Why Is the Luxury Industry So Nervous, and What Exactly Is It Afraid Of?

Rupert even believes new technology will cost jobs, widen the gap between rich and poor, and leave the wealthy too embarrassed to spend.

June, Monte Carlo, Monaco's capital of pleasure. Anton Rupert, the South African billionaire who chairs Richemont, the world's second-largest luxury group, took the stage at the Financial Times Business of Luxury Summit.

"I lie awake at night," Rupert said, openly admitting his anxiety. He said he had invited the other two luxury giants, LVMH and Kering, to join forces and build a global luxury e-commerce platform to cope with an increasingly harsh business climate. "We need to build a neutral platform for the luxury industry that is big enough," he said.

E-commerce is not the only thing keeping him up. Technology is changing how people shop, emerging markets rise and fall unpredictably, world events are whipsawing exchange rates, and old luxury houses are being forced to rethink who they are. Each of these hits the traditional luxury industry in its own way. Rupert even believes new technology will cost jobs, widen the gap between rich and poor, and leave the wealthy too embarrassed to spend.

Since CHANEL adjusted its prices worldwide in March this year, executives at many well-known luxury brands have faced the same string of questions whenever they appear in public: How do you see the market? What are you going to do about it? Reporters mostly get answers that are falsely upbeat, evasive and a little careless.

Why is the luxury industry so nervous, and what exactly is it afraid of?

"Opening physical stores" looks like a fool's game

"The high cost of traditional channels is more than even luxury brands can bear," He Bin, head of Greater China for the Italian luxury leather goods brand Tardini, told QDaily. Whether in China, the United States or Europe, he said, opening physical stores looks more and more like a foolish way to burn money.

In Tokyo's Ginza, on New York's Fifth Avenue, in Hong Kong's Central, sky-high rents scare off any luxury brand without deep pockets. In major Chinese cities such as Beijing and Shanghai, space in top shopping malls is almost impossible to get, and rents have climbed to 110 yuan per square meter per day. Lately, several celebrated fashion designers have closed the stores of their own namesake labels. Without a big luxury group behind them, independent brands can be crushed by rent alone. Add staff salaries, materials and other costs, and no one dares open a store without some confidence about foot traffic and sales.

Another big problem: under pressure from e-commerce, foot traffic at many physical stores is falling. Soon after Rupert spoke, in mid-June, LVMH announced it would close a luxury department store in Paris that belonged to selective retailing, one of the group's five business divisions. In Shanghai, the L'Avenue (Shangjia Center) mall, in which LVMH had invested, was sold off after performing poorly.

A dilemma: run e-commerce yourself, or hand it to someone else?

On March 31 this year, the luxury e-commerce company Net-a-Porter merged with Yoox. Richemont and Yoox's shareholders each hold half of the merged group. LVMH and Kering have also taken stakes in e-commerce sites, or license their brands to reputable online retailers.

CHANEL, which once swore it would never sell online, has licensed some of its jewelry to Net-a-Porter. Only Celine still insists that e-commerce will destroy the shopping experience luxury prizes most.

It is not just the young: people of every age, all over the world, spend more of their time online, and more of their shopping happens there too. McKinsey data from 2013 show that online sales made up 4% of the market and were growing twice as fast as the luxury industry as a whole. If that pace holds, online luxury spending could reach 20 billion euros within five years.

Things are changing so fast that most luxury brands know that if they give up on online sales, customers will give up on them. Yet they also fear that e-commerce is beyond their control and will ruin the customer experience.

Brands such as Gucci, CHANEL, Dior and Dolce & Gabbana have launched their own apps on the App Store, but most still use them mainly to publish news and information. Many brands' official websites, including Gucci's and COACH's, also sell products. But a McKinsey survey found that only 4% of respondents had ever downloaded a luxury app. And official websites come nowhere near e-commerce platforms in traffic or orders.

A few years ago, Salvatore Ferragamo officially authorized the Chinese e-commerce platform Xiu.com to sell its products online, but outsiders saw it mainly as a luxury brand clearing out inventory, and the two never looked like a natural fit. Outside of sites the brands own stakes in, such as Net-a-Porter, licensing has never caught on with luxury brands. Meanwhile, their campaigns against counterfeits on e-commerce sites of every kind now span nearly every continent.

The Apple Watch has turned luxury brands into followers

For a middle-class buyer who "earns a decent living" and has a fixed budget, buying an Apple Watch may mean buying one fewer Longines. And smart devices are replaced by new models again and again, with perhaps no end in sight. Smart devices can also easily be made more expensive: Apple has managed to sell sapphire-crystal and precious-metal editions of the Apple Watch to wealthier geeks.

"In the middle and late decades of the last century, quartz watches battered mechanical watches, and many Swiss watch brands went bankrupt outright. The Apple Watch's impact on the watch industry may only just be beginning," said Ren Guoqiang, senior partner and vice president for Greater China at Roland Berger. In his view, mechanical watches lost any functional advantage long ago; they survive only as antiques, collectibles and toys. The novelty of smartwatches is enough to make mechanical watchmakers nervous.

Bulgari and TAG Heuer, two of the more adventurous luxury watch brands, have already started experimenting with smartwatches. They can hardly sit still and wait for the end.

Young people love the flash of technology, tire quickly of what they own, think nothing of turning over their wardrobes, and favor accessories that are fresh rather than luxurious, which they can afford to buy often. That may be what watch brands should really worry about.

Still, smartwatches are fashionable and powerful but hold no lasting value, while high-end mechanical watches are the exact opposite. For now, the top tier of watchmaking need not panic about the Apple Watch. But technology advances every second.

Young people think the word "luxury" is not cool at all

A Bain & Company report says the luxury market's core customers are still people over 49, while consumers under 33 account for only 13% of global luxury spending. Older customers simply spend more; they do not have numbers on their side. And today's young people will grow old soon enough, so luxury brands have to lay the groundwork now if the business is to last.

Chart from KPMG: China's luxury consumers: Moving up the curve

But the world has been turned upside down. Young people today are not like European children of the last century, who went with their mothers to buy a bottle of Dior perfume at a tender age, occasionally borrowed their mother's Hermès bag to go out in their teens, and, once they earned their own money, saved for ages to buy a classic Prada dress.

Fast fashion has captured young people's minds. They buy cheap goods with abandon, throw clothes away after one season, and overhaul their wardrobes every few months. Few have the patience to buy one well-made, beautifully cut garment and look after it regularly...

In the United States, young people have grown bored even with traditional fast fashion. What they like now are fashionable sports brands, where "comfort" matters more than anything.

While Prada's results keep sliding, Miu Miu, its younger second line, is growing slightly.

The old luxury houses are racking their brains to win over these kids. Besides younger designs, they are doing more in marketing: millennials love social media and shopping online, care more about value for money, and shop more while traveling. Luxury brands have started collaborating with H&M and inviting teenage fashion bloggers to their shows... Instagram and Pinterest, the two photo-sharing sites most popular with young people worldwide, have begun putting "buy" buttons next to product images.

A McKinsey report says digital marketing directly accounts for 13% of luxury sales in physical stores and influences another 28%, a trend driven by the young.

Exchange rates: a disaster no one can dodge

Most luxury companies find that while most of their costs are in euros, up to 80% of their revenue comes in other currencies. Exchange-rate swings often send shoppers migrating en masse around the globe, and make brands' results hard to control.

When the renminbi's purchasing power rises, consumers shift their spending abroad, which hurts the domestic luxury market; Chanel adjusted its prices earlier precisely to close those price gaps. Where a luxury product's costs are incurred matters too: if all the contract manufacturing happens in China, a stronger renminbi pushes costs up.

A few years ago, Imran Amed, editor of Luxury Society, wrote in the Financial Times: "Although brands have always set different prices for different markets, recent currency fluctuations have unexpectedly widened the price gap for the same product across markets. This has given rise to a kind of fashion arbitrage and created new challenges for management."

When the currencies of the main luxury markets fall, company revenue shrinks. Many companies report their figures at both constant and current exchange rates, and part of their hard-won profit may be eaten up by currency moves.

Still hoping to strike gold in the BRIC countries?

The BRIC countries, Brazil, Russia, India and China, are often seen as the hope of the world economy. Luxury brands have long seen a golden glow around them too. After all, rapid growth is bound to create more newly rich people and a larger middle class, and since everyone loves beautiful things, surely they will open their wallets.

Yet some luxury brands that have gone into these countries already feel stuck in a quagmire.

China

In 2014, LVMH's core profit fell from 602 million euros in 2013 to 572 million euros, down 5% year on year. Asia-Pacific performed worst: in China, a sustained and forceful anti-corruption campaign suppressed demand from high-end buyers, and the decline in Hong Kong was even steeper.

Consumers in Greater China have gradually moved past the show-off phase into one where they want to express their individuality. Big logos are out, and people have started chasing niche, affordable-luxury brands. The newly affluent, well-educated middle class in first-tier cities changed first, and consumers in third- and fourth-tier cities are following, their tastes maturing as well.

Russia

In 2014, the Ukraine crisis, Western economic sanctions and falling oil prices drove the ruble down by more than 40%. Russians' spending on travel collapsed, while foreign visitors flooded into Russia to shop.

Russia's economy is fragile and heavily dependent on energy exports. A fall in global oil prices hits it hard, and the luxury industry takes the blow in turn.

Russia's population is aging fast. By 2030, among people earning more than US$150,000 a year, those 65 and older will make up 18%, while those aged 40-44 will make up only 14%.

India

With its huge population and fast-growing economy, India is expected to be the next China. For now, though, India's luxury spending is less than one-tenth of China's: 600 million euros in 2009 (against 6.6 billion euros for China), just 5% of global luxury spending.

India's rigid caste system makes it very hard to climb the social ladder, so a new middle class struggles to emerge. Religion and tradition are powerful, and on most formal occasions Indians still wear traditional dress. Surveys show that the two luxury brands Indians most want are both high-end makers of the sari, the traditional garment.

India's wealth gap is wide, and those who can afford luxury remain a tiny minority. A poor business environment, with backward infrastructure, widespread corruption, cumbersome procedures and a shortage of technology, keeps luxury retail from running efficiently there.

Brazil

Brazil is the wealthiest country in South America. According to the annual World Wealth Report from Merrill Lynch and Capgemini, the number of millionaires in Brazil has kept growing, although the financial crisis once shrank the fortunes of its wealthy class.

For now, the luxury market exists only in three major cities, Rio de Janeiro, Brasília and São Paulo; second-tier cities remain untapped.

Brazil is a young country: people under 29 make up 60% of the population. This shapes a distinctive feature of Brazilian luxury spending: shoppers are used to buying luxury goods in installments. Even when they can afford to pay in full, they still prefer to pay over time. But this also creates credit risk.

On top of that, Brazil's high operating costs and import tariffs mean the same handbag costs at least 50% more in São Paulo than in New York.

Luxury? It may be the most refined and respectable business in the world. Yet these days, Rupert is probably not the only one lying awake at night.