It has always puzzled me why people are so enamored of the luxury business. Those who work in it are often downright snooty, which is somewhat understandable. As they hobnob with billionaires, the purveyors of luxury may feel that minions like me are undeserving of their attention.
Then there are the many students I taught who aspired to work in the luxury business. This can perhaps be explained by the fact that these students would get to meet a "better class" of people and impress their friends and families.
More perplexingly, the company executives I encountered as a consultant frequently spoke wistfully of moving their business into the luxury segment. I assume here, since we are talking business, and given their target market, those in the luxury industry can hardly be opposed to wealth creation as the objective. Therefore, one should examine dispassionately the attractiveness of the luxury business in the context of its potential for wealth creation.
Let me at the outset, as a provocation, reveal my cards. I have always believed that luxury as a business is a waste of time. There is no real money to be made in it. What, you say!
While recognising that gross margins in this business are very attractive, often reaching or even exceeding 80%, my entire thesis is built on two arguments. First, true luxury with its premium pricing tends to have a small market. It is a niche business by definition and just not big enough for enormous value creation.
I’m not talking about Mercedes Benz, which sells more than a million cars annually (and which I first encountered as a public taxi in Amsterdam). Apple, L’Oreal and Audi are mass premium brands of a similar kind: they target large numbers of customers while ensuring that a small percentage of their product line reaches the luxury space. The luxury brands in these product categories are Vertu, Lancome and Bentley, respectively. The ownership of the luxury and mass premium brands may be common, L’Oreal and Lancome, for example, Nokia and Vertu, or Volkswagen, which besides owning Audi also has in its stable luxury marques like Bentley, Bugatti, and Lamborghini.
Second, a relatively less important and more controllable reason is that luxury businesses usually have poor cost and operational discipline. This dissipates the high gross margins that they generate. In the name of luxury, these companies are wasteful in their business practices, sometimes even taking pride in profligacy. I say this while understanding that they need to spend oodles on marketing in order to support their premium prices.
Let’s now turn to the evidence on wealth creation. To write this feature, I pulled out the list of the 40 richest people in the world that Forbes compiles annually. Investigating how these 40 individuals made their money or how their families made their wealth, there was no representation of luxury company owners, as far as I could observe – with one exception.
The outlier was Bernard Arnault of LVMH with his brilliant strategy of consolidating a fragmented luxury industry by acquiring luxury brands owned by traditional families. In contrast, those who created low-cost models in any given industry sphere had many more appearances, for example, Jeff Bezos of Amazon, the three Walton inheritors of Walmart, the two Albrechts of Aldi, Stefan Persson of H&M and Michael Dell. One could quibble, but the two founders of Google, Larry Page and Sergey Brin, who give away their products for free, and Amancio Ortega of Zara, who sells cheap imitations of designers, are also low-price moguls.
Moving off the top 40 rich list and thinking more anecdotally of examples, let’s consider how many Michelin star chefs or restaurants have become billionaires or billion-dollar businesses? None, compared to McDonalds and many other successful franchise chains that are highly prized. Similarly, in retail, the founders of Aldi, IKEA, Lidl, Migros and Walmart have all ended up among the richest people in their respective countries.
By comparison, Harrods, after nearly 200 years of existence, has a sum total of one store. That was sold in 2010 to Qatar’s sovereign wealth fund and the prime minister of Qatar flew to London to close the deal. Why did he take the trouble? Was it that large a deal for the sovereign fund? No, but people love being associated with luxury, including owning it. The returns may be low and the prospects limited, but you can tell your friends – probably other billionaires – that you own Harrods. The utility deriving from ownership compensates partially for the lack of adequate financial returns.
To conclude, of course there are a few billionaires in the luxury business, like Armani and Prada lower down the rich list. But in general, while the luxury business is about selling to the seriously rich, it is not going to make you seriously rich as an owner.
Nirmalya Kumar is Member-Group Executive Council at Tata Sons and Visiting Professor of Marketing at London Business School. His Twitter handle is @ProfKumar. This article is written in his personal capacity.