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Insider View: State of the Industry Assessment

An insider talks about the industry, and its woes.
by Dr. Frank Müller on November 28, 2016

Editor’s Note: The watch industry is undergoing throes of turmoil. Is this just turbulence, or a major storm threatening danger is in the cards. Our Special Correspondent, Dr. Frank Müller (The Bridge to Luxury, TBTL) gives his assessment of the State of the Industry in this article. Opinions expressed are solely of TBTL. 

 

The numbers could be better: The main performance indicator of the watch industry predicts another disappointing year with a likely decline of Swiss watch exports at -10% (2015: -4%, 2014: +2%). For Q2 2016, most major market players have already published shrinking revenues: Swatch Group –11%, Richemont –13%, Citychamps –18%, Seiko –20% while only few like Citizen (Q3 +5%) reported moderate progress.

Yet, taking a longer term look at the industry’s average annual growth rates between 2000 and 2015, overall she has done very well in the past: 5% for all exported Swiss watches and an even more impressive 12% for those with an export value of greater than CHF 3,000 per piece.

The healthy statistic was fueled by two factors:

1. strong growth rates in the BRICS states (especially China);

2. the renaissance of the traditional, complicated (and expensive) mechanical watch, a trend that started in the mid 90s.

For the last four years though, the industry has been increasingly struggling. And the outlook does not seem positive. The IMF forecasts global GDP to rise just 3 to 4% from 2017 to 2019 – as rates of recent years.

The industry is top heavy. High end (read: expensive watches with an export value of more than CHF 3,000) stands at approximately 60% of total total Swiss watch exports. This figure was 23% in 2000.

Hence, the watch industry’s future is in need of much more urgent attention than it did some 20 or 10 years ago. For some companies and brands the answer to it will certainly be one of survival.

 

graph1-swisswatchexport

 

Challenges

Currently, the watch industry is facing many external challenges: weakening economies, corporate governance measures to fight corruption, political instability (e.g. Ukraine, Syria, ‘Brexit’), volatile currency exchange rates. Not pleasant times, and indeed it has dampened consumer moods.

Demographic changes too are beginning to show their impact. The shrinking traditional consumer bases in important regions (Europe, Japan) are now increasingly having a younger generation who feel less inclined to spend on high-end products and a decided preference for the millenials to pay for service instead.

The Internet provides more information and knowledge to consumers, making brands more transparent and vulnerable. Over decades luxury consumption has been democratised, the image of luxury being diluted in the process. At the same time, some of its cultural roots are increasingly vanishing: for e.g. casual wear in office, electronic messages instead of hand written letters and time indication on smartphones. These represent significant challenges for manufacturers of fine suits, elegant writing instruments or mechanical watches.

Indeed, these exogenous factors bias the creation an unfavourable frame beyond the watch industry’s influence. If this happens, and the industry has failed to anticipate it, it would be disaster.

Is the industry resilient enough? A look back onto the last 15 years shows that on average, the watch industry has been hit by negative external impact approximately once every three to four years (9/11, SARS, Lehman, Greece, the Swiss National Bank detaching the Franc from the Euro, China’s anti-corruption measures etc.). Three to four years is generally the same time horizon of corporate strategic planning and budgeting. Rarely do the industry executives incorporate these external crises into their calculations. And these external influences extract their toll. The published balance sheets reveal the problem of short-termed scenarios:

Read also:   The Insider View: Swiss or German? Who makes the best watches?

As their hopes have not materialised in the last years, stocks pilled up – rotation rates (the relation between watches sold and still laying on shelves) have fallen by 30 to 45% over the last decade. To ease the pressure, some of the stronger brands have pushed exports, pressuring stock into the system. This is relatively common. And when the exports outpace the industry norms, the watches become stuck in the system. The brands record sales, but these watches do not end up with consumers. Eventually the system breaks down, and offer these watches to grey markets at significant discounts.

Consequently, TBTL estimates that today already 35-50% of all watch sales are sold to consumers with discounts – and for high-end pieces this with up to 50% price knock-offs!

The grey markets are full of merchandise. The BRICS states and their new upper and middle class consumers are not able or willing anymore to absorb the brand’s commercial ambitions – and this will remain the so for at least the next three years given the likely global political and economic environment. The industry’s glorious past cannot simply be extrapolated endlessly – it is time to adopt.

 

Innovate or die

Innovation could be one solution to escape depression. Each year some 10,000 novelties are launched. But they are generally of generic nature and vary just in case sizes, strap materials and dial colours or offer the next variation of a limited edition of tourbillons, annual calendars and so on. What we call pseudo-innovations. Where is the real innovation? Where is the beef. Precious little. And of those which are sparks, the industry has failed to sit up and take notice.

The call of the Smartwatch

Surprisingly, the industry is just about to miss one of the greatest opportunities to step out of its conservative box: the smartwatch. Listening to company and federation representatives, though, it seems the smartwatch is merely considered a potential supplement to business instead being a potential threat as a substitute.

Meanwhile, after a tentative start, the time machines offered by the IT-giants are beginning to look and feel better in terms of design and quality. They provide a lot of utility (e.g. seamless connectivity) and are relatively cheap. And being just one part of a larger product portfolio, Samsung’s, Apple’s or LG’s smartwatches will take advantage of huge marketing budget spill-overs from the brands’ notebooks or smartphone activities.

TBTL believes that in the next five years new market players will steal up to 20% market share from classical business for watches retailing between 200 to 1000 CHF.

As an example. Even if Apple sells just 5 million units each year, as some industry experts already gleefully express, that still represents 25% of the Swiss annual exports in volume. But so far, no one in the watchmaking industry is taking notice. Except for TAG Heuer and some minor efforts of other brands, no serious ‘home made’ offering has been launched.

As for a mechanical smartwatch, for example, no player has ventured into this small, however interesting niche bridging past and present watch making – though technically feasible. (Editor’s note: Hyetis offers one alternative, albeit a very esoteric offering from a micro-manufacturer.)

The call of micro-segmentation

Another option of innovation is unfortunately neglected: committed micro-segmentation. As an example, an estimated 500 million elderly people, having grown up with and therefore still being attached to classical time pieces, may want to purchase adapted watches: easy to put on a wrist, big numerals, providing a brand story attractive and relevant for the 60+.

Here again, industry outsiders are about to define a new market without the watch industry realising it.

Read also:   Geneva 2015: DeBethune DB25T Zodiac -Limited Edition of 20 Pieces

Line extensions are a third path of innovation. Montblanc or Victorinox are not historical watch manufacturers. But their examples show: The clearer a brand is positioned and the better it masters the peculiarities and needs of defined target groups, the more chances to expend into new product categories successfully. In their case, from pens and knifes to time pieces.

The watch industry is not one that has a huge tradition in refined customer segmentation. Marketing efforts and product line-ups are generally generic and do simultaneously reach out to hundred of thousands consumers of different ages, socio-demographic characteristics, regions etc. Consequently, there are hardly any strategic and credibly targeted offerings for opera lovers, hikers, food enthusiasts, medical doctors or photographers. Each of these segments would be big enough to nourish a courageous watch brand for decades if being well introduced.

 

The Nixon Mission is an example of a Smartwatch targeted specifically at a micro-segment.

 

California’s Nixon is a good example of how discipline in clear target grouping is able to create speedy success. Clever design, smart and innovative features to address each micro segment.

Yet, in brand reality the common denominator is to reach out to its highly heterogeneous customer bases. Global VIP testimonials pretending to be the brands’ long-term friends, have been used somewhat effectively in some cases. Some brands take enormous risks in searching image transfers from global sport heroes and teams in hoping that their performance remains high over time and will not be overshadowed by doping or unethical issues. These ‘ambassadors’ have short half-lives and are only desirable to be associated to until the next scandal demands their hectic replacement. Yet we see these scandals being common.

The call to creative advertising

In a stagnating and saturated industry of interchangeable offerings, branding is king to differentiate. But where are the epic stories of drama, love and triumph in the tradition of writers such as Shakespeare, Tolstoy or Hemmingway? Prestige and luxury is about the ability to create myths, strong emotions, exclusivity, exceptional offerings and credibility.

Brands need to address and please the consumers’ self-esteem and social status. This asks – the second actual trend in all and everyone embracing watch advertising – for more than un-creative campaigns consisting of big product pack shots, meaningless claims being changed every three to four years and the brand’s logo at the right lower corner of an advertising page. Patek Philipe’s generation topic can be considered a current exception to the rule or IWC’s campaign about the relationship of men and women a historical one – both having resulted into huge commercial successes.

Discounting and cheaper lines

Traditional wholesalers have been enlisted or pushed to carry a lot of merchandise while brands ventured into corporate retailing and online platforms in expectation of higher margins and better market control. But what contributions do corporate stores deliver to brand image if they are closed again after a few years only?

Brands have started not only to discount current collections but also to strategically introduce cheaper new lines – this in many cases after years of continuous heavy price increases. Yet trading-down does not happen in the void – it means to meet new competitors at lower levels of the industry’s brand pyramid and to deceive former customers who have once expected that brand values would be sustainable.

Consumers are not stupid and have learned the lessons the hard way after each crisis when their watches could instantly loose some 60 to 80% of original purchasing values. And today they make the experience that any price for any new watch which is easily available can be negotiated.

Read also:   Review: Rolex Air King

At the same time they have understood that brands expect them to wait months for a watch to be repaired or simply maintained.

These practices are untenable in the long run, and in an industry slowdown like what we are experiencing now, it is taking its toll. It will take a lot of time to regain the consumers’ trust and that special aura of exclusivity when the hype about the mechanical watch started some 20 years ago. But that will demand a new brand discipline otherwise consumers will spend their money in other prestige and luxury related product categories – as they increasingly do as studies from Bain et al. confirm.

 

graph2-shareprice

But to give her a credit: The industry has started to move. Richemont has commenced to buy back inventories from market partners cleaning the channels – and even made the action public.

The demand for consumer insights is rising among decision makers. And service providers such as Responsio provide for a first time relevant and representative data on customer preferences, buying behaviour etc. This will facilitate better brand positioning and target more sophisticated group definitions.

Generic product launches are decreasing. Costs saving programs have been introduced in many companies, unfortunately too often focusing on marketing budgets first, and forgetting about the saying: “publish or perish!”!

The industry’s concentration process continues. Over the last decade vertical integration has already been on the agenda. The larger players are buying suppliers and developing own retail capabilities whether off- or online. European or Asian investors have acquired traditional watch manufacturers like Corum, Eterna, Ulysse Nardin, Arnold & Son and most recently Frédérique Constant.

As the restructuring process speeds up further, the watch industry will likely follow the example of the car industry with its oligopolistic structures. Larger players will have streamlined their businesses; the smartwatch and new market players will have made their impact as the Internet with complete new business models coming along.

Sadly, the current downturn will have probably lasted too long for a lot of smaller and independent brands already facing difficulties to finance their business in being unable to attract banks or new owners. This is the likely fate for a number of traditional wholesalers, too. In the context of their scenario planning, owners should consider ways of exiting the industry with least harm as early as possible. Some brands though like Nomos or MBF, having constantly invested into creative marketing, PR and brand credibility, have excellent chances not only to survive but also to grow strongly.

 

Concluding Remarks

 

The industry needs to refresh her efforts to recreate the myth of watch making. But this will imply more strategic foresight, less commercial aggressiveness. This means an increase in creativity and effort in innovation, better target grouping, attractive branding, customer dialogue and service, and a focused dedication to detail. The industry need to address these structural problems. Awaiting for the Chinese, Russian or Arab customers to return in huge numbers will not be the answer to a structural problem.

Additionally, following the French or Italian luxury initiatives, the watch industry ought to set up promotional bodies like the Comité Colbert or Altagamma. In Germany, generic initiatives like “Handmade in Germany” or the “Meisterkreis” promote classical national craftsmanship. Perhaps it would be possible for the big groups and international wholesale chains to set-up “farm teams” in supporting young brands and talent in watchmaking.

What to expect from the future? In the next decade or so, we think the traditional watches will still be manufactured and sold to fascinated consumers. But the industry will have altered to a different one. Those who does not change will be changed anyway.

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Leave a response
  • Ben Gert
    November 29, 2016 at 4:46 pm

    Perhaps watch prices are simply too high compared to the value of the watch?

    Luxury watch brands used the Asian boom to jack up prices and increase spending so much on sponsoring, fancy advertising in glossy magazines, partnerships with celebrities, and very expensive retail boutiques in the most expensive locations of the world, that now they can’t go easily back to a lower price level (as it would also damage brand) – so they try to keep prices by offering more value e.g. Inhouse movement – but that again increases their cost and sunk investments, forcing them to sell high volumes to amortize that spend.

    I have recently been in China and saw some high end replicas of 5-10k$ watches, that are very hard to identify as such without a loupe (of course they usually have a cheaper 3rd party movement e.g. From Miyota) – costing ~300$ – it’s actually quite scary for anyone who wants to buy a used watch as the risk of getting a fake is increasing.
    Based on that I would guess that the avg. 5-10k$ watch probably costs 0.5-1.5k$ to produce for a big brand + some amortization of the R&D, rest is marketing & overhead (10-20% of price?), retail (50+% of price), profits (10-25%).

    If that’s true then I wonder when we will see the first direct-to-consumer high-end watch brand?
    Imagine a watch in quality equivalent to a 10-20k$ watch (production cost probably <1.5k or with 3rd party watch movement as basis for 0.5-1k), sold for 3-4k.
    If well done watch blogs should be great free marketing and sales could be direct based on word-of-mouth.

    Might be difficult for a new entrant due to lack of brand and product width but imagine Nomos would stop selling via retail stores and in return either slash prices by 40-50% – or even better: double the content per watch (hand refined upgraded movements that can compete with with entry-level PP/AP/VC watches) – they would be come the ultimate brand for watch insiders who don't buy a watch to show off a brand but for its feature (would also fit much better to a German brand than a swiss one)…

    Am I crazy? What do fellow readers think?

  • Garrett Hu
    November 29, 2016 at 3:28 am

    Just like traditional watches, the business model is also traditional. A traditional business model means you can’t keep up with the times. I was especially surprised to find out retailers have no price protection or extended terms from manufacturers which means the retailer owns the inventory once it’s sold so if the manufacturers drop their prices the retailers are stuck with higher cost inventories. Honestly besides Rolex and Patek, there are no other brands I would take that kind of risk for. These manufacturers just don’t understand it ain’t sold until the consumer buys it and flushes though the channel completely. Richemont buys back inventory is a good first step that should have been in place from day one.

    Rebuilding confidence in the consumer is just as important as rebuilding the retailers trust.

    1) Price Protection on any unsold inventory.
    2) Stock Rotation on slow moving old stock.
    3) Aging inventory rebates for holding inventory.
    4) Extended payment terms for holiday stock where retailers often bring in inventory 30 days prior to a holiday event.

    These kinds of “support” from manufacturers are standard in many industries that have a retail or distributed model.

    Stabilize your retailers first so they are not inclined to push to grey or discount heavily because the pressure is lightened with the right support. Then as gray market dries up and retailers stabilize discounts is where consumer confidence comes back.

    On the back end, manufacturers now get reports on sale through allowing better management of supply chains and know what models sell well to control access production.

    It’s going to take time but it’s going to get worse before it gets better, stock holders need to understand this be confident this will work but it’s a tough fight which is why we are in the situation now where just sell sell sell to make the numbers and deal with the problem later….well this is what happens operating in a silo.

    • Timothy Edward Treffry
      December 22, 2016 at 12:58 am

      Many high end marques have also screwed their traditional distribution networks by opening boutiques.
      Servicing restrictions, costs and times are also a problem. Independent repairers should have access to parts.

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