MG MT 22 3: Fi nal na l Pa per pe r
Project Group 01
Bollani, Lorenzo Ekinde, Mark Fuli, Iris Jakab, Tamas Schut, Martijn
History Foundation Luxottica Group, originally named “Luxottica di Del Vecchio e C. S.a.S”, was founded by Leonardo del Vecchio in 1961 as a contract producer of dyes, metal components and semi-finished goods for the optical industry. Leonardo del Vecchio, owner and chairman of the company, at the end of the ‘60s led the transition from contract manufacturer to independent producer through the widening of the range of Luxottica’s manufacturing processes. Such shift culminated in Luxottica’s first collection of prescription eyewear presented at Milan’s MIDO MIDO (an international optics trade fair) in 1971. 1971.
Distribution In the early ’70s, Luxottica sold sold its frames exclusively through wholesale dealers. However, after five years of development of its manufacturing capacity, initiated with the acquisition of Scarrone S.p.A., a Turin-based distributor with profound knowledge of the Italian market, Luxottica started to distribute frames directly and pursued a strategy of vertical verti cal integration. In the ‘80s, through the acquisition of independent distributors and the formation of subsidiaries and joint-ventures, Luxottica started its international expansion that c ulminated in the acquisition of Avant Garde Optics Inc., a wholesale distributor in the United States market. In 1995, through the acquisition of the United States Shoe Corporation, owner of LensCrafters, one of North America’s largest optical retail chains, Luxottica entered the retail market. Subsequently, Luxottica strengthened its retail position through numerous acquisitions including Sunglass Hut (2001), OPSM Group (2003) and Cole National (2004).
Luxottica’s strategy and industry evolution Luxottica’s Luxottica’s development strategy was based on heavy investments in products and R&D, together with acquisitions. Worth mentioning is the purchase of La Meccanoptica Leonardo, owner of the
Sferoflex brand and an important flexible hinge patent that enabled the Company to enhance the image and quality of its products while increasing its market share. Luxottica’s considerable investments in marketing and advertisements contributed to the evolution of the industry. Indeed, from the late ’80s, ’80s, what were first perceived as mere sight-correcting instruments, began to evolve evolve into “eyewear” and accessories to define people’s personal style. Accordingly, continuous aesthetic focus on everyday objects and designers’ interest in the accessories segment led Luxottica to embark on its first collaboration with the fashion industry, in 1988, by entering into a licensing agreement with Giorgio Armani. The Company followed up that initial collaboration with numerous others and with the acquisition of new brands, gradually building the current world-class brand portfolio and thereby increasing its commitment to research, innovation, product quality and manufacturing excellence. Starting in 2005, Luxottica began its penetration into key emerging markets such as China, the Middle East, South Africa, Thailand, India, the Philippines, Mexico, Brazil and Mediterranean Europe (see Exhibit 1 for a the history timeline).
Financial markets In 1990, Luxottica was publicly listed on the New York Stock Exchange under the name of Luxottica S.p.A (ticker LUX). LUX). Moreover, in 2000 Luxottica’s stocks were also listed on Borsa Italiana and admitted to Italy’s top 30 equities index
Luxottica today As of 2013, Luxottica is the undisputed leader of the eyewear industry with a market share of 48%.1 Moreover, it operates on a perfectly integrated scale, benefiting from economies of scale and costefficiency. Luxottica also has the largest brand portfolio of the industry, controlling more than 80%2 of major eyewear brands such as Ray-Ban, Oakley and Persol (Exhibit 2).
1
Source: Marketline http://www.forbes.com/sites/deancrutchfield/ http://www.forbes.com/sites/deancrutchfield/2012/11/2 2012/11/27/luxottica-sees-itself-as-king-rais 7/luxottica-sees-itself-as-king-raising-questions-a ing-questions-about-brand-authenti bout-brand-authenticity/ city/
2
In recent years, Luxottica has enhanced its position both in the high-end niche, opening new stores in New York, London and Miami, and in the internet segment, launching the “Ray“Ray-Ban Remix” project, an online platform allowing customers to personalize their Ray-Ban eyewear. Approximately 60% of the company’s company’s sales sales volume comes from the sales of sunglasses, while the rest from general eyewear and eye impairment’s glasses. North America is by far the biggestmarket biggest market and it accounts for 58% of total sales. On the other hand, the Euro Area accounts Asia-Pacific accounts for 19% and 13% of total sales, respectively3. Luxottica has recently increased its focus on emerging markets, especially China and Latin America whose sales are expected to account for 20% of total revenues by 20164.
3
2013 Merrill Lynch report on Luxottica Group – Research Research Analyst Flavio Cereda 2013 Merrill Lynch report on Luxottica Group – Research Research Analyst Flavio Cereda
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Value Drivers Enhanced production and distribution performance As of today, Luxottica operates six plants in Italy, two in China, two in North America, and one each in India and Brazil. In the near future, production is expected to increase and distribution is expected to accelerate. Specifically, the bulk of Luxottica’s production is projected to shift from Italy to the emerging markets such China, Brazil and India. As a result, Luxottica will likely benefit from an increase in capacity, decrease in production cost as a result of cheaper workforce and less strict regulation. Moreover, the increase in the production will be accompanied by ongoing improvement in the distribution platform, and greater efficiency (Exhibit 3 & 4).
Emerging markets A key point of Luxottica’s growth strategy is increasing the company’s exposure towards emerging markets. Indeed, the eyewear industry in such markets is still in the early stages of development, and a rise in the upper middle class consumers and consumer brand awareness is expected. More in specific, Brazil is expected to rank second in Luxottica’s wholesale segment, in terms of revenues by 2015, as a more than double increase in sales. Luxottica is also focusing on India for the first time and it is increasing its exposure to China with a 40% CAGR planned for 20155. In conclusion, a further benefit of the emerging markets’ penetration is the reduction of Luxottica’s excessive reliance on North American trends (Exhibit 5).
Business model: wholesale vs. retail One of the competitive advantages underpinning the Group’s past and future successes is the vertically integrated structure that Luxottica has built over decades. The Group’s present structure, covering the entire value chain is the result of a far sighted and gradual process.
5
2013 Merrill Lynch report on Luxottica Group – Research Analyst Flavio Cereda
Vertical integration of manufacturing was gradually accompanied by the expansion of distribution, first wholesale and from 1995, retail, and by the creation of a key presence in the high value added business of lens finishing. Direct distribution allows the company to offer its products directly to final users and better understand customers’ taste (Exhibit 6). Analysts6 expect an increase in sales for both retail (NAM 4%, EM +10-15%, Australia +7%, YOY) and wholesale (Western Europe +4-7%, NAM +10-15%, EM 20-30%). In particular, for wholesale the expected sales’ CAGR to 2015 is 12%. Moreover, the strategy of the company is to decrease the share of wholesale revenues deriving from licensed brands through acquisitions.
Finally, benefits are
expected from the Armani license launched in 2013, which will further strengthen Luxottica’s strategic position towards the wholesale. As opposed to the increase in the wholesale business in the emerging markets, the focus of retail segment remains on developed economies such as North America where Sunglass Hut and LensCrafters are expected to account for most of the profits.
Demographics and macro-world trends The macro-world trends seem to paint a bright future for the industry’s long term prospect. Indeed, being part of the so-called “soft luxury” sub-industry, Luxottica will benefit from the recovery of the global economy and from the wealth effect associated with general changes in expectations. As far as the demography is concerned, Luxottica will benefit from a growing and ageing population with increased need for eye-correction due to behavioral changes. In specific, 500 million vision correction wearers are projected by 20207 (Exhibit 7 & 8).
6
2013 Merrill Lynch report on Luxottica Group – Research Analyst Flavio Cereda 2013 Merrill Lynch report on Luxottica Group – Reasearch Analyst Flavio Cereda
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The Eyewear Industry Industry analysis In order to analyze the industry in terms of revenues, profitability, and structure, a definition of the industry in which Luxottica operates is needed. After defining the industry, the revenues and profitability will be discussed, followed by a discussion on the industry structure using Porter’s five forces analysis. Luxottica’s industry can be defined as the eyewear industry, which can be divided in the following segments: contact lenses, and spectacles.8 Each of these segments can be further broken down, with the subsegments daily disposable, weekly/monthly disposable, traditional, and extended wear for contact lenses, and spectacle frames, spectacle lenses, sunglasses, and readymade reading glasses for the spectacles segment. Exhibit 14 shows the segment breakdown of the industry. Of the two segments, spectacles has been historically the largest in terms of revenue with, on average, 87% of total revenues being earned in this segment (see Exhibit 15). Over the past 15 years, the eyewear industry has shown an attractive compounded annual growth rate of 4.1%, seeing total revenues grow from $66.9bn in 1999 to $122.9bn in 2013. To estimate industry profitability, the net income of four companies9 was used to calculate an industry average profitability. As can be seen, at the beginning of the century the average industry profitability rose to around 10%, before falling down to 6%. After a short increase to 8%, profitability fell again due to the economic crisis to around the 6% level. In terms of growth and profit margin the market seems attractive, although this has to be further investigated by looking at the industry structure. It is, however, also important to compare this industry to other industries and national averages in terms of profitability. As Porter (2008) argued, the return on invested capital (ROIC) is an adequate measure to compare profitability across industries, as it looks at how much return every dollar invested in capital generates. This measure is not distorted by
8
Source: Passport (2012) The four companies are: Luxottica, Safilo, Marcolin, De Rigo
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differences in capital structures or tax rates across industries. In order to determine the industry’s average ROIC, it is important to consider what companies should be included to calculate this average. Exhibit 16 shows the industry ROIC based on three different peer groups over a period of 15 years. The first includes companies that are mainly active in the spectacles segment (which are Luxottica, Safilo, De Rigo and Marcolin), which have a 15-year average ROIC of 7.6%. The second group adds companies that are (also) active in the contact lenses segment (Fielmann AG and Essilor International). This group has an average ROIC of 11.1%. The third group adds companies that produce, in addition to spectacles and/or contact lenses, also other (unrelated) products, such as medical equipment (Carl Zeiss and Hoya Corp). Including these companies results in an average ROIC of 11.5%. Independent of which composition of companies is used to determine the industry’s return on invested capital, the eyewear industry has a below-average ROIC. Porter (2008) found that the average industry ROIC in the US over the period 1996-2002 was 14.9%, compared to a maximal ROIC of 11.5% in the eyewear industry. This puts the eyewear industry amongst the 5 lowest performing industries that Porter (2008) discussed. To investigate where these low returns on invested capital come from, despite reasonably attractive growth and profit rates, we now turn to analyzing the industry structure using Porter’s five forces analysis.
Porter’s five forces Buyer power
The eyewear industry is characterized by a large number of individual consumers the players in the industry can sell their products to.10 These consumers buy on an irregular basis, causing them to have low bargaining power. As eyewear is a product that is highly sensitive to fashion trends, determined by designers and buyers, the demand for the eyewear is subject to very sudden and sharp changes in these fashion trends, increasing buyer power. Another issue from the viewpoint of the producers is that
10
Source: Marketline (2012)
11 brand loyalty is mainly focused on the designer behind the brand and not the producer . Even if brand
loyalty is high, this will not be a guaranteed benefit to the producers and retailers of the spectacles, as after a contract period the designer can enter an agreement with another producer. Combined with the low switching costs faced by consumers (once a pair of glasses from a certain brand is bought there is nothing stopping the consumer from buying a pair from another brand) this increases buyer power. As mentioned before, however, consumers buy very infrequently. On average, consumers replace their spectacles every 3 years.12 This lowers the bargaining power buyers have and this frequency of replacement is expected to decrease. Most contact lens wearers replace their spectacles every 3-4 years, whereas non-contact lens wearers replace their spectacles every 2-3 years. As the contact lenses segment is on the rise and growing at a higher rate than the spectacles segment, consumers will most likely replace their spectacles less often.13 This will most likely increase pressure on the sellers of spectacles, as they are faced with a lower demand. Consumers are still willing to pay a decent amount for branded designer spectacles though, with average unit sales prices around $200 in the US in 14
2013. As contact lenses are gaining in popularity, they are increasingly becoming a substitute for spectacles. Another possible substitute is laser vision correction surgery (LASIK). Spectacles are thus facing increasing resistance from substitutes, thus increasing buyer power. A final factor that decreases buyer power is that consumers experience a sense of choice when buying spectacles, whereas in reality the market is dominated by just a few large players. This lack of buyer information and transparency in the market has assisted companies to keep prices high, indicating low buyer power. Given all the factors and issues discussed above, it can be concluded that buyer power in the eyewear industry is medium. Supplier power
In analyzing supplier power it is helpful to make a distinction between the suppliers of raw materials and the designer brand many companies sign agreements with. Starting with the suppliers of raw materials, it can be said that their power is relatively low. The inputs used to produce spectacles are 11
Source: Marketline (2012) Source: Marketline (2012) 13 Source: Euromonitor (2012) 14 Source: Euromonitor (2013) 12
fairly common and can mostly be bought from a wide range of suppliers. Using Bloomberg’s supply chain analysis function for Luxottica reveals that the company has a lot of suppliers of which each makes up just a small part of Luxottica’s cost of goods sold, implying that there is no critical dependency on major suppliers. Because of the standard inputs switching costs are low. Given this, the threat of forward integration is negligible, as manufacturing and distributing spectacles lies far away from suppliers’ core businesses. The power of raw material suppliers is thus low. Turning to analyzing the designer brands, it can be said that their power is medium to high. A licensing agreement with one of the larger designer fashion houses in the world results in an important supplier dependency for producers, as these agreements can account for a large part of revenues. In 2011, Safilo lost the licensing agreement with Armani Group which was picked up afterwards by Luxottica.15 The licensing agreement was estimated to make up 15% of Safilo’s revenues, indicating the importance of these agreements. For designer brands, it does not really make a difference who produces their products, so switching costs for these suppliers are low. Another factor that increases their bargaining power is the fact that there is only a limited number of these design brands, making them relatively scarce suppliers. Setting up a new, world-wide recognized designer brand is not easy, increasing the dependency on these players due to their low substitutability. As with raw material suppliers, the threat of forward integration is low, as these designer brands focus on the design of all the products that make up the brand, as opposed to (also) manufacturing the products. This dependency is, however, mutual to some extent. There are not many manufacturers that can produce and distribute on the scale and with the quality that is required for these well-known brands to be sold globally, increasing the dependency of these brands on the manufacturers. One final important notice is that these designer brands are produced partially through licensing agreements, whereas another portion of these brands is owned by the producing company itself (e.g., Ray-Ban is owned by Luxottica). Although important, the relative importance of these suppliers that are contracted under licensing agreements should not be overstated. In conclusion it can be said that supplier power is medium.
15
Source: Euromonitor (2012)
Threat of new entrants
The eyewear market is expected to grow over the coming years, with growth coming to a large extent from the contact lenses segment.16 This makes the market more attractive for new entrants as they do not have to steal away existing business from incumbent firms. The scale of incumbents, however, makes it difficult to enter the industry. These large firms have signed important contracts with designer brands, which are to a large extent responsible for the brand loyalty in the industry. Due to the low switching costs faced by customers, the license agreements become even more important to ti e customers to a company. For new entrants it will be very difficult, if not impossible, to obtain these licensing agreements, which therefore form a huge barrier to entry. Even if a new company achieves successful entry, incumbent firms are likely to retaliate. The market is divided between a small amount of players, making it easier for these players to assess what is happening in the market and thus making retaliation more likely. Also, these players charge high prices (as discussed above), which indicates that they can cut prices if needed to exclude a new entrant from the market. Another difficulty for new entrants has to do with the distribution channels used to sell products to the consumer. Retail stores still remain the most important distribution channel, with 76% of distribution going through these stores17 and internet distribution expected to remain around 3% of the total market in terms of revenues.18 Given that some of the incumbents (e.g., Luxottica) are forwardly integrated companies that also own retail stores makes entering the market even more difficult. This can, however, be countered by new entrants by introducing new business models. One new entrant that has successfully introduced a new business model is Warby Parker, which almost exclusively sells its products online at a fraction of the costs compared to its competitors.19 The introduction of such an internet-based business model is not without its disadvantages though, as physical retail stores remain an important channel for consumers to get professional advice regarding their (prescription) eyewear and consumers continue to get more aware of this.20
16
Source: Euromonitor (2012) Source: Euromonitor (2013) 18 Source: Euromonitor (2012) 19 Source: Marketline (2013) 20 Source: Euromonitor (2013) 17
It remains a difficult task for new entrants to successfully enter the eyewear industry, therefore the threat of new entrants is characterized as low. Threat of substitutes
The threat of substitutes can be seen as low. There are only a few possible substitutes for eyewear products, depending on what purpose the products are used for. Spectacles used as fashion accessories do not have a real substitute. Prescription spectacles can be substituted by contact lenses and vice versa, although these are substitutes produced within the same industry. Another substitute is laser vision correction surgery. Contact lenses and spectacles are, however, not mutually exclusive substitutes. As said before, contact lens wearers replace their spectacles more often than non-contact lenses wearers, implying that consumers use these products in addition to each other.21 The switching costs between these substitutes is low, although this does not really increase the threat of substitutes as the most common substitutes are produced within the same industry. Degree of rivalry
The eyewear market is characterized by a large amount of players, although there are just a few players that have actually significant market share22. In the eyewear market there are only 7 companies that have a market share of 1% or higher. The smaller companies are niche players who do not have real market power. In the different sub segments the market can be even more concentrated. In the sunglasses sub segment, for example, Luxottica is estimated to have around 34% market share23 and Luxottica’s overall market share in the segments it is active in is estimated to be as high as 48%.24 The fact that just a few players control the market decreases rivalry. The market offers an attractive growth rate, also decreasing rivalry, as competitors do not have to fight over the same piece of the pie.25The growth in the industry is mostly fueled by contact lenses and emerging markets. Although the products sold are perceived different by consumers, especially spectacles and sunglasses, this product differentiation only benefits the designer brands in terms of brand loyalty. The producers
21
Source: Euromonitor (2012) Source: Euromonitor (2014) 23 Source: Euromonitor (2013) 24 Source: Marketline (2013) 25 Source: Euromonitor (2012 and 2013) 22
of these products do not enjoy any loyal customer base, which makes the licensing agreements with these designer brands very important. Given that there are only a limited amount of designer brands and these licensing agreements are signed for longer periods, the rivalry increases in the industry. Another important factor increasing rivalry is the introduction of new business models and strategic partnerships. As mentioned earlier, Warby Parker successfully introduced a new business model, which entails selling low cost spectacles directly to the customer through internet channels. Luxottica recently signed a contract with Google to help the company design and build future versions of Google Glass.26 Expanding the industry to these new arenas will increase rivalry as incumbents will try to compete in additional segments. Given the abovementioned factors, the degree of rivalry in the eyewear industry can be characterized as medium, higher in terms of rivalry for designer brands, yet low when prices are considered. Conclusion
Given the five forces described above, it can be concluded that players in this industry are able to create and capture value. According to Brandenburger (2002) potential for profit arises when customers’ willingness to pay exceeds the minimum suppliers will accept. Given the profitability in this industry, this is certainly true. As the threat of substitutes is low, the willingness to pay for spectacles has been consistently high. Who captures the value is determined by the relative strength of each of the other forces. Given that buyer and supplier power is medium, the players in the industry are able to capture some, although not all, value. The low threat of new entrants keeps profits at a reasonable level, although the existing competition between incumbents puts downward pressure on profit margins. Considering the medium to high strength of the forces that mainly determine the value captured, it is not surprising that the eyewear industry’s profitability is low compared to the average industry profitability (as discussed at the beginning).
26
Source: Etherington (2014)
Financial Analysis Luxottica’s financial performance appears very solid throughout the years. In specific, except for the years of the crisis, i.e. 2008 & 2009, the Company has benefited from positive growth along all major indicators of profitability. According to the company annual report the success of Ray-Ban and Oakley are among the main factors behind the company’s positive results over the past years. Another element that has played an important role has been the incredible growth of Sunglass Hut, one of Luxottica’s retail businesses. With an average revenues’ growth of 9.5% for the past 10 years (Exhibit 9), the company is constantly expanding its business and consolidating its position through acquisitions and expansions in new markets27 (Exhibit 10). The revenues split between the retail and wholesale segment has been stable throughout the past 10 years, with an average split of 37% (wholesale) and 63% (retail) – (Exhibit 11). As for the regional split, Luxottica, whose revenues are mainly concentrated in North America, has been increasing its exposure to both Europe and key emerging markets (see Value drivers-emerging markets for more details; see Exhibit 12 for 2013 revenues split of revenues). Also under the standpoint of operating profitability and net income, both with a 10-year growth average of 10%, Luxottica appears extremely solid (Exhibit 13). To better assess the Company’s performance, we also compared Luxottica’s results against the average of its closest competitors28 along several key dimensions29. Across all such dimensions, the difference between Luxottica and its competitors appears to be quite evident, with Luxottica consistently outperforming the industry (Exhibit 14). Finally, of interest is looking at the years of the recent financial crisis. Quite evident is the severe impact of such crisis on the optical industry (Exhibit 14), but even more striking is the narrow time frame within which Luxottica managed to recover, further proof of the financial solidity of the company. Indeed, as Luxottica’s CEO Andrea Guerra stated, the financial crisis was in fact over in 27
See “History section” for details about the company development Safilo, Marcolin, De Rigo 29 Revenues, gross profit, opeartin profit, net income, operating margin 28
2010 for Luxottica, with its revenues growth turning positive once again. On the other hand, Luxottica’s key competitors30 only recently showed signs of recovery with results similar to the precrisis years.
30
Safilo, De Rigo, Marcolin
Competitive Positioning Introduction Many people believe that the difference in price between a 50$ and a 250$ pair of sunglasses is motivated by the difference in quality of materials and labor costs incurred in the manufacturing process. Moreover, it is also believed that a 500$ BVLGARI frame is more valuable than a 200$ Dolce & Gabbana one, as they are thought to be produced by two different companies. Nonetheless, this is only partially true, because it turns out that Luxottica produces both D&G and Bvlgari spectacles, and their production cost is very similar. Hence, you may be asking yourself whether these expensive brands are worth the price retailers charge.
Cost A study by Lois Olson, professor at San Diego University, estimated that the manufacturing cost of a pair of spectacles in one of Luxottica’s Chinese factories is in the range of $3 to $4, and that the difference between the production cost of different Luxottica’s brands is negligible31 . Moreover, adding all possible upgrades, the overall cost does not exceed $5. For example, it has been estimated that the cost of polarizing lenses is approximately 17¢. For this reason, it is evident that the retail price is very different from the costs manufacturers incur (Exhibit 17). Given that both Safilo and Marcolin have progressively transferred their facilities to developing countries, we can expect them to be facing a similar manufacturing cost structure with respect to. Hence, we do not expect Luxottica to be benefiting from cost advantage in the manufacturing process. Nonetheless, looking at the portfolio’s composition of the three companies, we can identify a difference in their cost structures, which stems from the royalty fees. Proprietary brands generate 70% of Luxottica’s revenues, with Ray-Ban and Oakley making up nearly 45% of the total32, while Safilo
31
Doug Myrland: Why Do We Pay Hundreds for Shades that Cost $3 to M ake? http://www.kpbs.org/news/2009/jun/22/why-do-we-pay-hundreds-shades-cost-3-make/ 32 Halah Touryalai: Ray-Ban, Oakley, Chanel Or Prada Sunglasses? They're All Made By This Obscure $9B Company
and Marcolin’s proprietary brands account for only 25% and 5% respectively. This gives a cost advantage to Luxottica, as a higher reliance on proprietary brands results in lower royalty costs as a percentage of sales. In particular, royalty costs approximately represent 2.0% of Luxottica’s total revenues33, while for Safilo and Marcolin they account for 7.7%34 and 15.0%35 respectively. If we control for the differences in the mix of licensed versus proprietary brands, royalty fees respectively account for 9.6% and 15.8%36 of Safilo and Marcolin’s licensed sales. On the other hand, royalty fees represent only 6.7% of the Luxottica sales of licensed brands.
Price Dr. Jay Duker, chair of ophthalmology at Tufts Medical Center, has argued that “you can get a pair of sunglasses for about $40 that offers 100% protection against ultra-violet rays”, and that “with $70 you should be able to get a pair with decent quality polarizing lenses that cut out glare”. “Beyond that [price], the medical benefits tail off pretty fast”37. However, if we look at a sample of glasses that are produced by Luxottica and by its main competitors, it is evident that the spectacle prices differ to a large extent, as they span from $55 of a Polaroid pair produced by Safilo, to $550 for a pair Bvlgari glasses manufactured by Luxottica. Moreover, there is a big variety of prices even within the brands produced by the same company. For example, Luxottica manufactures both $90 Vogue sunglasses and the aforementioned $550 Bvlgari ones. It is therefore clear that spectacle prices both incorporate a huge markup and do not depend on which company produces the brand. The most important factor that affects their prices is ultimately the licensor brand. By securing license agreements with companies operating in different segments of the apparel industry, eyewear producers indirectly position their glasses in different market sectors according to the underlying licensor’s reputation. Besides, given that most of the brands under http://www.forbes.com/sites/halahtouryalai/2013/07/02/ray-ban-oakley-chanel-or-prada-sunglasses-theyre-all-made-by-this-obscure-9bcompany/ 33 2013 Luxottica Annual Report, pg 92 34 Source: Safilo website 35 2012 Marcolin Annual Report, pg 52 36 Calculated by dividing the actual share of revenues which is lost in terms of royalty fees by the share of the revenues which are attributed to licensed brands 37 High End Sunglasses and “Knock Off” Shades May Have No Difference in Quality http://www.gwob.com/high-end-sunglasses-knock-shades-may-difference-quality/
Luxottica’s umbrella are positioned in the high-end segment of the clothing industry, Luxottica is charging average final prices greater than $100 on almost all of its glasses, reaching prices of even $600 for specific brands. The high markup that Luxottica applies to its products is reflected in the margins the company is capturing. By looking at Luxottica’s 2013 annual report, it is visible that the company earns a gross profit of approximately 66¢ on each dollar of sales and, even after deducting sales, advertising, overhead and brand licensing costs, the company is still earning 52¢ on every dollar of sales38. Moreover, we can conclude that Luxottica benefits from an additional advantage over its main competitors due to its vertical integration. With its strong presence in the retail business39 Luxottica is capable of capturing the total value created in the value chain from the manufacturing stage to the final customer. On the other hand, both Marcolin and Safilo have to rely on third parties as they have historically operated through wholesale distributors, thus, giving up part of their margin. Nonetheless, it is still difficult to conclude whether Luxottica has a price advantage over its competitors because, as already mentioned, the final price charged on consumers is not dependent on the producer’s brand (i.e., Luxottica, Safilo or Marcolin), but rather on the licensor’s one. The frequent and numerous portfolio restructurings in the licensed brands market may give temporary price advantages to different manufacturers. An example of this is Armani’s decision to switch from Safilo at the end of 2013, which resulted in a decrease in sales for Safilo by 15%. Additionally, the similarity between manufacturers’ gross margins is a second factor that demonstrates the difficulty in determining whether a producer has a price advantage, as both Luxottica and its competitors report gross margins in the range of 61% to 66%40.
38
2013 Luxottica Annual Report, pg. 11 See Financial performance analysis for a detailed breakdown 40 2013 Safilo Annual Report, pg. 55, and 2012 Marcolin Annual Report, pg. 12 39
Willingness-to-pay Over the last five years, Luxottica has been experiencing an increase in its market share to approximately 48% in 201241. This positive trend can be attributed to a number of factors, including its capacity to offer more value than its competitors to customers, measured as the spread between the unobservable willingness-to-pay for its spectacles and their final price . Nonetheless, this effect is mitigated by a number of factors. As already mentioned, the consumers are willing to pay a premium for a pair of glasses with the brand name on the glasses rather than the manufacturer’s name. Moreover, Luxottica finalized several acquisitions (e.g. Oakley in 2007 and Alain Mikli in 2010) and underwent a number of portfolio restructurings in its licensed brands (e.g. Luxottica lost Salvatore Ferragamo, but gained Armani in 2013). Hence, it could be argued that such portfolio changes, rather than the difference in “consumer surplus”, caused Luxottica’s growing market share. Therefore, we cannot conclude with certainty whether Luxottica is offering a better willingness-to pay/price trade-off than its competitors.
Sources of competitive advantage As already mentioned, competitors are in line with Luxottica’s manufacturing performance regardless of their smaller size, as Safilo and Marcolin respectively earned gross margins of 62% and 61% in 2013. Nonetheless, it is clear that Luxottica benefits from a competitive advantage over its competitors that stands at the base of its success. We have identified three main factors which stand at the origin of its profitability. Vertical integration
Looking at the value chain of the eyewear industry, it is immediately clear that Luxottica’s retail distribution, consisting of more than 7,000 retail locations worldwide42, allowed the company to place
41
Passport Data, Euromonitor International 2013 Luxottica Annual report, pg. 99
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itself in a dominant position relative to its competitors. This allows Luxottica to capture a greater share of the overall value created in the production process and puts competition in a “chokehold”43. Licensed portfolio
Secondly, over the last years, Luxottica was capable of adding to its portfolio a number of licensed agreements with some of the most attractive brands in the industry, including Armani (2013)44 and Michael Kors (2014)45, which will enable the company to further increase its market share. Proprietary portfolio
Lastly, through a number of successful acquisitions and reevaluation of underperforming brands over the last twenty-five years, Luxottica has built up a portfolio of lucrative proprietary brands, including Vogue (1990), Persol (1995), Ray-Ban (1999), and Oakley (2007). This portfolio is of extreme importance for Luxottica, as it accounts for approximately 70% of net sales46. On the other hand, competitors have to rely more on licensed brands, which eventually results in less st able revenues over the long run.
43
This concept is explained in more detail in the section on scope decisions. Sulabh Madwal: Luxottica Winning Licence War as Safilo Tries t o Repair Damage http://blog.euromonitor.com/2013/11/luxottica-winning-licence-war-as-safilo-tries-to-repair-damage.html 45 Luxottica signs license deal with Michael Kors http://www.reuters.com/article/2014/04/15/us-luxottica-group-kors-idUSBREA3E1C420140415 44
Vertical and Horizontal Scope Summary We proceed with the analysis of Luxottica’s vertical and horizontal scope, attempting to explain the economic logic underlying the apparent success of this company. We attempt to highlight why Luxottica is in a position where competing retailers want to sell Luxottica’s products, while competing brands want to retail in Luxottica’s shops. First of all, a historical overview puts our analysis in context. Detailed analysis of scope decisions follows. We analyze the company’s horizontal scope, covering in detail the two most important layers of Luxottica’s business: brands and complementary businesses. We continue with vertical integration, decomposed into two parts: downward integration and upward integration. Moreover, we also analyze the scope decisions of Luxottica’s most important competitors. Considering the extensive analysis, we judge the answers that Luxottica gives to the Better Off Test and the Ownership Test. Finally, we finish the analysis by evaluating the results of the company strategy.
Short historical overview from a scope perspective Founded in 1961, as a contract supplier for the optical industry, Luxottica started gradual integration in the 1960s by building up its capability to produce complete pairs of glasses. Arguably, we can identify a conscious direction towards vertical integration, confirmed by Leonardo Del Vecchio’s strategy. He decided to vertically integrate the company both upwards and downwards, while expanding both geographically and in terms of brands and services. The ultimate goal was to establish a company that is able to design, produce and market the glasses. As a first-mover, Luxottica started to distribute frames directly to the market in 1974 by acquiring Scarrone, thus gaining access to vast expertise about the Italian market and a powerful distribution channel. After consolidating the Italian market, the horizontal expansion continued in the 1980s, by establishing subsidiaries and acquiring other distributors. Moreover, Luxottica entered the eye care insurance business in 1988 with the launch of EyeMed Vision Care.
In the 1990s, Luxottica continued its expansion on both the horizontal and vertical platforms. By acquiring prestige brands, such as Vogue (1990), Persol (1995) or the biggest hit, Ray-Ban (1999) and entering into licensing agreements with luxury powerhouses such as Bvlgari (1997) and Chanel (1999), Luxottica significantly increased its reach. On the other hand, integration of retail channels has also accelerated: Luxottica acquired numerous retail companies; an exhaustive list can be found in Exhibit 18. With subsequent development in the 2000s, nowadays Luxottica is a clear eyewear powerhouse, possessing a market share of almost 50%. Although it cannot be called a monopoly according to the legal jargon, it dictates trends, effectively sets pr ices, designs and retails 80% of the world’s major eyewear brands. It is estimated that if you enter an eyewear retailer, the chances of buying a Luxottica product is 70%.47 Turning to the technical part, at the end of 2013, Luxottica’s wholesale distribution network covers more than 130 countries across the globe, it has 20 distribution channels and over 40 commercial subsidiaries. It also operates more than 7000 retail stores worldwide. Its brand portfolio is clearly the strongest in the whole industry.
Scope Luxottica’s highly integrated business model complicates the analysis of its scope decisions. Namely, given that the company is not only an eyewear manufacturer, but a retailer as well, the line between horizontal and vertical integration becomes blurr ed. For example, how shall the company’s acquisition of Sunglass Hut be treated? Is it a market consolidation, such that one competitor acquires another or rather vertical integration, thereby a manufacturer engaging in forward integration? In the following analysis we assume that Luxottica’s main profile is manufacturing, therefore we treat retail acquisitions as vertical integration. On the other hand, complementary services are treated as horizontal diversification.
47
Source: Eric Coppola: The Eyewear Market: Luxottica’s Leadership, Strategy and Acquisitions (2012)
Horizontal
Luxottica has been active in penetrating new markets and geographies by actively acquiring competitors and complementary businesses. At the same time, the company has not diversified into segments unrelated to eyewear. In order to fully understand the scope decision, we describe two levels of horizontal expansion, realizing that they are crucial for establishing Luxottica’s leading position. First, the company has been actively acquiring new brands, at the same time entering into licensing agreements with other companies, thus producing (and also designing) on behalf of them. Second, it has also reached out to complementary services by launching EyeMed Vision Care, now the second largest vision benefits company in the United States, thus gaining control over the buyers’ side of the market. A. Global leader in eyewear brands
The overwhelming majority of renowned brands are associated with Luxottica. However, clear distinction should be made between two lines of brands: Luxottica has a portfolio of brands that are owned by the company and another portfolio that are licensed. However, control of Luxottica is evident in both groups: it is not only a sole producer of the licensed brands, but it also designs these products, with inspiration from the current collection of the respective licensed brand. Luxottica contracts with names like Chanel, Polo Ralph Lauren, Versace, or Tiffany. It virtually controls its own brand portfolio that includes names like Ray-Ban, Persol, Oakley, and Alain Mikli. Exhibit 2 contains an exhaustive list of its portfolio of brands. We believe that the underlying economic logic is twofold. On the one hand, Luxottica’s gains are larger the larger its market share. On the other, it can successfully differentiate its products by using different brands, while the cost of production is not materially different. As a result, it can maximize its revenue from customers. B. Complementary services
Luxottica launched EyeMed Vision Care, the second largest vision benefits company in the United States, as of 2012. The company has an extensive network of doctors nationwide,
together with retail locations. Serving more than 35 million customers, it provides Luxottica with a great opportunity to orientate more customers towards buying a Luxottica product. It also provides an online information portal for eye care and eye health related topics.48 Vertical
Leonardo Del Vecchio realized early on that two factors are key in the luxury industry: quality and deep understanding of customer base. Therefore, he strived to implant it in his company. Leveraging on the extremely integrated structure, 50 years after its foundation, the company has a deep understanding of its customer base, while also having a comparative advantage in product quality. It is indeed crucial when you contract with brands like Burberry, Donna Karan or Bvlgari, and especially when you charge a markup as high as Luxottica. In fact, their ambitious aim is to “deliver the same «Made by Luxottica» quality everywhere in the world.”49 The benefit of staying in direct contact with the customers is twofold. On the one hand, you can identify upcoming trends in customer tastes, shifts in their needs and their willingness to pay, thus you can serve them better. On the other, you can directly influence the above mentioned trends, given that you do not have to rely on a third party retailer. Also, this type of integration makes Luxottica able to fine tune its customer segmentation. We analyze the company’s vertical integration by decomposing it in two parts: upward integration and downward integration. Upward integration means mainly manufacturing, while downward integration mainly deals with retailing. For a representative graphic, see Exhibit 19. A. Downward integration: Manufacturing efficiency
In order to successfully position itself as a market leader, Luxottica has to achieve two fundamental goals at the same time: i) high level of efficiency in order to produce cheaply and ii) industry champion quality. It has therefore integrated the whole value chain backwards: it designs processes and assembles the frames and lenses. The logic underlying is mainly
48
http://eyesightonwellness.com/ Luxottica Annual Report 2012
49
efficiency: the company should ensure that introduction of new operating methods is quick, utilize as much synergy as possible, and introduce innovations quickly, thus optimizing production time and costs. The company made significant progress with this. It is able to better cater consumer needs, thus allowing the company to focus on customer segmentation with a wide range of products, extracting the most from every segment. In particular, Luxottica operates manufacturing facilities in Italy, China, Brazil and the United States. Over the years, the company put in place a consistent production system in its Italian facilities; three plants focus on plastic frames50, while another two on metal frames.51 Also, Luxottica utilizes one single quality management system throughout product development to procurement, operational analysis and performance management. In every Luxottica facility, “quality and process control teams regularly inspect semi-finished products, verifying the feasibility of prototypes in the design phase, controlling standards in both the product development and production phases, subsequently checking for resistance to wear and tear and reviewing optical properties in relation to type of use.”52 On the other hand, this level of integration facilitates faster and more detailed information flow, resulting in reduced transaction costs. Transaction costs are also lowered by integrated logistics services: Luxottica uses a globally integrated distribution system, which is supplied by a centralized manufacturing programming platform. It has 20 distribution centers worldwide and four main hubs in strategic locations:
50
Sedico (Italy)
Atlanta (US)
Ontario (US)
Dongguan (China)
Agordo, Sedico, Pederobba and Lauriano. Agordo and Rovereto. 52 Annual Report 2012 51
These hubs “operate as centralized facilities, offering customers a highly automated order management system that reduces delivery times and keeps stock levels low.”53 B. Upward integration: World class retail chain
Luxottica’s distribution channels enable the company to reach the extraordinary financial performance described above. It has established this presence through acquiring competitors and covering new geographies. Today, Luxottica is a leader in the North American prescription market through its LensCrafters and Pearl Vision brands; it sells licensed brands using Sears Optical and Target Optical stores. The OPSM and Laubman & Pank brands serve the Asian market, with LensCrafters also present in China. The company has global presence in the sun and luxury eyewear industry, marketing the following brands:
Sunglass Hut
ILORI
The Optical Shop of Aspen
Bright Eyes brands
Adding to this the O-stores retailing Oakley products (not limited to eyewear; Luxottica outsources production of Oakley accessories), and the e-commerce business, we can conclude that Luxottica covers the global market.
The competition As described above, Luxottica’s closest competitor is Safilo Group. This company has a very similar business model as Luxottica: it owns some of its brands, while licenses others. Also, it operates with an integrated structure, owning manufacturing facilities together with distribution channels, thus effectively controlling the entire business value chain. Safilo Group states that it has a competitive advantage in product design, especially for the high-end brands.54 Looking at the value chain, there is one significant difference: Safilo, together with its in-house manufacturing, outsources some 53
Source: Luxottica website Source: Safilo website
54
production to third- parties in Italy, China, and the United States. In addition, Safilo’s products are mainly sold through wholesale channels, which is another clear difference.55 In sum, we can conclude that Safilo, although following the footsteps of Luxottica, is not as highly integrated. Comparing the operating results, it is apparent that Luxottica is more efficient, given that its operating margin was 14.4% in 2013, which is significantly higher than Safilo’s 10.9%. In terms of net margin, Luxottica has a more than twofold advantage.56 These results indicate that the highly integrated business model is superior in the eyewear industry. In fact, with its manufacturing efficiency and extensive retail channel, Luxottica is able to outperform the competition. Also, major part of Luxottica’s revenue is created by the retail sector.
The Better Off Test and the Best Alternative Test Applying the theoretical concepts learned in class, we examine Luxottica’s integration strategy from the point of view of the Better Off Test and The Best Alternative Test. First, we ask whether Luxottica is better off with the diversification strategy described above. We believe that indeed, there is overwhelming evidence for the diversification Luxottica is pursuing. Its strategy is extremely consistent, since it acquires businesses that are either complementary brands, or are significantly related to eye care. In fact, three major arguments support this decision. 1. Luxottica is able to benefit from economies of scale as it sources more brands. Nevertheless, the cost of manufacturing and design is identical in the industry, independently from the brand. Therefore, it does not require considerable effort from Luxottica to add an additional brand to its portfolio, while the increased production numbers reduce marginal cost. 2. On the retailing side, stores can serve as one-stop shops for Luxottica products, selling solely its products. This cannot be achieved with third-party stores. Moreover, Luxottica can effectively block other firms from reaching the market, as it was made clear with Oakley in 2007-2008. Another, maybe unfair, advantage is that Luxottica is (theoretically) able to sell
55
In fact, 93% of distribution goes through the wholesale channel. as opposed to approximately 40% for Luxottica. Net margin of Luxottica in 2013 was 7.5%, while only 3.5% of Safilo.
56
only their brands, and consumers still feel that they can choose from a variety of different producers. 3. EyeMed Vision Care, on the other hand, perfectly fits into the strategy of offering complementary products and thus incentivizing the consumer to purchase Luxottica products. Second, we determine whether the firm should own the abovementioned channels. On this front, three trends are apparent: 1. In the luxury business, brands and customer relationships are of key importance. Therefore, it is advised to own the selling outlets and Luxottica has made the right decision. 2. As described above, its high operating margins justify that Luxottica is able to attain a higher manufacturing efficiency than the competition. Therefore, it makes the right decision when it comes to owning the production facilities. 3. Related to what has already been mentioned, by owning stores Luxottica is able to keep competitors from being able to access customers. All in all, we believe that Luxottica gives good answers to both tests and recommend that they do not alter the strategy. Nevertheless, we also think that it might be a smart decision to establish a higher presence in the e-commerce market (following a more detailed discussion).
The result We believe that Luxottica has succeeded remarkably with establishing this extreme form of integration, on both the horizontal and vertical side. It covers all main markets, controlling the majority of eyewear retail distributors and also an eye care benefits company. It also possesses the best brand portfolio, both concerning proprietary and licensed brands. Thus, it oversees a big portion of the eyewear market. In fact, some critics argue that Luxottica has too much power in the marketplace. They address that this strategy effectively eliminates serious competition, since “if you make glasses, you want to be in their store, and if you have stores, you want to sell Ray-Bans” 57 , Therefore Luxottica effectively puts the competition in a chokehold. At the vertical integration front, Luxottica 57
Luxottica was featured in CBS 60 minutes, arguing that Luxottica products are overpriced due to its extensive market power. http://www.cbsnews.com/news/sticker-shock-why-are-glasses-so-expensive-07-10-2012/
mastered efficient production, kept design in-house, and ensured high quality. Also, it succeeded with getting close to customers by keeping retail channels in-house. An apparent indicator of Luxottica’s success is the enormous difference between the production cost of Luxottica and the price it charges its customers: it is essentially a price maker. The majority of Luxottica products are assembled in Italy, thus allowing Luxottica to label them with “Made in Italy” labels, as a clear indicator of quality. However, the parts themselves are mostly produced in China, bearing really low production costs. The manufacturing cost of one pair of Luxottica glasses varies between $3 and $7, while the retail price of the same pair of glasses depends on the exact brand, but is often in the range of $200 - $850. Although this is also enabled by marketing efforts, brand image, and consumers’ misconception of choice, it is evident that Luxottica is very successful pursuing the strategy of extreme integration.
Analysis of Forthcoming Change in the Company’s Industry In this section trends that can have a profound influence on the industry’s profitability will be discussed. Although the industry is faced with a multitude of different trends, not all of these are expected to create major changes. The most important trends and their implications are therefore discussed. The first important trend is the strong growth that emerging markets will see over the next five years58 with Luxottica having the top 1 or 2 position in all of these regions.59 Especially Brazil, India, and China will fuel the growth of the industry. These countries are amongst the fastest growing countries in the world, with strong GDP growth rates, and a middle class that is getting larger and more affluent.60 As these demand in these markets expand, the players in the industry can increase their revenues and profitability by catering to the demands in these countries. Not all players are evenly well-situated to take advantage of these changes, as the growth in Asia Pacific for example is due to increasing demand in contact lenses.61 These trends provide important opportunities for Luxottica, which has a particularly good position in Brazil and China.62 Mainly through acquisitions Luxottica has been able to gain a strong foothold in Brazil, where it currently enjoys double-digit growth and has a growing network of retail stores to push its products. In China Luxottica has a similar position, although here the potential has not been fully utilized yet. China does not rank in Luxottica’s top 10 countries in terms of revenues, whereas China is already the seventh largest market with a very attractive expected growth rate. Another important trend that will fuel growth is the increasing demand for contact lenses.63 Disposable contact lenses are getting more popular than traditional permanent lenses. Daily disposables are expected to face the largest growth over the coming five years, despite the premium consumers have to 58
Source: Euromonitor (2013) Source: Euromonitor (2013) 60 Source: Euromonitor (2013) 61 Source: Euromonitor (2012) 62 Source: Euromonitor (2012) 63 Source: Euromonitor (2013) 59
pay for these products. These products are gaining in popularity due to the elimination of the associated cleaning procedures. Given that consumers are willing to pay a premium for these lenses, the industry is likely to enjoy higher profitability as a consequence of this increased demand. Luxottica, however, has no presence in this segment of the market, and will therefore not experience a change in its profitability. A third trend that will increase the demand for eyewear products is the rising rates of myopia and the ageing population.64 Myopia, being nearsighted, is the most common visual impairment problem in the world, with around a quarter of the adult population suffering from it. With the rapid increases in myopia rates and children being diagnosed at earlier ages with myopia, the demand for eyewear products will increase. The rising ageing population will also increase the number of people potentially in need of eyewear products. By 2020 the population aged 65 and above is expected to be 41% higher than in 2010.65 These two factors will increase demand for eyewear products over the next ten years and provide opportunities to increase profitability throughout the industry. These trends will not impact Luxottica in any different way than its competitors, but will definitely provide growth opportunities for the company. Another important trend is the increased use of eyewear products as fashion accessories.66 Clear and over-sized spectacle frames and sporty looks, and disposable and colored lenses are currently gaining popularity. Consumers are willing to pay a premium for these products that are deemed more fashionable than standard eyewear products, which are purely aimed at vision correction. This increased willingness to pay will impact the profitability of the industry, although these fashionable products are subject to trends and fads, and will therefore impact the industry at different and unpredictable moments. Luxottica is not positioned properly to take advantage of the rising demand for any type of lenses, as they do not produce these. With their luxury eyewear and sunglass brands, however, such as Ray Ban, the company has a fair chance of profiting from this increasing willingness to pay.
64
Source: Euromonitor (2012) Source: Euromonitor (2012) 66 Source: Euromonitor (2013) 65
The final trend is the introduction of new business models, such as Warby Parker introducing a pure online retailing model. 67Although physical retail stores remain important for consumer to get advice, the significant lower prices of these new competitors may decrease the willingness to pay of consumers, and thus ultimately cause lower prices. The profitability of the industry will then come under pressure. These new business models have the potential to change the industry rapidly, as exemplified by Warby Parker, which grew dramatically since it was founded in 2010.68
67
Source: Euromonitor (2013) Source: Marketline (2013)
68
Threats to Profitability and Recommendations Growing alternatives From a more long-term perspective, the firm’s profitability may be hurt by the growing acceptance of vision correction alternatives to prescription eyeglasses, such as laser eye surgery. There are three main procedures which are commonly used for vision correction: Laser-Assisted in Situ Keratomileusis (Lasik), Photo-Refractive Keratectomy (PRK) and Laser Assisted Subepithelial Keratectomy (Lasek). With technological advancements, the cost of refractive optical surgery has decreased to a considerable extent. Since 1992 when the LASIK procedure was first introduced under FDA supervision69, more than 11 million interventions have been performed in the US and more than 28 million were performed worldwide70.
Proprietary vs. licensed brands Luxottica retails both proprietary and licensed brands. The licensed brands are usually associated with top names in the fashion industry (e.g. Chanel, Prada, Miu Miu, Dolce & Gabbana, Bvlgari, Burberry, Armani etc.) while the proprietary brands include Luxottica’s main brands: Oakley, Ray-Ban and Persol. Luxottica enters into licensing agreements to retail non-proprietary brands. These contracts have terms of three to ten years and usually require Luxottica to make advance and royalty payments. Such advance payments can go up to hundreds of millions of dollars (e.g. advance payments for the FY2012 totaled $73.8m)71. However, the profitability of licensed brands largely depends on the terms of the licensing agreement and on the renewal of such agreements. Luxottica has constantly reduced the dependence of its topline growth on licensed brands. As Exhibit 20 shows, the ratio of proprietary brands (as a % of overall revenues) has increased from 57.2% in 2008 to 70.3% in 2012. However, a substantial portion of th e revenues (approx. 30%) is still generated
69
http://www.fda.gov/MedicalDevices/ProductsandMedicalProcedures/SurgeryandLifeSupport/LASIK/ucm192109.htm http://bmctoday.net/crstodayeurope/2013/02/article.asp?f=ndyag-treatment-of-epithelial-ingrowth 71 Source: Annual Report 2012 70
from licensed brands. We think this may expose Luxottica to vulnerabilities from the non-renewal or the renewal with unfavorable terms of these contracts. For example, in 2013, Safilo failed to renew its license with Armani. This led to an estimated loss in revenues of approximately 15%. Even though for the FY2013, no single licensed brand provided more than 5% of sales72, we think that unfavorable terms or non-renewal can harm Luxottica’s performance. In this view Luxottica should continue to expand the share of revenues generated through proprietary brands in order to reduce its exposure to non-proprietary brands.
Exposure to the US market Currently, approximately 60% of Luxottica’s revenues are generated in the North American market. This exposure is usually considered to be a point of vulnerability that may pose a threat to its profitability. Weakened general economic activity in North America or the entering of further competition in the market exposes Luxottica’s financial performance.
Counterfeit products In recent years there has been rampant growth in counterfeit products. Only last year the number of wearing apparel and accessories seized by the US Customs and Border authority amounted to $116 million73. This was up 27% from the previous year and the seized materials were usually related to high-end fashion apparels (including eyewear). This excessive growth in counterfeit products hurts both short-term and long-term profitability. In the short-term, customers reduce spending on luxurious products, fearing that they are buying counterfeit products. In the long-term, brand reputation is hurt by the easily imitable design.
Warby Parker business model We covered in depth the rising trend of online stores which reduce retail stores’ costs in the industry trends paragraph.
72
Source: Annual Report 2013 http://www.usatoday.com/story/money/business/2014/03/29/24-7-wall-st-counterfeited-products/7023233/
73
Appendix Exhibit 1. Luxottica’s company history
•
1971
Foundation •
•
First collection
1961
Lisiting on Borsa Italiana
• •
Listing in NYSE Acquisition of Vogue
•
•
2001 Entry into sun retail
•
1999
Acquisition of Persol Entry in retail distribution
1974
•
2000
1990
Entry in wholesale distribustion
•
Acquisition of Ray-Ban
1995
Retail expansion in China
2007
•
2005
Exhibit 2. Proprietary brands and licensed brands
Acquisition of Oakley
•
Retail expansion in LATAM
•
2009
Exhibit 3 & 4. Production mix and volume
Exhibit 5. Geographic distribution of the wholesale unit
Exhibit 6. Revenue mix by brand type
Exhibit 7 & 8. Demographic trends
74
Exhibit 9. Luxottica’s operating performance
12 000 000 10 000 000 8 000 000
Revenues
6 000 000
Gross Profit
4 000 000 2 000 000 0 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013
Exhibit 10. Eyewear market forecast
74
Source: IMF
Exhibit 11. Revenue distribution
73%
80%
70%
66%
66%
56%
60%
44% 40%
27%
30%
34%
34%
2006
2007
61%
60% 40%
39%
61%
39%
61%
39%
59% Wholesale
41%
Retail
20% 0% 2004
2005
2008
2009
2010
2011
2012
2013
Exhibit 12. Revenue growth
Exhibit 13. Performance comparison
Revenues 10 000 000 8 000 000 6 000 000
Luxottica
4 000 000
Competitors Avg
2 000 000 0 2004
2005
2006
2007
2008
2009
2010
2011
2012
Gross profit 8 000 000 6 000 000
Luxottica
4 000 000
Competitors Avg
2 000 000 0 2004
2005
2006
2007
2008
2009
2010
2011
2012
Operating Income 1 500 000 1 000 000 Luxottica
500 000
Competitors Avg
0 2004
2005
2006
2007
2008
2009
2010
2011
2012
-500 000
Net income 800 000 600 000 Luxottica
400 000
Competitors Avg
200 000 0 -200 000
2004
2005
2006
2007
2008
2009
2010
2011
2012
Operating Margin 20,00% 15,00% Luxottica
10,00%
Competitors Avg
5,00% 0,00% 2004 -5,00% -10,00%
2005
2006
2007
2008
2009
2010
2011
2012
Exhibit 14. Industry structure
75
Eyewear
Contact lenses
Spectacles
Daily disposable
Spectacle frames
Weekly/monthly dis osable
Spectacle lenses
Traditional
Sunglasses
Extended wear
Readymade reading lasses
Exhibit 15. Industry profitability
76
130 000 120 000 110 000 100 000 90 000 80 000 70 000 60 000 50 000 40 000 30 000 20 000 10 000 0
12,0% 10,0% 8,0% 6,0% 4,0% 2,0% 0,0%
Contact Lenses
75
Source: Euromonitor (2012) Source: Euromonitor (2014)
76
Spectacles
Profit margin
Exhibit 16. Industry ROIC
77
20 15 10 5 0 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 Spectacles only
Eyewear
Eyewear & other
Exhibit 17. Price structure of designer eyewear
Exhibit 18. Luxottica’s key retail acquisitions
77
Source: Bloomberg (2014)
US Shoe Corp.
1995
SunglassHut
2001
OPSM
2003
Cole National
2004
Multiopticas Internacional
2009
Stanza
2011
High Tech
2011
Erroca
2012
Tecnol
2012
Sun Planet
2012
Salmoiraghi & Vigano
2013
Exhibit 19. The supply chain
78
Exhibit 20. Luxottica’s brand distribution 80,00% 60,00% 40,00% 20,00% 0,00%
78
Source: Luxottica website
Designer Proprietary
