Fancy labels fray easily. Gucci hit the skids around 2022 when shoppers, particularly from China, became tired of the over-the-top designs the brand had become known for. Sales at the Italian label fell 18% in the first three months of this year.
Balenciaga, which like Gucci is owned by LVMH’s rival Kering , is also in the doldrums. It hasn’t recovered from the fallout caused by a strange 2022 ad campaign showing children with teddy bears wearing bondage gear.
Independently listed Burberry and Salvatore Ferragamo have been in trouble for longer. The British trench coat maker has been in revamp mode for almost seven years, with little to show for it. Burberry’s share price has roughly halved since the company launched a major makeover in late 2017. A long run of weak sales has hit Ferragamo’s stock even harder over the same period.
Brands looking for a fix tend to reach for the same tools. They hire a new creative team to come up with a fresh look and then invest heavily in advertising and store refurbishments to catch shoppers’ attention.
In the background, they pull their goods from third-party retailers to stop end-of-season discounts. Department stores like Saks Fifth Avenue or Harrods can cover their costs even if they sell goods 60% below the headline price, but posh labels suffer when they end up in the bargain bin.
Brands pour resources into overhauling their handbag range, as a hit bag can help profit margins. Bottega Veneta’s pouch, which went viral in 2019, is a good example. Burberry is now trying this tactic: Bags designed by the company’s new creative director, Daniel Lee , are 58% more expensive than those they replace, Bernstein data shows.
Betting on luxury turnarounds is like roulette. Sometimes shareholders make a killing. Anyone smart enough to buy Kering’s stock in mid-2016, right before a previous Gucci revamp ignited sales, was sitting on a 520% return including reinvested dividends five years later.
But most makeovers are disappointing, with lots of nasty snags for shareholders. Luxury brands have high fixed costs, such as expensive rents on their flagship stores, so weak sales have a big impact on earnings. Kering recently warned that group operating profit may fall 45% in the first half of this year because of slow sales at Gucci. The need to beef up ad spending while reducing exposure to department stores compounds the pressure on margins.
It may be becoming harder for smaller brands to win back market share. LVMH mushroomed in size during the pandemic, giving it deeper pockets than ever. The company’s marketing budget swelled from €6.3 billion in 2019 to more than €10 billion last year, equivalent to $10.8 billion at current exchange rates. That is almost three times Burberry’s annual sales. The sheer weight of these ad dollars makes it almost impossible for rivals to stand out. Even though Kering is a major luxury group in its own right, it hasn’t grown as fast as LVMH in recent years. This may be creating a vicious spiral as it now struggles to match its rival’s marketing muscle.
Brands that rely on affluent shoppers instead of the very rich are also at a disadvantage. This part of the market is shrinking: Consumers that spend less than €5,000 on designer goods a year now account for around 60% of global luxury sales, down from 70% in 2016, according to Boston Consulting Group. Gucci, Burberry and Ferragamo all fall into this camp.
Aspirational shoppers are the first to close their wallets when the economy sours, as is happening today. Brands made the slowdown worse by alienating their core customers with aggressive price hikes during the pandemic.
Growing reliance on outlet stores is another problem. Last year, 13% of global luxury sales were made in the off-price channel, according to Bain & Company, up from 5% a decade ago. Dependence on outlets to clear unsold stock undermines brand turnarounds. Shoppers won’t pay full price if they believe they will be able to buy the products at 60% off in an outlet store.
Burberry generates a quarter of its sales in off-price stores and more than half of group operating profit, according to Bernstein estimates. Ferragamo also has high exposure. Sales made in outlets are lucrative because rents are relatively cheap and footfall is high. Burberry can’t quit this image-harming part of its business without sacrificing a huge chunk of earnings—a Catch-22.
Kering’s and Burberry’s stocks look particularly cheap at the moment. Their shares trade at 16.5 and 17.8 times projected earnings, respectively, compared with 27 times on average for Europe’s top luxury companies.
But investors should wait for early signs that turnaround plans are working before jumping in. Social media chatter can show whether or not runway shows are generating excitement. So far, new collections at Gucci and Burberry aren’t setting the fashion world on fire.
Between earnings reports, a simple way to tell whether or not a turnaround is working is to visit a brand’s flagship. “Traffic doesn’t lie. If there is no one in the store, the brand isn’t relevant,” says Bernstein analyst Luca Solca .
Fashion history is full of top designers who lost their edge. For every Coco Chanel there was an Elsa Schiaparelli , whose namesake label is now a bit player. The chances of making a successful comeback in the luxury goods industry seem to be lower than ever.
Write to Carol Ryan at carol.ryan@wsj.com