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The Vuitton Money Machine


Thunk. Thunk. Thunk. Behind a locked door in the basement of Louis Vuitton's (LVMHY) elegant Paris headquarters, a mechanical arm hoists a brown-and-tan handbag a half-meter off the floor -- then drops it. The bag, loaded with a 3 1/2 kilogram weight, will be lifted and dropped, over and over again, for four days.

This is Vuitton's test laboratory, a high-tech torture chamber for its fabled luxury goods. Another piece of lab equipment bombards handbags with ultraviolet rays to test resistance to fading. Still another tests zippers by tugging them open and shutting them 5,000 times. There's even a mechanized mannequin hand, with a Vuitton charm bracelet around its wrist, being shaken vigorously to make sure none of the charms falls off.

Think Louis Vuitton, and what comes to mind? Certainly not some robot that batters bags all day. Most likely, it's those glossy ads -- you know, the ones with supermodels draping their lithe frames over Vuitton luggage against a striking gold-and-turquoise desert landscape. Or the crowd of Hollywood celebs, fashionistas, and even Rudy Giuliani, partying at a champagne-soaked 150th birthday party for Vuitton in a tent next to Lincoln Center in New York last month. Or the sleek new Vuitton retail temples, from Fifth Avenue to Tokyo's fashionable Omotesando district, where shoppers plunk down $1,000 and up for a handbag in the new Murakami line.

Vuitton trades brilliantly in the stuff of desire and ego. Yet creating a buzz is the stock in trade of every fashion and luxury house. Flip through Vogue, Vanity Fair, or Elle, and you'll find pages and pages of half-naked models, legs splayed, dangling handbags from Vuitton and rivals Gucci (GUC), Prada, and Herm?s. In the glam department, Vuitton is great but not alone.

You have to peek behind the glittery facade to see what makes Vuitton unique -- what makes it, in fact, the most profitable luxury brand on the planet. There's the relentless focus on quality. (That robot makes sure Vuitton rarely has to make good on its lifetime repair guarantee.) There's the rigidly controlled distribution network. (No Vuitton bag is ever marked down, ever.) Above all, there's the efficiency of a finely tuned machine, fueled by ever-increasing productivity in design and manufacturing -- and, as Vuitton grows ever-bigger, the ability to step up advertising and global expansion without denting the bottom line. "Their operating metrics are second to none," says Lew Frankfort, chief executive of U.S. handbag maker Coach (COH), who wants to surpass Vuitton's success someday.

Good luck, Lew. The Vuitton machine is running mighty smoothly right now. With $3.8 billion in annual sales, it's about twice the size of runners-up Prada and Gucci Group's Gucci division. Vuitton has maintained double-digit sales growth and the industry's fattest operating margins as rivals have staggered through a global downturn the past two years. That power was underscored anew on Mar. 3, when parent LVMH Mo?t Hennessy Louis Vuitton (LVMHY) reported a 30% earnings increase for 2003, fueled by a record-high 45% operating margin at Vuitton. The average 25% margin in the luxury accessories business is 25%. "The sky's the limit," says Yves Carcelle, the charismatic former textile executive who has run Vuitton since 1990 and is widely credited with masterminding its turbocharged growth.

LEVITATING ACT. LVMH Chairman Bernard Arnault says the brand will keep roaring ahead, even though it has already quintupled sales and increased margins sixfold since he bought the company in 1989: "Of all the luxury brands, Vuitton has the greatest potential for growth." Although LVMH doesn't disclose sales for Vuitton alone, analysts reckon they grew at least 16% worldwide last year and are likely to repeat that feat in 2004. Thanks to Vuitton's levitating act, LVMH's Paris-traded shares have almost doubled in the past 12 months, to more than $75 (60 euros).

Compare that with Gucci, which not only posted disappointing sales and reduced ad spending last year but also was rocked by the announced departure of designer Tom Ford. And whereas Ford had reshaped Gucci in his own rock-star-inspired image, the power of Vuitton extends beyond the persona of well-regarded chief designer Marc Jacobs.

Does Vuitton -- which started as a maker of steamer trunks during the reign of Napoleon III -- have its best days ahead of it? It still needs to wean itself from Japanese customers, who account for an estimated 55% of sales. Vuitton must build sales in the U.S. while tapping into rising affluence in China and India. It also needs to fight increasingly sophisticated global counterfeiting rings. Most of all, because Vuitton markets itself as an arbiter of style, it needs to keep convincing customers that they're members of an exclusive club.

Carcelle dismisses suggestions that Vuitton has limited growth potential. Yet it's a crucial question for LVMH, which draws an estimated 80% of its profits from Vuitton, thus propping up less-successful units, from the DFS duty-free retail chain to couturiers Christian Lacroix and Givenchy. "If LVMH didn't have Louis Vuitton, it would be a disaster," says Armando Branchini of InterCorporate, a Milan luxury consulting group. The touchiness of this issue was underscored recently when LVMH won a ruling in France that a Morgan Stanley (MWD) analyst, who had cited Vuitton's "maturity," had downgraded LVMH's shares unfairly. Morgan Stanley is appealing the decision, which awarded LVMH at least $39 million in damages.

These are serious concerns. But Vuitton has some serious strengths. One is the loyalty of its clients, shoppers who think one Vuitton bag in the closet just looks too lonely. "I save up for a while, and then I spend a lot on one item," says Elizabeth Hanny, an Indonesian civil servant leaving Vuitton's boutique on Paris' Avenue Montaigne with a cylinder-shaped Papillon monogrammed toile bag that she just bought for $665. Hanny, 35, has shopped at Vuitton since she was 20. Vuitton strategy is to move such shoppers up from the classic tan-and-brown monogrammed bags to newer lines such as Murakami, which starts at around $1,000, and Suhali, a line of goatskin bags that average more than $2,000.

Women aren't the only Vuitton addicts. Meet Jean-Fran?ois Bardonnet, 51, an independently wealthy Frenchman who's a sucker for Vuitton briefcases, wallets, even eyeglass cases. "You buy into the dream of Louis Vuitton," he says. "We're part of a sect, and the more they put their prices up, the more we come back. They pull the wool over our eyes, but we love it."

Vuitton was already the world's biggest luxury brand when Arnault acquired it in 1989. But the previous owner, France's Racamier family, had focused mainly on building a Japanese clientele that accounted for 75% of sales. Then in the late 1990s, luxury accessories became red-hot, with long waiting lists for bags such as the Kate Spade tote and the Fendi "baguette." Vuitton's classic brown bags, still renowned for their quality, looked dumpy by comparison.

Enter Jacobs, a streetwise New York designer associated with the grunge look. He seemed a risky choice for Vuitton when Arnault hired him in 1998. But Jacobs' fresh, unfussy aesthetic was a perfect fit, and the new ready-to-wear and shoe lines that he has introduced -- though they account for less than 15% of Vuitton sales -- draw younger customers in the door. Last spring, Jacobs teamed up with Japanese artist Takashi Murakami on a multicolored line of bags, incorporating images like cherry blossoms and eyes into the traditional LV monogram and adding shiny metal trim. Vuitton sold more than $300 million of them last year. "Vuitton is a status symbol, always has been," Jacobs says. "But now it's sexier, bolder." While the Jacobs touch has attracted younger buyers, Vuitton continues to attract older clients with its quality and lifetime free repairs.

Vuitton owes much to Jacobs. But it owes just as much to executives such as Emmanuel Mathieu, a former factory manager at food and beverage giant Danone, who has headed Vuitton's industrial operations since 2000. On Mathieu's watch, Vuitton has boosted manufacturing productivity 5% a year, with improvements ranging from more efficient leather-cutting equipment to a new teamwork model in factories loosely modeled on the quality circles pioneered by Japan's auto makers. Five years ago, Mathieu says, it took 12 months from the time Vuitton decided to launch a new product until the item hit stores. Now it takes about six months. "We're always looking for ways to improve," Mathieu says.

Managers such as Mathieu have helped transform Vuitton from an overgrown cottage industry into a 21st-century business. Vuitton's manufacturing is still labor-intensive, with a team of 24 workers producing about 120 handbags a day. But, says Andrew Gowen, a London-based analyst who until recently covered LVMH for Lehman Brothers Inc. (LEH), "they've achieved pretty close to the perfect balance between mechanization and handmade." Gowen, who has visited the factories of Vuitton and competitor Herm?s, says they are "worlds apart. At Herm?s, it looks like you stepped into the 14th century, just rows and rows of people stitching." Herm?s bags cost more, but its operating margins are only about 25%.

To see how the Vuitton machine works, consider the Boulogne Multicolor, a new shoulder bag that went on sale this month in Vuitton stores worldwide for about $1,500. With the success of the Murakami line last year, Vuitton marketing executives quickly began looking for a way to capitalize on it. Canvassing store managers, they learned that customers were asking for a Murakami shoulder bag. In a workshop attached to the marketing department, technicians took a classic bag, the Boulogne, reworked it in multicolored toile, added metal studs and other touches, and dubbed it the Boulogne Multicolor. "We wanted to have some elements that were striking, while retaining the history," marketing chief Pascale Le Poivre says. The prototype went directly from the marketing department to top execs, who approved the bag without any involvement by Jacobs' high-profile design team. Moving to production was easy: Factories could use existing templates.

TEAMWORK PAYS OFF. By June, the prototype was on its way to Vuitton's factory in Ducey, an airy, glass-sheathed building near the Normandy coast. On the factory floor, workers feed canvas and leather into precision equipment that cuts out the pieces of each bag, cookie-cutter style. Other workers sit at sewing machines, each performing a different task such as stitching in lining.

As at all Vuitton factories, employees at Ducey work in teams of 20 to 30. Each team works on one product at a time, and team members are not only encouraged to suggest improvements in manufacturing but are also briefed on details about the product, such as its retail price and how well it is selling, says St?phane Fallon, a former manager for Michelin who runs the Ducey factory. "Our goal is to make everyone as multiskilled and autonomous as possible," says team leader Thierry Nogues.

The teamwork pays off. When the Boulogne Multicolor prototype arrived at Ducey last summer, workers who were asked to make a test production run quickly discovered that the decorative metal studs were causing the zipper to bunch up, adding time and effort to the assembly process. The team alerted factory managers, and within a day or two, technicians had moved the studs a few millimeters away from the zipper. Problem solved.

Such efficiency helps compensate Vuitton for its decision to keep most manufacturing in France, one of the world's most expensive labor markets. Of the 13 factories that make Vuitton bags, 11 are in France -- and the other two are across the border in Spain. Why not manufacture someplace cheaper? "The question gets raised all the time, but we feel more confident of quality control in France," says Mathieu.

Productivity alone won't sustain growth. So while most luxury groups cut their ad budgets last year, Vuitton boosted spending an estimated 20%, including a global campaign featuring Jennifer Lopez. This year's campaign, shot in the Dubai desert, features supermodels including Naomi Campbell and Kate Moss. "We used to be modest, too modest," Carcelle says of Vuitton's advertising strategy. "Now we've taken it to a new level." Even so, Vuitton is so big that analysts reckon it spends only about 5% of revenues on advertising, half the industry average.

Other companies are trying hard to emulate Vuitton's success. Coach has repositioned its once-utilitarian bag as a snazzy accessory, widening margins to 29%. Venerable Herm?s is expanding its retail network and recently hired designer Jean Paul Gaultier to freshen its image. Vuitton will try to outpace these rivals as it carefully opens boutiques around the world. Arnault is especially pleased that the U.S. stores, which once posted 75% of their sales to Japanese tourists, now are thronged with local shoppers who account for 85% of sales. That's helping Vuitton reduce its risky dependence on Japanese customers. Vuitton's sales in Japan grew 12% last year -- respectable, but lower than companywide sales growth. "Almost every grown-up Japanese woman already owns at least one Louis Vuitton item," says Akira Miura, chief editor of WWD Japan, a fashion paper.

As Vuitton expands, other hazards appear. Counterfeiting has risen sharply in the past five years, largely because of China. Interestingly, Chinese spurn the fake bags, which are mainly exported to Europe and the U.S. or sold to tourists. Pressed by Vuitton, Chinese authorities closed one factory last July in Guangzhou. "It's a menace we take very seriously," says Bertrand Stalla Bourdillon, director of intellectual property.

Another menace would be the departure of key personnel. Early this year, there was speculation that Jacobs might leave unless LVMH gave more backing to his clothing line. But his contract runs until 2008, and Arnault recently has been singling out Jacobs' label as a rising star in LVMH's portfolio.

For Vuitton, the biggest challenge may be to keep this powerful machine under control. The company opened 18 stores last year, about twice the rate of store openings a decade ago. "The temptation with a lot of brands is to immediately find new outlets, new sources of distribution, and price points," says Marc Gob?, a New York-based principal in the brand consulting group Desgrippes Gob?. Not Vuitton. "They are extremely disciplined," Gob? says. Arnault promises that Vuitton will never lose its discipline or its focus on quality. "That's what differentiates Louis Vuitton," he says.

The message seems to be getting across. Just ask Ariella Cohen, a 24-year-old Manhattan legal assistant who already owns a Vuitton messenger bag and several Vuitton accessories, and now covets high-heeled Vuitton sandals -- even though she'll have to put her name on a waiting list. "Louis Vuitton never goes out of style," she says as she leaves Vuitton's Fifth Avenue store. With luck, the Louis Vuitton machine will never run out of steam. By Carol Matlack

With Diane Brady in New York, Robert Berner in Chicago, Rachel Tiplady in Paris, and Hiroko Tashiro in Tokyo


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