We Study Billionaires - The Investor’s Podcast Network - TIP643: The Luxury Strategy w/ Christian Billinger

Starting point is 00:00:00 You're listening to TIP. Over the past 20 years, some of the best performing companies in the stock market have come from the luxury sector. For example, Hermes and LVMH, which are both companies based out of France, have compounded at 21% and 16% respectively. The thing about these luxury brands, though, is that you need to take almost everything you learned about business and economics and essentially throw it out the window. For instance, when the best luxury companies increase their prices, they often do. sometimes see higher demand for their products and not lower. And the Hermes CEO is on record for saying when a product sells too well, they'll pull it off the shelves. To help break down the DNA of luxury companies, I'm joined by Christian Billinger to talk about the lessons from the book,

Starting point is 00:00:47 The Luxury Strategy by Capfer and Bastion. Christian is the chairman of Billinger for Volstein's AB, which is a privately held company based out of Sweden that invests in publicly listed equities. His firm seeks to generate attractive long-term total returns without employing financial leverage. During this chat, Christian and I cover how luxury companies create their own demand. The primary difference is between a premium and a luxury product, what the non-return effect is and how it can make luxury companies more resilient, an overview of Capfer's anti-laws of marketing, which is definitely my favorite part of the book, how luxury brands approach e-commerce and pricing, and much more. I've really enjoyed reading through this book, and Christian is the perfect guest

Starting point is 00:01:29 to bring on the show to discuss these topics as he's been invested in the luxury sector for many years. This is a fascinating discussion unveiling the luxury sector, so with that, I hope you enjoy today's episode with Christian Billinger. Celebrating 10 years and more than 150 million downloads. You are listening to the Investors Podcast Network. Since 2014, we studied the financial markets and read the books that influence self-made billionaires the most. We keep you informed and prepared for the unexpected. Now, for your host, Clay Fink. Hey, everyone, welcome to the Investors Podcast. I'm your host, Clay Fink, and today we bring back Christian Billinger. Christian, it's great to have you back on the show.

Starting point is 00:02:21 Pleasure to be back. Thank you for inviting me again, Clay. Good see you. So over the past few months, Christian, as you know, I've taken an interest in the luxury sector, which for someone like me that grew up in the Midwest, it's something that's very new to me and something I don't have a lot of real-life exposure to, yet I've heard all about it when it comes to the stock market. Because some of the best performing companies have been coming from the luxury sector, to name a few, that includes LVMH, Ferrari, and Hermes. These companies, they seem to break all the standard rules of capitalism and how to succeed in business, which, in my opinion, makes them very interesting companies to study.

Starting point is 00:02:59 So for the audience, Christian pointed me to this book called The Luxury Strategy by Capfer and Bastion to help me better understand the industry. And I've invited Christian onto the show to share with the audience what he's learned from this sector. So to help set the stage for this conversation, Christian, how about you start by just talking about your experience with the luxury industry? Yeah, sure, delighted to. And excited to have this conversation about the sector and the book specifically. So I've been invested European equities for 20 years now. So my experience is as an investor, not as an operator, but I've looked at the large European conglomerates, which tend to be French. So LVMAG, Hermes, and we've been invested in those two for a number of years.

Starting point is 00:03:43 We've also been invested in Remy, Quantrol, for a few years, which, although formally speaking is a spirits business, much of their revenues and even more of their earnings generate from or derive from sales of what you would consider a true luxury property. product. So I've looked at the space for a number of years, and I think being based in Europe and being sort of predominantly focused on European equities, as you alluded to, that's been one of the best sort of corners of the European market to be generating returns in for the last decade plus. So that's my experience as an investor. So I'm big on just getting everyone on the same page. So luxury, I think, is going to mean a different thing to almost everybody. How would you

Starting point is 00:04:24 define it if someone were to ask you to do so. So there are so many ways of defining it. And it depends on which point of view you take. Are you trying to define this as a consumer or as an operator? But I think for the purposes of this conversation, I think the most meaningful way to define it is as an investor. And I think in some ways you could argue, what does it matter, whether you call it a luxury business or a premium business or a fast-moving consumer goods business. But I think it does matter because it has a real impact on how durable, you know, the competitive advantage of the business is and what the metrics look like and how you should think about sustainably high returns on capital, etc.

Starting point is 00:05:01 So I think it does matter whether a business actually operates as a true luxury business or not. So there's a few things that I would look at to get a sense of whether we're looking at a true luxury business. Possibly the most crucial one is, are we looking at what I would call a singular product or experience? And I think we'll get back to the comparison between luxury and premium, et cetera, but the idea of a singular product or experience is that these tend to be products or services that cannot easily or cannot be compared to any other product or service, right? So they have a real identity as opposed to a positioning in the market. And therefore, it's often more difficult to define the competitive set. And the true competitive set would often be

Starting point is 00:05:43 much broader than for most other consumer goods businesses you look at. So singularity is one word I would keep in mind. And then I think in terms of how these businesses are run, one of the sort of main lessons I've taken from looking at these companies is that they tend to do the right thing, most of the time at least. So they seem to have a very long time frame. They invest up front. Now, these are generalizations, but generally speaking, they care about product quality, even in situations or even when looking at aspects of a product or service that the customer may not be willing to pay a premium for. So there's a real sense of company. So there's a real sense of companies doing the right thing over time. So if you look at Hermes is a good example of that,

Starting point is 00:06:23 Chanel is a good example of that. Keeping in mind that some of the companies that are formally classified as luxury companies, I wouldn't consider to be luxury companies. So clearly that applies to some of the American, you know, if you look at a coach or Michael Korse, I think are good examples of that. But even if you look at some of the European names like a Burberry, and I know Kaffer sort of refers to Burberry a number of times in his book, and he says it's not really or truly a luxury business if you look at the way they operate. So I think that's also so important to keep in mind. So there are probably two of the key things that I would look at to determine, are we looking at a true luxury business? And then you can go into all kinds of detail. But I think

Starting point is 00:07:01 they would be the two ones I'd look at. In terms of the experience from the customer point of view, I think it's also important to remember that there needs to be a social element to the product or service for it to be a luxury in a commercial sense and in a sort of financial, you know, investor sense. And so the idea there is if you look at many artisans or makers of high quality bespoke goods, they may very well be high quality products, but there's no social dimension, right? So there's no element of showing off, if you will, to use this slightly sort of negative connotation. And so therefore, I think in a, for the purposes of our discussion, the artisans and the sort of small independent bespoke makers would not be considered luxury businesses, right?

Starting point is 00:07:43 So they would probably be two or three things I would look at, Clay, to figure out if I'm looking at true luxury business. And then finally, the fact that these businesses and the market overall tends to be driven more by the offering than the demand side. So in some sense, these companies create their own market. They create their own demand by offering things to the consumer that the consumer may not realize they need or desire or even dream of, right? So there's a number of unique characteristics to these businesses, which I think make them very interesting to study. Sometimes it's difficult to determine if you're looking at a true luxury business or not. And sometimes within these large groups, take an LVMH, for instance, some of their offering for some of their

Starting point is 00:08:21 brands, take cosmetics or perfumes. Some of that offering, I probably wouldn't classify as a luxury business, right, but they're still part of the group and they generate some revenues at group level. And then you have some parts of the business, say the LV or Dior brands, and especially leather goods and apparel, where it's much easier to say that this operates as a true luxury business. So, you know, you can attempt to draw these distinctions, but I think sometimes the lines are blurred, Yeah, so those are probably a few things to keep in mind. Yeah, that was wonderful. There's a lot of strings that are going to be pulling throughout this conversation on a lot of the points you made there.

Starting point is 00:08:57 My next question is just looking at the luxury market overall. It's a very large market. Many people might think about clothes or bags or watches or cars that Ferrari sells. What product categories do you think are most prevalent within the luxury space? So I think when you talk about personal luxury goods, and that's usually when you look at the listed groups, certainly the French conglomerates and the Italian sort of often still family control businesses, they would most often be active in personal luxury goods. And so these would be things like clearly handbags, apparel, what we call hard luxury, which is jewelry, right, watches, those kinds of things. But it wouldn't include things like, you know, depending on which definition you choose. But if you look at cars for instance, they usually wouldn't be included in the definition of personal luxury, which I think when I look at Bain's numbers, I think they say for 20, 23, the total luxury market as they define it was something like 1.5 trillion euros. And I think about a quarter of that is personal luxury,

Starting point is 00:10:02 what they define as personal luxury, so say 400 billion US or so. And then in addition, you have things like fine art, fine wine, yachts, all these kinds of things. And also on the experience side, So luxury holidays and cruisers, but they wouldn't be sort of included in the definition that applies to the sort of European listed conglomerates, which I think is perhaps the most relevant one to think about, you know, for us as investors in these companies. So that's probably the broad breakdown of the market. And Capferr makes it very clear that there's a very big difference between a premium product and a luxury product. He tells one example of Ford trying to kind of weasel their way into being a luxury brand to which they failed. It's been viewed as,

Starting point is 00:10:48 you know, a classical car company that provides cars to the masses. So it's just not a market they could really get into. If you were to try and explain the difference between just a very high quality or a premium product and a luxury product, how would you describe what those main differences are? One interesting sort of categorization that I've heard is that luxury tends to be French, fashion tends to be Italian, premium tends to be German, and mass prestige tends to be American. That's obviously, I'm sure, highly offensive to some people, and, you know, it's a very broad generalization. But I think it gets the idea across, right? I think most people can probably see that there's some sort of reflection of these different cultural identities in there. So I think

Starting point is 00:11:32 what distinguishes luxury from premium is this idea of singularity, by which I mean that the luxury groups, you know, everything they do from their product offering to the way they market these things, to the way they price and distribute them, is focused on this idea of singularity, right? So that these products aren't easily compared to other products in the same or similar categories. When you look at premium, on the other hand, and I think the classic example that Kepferr refers to is cars, right? So if you look at German cars, these would often be thought of as a premium product. And the crucial point there is that you can compare them in terms of performance, right? So whether it's in terms of speed or whether it's in terms of boot space or whether in terms of emissions or range with electric

Starting point is 00:12:19 vehicles or any of these things. And so therefore you can compare performance across a number of metrics. And therefore, you can also, as a consumer, you can take a view on whether, you know, on the equation of price versus value. But that's much more difficult or often impossible or irrelevant when it comes to luxury goods because the way they're marketed, right, is much more about identity than it is about positioning. And so, for instance, you would never see Elmes marketing any of their products relative to Chanel or even to make reference to any of their competitors. You rarely ever see, or I would argue, you probably never see any product claims in the advertising, right? It's usually very sort of minimalist, right? It's all about the identity and the feelings and emotions that that evokes. So hopefully that

Starting point is 00:13:05 makes the idea between premium and luxury clear. Because I think often there, if you're not being sort of disciplined with these definitions, I think many people interchange the two or say, you know, higher and premium or that I think from an investor and operator point of view, they're very distinctive ways of running a business. Yeah, this is really interesting because I think a key part of luxury you mentioned is sort of social signaling, signaling to others, sort of your values and signaling your wealth to some degree too. Even in America, you mentioned America, you can just look at brands like Apple and Starbucks. They certainly aren't luxury, but you're still sort of signaling something. So there's something to it where, you know, like an Hermes handbag

Starting point is 00:13:48 that costs over 10,000 euros to purchase. There's something to it where there's a history behind the company and this appreciation for the way they do things. And it's signaling something very different to your values? Yes, absolutely. Yeah, I think, I mean, you touched on the heritage point. I think that's another important aspect of these businesses. You know, most of them, of course, coming out of Europe, France, Italy, specifically, I think that's one of the things that will hopefully mean, as an investor in these companies, that will hopefully mean that they can better withstand the challenge of new entrants. If you look at the Chinese market or the Indian market, there's another good book on the sector called Selling Europe to the world.

Starting point is 00:14:29 believe, which sort of talks about this idea that in a way, you're, you know, we're exporting this sort of cultural identity to other markets and parts of the world. So that's another very important aspect of these businesses. Most of the brands, if you look at the LVMH portfolio of 75 or 80 brands, most of these go back, with some exceptions, go back a long, long time. And if anything, I think somewhat unique feature of them is that they often improve over time, right? So they become more durable. There's an element of Lindy to refer to that idea, right? So often with these brands and businesses, the longer they've been around, the longer their life expectancy. So selling Europe to the world, I'm curious if you know geographical breakdown. Obviously, a lot of these French companies

Starting point is 00:15:13 are going to be prevalent in France and other areas of Europe. And I know China is a very prevalent and growing market. How do you look at or what are you seeing in terms of geographical breakdown in what markets, except this idea of luxury. Certainly over the last couple of decades, China's been the big, it's been a very big part of the overall market. So if we refer to Chinese purchases, so that would include purchases both made in China and elsewhere, predominantly in Europe, by Chinese consumers. I think over the last 20 years, that's been something like, let's say the Chinese

Starting point is 00:15:43 account for about a third of the personal luxury market. But I think over the last two decades, they've accounted for something like two-thirds of the growth of that market. So clearly that has been the big driver of that market. And then you've had relatively similar proportions accounted for by European and American consumers. So that's been the sort of broad splits. And so I think it's right that people are concerned about any, you know, deceleration in China. But it's a very large market fragmentation, certainly behind LVM age remains, you know, very significant.

Starting point is 00:16:17 So I think there are opportunities to growth both organically in terms of consolidation And then, of course, you see these large groups entering new adjacencies. So in the case of LVMH, for instance, they've been investing into experiences. So they've been acquiring hotel chains and the like. So I would like to think that there's significant runway for growth here. And on top of that, you know, we touched on this idea that these companies effectively create the market themselves. And so I think in some ways they're more in control of their own destiny than some of their

Starting point is 00:16:48 consumer groups because, you know, assuming they can provide products and experience that consumers are willing to pay for, it's probably wrong to say that there's limitless growth, but I think there's much more opportunity. If you get it right, there's more opportunity to grow for a long period of time than there is in some other more sort of consumer demand-driven industries. And I think that's an important point to get into a little bit more. Hundreds of years ago, luxury was sort of reserved for the kings, the emperors. know, extremely exclusive. And now the luxury sector is sort of seeing some tailwinds where these very wealthy people, this class has sort of grown and grown over the years. You know, they also

Starting point is 00:17:28 expand internationally. They expand a new product segments. So it seems like the luxury sector has a lot of wins at its back in terms of growth as well. I'm curious if you could speak more to that. Yeah, so in terms of the customer demographics, if you speak to these companies, they will say we don't sell to the very rich generally. Well, of course, they do sell to the very rich, but most of their revenues, they would argue, are not from the very rich. It's from the, as called them, the mass affluent. Having said that, the numbers I've seen from Bain, I think for 22, suggests that about 2% of customers by volume, account for about 40% of personal luxury purchases by value. So clearly there's a very significant skew there. And I think it's also

Starting point is 00:18:09 increased, that skew has increased in recent years. So through the pandemic, the rate of increase in terms of spending for the very wealthy or high spending customers has been much higher than for the low spending customers or lower value customers. So I think there's been a bit of a polarization there. And you can also see that when you look at which of these companies have done the best in the last, say, three or five or seven years, generally speaking, the brands that sell to the wealthiest demographics, right? So clearly, Hermes, Chanel, Cuccinelli, to speak of a sort of smaller player, although listed. So that's been one of the key trends there. And you can also see that these companies are, you know, spending more time and effort and money on entertaining these

Starting point is 00:18:52 very important high spending clients, right? So there's a real sort of battle, I think, for their attention. So there's much more going on in terms of private events and viewings and dinners and travel, etc. So I think that's one important thing to keep in mind. Another one is that, of course, these demographic characteristics will vary by market. So if you look at the Chinese, typically if there is one luxury consumer, they would tend to skew much younger, right? And then if you look at, say, Western European or American consumers, they will probably much more often be self-made. So there's a number of these things to keep in mind. But yeah, they're probably one or two of the sort of important trends in terms of customer demographics. Let's take a quick break and hear from today's sponsors.

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Starting point is 00:23:30 Go to Shopify.com slash WSB. That's Shopify.com. slash WSB. All right, back to the show. One of the interesting points that resonated with me in the book was what Capfer called the non-return effect, which very much reminded me of the hedonic treadmill that many people fall into. So the hedonic treadmill explains how once one makes more money, their expectations and their desires rise with that rise in income.

Starting point is 00:24:02 And humans were kind of hardwired to always want more. but more stuff doesn't always make us any happier because we eventually become accustomed to that new lifestyle and just want more and more things. So Catfur had written, once people have tasted luxury in whatever area, it is very difficult for them to turn away from it. Have you found this concept to be true in your research and experience in this space? Yes, I think it becomes, you know, it's difficult to put numbers on these things or find sort of empirical data to back it up. But yes, the idea that once you've started moving up this ladder of consumption, that it's very difficult to sort of step back down again, I think makes a lot of sense. And this is my personal opinion. But I would think it's partly to do with the fact the sort of functional aspects of these

Starting point is 00:24:49 products, right? Because even though they are supposed to be singular and not to be compared to other products, often they do have, you know, superior product characteristics. So if you look at a Lorapiana Kashmir sweater or many of these other. other products. Objectively, they are very high quality. I think that's one aspect of it. And then you have the other aspect, which is more social and to do with prestige, right? So once you've sort of entered into the realms of the prestige that comes with buying these products and services and the access you get through invites to parties and travel and exclusive events and, right, I think it's very difficult to sort of step back from that. And I think you see this idea as being employed in other

Starting point is 00:25:30 businesses that aren't necessarily traditional luxury businesses. So if you look at the airlines, for instance, and the idea of reward tickets and companion tickets, I think many of us have had this experience where, you know, that's the first time you maybe get on a plane and you get a business or a first class seat. And then, you know, next time you may actually consider, should I be paying for that? Because the experience was so special. And having experienced it, I don't want to go back to what I had before that. So, yeah, I think it makes a lot of sense. And that clearly makes these businesses is more robust in a way because all these high spending consumers, I think in fact the example Kaffir talks about is that even when you look at sort of high and ultra high net worth individuals,

Starting point is 00:26:09 they are more likely to cut back on essentials than they are on their luxury spending because that just isn't an option. I don't know what the numbers are, Clay, but I think it makes a lot of sense and it fits nicely with my sort of impression and understanding of consumer dynamics in this industry. So another one of the interesting things, just about these world-class luxury companies is that they just seem to break all the rules of business and they're somehow able to get away with it. In fact, Capfer put together what he called the 24 anti-laws of marketing that have been utilized by the world's most profitable luxury companies. So Christian and I are going to be getting into a few of these to better understand this industry. The first

Starting point is 00:26:52 anti-law of marketing is, forget about positioning. Luxury is not comparative. And this implies that luxury is really just in a league of its own and doesn't want the consumer to be comparing it to any other brands. You've got into this a little bit, so I'm not sure if there's any other comments you have, just speaking to the importance of uniqueness within a luxury product. Yeah, I think it comes back to the concept of these products being singular, right? I guess what I would add is the entire, it's not just about the product and the advertising, but it's the entire business model. So if you look at the way brands like LV and Dior and Nelmes, and Chanel, the way they retail the product, for instance, they control the value chain.

Starting point is 00:27:33 They're highly vertically integrated. So they can make sure that no competing products, so to speak, are available, right? So they can really sort of push this idea of singularity because they control that value chain. And it comes back to the way these products are being marketed. So I think, yes, the rule number one fits very nicely with a few of the sort of themes or unique aspects of the luxury business that we've talked about. I should say that in some ways, some of the companies you see in the luxury space may or may not be breaking one or two of these rules these days. I think since Capra wrote a book, some things have changed. I think with some of these groups, especially LVMH, because of the scale they're now at, you know, some of these rules, which we may come back

Starting point is 00:28:15 to, aren't perhaps being followed quite as closely as they were. So the idea, for instance, of do not sort of use any kind of celebrity involvement or celebrity endorsement in your advertising. Clearly, if you look at brands like LV, that is no longer the case. And there's one or two other ones. I guess the internet distribution aspect, I think, is another one where you could argue that some of these companies no longer just communicate or advertise online, but they also sell meaningful volumes of products online. But I think on the whole, when I go through the list of the 24, the vast majority

Starting point is 00:28:47 of them still seem to hold. And especially, where I would argue, you know, for the companies that we consider to be the highest quality and truest to the luxury model, almost all of them still hold. So I think they're a very interesting set of anti-rules or anti-laws. And actually, they're also useful for looking at other businesses, you know, be it Apple or Ferrari or, you know, a Remy or many other examples of businesses that seem to be operating according to these anti-laws. So with regards to the celebrities, you know, you have the Nikes of the world paying celebrities millions and millions of dollars to wear their product. But in the terms of these luxury

Starting point is 00:29:23 companies, you know, ideally they want these celebrities just to be wearing their products and showcasing it without, you know, having to necessarily pay them or put their face on a commercial or whatnot. Is that correct? Exactly. I think that's what they would like. And if you look at the case of Elmes, that is what they're getting because they don't do any endorsements or, and they certainly wouldn't pay anyone to sort of expose their products. I don't know the details in Louis Vuitton's case. You know, when you look at their campaigns with Nadal and Federer or with Messia and Ronaldo and I don't know what the details are in terms of the sort of financial side of things. And I'm not necessarily saying that it's a bad thing, but I think it has changed the way the business operates or the way they

Starting point is 00:30:02 sort of communicate with the consumers somewhat. And if you look at their involvement in the Olympics this summer in Paris, I think on some level, you could argue that partly at least they look a little bit more like traditional large consumer goods group, because also if you look at the other big sort of names that are, you know, major sponsors of the event, they are historically, there are companies like Coca-Cola and P&G. And I wouldn't want to bet against Bernard Arnold. I'm sure he knows what he's doing. But I think it may, for some of the brands at least,

Starting point is 00:30:30 it may, over time, change the dynamics and the way we should analyze them. I think it's too early for that, but it's certainly one thing to keep an eye on. Will LVMage still be following these anti-laws in five and 10 and 15 years' time? I'm more confident that the likes of Chanel and MS will. Having said that, you know,

Starting point is 00:30:49 there's other successful ways of running a business. but it may require us to change the lens we use to analyze these companies somewhat. Yeah, you're getting to kind of anti-law marketing number four there, which is keep non-enthusiists out. There's this slippery slope where a luxury company is like any other company in that, they want to grow. But they have to be very careful and thoughtful of their growth. And part of the appeal of luxury is being exclusive. You can't be an exclusive company if you're going to the Olympics and trying to, appeal to a broad mass audience because, you know, if you release new products that are at, say,

Starting point is 00:31:26 a lower price point, you know, that may lose the appeal of your original product category. So could you speak more to anti-law of marketing number four, which is keep non-enthusists out? Yeah. So just to touch on what you said now, I think if you spoke to management of these companies, they would say that there's a very sort of clear price ladder, right, and that they're able to, segmentation and that they're able to sell products like cosmetics and perfumes for customer recruitment, and they would sell these through different channels than the channels through which they sell their sort of very highly priced handbags and apparel, etc. So I think they would argue that you can do both. That remains to be seen, of course. In terms of keep the non-enthusiasts out,

Starting point is 00:32:12 yeah, historically the idea with luxury has been that you need to focus on scarcity. And if there isn't real scarcity, you need to create scarcity, right? You need to restrict supply of these products. So there's been a question mark around this for a long time now for brands like LV for instance. And if you put the question to the company, they will say, we've been getting this question for the last 20 years. We were getting this when LV was a $500 million dollar brand. We're still getting this question. But of course, at some point you will run up to that sort of critical level. I think what some now argue is that it's more about discovery than scarcity. So this comes back to the idea of making it somewhat difficult for the customer to access your product or service, right? And that is, in fact, part of the

Starting point is 00:32:58 appeal of these products and services. So if you look at Almes, for instance, to take an example that most people are familiar with, the way you get an allocation or the way you get access to, you know, the Birkins and the Kellys is that you need to have, you need to establish a relationship. You need to be buying other products, right? There are certain things you need to sort of take off to get to the point where you can actually buy one of those bags. Some people would argue that process of discovery is more important than the scarcity as such. And then there's a couple other aspects I would touch on there. One is that for the historically at least, these brands have been able to expand geographically, right? So even if the product or the brand was becoming highly visible

Starting point is 00:33:36 in some markets, they could expand into some other part of the world. I think they're running up against a limit there. Certainly if you look at the very large brands, so if you look at LVD or Chanel and Almes, I think, you know, for them, that's becoming increasingly difficult. And then you have the question of visibility. So, you know, with some of these products, a very large proportion of purchases are made by a relatively small number of consumers. And so if you look at handbags as an example, in many cases, that means that only one of these bags will be visible at any given point in time, right? Now, some would argue that might change if you have secondhand retailers and if you've had experience here, like rent the runway and all of these businesses. So far, it's been very difficult

Starting point is 00:34:18 for them to sort of build any momentum, but I think it's certainly one thing to watch. I would like to think a company like LMS is better protected because simply for the fact that you cannot purchase the most desired products if you haven't gone through that sort of process. But this growth paradox, I think, is one of the key questions for any long-term investor in the sector, as in for how long can you grow at these kinds of rates and still be perceived as an exclusive or operate as a luxury kind of business model. And it's a real question. And it's probably one of the top two or three things that I worry about when I look at the very long term sort of outlook for these companies. Yeah, the point on scarcity is quite a paradox because we really live in a

Starting point is 00:35:00 world of abundance. Ferrari, for example, they produce somewhere between 7 to 10,000 cars per year. and just for reference, Ford produces north of four million cars per year. And then from the book, they pulled a quote from the Hermes CEO. He's been on records for saying that when a product sells too much, we stop producing it. I was actually doing some reading on Hermes before this. And I believe the Birken bags, they stated in an earnings call that they're producing as many as they can, but it's just such a time-intensive process and that only so many people in the world know how to make these bags. So maybe to some extent, not everybody is purposely limiting how

Starting point is 00:35:39 many products they're able to produce. But yes, scarcity is certainly a very important factor to this, because if everyone has access to that, then, you know, it loses its appeal as well. I think that sort of touches on what Kaffererer to refer to the book talks about. I think he calls it the dream equation where he says, you know, one of the key things in this business is to increase awareness of a brand at a higher rate than the penetration of the brand, right? So you want to make more and more, not necessarily potential consumers, but you want to make more and more people aware of your brand, but you don't necessarily want to grow consumption in volume terms at the same rate. I think with El M.S, for instance, they do manage, they may be producing

Starting point is 00:36:17 as much as they can, but they're not growing capacity as much as they could. And so they manage that very carefully. Of course, there are restrictions, and especially for these highly vertically integrated businesses, right, in terms of access to skill, labor especially. And I think with El M.S., you've also seen in recent years, while it's an exceptional brand, they've had some issues with service levels and the sort of quality of the store network. So I think there are restrictions or constraints on the retail side of things as well that need to be managed carefully. But yes, it feels like some of these companies are doing a very good job at it still at scale. And in fact, I think most of the examples I've referred, I don't think we've seen any of the big four have any big trip-ups there

Starting point is 00:36:57 so far. But yeah, I think over 10 and 15 and 20 years time, this will be one of the, top things to watch. So anti-law number 13 is raise your prices as time goes on in order to increase demand. One would obviously think that increasing prices would generally mean you're appealing to a smaller customer base, but the luxury customer base is much different than most companies. How can increasing prices actually increase demand? So partly this comes back to the idea of selling a singular unique product, right? And I think part of the idea there is that you price your product so that it is perceived as being unique or singular in a way, right? And price is supposedly irrelevant. Having said that, you've seen for some of these

Starting point is 00:37:44 companies recently, they have been getting some pushback for what are perceived to be excessive price increases. So Chanel, I think, is the most sort of visible example of this, where there's been a lot of attention at least paid to the price increases they've taken on some of their flat bags and through the pandemic. Having said that, when you look at their actual performance and the growth of the business, I must say it's difficult to say whether this is just sort of social media noise or whether it's actually genuine pushback from their consumer base. And so far it seems to be the former, but we will have to see. I think, yeah, clearly in some cases, I think the pricing of these, and Kaffra talks about this in the book. The idea with, if you operate, a true luxury business model is that

Starting point is 00:38:29 you only ever increase prices, right? And certainly we've seen that in recent years, and especially with the sort of, to call it the best or strongest brands in the business, like Chanel and Almes and to some extent, some of the brands, LVMH brands, and including some smaller, lesser, perhaps less visible brands like El Doropiana. So yes, the way you think about price here is clearly very different from most other businesses. And I guess, as, you know, if you compare this to what we said about the premium idea of a premium business, for instance, there, you can compare product and you can therefore look at what you're getting versus what you're paying. And I think one key element of these businesses and these products is that it is very difficult to compare. And in fact,

Starting point is 00:39:08 usually the consumer doesn't even want to make that comparison, right? So yes, they're very different dynamics. We will have to see whether, you know, some of these price increases we've seen in recent years will turn out to sort of be excessive and whether that will have any impact on the brands. But so far, I don't see any evidence of that. And an important point to tie in here is that luxury companies aren't typically looking to reduce costs just for the sake of increasing their profit margins because typically this can lead to a lower quality product or service or experience. Ideally, they want to increase their price, but also increase the value that's being provided as well. And approaching it that way, looking at how can I provide more value instead of how can I increase the profit by decreased. scene costs. Yeah, and I think it also comes back to the idea of heritage, right, and sort of

Starting point is 00:39:59 cultural identities. So if you look at these predominantly European brands, part of what you're selling here is the idea of take some of these French brands, for instance, you know, you're selling the idea of these, you know, French heritage and French traditions and French culture, right? So the idea that you would outsource that production or relocate that production to a low-cost country, I think, it just doesn't fit with the DNA of these businesses, right? And then there's another aspect of that, which is that the strong have been getting stronger in this industry and have therefore been able to, so the likes of LVMA, Chenal, et cetera, have been taking significant amounts of market share in recent years and therefore, you know, and it's a virtuous circle.

Starting point is 00:40:37 So they've been better able to reinvest in product quality and branding and I think they have more headroom in terms of producing, in the case of many of these brands, producing all of their volumes in sort of high-cost locations like in France or in Italy or other parts of Western Europe. So the last anti-law I wanted to touch on here was number 24, which says just sell marginally on the internet. So e-commerce is, of course, a very important part of our economy today. So they'd be leaving a lot on the table if they just never set up an e-commerce store. But part of the appeal of these luxury brands is, you know, the experience of going into the store and speaking with their representative that tells a story and explains that singularity that you're talking about.

Starting point is 00:41:22 What's the consensus on selling luxury online? I think part of it is that there is no real consensus, I think, so far, right? Historically, these products, as you said, have been deemed not to be a good fit for the online model, right? Having said that penetration of online, this will vary hugely buy segment and price point and brand, but if you look at the overall personal luxury goods market, as we defined it earlier, I think that number has gone from rough numbers, but from somewhere around 10% five years ago, five or seven years ago to say 25% now. So clearly penetration has increased hugely. There's quite a few sort of pure play online businesses in this space, but generally they've had a very difficult time, especially coming out of the pandemic. So you look at Farfetch, Richemort, have an investment in Yukes, Netaporter. They've also had a very difficult time. The strong brands, have been very reluctant to move any of their distribution online. They now have some of their own brand.

Starting point is 00:42:22 If you look at LVE, for instance, there is some distribution online of certain products, but it's very selective. And I think one of the points that Kaffer makes in his book is that it's perfectly fine for these companies to communicate and to market or sort of engage in brand building online, but the distribution part is much more difficult or challenging. And so I'd say it's certainly happening.

Starting point is 00:42:44 Capferr makes the point that it isn't a very good fit because you're missing out on a few key elements of the luxury experience and especially fiscal retail, which is still unusually, which is hugely sort of important for these brands. And if anything, I would argue you've seen the opposite in this space where the level of investment in the store network has been extraordinary in recent years. And you might have seen many of these companies spending huge amounts of money on very prime real estate. So, you know, in the case of LVMH, there's a couple of very significant investments. They've made. made in Paris and New York and similarly for Prada and Gucci, right? This has been all over the news. So I think it seems like there's a bit of polarization here as well, where the sort of true luxury players are really holding out and they're very selective in the way they distribute online. So I think it's difficult to sort of answer this generally for the whole space, but it's certainly happening. In some ways, it may also help crystallize the true luxury players from the rest of the group. Let's take a quick break and hear from today's sponsor. No, it's not your imagination. Risk and regulation are ramping up, and customers now expect

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Starting point is 00:47:11 Maybe you could speak to how fast. some of these markets are growing, what markets are more mature, and maybe which markets present opportunity for growth. Speaking with some guests on the show, I've seen kind of China was like a growth story for a lot of just a broader economy throughout the 2000s and becoming more mature these days. But now India seems to be, you know, more so on the rise. So I'm curious if India has any role to play in the luxury space. I'm sure it will do. I think certainly for now, and when you speak to many of these companies, they will say that the next China is still China. So I think many of them feel that there's a lot of opportunities still there.

Starting point is 00:47:48 In terms of the big picture, you know, if you come back to the personal luxury goods market of, say, 400 billion or so, I mean, the big growth drivers in terms of category, if you look at the last decade, for instance, has been certainly the leather goods. That's been one of the highest growing categories. And on the other hand, if you look at watches, that's been a much more difficult part of the sort of sector. So there's differentials in terms of category growth rates. And then in terms of geographies, of course, as I said, Chinese consumers have accounted for something like two-thirds of growth in the sector.

Starting point is 00:48:18 So that remains a hugely important part of this market. And most of these companies still feel that there's a lot of untapped potential there. India is very interesting, not just for the luxury groups, but generally speaking, I think there's so much positive sentiment around. I mean, that may have changed somewhat, I think, depending on the way you look at it, the recent elections. But on the whole, there's been really positive sort of moment. momentum there. I think it's just that the base effect means that for now, that will, and for the

Starting point is 00:48:44 foreseeable future, that will, you know, remain a much less significant driver. If you look at the last decade, the US has been, depending on category, but mid-single-digit growth or a bit less than that, and Western Europe has been relatively flattish. So there's a lot of differential in terms of geography and category. You know, one of the nice things, the large diversified conglomerates is you're getting some sort of, well, one, you're getting diversified exposure, right? So you're getting different categories and different price points and geographies, but also, as I mentioned earlier, the strong have been getting stronger. So if you look at LVMH, for instance, between the financial crisis and the pandemic, they averaged about 10% organic growth, which is much higher than the overall

Starting point is 00:49:24 market. So you've been getting a lot of outperformance from these big groups, right? And so there's a number of things to consider, right? The overall market, the divergence you're seeing between geographies and categories and also the sort of large diversified conglomerates versus the small, call it independent or family controlled players, many of which are Italian and many of which have struggled, I think, to actually have enough resource to invest in the critical store network and fiscal retail. So there's a number of things to consider when you sort of try to figure out where you want to be exposed. So this might be a really unfair question. Who do you think is the typical luxury consumer. Maybe this would be helpful to the audience just to get a sense of

Starting point is 00:50:08 proportion of the population sort of falls into this category. So as we touched on earlier, these companies will argue, certainly the large diversified groups would argue that it's not primarily the very rich, it's the mass affluent. But it does seem like a small proportion of their customer base accounts for a large proportion of purchases, the 2% of customers driving 40% of purchases, I think speaks to that fact. And then, of course, you have differences between geographies. I think we touched on this earlier, but the fact that, for instance, in China, you're looking at a very different typical luxury consumer than you would do in Western markets. And also, you have the fact that these things tend to sort of change over time. So, you know,

Starting point is 00:50:52 the average age and other sort of characteristics of the consumer base here will have changed over time. So I think apart from that, it's probably difficult to say much about who the typical consumer is, because within that sort of mass affluent group, there's such a wide variety. What you can say is that some of these companies, if we speak about for our purposes, I guess the focus is on the listed groups. What you can say is they certainly sell to different kinds of demographics, right? So I mentioned Chanel, MS, and Cuccinelli, certainly. They will sell to a, you know, if you look at average earnings, a net worth and age, that will look very different. right, from many of the brands in the LVMH group. So that's probably also, as an investor,

Starting point is 00:51:32 I think that's relevant to keep in mind when you're trying to figure out where do I want to be exposed here. Circling back to pricing, I wanted to share a piece here from the book from Capfer. When we evokes the word luxury, the adjective, expensive, immediately comes to mind, and yet it is probably the relationship between luxury and price that things become most complex and surprising. At a conceptual level, we know that luxury is translated in a product through a high symbolic value. This symbolic value, essential to luxury, is very difficult to quantify and in any case is highly relative. It cannot be given a precise figure. And yet luxury must be paid for, and therefore it must have a price. How do you think about the pricing of luxury products?

Starting point is 00:52:18 I think generally speaking, it comes back to the points we've made earlier about the fact that these products are not prone to comparison, right? And the other thing to keep in mind is, broadly speaking, that the competitive set is very broad for these products or services, right? So I think one of the examples, Capra makes this, if you're looking at some of the prestige champains, for instance, what is the competitive set there? If you're looking to purchase one of these as a gift, you know, you may also be looking at a piece of jewelry or you may be looking at a painting or an experience of some kind. So I think it's much, but he actually puts a number on this, I think. I can't speak to whether, you know, how sort of what the empirical basis is here. I think he talks

Starting point is 00:53:00 about a minimum for somewhat comparable products, a minimum price premium of 30% for a luxury product, but it probably should be no more than 100%, I think he says. I don't know how he gets to those numbers. It seems very sort of precise. I mean, what's the empirical evidence? Well, one thing to keep in mind is that, of course, some of these are seen as stores of values. So if you look at resale values, for some of these, for some of the strongest brands, of course, they're trading at a premium or trading at sort of par in the resale market. So if you look at the Birkins and the Kellys and, but also, of course, when you look at some of the prestige or, I should say, luxury watches. And so that has a real significance for the way you price your product, right?

Starting point is 00:53:43 because to many consumers, you know, that means that these are seen as investments, or at least that sort of eliminates the downside risk, because if you want to offload some of your collection, you can do so perhaps even with a gain. So I think that matters. And then for the global brands, they also need to manage these price, sort of interregional price differences, right? Because of course, for many years, we've had the phenomenon of the Daegu, the Chinese professional shoppers, coming over to Europe and other parts of Asia to bring a lot of product back to China. So the European brands have had to be very careful about how they managed that as well. So some of these are more to do with brand and identity and the broad competitive set. Some of it is to do with resale values

Starting point is 00:54:26 and sort of managing that equation. And some of it is more, say, call it operational or more short to medium term commercial. So without being able to put numbers on these things, I think these are some of the considerations of managing these brands successfully from a pricing point of view. Yes, certainly signals pricing power when your customers can sell what is you're selling in the secondary market at a price higher, you know, the next day. So the well-known luxury brands are very large companies, and it leads me to want to potentially look at some of the smaller names, but this can be a difficult line to cross and a bit dangerous because there's a fine line between true luxury and we'll call it the rest of the pack.

Starting point is 00:55:10 When looking at a smaller name, do you think there's maybe some pitfalls you'd watch out for to maybe help distinguish other than some of the things we've mentioned already in trying to identify true luxury versus the rest of the pack? Yeah, so one of the difficulties, I think, is heritage and track record. So small doesn't necessarily mean that it's a recent brand, right? But if it is, then I think that's a real something to keep in mind here, right? Many of these are first generation still.

Starting point is 00:55:38 So if you look at a Cuccinelli, for instance, which, you know, where you haven't seen, and in fact, LVMAG, although very large, is in a similar situation where they still haven't proven themselves as multi-generational businesses. Another, so I think governance and succession is one thing to keep in mind when you look at some of the smaller, call them independent players.

Starting point is 00:55:56 I think another one is, and we've seen many of the Italian groups, several of whom are now part of the large French conglomerates, like a Bulgari, for instance, have strong. I struggled, I think, to fund, you know, both in terms of financial and sort of human resources, to fund the certainly international expansion of their store networks. So I think that's another thing to keep in mind, do they have the resource and sort of ability to grow internationally? And then thirdly, the risk profile of these companies will vary depending on if you're looking at, so when you say as, you know, smaller independent player, most probably you're looking at a

Starting point is 00:56:31 much more focused portfolio, both in terms of geography, but also in terms of product range, right? So, of course, if you get it right, on the upside, there's much more opportunity, but equally you would probably be much more dependent on, often they're mono brands. So you look at LVMH with 75 or 80 brands in there. Many of these smaller independent groups will have, you know, one brand and a very narrow product range. And they may also be quite limited or focused geographically. That's not to say that they're not equally good businesses, but it can have a real impact

Starting point is 00:57:02 on the risk profile. I would probably focus on those aspects. So one of the things that sparked the idea for this episode was that my co-host, Dig Bruterson, he had told me that Hermes was probably the best company he's ever analyzed. And when he says something like that, it really grabs my attention. This is a company that essentially sells one of their main products is the Birkenbag, which sells for 10 or 20,000 euros plus. I'll just be clear that him or I don't own this stock.

Starting point is 00:57:31 We're just talking about the business itself and the value. is a whole other discussion. And you talked about the heritage and sort of the family ownership of some of these luxury companies. Hermes, they're on their sixth generation of family ownership. And they were started all the way back in 1837, which in itself is another interesting aspect of this company. But it can be painful for value investors to see a company like Hermes trading at a PE of around 50. What are some of the things investors should take into consideration when looking at the valuation of luxury companies in particular that, you know, make them just fundamentally different than when you're analyzing other companies.

Starting point is 00:58:13 So personally, I don't necessarily think MS is the best business I've ever looked at. I think it's very good. I think it's an exceptional brand. I think the business actually, although very good, I think potentially isn't being run as well as it could be, which is, you know, an interesting conversation in itself. but if you look at the store network and the customer experience, and I think some of that is intentional. Coming back to Kaffer, he talks about dominate your customer

Starting point is 00:58:36 and make it difficult for the customer to buy the product and all these things. And I think people inside the business would acknowledge this, that there are some aspects of the business that could probably be better managed. But having said that in terms of valuation, so generally speaking, valuations reflect, I think, on the whole, relatively well, the sort of differentials you see in growth rates and resilience, to some extent the strength of the balance sheets of these companies.

Starting point is 00:59:01 And so, of course, if you look at the top end, you look at LMS trading on 45 or 50 times earnings, right? And then you have the large conglomerates. If you take LVMAG trading in the low 20s, and then you have at the sort of lower end, you have companies like Burberry and a number of other examples that are, you know, call them turnaround candidates or less well-man. And some wouldn't even include them as being true luxury businesses. but for reference, they're trading in the low teens perhaps. So, you know, there are significant differences within this group. And I should say, you know, we've been invested in these for a long

Starting point is 00:59:35 time, but we haven't been buying Almas or LVMA for a long time. And in fact, if anything, we've slightly reduced these holdings in the last year. So clearly they're not as attractively valued as they were. Yeah, I think on the whole, the market sort of clearly gets the ranking in terms of quality and in terms of how, while they operate a luxury business, model. I think that's reflected in their valuations. The other thing to say is that, and this is also something the book touches on, is, you know, if you look at reinvestment rates, these aren't necessarily businesses where you should just be looking at the CAPEX statement to get a sense of how much they reinvest, because of course, much of their spending goes through OPEX, go through the income statement.

Starting point is 01:00:15 So you get to the question of, you know, are these companies over or under earning? And I think it's fair to say that certainly LBMH and Almes. Now, Chanel is obviously not listed on the exchange, but These tend to be businesses that invest for the long term because of their shareholder structures and the culture at these companies. So I think that's worth keeping in mind. Having said that, I think they've had a lot of things going their way in recent years, right? Certainly through and coming out of the pandemic, we have some companies in our portfolio where we strongly feel they're under-earning. I wouldn't include the luxury goods companies there, right? I think they've had a pretty good time and on top of that they've been rated quite highly by the

Starting point is 01:00:52 market. So those are the broad sort of considerations, I think, when it comes to valuation. Of course, LMS always looks expensive, despite that it's been an incredible investment over one and two decades and longer. Some of these companies, like Eberberberi, has looked inexpensive for a long time, but it's not been a good place to be invested. And in fact, it probably in some ways, it's interesting because we're discussing this book, I think in some ways, the valuations seem to reflect how well they follow many of these concepts and strategies. Now, I'm sure they were doing that long before the book came out, but that does mean that this is a good sort of book to be going through, I think, for anyone looking to invest in the sector, because it can also give you a sense of, you know, where the real

Starting point is 01:01:34 quality in this sector is. You mentioned earlier the importance of, you know, the transition of ownership over time and transition to managers. And when you have, say, in the case of Vermez, for example, they're on their sixth generation. There's more confidence with investors on, you know, where this business will be 25 plus years from now in terms of the new ownership and who's going to be running the company and how the brand's going to be taking care of over time. So not only is the company building trust with customers and the long tenure of that heritage, but it's also building that trust with shareholders as well and, you know, having that long-term mindset that endures. And, you know, that is essentially implied in the terminal value for

Starting point is 01:02:16 investors. Yeah, I agree. I think LMS is probably the best example. If you look at the listed groups of business where you can have some confidence in the sort of succession and the future governance of that business. And then I think with most of the others, to some extent with LVMAG, certainly with some of the other businesses in this sector where you have a much more institutional shareholder structure. I think you're much more dependent on external professional management coming in to run the business. And so you look at Burberry, for instance, and the sort of turnover they've seen when it comes to management and creative lead. And so that's something else to consider. But yeah, I think the big one to watch here is, of course, what will happen at LVMH when you

Starting point is 01:02:54 look at the listed groups. But you're right. I mean, they haven't, so far haven't proven themselves as a multi-generational business. So we'll have to see, having said that it's a large, diversified groups. I think in some ways, the nature of that business provides some protection. Yes, certainly, that's a big, important question for anyone investing in this industry. Historically, what have you seen in the luxury space during recessions? Is there cases where there's a sharp pullback in demand for these types of products? Or how has that looked historically? It's no doubt a cyclical industry. And so the most recent example would be, I mean, it's a very unusual experience. But if you look at 2020, I think for LVMA age, their top line was down something like 15% and their EBIT was down

Starting point is 01:03:37 almost 30%. So clearly, now that's an unusual. That's perhaps not a normal recession. But I think it does show you that there's also a lot of operating leverage in these businesses because they have a meaningful production facilities, but especially they have a store network, right? And so you certainly have an earnings cycle in these businesses. The other thing to keep in mind is it doesn't sort of hit everyone with the same magnitude or impact. So I think we mentioned this earlier, that if you look at recent experiences, that the strong have been getting stronger, and certainly the brands selling to the wealthier consumer, like the Chanel's and Almes and Couchin Nellis, they have been much better able to weather any downturn. So yes, it's cyclical. I think as an

Starting point is 01:04:21 investor, that's part of the opportunity, right? You get earning cycles, you're exposed to the economy, to asset values, and also you get cycles of sentiment here, right, whether people are concerned about tariffs or what have you. But I think as a long-term investor, if you're confident in the quality of these businesses, that's welcome. That's where the opportunities are. Great. Well, that's all we had for this first episode on a luxury primer. Christian and I will be talking in next week's episode on some of his holdings in the luxury space. So be sure to come back and tune into that next episode that comes out a week from now. So Christian, before I let you go, I want to give you a chance to let the audience know how they can connect with you if they'd like and learn more about what you're up to.

Starting point is 01:05:04 Yeah, sure. I think the best place to go is to our website, which is Billinger forvaultling.orgline.org. and there's articles and podcasts and you can see our holdings and you can find contact details. So yeah, I'd love it if anyone wants to discuss this or other topics. Wonderful. I'll have that linked in the show notes for those that are interested. Christian, thanks so much. I look forward to chatting again soon. Thank you.

Starting point is 01:05:26 Look forward to it. Thanks again. Thank you for listening to TIP. Make sure to follow We Study Billionaires on your favorite podcast app and never miss out on episodes. To access our show notes, transcripts or courses, go to theinvestorspodcast.com. This show is for entertainment purposes only, before making any decision consult a professional. This show is copyrighted by the Investors Podcast Network. Written permission must be granted before syndication or rebroadcasting.

We Study Billionaires - The Investor’s Podcast Network - TIP643: The Luxury Strategy w/ Christian Billinger

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