Ironically, the discounting that luxury retailers Michael Kors Holdings Ltd (KORS) and Coach, Inc (COH) provided customers is the same reason that they themselves will continue to have discounted stock prices. The growth provided by outlet stores is essentially a brand erosion poison that will deteriorate the long-term potential of both retailers. Coach is facing brand perception issues today that Michael Kors will face tomorrow (by tomorrow I actually mean at some point in the next 1-3 years).
There is a difference between value and perceived value. True value is the intrinsic value of the product based on the quality characteristics, how well it serves its purpose, and since this is specific to luxury retail, how well it displays social status. The perceived value is correlated mostly with the brand image. While I have no study to prove this, I guarantee I could take two purses: one luxury brand and one discounted brand of the same quality characteristic and people would, on average, make biased assertions on why the luxury branded one is of better quality.
When you discount your luxury product, the perceived value deteriorates and so does your ability to charge a premium. Suddenly, more customers are wearing the same purse, the underlying value has not changed significantly, but the perceived value certainly has. A true luxury goods retailer should never discount their products; especially their flagship products. In fact, discounting is a disservice to customers. Why punish your customers who value the product and are willing to pay full price?
Another interesting piece to note, lower price does not mean more enjoyment, in fact, in a popular study with wine tasting, higher price of the wine increased the perceived value of the wine, and the research even goes so far as to say it not only affected perceived value but actual value.
We hypothesized that changes in the price of a product can influence neural computations associated with experienced pleasantness (EP)." Because perceptions about quality are positively correlated with price, the scholars argued that someone might expect an expensive wine to taste better than a cheaper one. Their hypothesis went further, stipulating that a person's anticipated experience would prompt higher activity in the part of the brain that experiences pleasure, the medial orbitofrontal cortex, or mOFC, in the forehead.
Since retail is such a sensitive industry, brand perception is everything. Per the latest 10-K Michael Kors has continued to increase their outlet store footprint. While many short-term strengths have helped the company deliver more products at a healthy margin, this continued growth will engulf the company and deteriorate future brand image and future margins.
If you were to search for Louis Vuitton (OTCPK:LVMUY) outlet stores, this would be the closest you would come up with.
Since the products are not discounted, customers don't have to delay buying or try and time out a sales cycle because they trust that the company will not discount in the future. Therefore, many customers appreciate the fact that they don't have to worry about when they buy a luxury good because they know the price is fair. This also can actually drive the price of these goods up in value versus down.
Of course, if you're able to afford Vuitton and Hermes, paying thousands of dollars for a bag probably won't sting as much. The Boston Consulting Group tracked seven luxury handbag brands from 2002 to 2012 and found that prices rose by 14% annually, when inflation averaged 2.5% per year.
When looking at the valuation metrics of these three companies, Mr. Market has flip flopped the valuation of Coach and Michael Kors. In fact, while my thesis has pointed negatively at Michael Kors, their valuation should be much higher than a PE of 9; closer to 15. Coach should be much lower than 20; closer to 12. Louis Vuitton is fairly valued and deserves a premium valuation at 24. An interesting short-term strategy would be a pairs trade between Coach and Michael Kors, where you buy Michael Kors and short-sell Coach. Keep in mind this strategy has a time element to it, considering my point of view that the brand image of KORS will deteriorate in time. The short-term strengths of Michael Kors include a three year sales growth rate of 20%, a strong profit margin of 25%, and a high return on equity of 40%. If you are interested in why these metrics are important or what are good metrics in researching a stock check out this short video. These metrics should propel the company forward for a few years until the inherent brand deterioration takes effect and the Michael Kors of tomorrow becomes the current Coach.
Upon researching this topic I came across Elon Musk's view of never discounting in his message to employees.
For additional reading on luxury management there are two books I'd recommend:
Luxury retail is a fickle beast, where customers preferences and perceptions can change like the seasons, so why give any reason for your brand to lose its image by discounting a luxury product - this I will never understand. Management teams should consider the implications of the long-term effects of discounting and brand perception versus the current system of it'll save me today and kill me tomorrow mentality which seems to be driving the decision process of luxury retail. I have never been much of a proponent of short-selling, but if I hear that Louis Vuitton is starting to discount their products, that'll be my first position.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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