Friday, July 11, 2008

Luxury consumption: will it really be affected by recession?

The talk of medium-term recession is in the air. The mainstream media everyday reports so many gloomy results on various fronts that reading a newspaper in the morning makes the breakfast an undesirable event at times. One of my friends has just told me she has actually stopped eating breakfast, for the reason being the prices of food products have gone drastically up and it’s getting harder to make ends meet.

Consumers consume products to satisfy two major needs, namely, (a) utilitarian needs: basic needs such as food, thirst, shelter etc. and (b) hedonistic needs: which includes largely wants such as entertainment and status which mainly focus on pleasure.

Luxury consumption adheres to the later part of the needs and if asked any consumer would state that in tough times the first they will cut is the luxury consumption. However, in my opinion, it doesn’t seem to be the case. Over the past few years of unprecedented economic growth, luxury consumption has caught the eyes of the masses. Historically, such pleasure seeking behaviour was observed in more ‘well to do’ class of society. However, in recent years, our appetite to consume luxury products has increased voraciously.

From my own experience, finding a Louis Vuitton, Gucci or Prada accessory while sitting on a train in London Underground is as common as a finding the Metro newspaper (available freely to every reader on London underground).

On the academic front, we have good many forecasting models which provide some assistance in predicting how utilitarian products will fair in such recessionary scenario. However, we only have anecdotal evidence with regards to luxury products.

Financial analysts using historical sales data predict that luxury goods companies such as Moet Hennessy Louis Vuitton (LVMH) or GUCCI are traditionally hit hard by economic downturns. There is evidence of the same too as LVMH saw it profits drop by at least 20% in the aftermath of 9/11. According to Financial Times, in 2008, Bulgari felt slower sales growth in March, Richemont at the end of last year, while Gucci sold less in the first quarter than last year.

Furthermore, analyst at Lehman Brothers, points out that 50-60 per cent of the luxury goods industry's consumers remain in classic, developed markets, which are hit hard by the recession. While there seems evidence that luxury goods consumption will be hit hard, I tend to disagree with the analysts due to following:
1. Mass consumption behaviour: As I stated earlier luxury products have come much closer to becoming necessity in case of many affluent customers who still represent middle class in the socio-economic classification terms. This was hardly the case in earlier market scenarios.
2. Geographical scope: Half of the luxury consumers live in the Eastern emerging markets. The glitter of Dubai and Shanghai shows the dominant presence of Eastern consumers in consuming luxury products. While market such as India and most other parts of Asia underexposed to global luxury brands, the scope of growth is too hard to predict.
3. Tourism trends: There is an unprecedented growth in terms of tourist travelling from Asian markets to the Western markets. For examples, Indian tourists took the number one spot in terms of visitors to the UK displacing Japanese consumers who has reigned on that spot for a long period of time. Tourists have a huge tendency to purchase luxury goods as souvenirs and such behaviours have to be accommodated in the overall prediction however that will be too difficult to address without substantial research.

The above three points, when included in any economic analysis of luxury products can skew the overall results. They surely seem to have the propensity to create a mini ‘black swan’.


R. Wright said...

5 months after this posting I'm afraid I must report that Dr. Shukla is wrong. Luxury is getting hit both at a retail sell-through and a wholesale order level as nervous retailers in key developed economies are minimizing stock liability and hedging forecasts. Even affordable luxury sectors like designer fragrances are feeling the slowdown going into the important Christmas/gift giving seasons. The Duty Free sector is being hit hard as British, American, German, Japanese and PRC passenger numbers show sharp declines in the 3Q accompanied by lower spend per passenger.

The super rich will always spend but may continue to seek more niche products where's as Mass consumption of mainstream luxury will feel the bigger hit.

R. Wright

Dr. Paurav Shukla said...

Interesting observation from R. Wright and several observation which I don't deny however, coming to questions of how hard the hit will be there are both sides of the coin.

Firstly, we cannot generalize the luxury market impact from a single industry (i.e. Perfumes). There are ample other examples where things show a picture otherwise.

Such as Burberry has posted 13% growth, Cartier and Van Cleef & Arpels jewellery, gained 10% in sales at the end of Q3 2008. There are ample other examples.

Second, it is also important to understand that the scope of this recession is much wider than the 2001 recession and there will be some dent in the luxury marketshare however, my point was regarding how hard will it be hit. The 20% drop which we saw after 9/11 for many luxury brand will not be the case and I still believe the same. Some drop in sales is inevitable but that doesn't mean it will be a drastic drop such as the one observed in 2001. I have already provided the reason why it will not be.

I will end this with a quote from Micha Wyatt, the Quintessentially Events organiser, "high-earning clients are still spending but they are toning down their flashiness: Metaphorically speaking, the new fashion trend might be the plain white button-down shirt, but the fabric and finish are still premium quality."

Unknown said...

I think the more important issue is one of moral psychology. The Riche, Old and Nouveau must realize that they made their fortunes on the backs of the rank and file of society. This is true no matter how far removed they feel they are from that. As we find ourselves deeper and deeper into a recession the concept of what luxury purchases are will change. the arrogance of the super rich is being challenged daily and those who are smart will understand that consumption must be more moderate and less decadent. Proper decorum will dictate this going forward. This will be a part of the luxury demographic(rich people) being more conservative in their spending albeit still at a different level than the average individual.

Kelvin Gorillaspeaks Jones
Author 80 pound chimp or 800 pound Gorilla which one Ru ?

Dr. Paurav Shukla said...

Really an interesting observation Kelvin. In a recent study we observed high level of social awareness among consumers. For example, when going to a party at a Banker's house one of the respondent stated that they dressed modestly in comparison to earlier times. This was because they knew that some people who will be attending that party may have lost jobs recently. By wearing modest clothes they were avoiding the snobbish statement and at the same time showing emphathy to others.