Newsletter – August 2009

The curse of the “high end”

Nothing like a good old crisis to challenge our assumptions and change our perspectives. In the old days – say before the end of 2008 – it was said that no matter what the type of business, being at the high-end of it was the better spot. Less pressure on boring things like operational efficiency, higher margins and a set of well understood product or service attributes that had to be honed to secure the following of a devoted customer base. And since we’re talking high-end, the customer base is better off, and less sensitive to the ups and downs of the business cycle.

The first cracks in our somewhat idyllic image of the high end came when the notion of what is and is not high end was challenged a few months into the downturn. There was talk then of luxury brands being better placed to withstand the downturn because they catered to the needs of the wealthiest among us. And so it came as a surprise that familiar brand names – leather goods come to mind – that are household names associated with luxury reported steep declines in sales. We suddenly realized that our understanding of what characterizes high end had not quite integrated the changes brought by the age of mass communication. If major “luxury” conglomerates invest in massive global brand promotion campaigns, it is to get the attention of a potential client base that is bigger than the happy few.

So our understanding of what constitutes high end and what doesn’t has lost relevance, and the notion that being high end constitutes a protection from the business cycle doesn’t seem to make so much sense anymore. The high end of any market is fully exposed to downturns as soon as it has reached a size that is of relevance for observers of our economies. Immunity from the business cycle is the preserve of players that are so small – the world of “true luxury” – that they barely register on any one’s radar.

But things don’t stop here. The news these days is full of stories telling how various companies react to the current challenges they face, and these stories do not paint a pretty picture of high end companies. Let us look at things within industries, so as not to skew the comparisons.

Take for example the automobile industry. Here the challenge is twofold: the business cycle and massive upcoming structural changes (carbon emissions). What do we hear from high-end players? Ferrari has been more or less openly worrying about being legislated out of business, Rolls Royce is considering associating its brand name to a limited edition of Minis, and Aston Martin badges will soon be seen on special models of the Toyota iQ (the Cygnet). As for Porsche, the company has been busy trying to take over another car manufacturer lately…As to real core business new models, these are increasingly out of step with prevalent industry wide trends.

The contrast with the mass market end of the industry is stark. Despite the problems created by the build-up of significant over capacity in the last decade, it is there that we see players aggressively addressing the challenges they face by proposing concrete advances in propulsion systems, radically rethinking their product to offer smart and compact urban mobility or breaking new grounds with no frills and seriously cheap “packages”. Even GM is coming out of bankruptcy with an interesting model for the future.

The airline industry provides another striking example. Low cost carrier Ryanair has been in the news lately with measures it was considering to improve profitability, including paying for access to the on board toilets, charging a surplus fee for overweight passengers or introducing stand-up passenger accommodations. Although these measures are rightly considered outlandish, and have more to do with clever communication than anything else, they add to the perception, started by rise of the low cost carriers some years ago, that it is at the lower end of the industry that the skills – and the means – of survival are the best. All players in the industry are having to slash routes and ground planes to absorb the current downturn, but it is striking, and very revealing, that the latest cost cutting measure announced by British Airways caused about as much uproar than the Ryanair announcement. What was the cost cutting measure in question? Business class passengers would have to forgo their usual treat when boarding the plane and make do with coffee in a paper cup.

The same story could be repeated using other industries as examples. The message is certainly not that companies – or management teams – at the high end are less competent or imaginative than their lower end counterparts. It is an altogether more somber one: not only is high end not immune from economic downturns, it may well be more vulnerable to it in certain circumstances.

The problem for high end companies is that in order to reach that status, they have to create, develop and reinforce product (or service) attributes that are so strong that they become co-substantial to their offering, and that customers demand if they are to pay the premium price. And these concrete attributes soon become non-metaphorical straight jackets that place formidable constraints on the future of these companies. By comparison, lower end companies for whom value for money is the driving concept face much more generic customer expectations and have therefore many more “degrees of freedom” when rethinking their offering.

None of this is to say that high end companies and luxury brands are doomed, of course. But it certainly means that turning around a high end company that faces an uncertain future is a formidable challenge. It is probably there that the demand for managerial talent will be greatest in the years to come, and that, beyond the unavoidable failures, the most interesting turnaround stories will be written.

Edgar Brandt Advisory SA

The curse of the “high end”

Nothing like a good old crisis to challenge our assumptions and change our perspectives. In the old days – say before the end of 2008 – it was said that no matter what the type of business, being at the high-end of it was the better spot. Less pressure on boring things like operational efficiency, higher margins and a set of well understood product or service attributes that had to be honed to secure the following of a devoted customer base. And since we’re talking high-end, the customer base is better off, and less sensitive to the ups and downs of the business cycle.

The first cracks in our somewhat idyllic image of the high end came when the notion of what is and is not high end was challenged a few months into the downturn. There was talk then of luxury brands being better placed to withstand the downturn because they catered to the needs of the wealthiest among us. And so it came as a surprise that familiar brand names – leather goods come to mind – that are household names associated with luxury reported steep declines in sales. We suddenly realized that our understanding of what characterizes high end had not quite integrated the changes brought by the age of mass communication. If major “luxury” conglomerates invest in massive global brand promotion campaigns, it is to get the attention of a potential client base that is bigger than the happy few.

So our understanding of what constitutes high end and what doesn’t has lost relevance, and the notion that being high end constitutes a protection from the business cycle doesn’t seem to make so much sense anymore. The high end of any market is fully exposed to downturns as soon as it has reached a size that is of relevance for observers of our economies. Immunity from the business cycle is the preserve of players that are so small – the world of “true luxury” – that they barely register on any one’s radar.

But things don’t stop here. The news these days is full of stories telling how various companies react to the current challenges they face, and these stories do not paint a pretty picture of high end companies. Let us look at things within industries, so as not to skew the comparisons.

Take for example the automobile industry. Here the challenge is twofold: the business cycle and massive upcoming structural changes (carbon emissions). What do we hear from high-end players? Ferrari has been more or less openly worrying about being legislated out of business, Rolls Royce is considering associating its brand name to a limited edition of Minis, and Aston Martin badges will soon be seen on special models of the Toyota iQ (the Cygnet). As for Porsche, the company has been busy trying to take over another car manufacturer lately…As to real core business new models, these are increasingly out of step with prevalent industry wide trends.

The contrast with the mass market end of the industry is stark. Despite the problems created by the build-up of significant over capacity in the last decade, it is there that we see players aggressively addressing the challenges they face by proposing concrete advances in propulsion systems, radically rethinking their product to offer smart and compact urban mobility or breaking new grounds with no frills and seriously cheap “packages”. Even GM is coming out of bankruptcy with an interesting model for the future.

The airline industry provides another striking example. Low cost carrier Ryanair has been in the news lately with measures it was considering to improve profitability, including paying for access to the on board toilets, charging a surplus fee for overweight passengers or introducing stand-up passenger accommodations. Although these measures are rightly considered outlandish, and have more to do with clever communication than anything else, they add to the perception, started by rise of the low cost carriers some years ago, that it is at the lower end of the industry that the skills – and the means – of survival are the best. All players in the industry are having to slash routes and ground planes to absorb the current downturn, but it is striking, and very revealing, that the latest cost cutting measure announced by British Airways caused about as much uproar than the Ryanair announcement. What was the cost cutting measure in question? Business class passengers would have to forgo their usual treat when boarding the plane and make do with coffee in a paper cup.

The same story could be repeated using other industries as examples. The message is certainly not that companies – or management teams – at the high end are less competent or imaginative than their lower end counterparts. It is an altogether more somber one: not only is high end not immune from economic downturns, it may well be more vulnerable to it in certain circumstances.

The problem for high end companies is that in order to reach that status, they have to create, develop and reinforce product (or service) attributes that are so strong that they become co-substantial to their offering, and that customers demand if they are to pay the premium price. And these concrete attributes soon become non-metaphorical straight jackets that place formidable constraints on the future of these companies. By comparison, lower end companies for whom value for money is the driving concept face much more generic customer expectations and have therefore many more “degrees of freedom” when rethinking their offering.

None of this is to say that high end companies and luxury brands are doomed, of course. But it certainly means that turning around a high end company that faces an uncertain future is a formidable challenge. It is probably there that the demand for managerial talent will be greatest in the years to come, and that, beyond the unavoidable failures, the most interesting turnaround stories will be written.

Edgar Brandt Advisory SA