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Polo Ralph Lauren (NYSE:RL) is a leading American luxury lifestyle company that specializes in high end wear for men and women as well as accessories, fragrance and home decor. The company competes with other premium apparel and accessories players like Coach (NYSE:COH), Liz Claiborne (LIZ) and AnnTaylor (NYSE:ANN). Polo Ralph Lauren’s full priced retail stores, which include the Ralph Lauren, Club Monaco & Rugby stores, constitute 17% of the $70 Trefis price estimate for Polo Ralph Lauren’s stock.

We estimate that Licensing Royalties, paid by Polo Ralph Lauren’s licensing partners to the firm based on their sales of Polo branded products, account for about 6% of the $70 Trefis price estimate for Polo Ralph Lauren’s stock. The company has been converting licensee operations to in-house operations in recent years, which is leading to higher revenues and more control over product branding.

Decline in Licensing Revenues

Polo Ralph Lauren’s licensing revenues have declined consistently over the past five years from $250 million in 2005 to $180 million in 2009.

The decline has been primarily due to the acquisition of the licensee operated businesses in Japan and Asia by Polo Ralph Lauren. The conversion of licensed business into directly controlled business has both negatives as well as positives for the firm. Some of these are discussed below:

Negative Factors

1. Declining margins at Polo Ralph Lauren

Conversion of licensee business into directly controlled business has led to declining margins at Polo Ralph Lauren since the margin for the licensing business is significantly higher than that of the directly controlled retail business.

Licensing has high margins since the licensee bears the costs of production and selling while Polo Ralph Lauren earns a flat fee based revenue. The Licensing Royalties segment’s EBITDA margin is nearly 4x the retail business EBITDA margin and 3x the wholesale business EBITDA margin.

2. Difficulties in expanding into newer markets: Increased expenses and risks

One of the primary reason that brands allow licensees to market their branded products is the ability to reach newer markets and a wider consumer base without having to develop additional distribution capabilities.

As Polo continues to cut back on licensed operations, as part of its long term strategic plan, it might face difficulties expanding at a fast rate in the future. This coupled with the fact that Polo has aggressive plans to expand internationally could mean significant capital expenditures by the firm in developing its own distribution capacities and thus considerable risks for the firm in the future.

Positive Factors

1. Higher Revenues for the firm

In the licensed business, Polo Ralph Lauren has to share the value added with the licensee and receives only a fee based revenue. On the other hand, in a directly controlled business, Polo Ralph Lauren recognizes the entire sale amount as its revenue. As such, this increase in revenue makes up for the lower margins as the additional profit is kept by the firm alone.

2. Greater control over the business

While higher revenues and income are realized in the case of the directly controlled business, there are intangible benefits as well. Having greater control over its products makes it easier to implement branding strategies and bring its operations in sync with the firm’s long term goals. Brand positioning, pricing and inventory management are some of the areas where the firms gets more control.

Disclosure: No positions

Source: Polo Ralph Lauren's Evolving Business Model