Thursday, June 21, 2012

The Luxury Watch Industry

Market Size

As most luxury watches are Swiss made, we take the Swiss watch sales published by FH.  These are export prices; multiply by 2.5 to 3 to get the retail values. The numbers are not broken down into segments: the total covers everything from a million dollar handcrafted luxury piece to a $35 dinosaur watch.

The hard luxury industry is highly cyclical - we have a 22% decline in 09:

2011 export sales were 19.3b Swiss francs, or 16b euros.  Multiplying by 3 for retail price, gives 48b total market size.


China is an important source of demand.  29.7% of 2011 Swiss Watch sales went to HK and China, however this does not account for overseas travelers:

Mainland Chinese tourists may account for 40% of all luxury sales in Europe.  This means Mainland China may account for 30-40% of the Swiss Watch market.

China represents a huge growth opportunity and a risk.  Johan Rupert (CEO of Richemont) colorfully likened it to having a black tie dinner on top of a volcano. "There is a volcano somewhere, whether it’s this year, in ten years’ time, or in twenty years’ time. We are exposed to China.  I think they are going to travel more...I think they are going to survive....we are now a ‘China play’...Personally, I don’t think anything’s going to go wrong in China. That’s my view, but I know nothing, and I mean it. I may be too optimistic about China, but if you have differing views, remember, it’s critical."


The Players

Looking at the largest players, which price segments they operate in, and guessing their market share:
  • Swatch: Multitude of watch brands, from basic watches (like the dinosaur above) to high end luxury.  Best known brand is Omega.  For FY11, (finished timepiece) sales were CHF 5.9b, or 4.9b Euros.  Did not find their percentage of retail vs wholesale sales in the annual report, nor a breakdown of basic vs luxury.  Lets assume 75/25 wholesale/retail with 50% retail margin: gives 8.5b Euros or 17% market share.
  • Rolex. A secretive private company, only in the luxury segment.  Estimated to produce 1m pieces a year, lets assume at a retail value of US 8K each, gives total Euro 6.4b a year, or 13% market share.
  • Richemont (CH:CFR). Publicly listed company controlled by the Rupert family, owing Cartier (watches and jewelery), Van de Appels (high end jewelery), and several watch brands in the Luxury and High End luxury range.  Richemont's FY11 watch revenue was 3.3b Euros, or 7% market share.  Probably higher, as 58% of the company sales (not necessarily watches) are to wholesalers.  Lets estimate 9% market share.
  • LVMH: (Tag Huer, Zenith, Bulgari, Hublot) Lists 1.9b Euros revenue for watches and Jewelery (not broken down).  If 70% of these sales are watches, that gives 4% market share.
  • Independents: People who set up their own watch company, e.g.: Frank Muller
As I don't have the numbers, these are really rough estimates...guesses upon guesses.  Would be better to break down into different segments, as basic watches and high-end luxury items are different markets, not competing substitutes.  Except for Swatch, all these players only deal in the luxury market, and Rolex is probably the leader there

ETA Watch Movements

An estimated 2/3 rd of all Swiss made watches use movements from the Swatch group (for example).  As a near-monopoly under anti-trust regulations, it was required to provide to other companies both watch movements (to put them in a watch case and sell) or mechanical ébauches (allowing the buyer to modify the watch movement before assembly).  Swatch objected, and in 2004 was told it could stop selling ébauches after a transition period till 2008.  Swatch announced in 2009 that they would also reduce the supply of completed movements, though this has since been delayed to start in 2013.

Few alternatives Swiss companies could pick up the slack, main one is Selitta.

A harder issue is assortments (e.g.: hairsprings).  Swatch's Nivarox is the only major Swiss supplier, and they are reducing assortments by 5% in 2012.

How do the different players handle this?

Barriers to Entry

There are two main barriers to entry:

First, time and money to build the capacity to produce watch movements and assortments:

“If we have to make assortments one day, we’ll make assortments. Obviously it’s difficult. It will take money. If we have to spend $20 million or $30 million to manufacture hairsprings, we can do it. It will take time. Initially they will cost much more than Nivarox hairsprings because only 50 percent will be good. We will have to go through all the hurdles.”

Second, time and money to start a brand.  Takes years of plastering your advertisements everywhere, as well as getting celebrities to endorse (or better still, to wear because they really like it), and generating buzz to build a brand which is recognizable to 'normal' people (not just watch lovers).

 How do companies enter this business?  Some examples:

  • Franck Muller: Started designing/producing individual pieces for private clients in the 80s.  Built a tourbillon watch back when few others were able to do so; dubbed 'Master of Complications'.  House of Franck Muller started in 1993, famous for curvex shaped watch and for putting colorful numbers on the face.  Some watches use ETA movements.  Currently produces 40000 pieces a year.
  • Azimuth: Started in 2003 in Singapore, with attention-catching designs (spaceship watch, robot watch).  Very niche.  As of 2009: produce around 1500 pieces a year with selling from SGD 2.5 to 7K.  Most of their watches appear to be modified ETA movements.
  • Nomos Glashutte: started in 1990, Germany.  Watches have classical, bauhaus style design.  First watches used ETA movements, after 2005 they start to manufacture (some or all models?) fully in-house.  Very little marketing: may advertise in German watch magazines, and managed to get articles in Forbes and The Atlantic TimesFew authorized dealers, most sales done online.  Watches cost from 1000 to 5000 Euros.  Don't know their annual production.

From these examples, it seems that either you start at the very high end like Frank Muller, with limited production for individual clients, or at the low end (that is, low end for luxury goods).  Both these sidestep the advertising costs.   At the low end, they all started off using ETA movements: seem to rely on eye catching design for watch-lovers to discover their offerings (probably online).  Azimuth and Nomos are at that stage now - sort of flying 'under the radar', serving a niche market.  Frank Muller has somehow managed to move into the mainstream, where the brand is now recognizable by normal people.

Swatch's restriction on movements and assortments, as well as proposed tougher 'Swiss Made' labeling regulations may make it harder to start a new brand from scratch in the future.

Morningstar gives both Swatch and Richemont a narrow economic moat.  I agree - although hard, its possible for a brand new company to start up and go mainstream within 20 years.


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