultimately, it will depend on a variety of factors, including economic conditions, cultural trends, and individual preferences.