Q: Why are there so few American Luxury Brands?
A: The corporate finance system
To truly answer this question, we need to define both what a luxury brand is, and what corporate finance is.
The remainder of this letter may sound elitist, but you can’t talk about luxury without talking about the target customer—people with money. If that bothers you, then smash that unsubscribe button now and keep on trucking.
The “what is luxury” section draws heavily from the work of luxury scholar Thomai Serdari and case studies on heritage European luxury brands like Louis Vuitton.
What is a luxury brand?
Language concerning luxury - “couture”, “bespoke”, “exclusive” and even the word “luxury” itself - has been bastardized by marketers to the extent that it no longer has any meaning. But there are pretty strict criteria for what constitutes a true luxury brand.
There are three segments of the luxury market: (1)Absolute, (2)Aspirational and (3)Accessible.
The (1)Absolute Luxury customer has enough money to do all of their consumer shopping with luxury brands. This group is the global 0.1%. They are living off capital gains, not a salary. A product with excellent quality and craftsmanship is table stakes for this customer. The entire purchasing experience must be well considered and special—Absolute Luxury speaks to all five senses.
The (2)Aspirational Luxury customer indulges in luxury brands “as a treat”, or invests in luxury categories that overlap with his/her interests or hobbies. These people are the global 10%. They are living off (large) salaries or may have recently sold a business or experienced some other liquidity event.
There are two sub-segments of Aspirational Luxury customers: the hobbyist (repeat, dedicated customers) and the casual customer (infrequent purchasers). An Aspirational Luxury customer may drive a Toyota, but spend six figures on a watch. Because they care about one thing, but not the other.
The (3)Accessible Luxury customer is the rest of the market, who purchases from luxury brands because they want to feel like they’re part of an elite group. This customer is looking for the most logo for the money.
To qualify as true luxury brand, you must have an Absolute Luxury offering. To meet the stringent demands of the absolute luxury customer, you must specialize in some form of craftsmanship, aka savoir faire (literally “to know to make”).
Ideally, your craftsmen and women become so skilled that they develop innovative techniques over decades of honing their skills. For example - the tumbler lock developed by Louis Vuitton or the curved watch case developed by Franck Muller.
To achieve this level of craftsmanship the you must, at a minimum, own your production facilities—no outsourcing to a third party factory. Ideally, you are vertically integrated and own the source of your raw materials.
The pinnacle of Absolute Luxury is an artist and a craftsperson collaborating to make something intriguing, innovative and beautiful.
And this is the part where we must come down from the clouds and talk about how the corporate finance system makes it difficult for this kind of luxury production to thrive in the United States.
What is the corporate finance system?
C.R.E.A.M. = C(orporate finance) Rules Everything Around Me
If you are the employee of a well-managed company, the corporate finance system determines what you work on, who you work with and whether or not you’ll have a job tomorrow. So you should make an effort to understand it, even if finance makes your eyes glaze over.
Corporate finance is a set of frameworks that help a company make decisions that will maximize the return on its investors’ money. Part of this decision making process is determining what projects the company should pursue.
To inform these decisions, a corporate finance team will build out a Profit and Loss model for the project that covers the first ~ten years of its life. The model will include projected revenue, expenses, and any opportunity costs.
The objective is to take a random, complicated, real life situation and make it look as much like a financial instrument as possible. The company wants to understand how much they will get paid back, and when, and how that compares to other alternatives.
The outcome of the model is two measurements:
Net Present Value of the Project: how much is tomorrow’s (projected) money worth today?
Payback Period: if we put $100 into this today, how long will it take use to earn that $100 back?
The corporate finance team compares these two outcomes to the value of all the activity the company is currently engaged in. If launching a new project won’t perform at least as well as what they’re already doing, why do it at all?
One big caveat: a lot of what you plug into the model is a series of guesstimates, so the process is only as good as the culture of the company. If there is a bad actor at the top with too much power, the corporate finance minions can make the numbers justify whatever the boss wants to do.
In companies with really bad corporate governance there is no process—the owner just does what he or she wants until the money runs out.
If you’re an outsider looking to invest in a company, you want to be confident your money is being used wisely. Without a mechanism to enable that trust, no one will invest in anything and a major pillar of capitalism will collapse. The corporate finance system enables trust between investors and entrepreneurs.
In the less regulated private market, you perform due diligence on a company’s decision makers however you see fit. Like doing a 30 minute vibe check.
But most of us normies will be investing in the public market (i.e. buying STONKS on Robinhood). So we would look at the list of a company’s largest shareholders to be sure that we’re comfortable with who is in control.
Why does this matter? Shareholders are the enforcers of the corporate finance system.
When everyone plays by the rules, sound decision making should follow, resulting in mistakes that come from bad luck instead of hubris. There is little little incentive for anyone to show up at a shareholder meeting and raise hell.
But stock analysts, hedge fund employees and other random yahoos are all using whatever information they can find to run their own corporate finance models and assess how much money they think the company should be making.
If a company delivers results that are consistently below these expectations, it may invite the attention of an active(ist) investor. An activist will engage in tactics like releasing scathing powerpoint takedowns in an attempt to rally the other large shareholders and toss out the existing board of directors and management team.
Because you make a lot of money running a publicly traded company, and because losing publicly is embarrassing, there is a major disincentive for anyone to go rogue and make decisions that run afoul of the corporate finance system.
Where are all the American luxury brands?
Why are there so few true luxury brands founded in America? Because founding a true luxury brand requires you to break all the rules of the corporate finance system.
Let’s look at the three major corporate finance “rules” you must break to be luxury:
In America we simply don’t have diverse manufacturing capabilities anymore. Most companies and brands founded here do their manufacturing overseas to lower costs, and outsource their manufacturing to decrease risk, especially in industries that are driven by consumer tastes.
Those are corporate finance decisions. Let’s say you are an investor presented with a choice of funding the launch of one of two companies:
The startup costs of Company #1 include: high quality raw materials, the salaries of three experienced crafts(wo)men, top of the line tools or machinery for each worker, and a space to put everything in.
The founder needs six months to train the workers on his revolutionary manufacturing method, honed over decades of experience. And each item takes 2-4 weeks to produce. So the first batch of products will not be available for sale until at least 7 months post-launch.
When the product is ready, the retail price will be higher than almost anything that exists on the market. The founder will need to appeal to a small group of wealthy enthusiasts. It will take time to identify these people and educate them as to why this product is not only better than anything else on the market, but more special.
The startup costs of Company #2 include: mid- to high-quality semi-finished materials, capital to finance production of the first run of goods at an overseas factory, a PR firm, a standard eCommerce website, and a digital marketing budget.
The founder of company two has samples of the goods (s)he sourced from a third party factory, and that factory can spring into action once they receive a deposit. The company will be ready to start shipping orders from its website in under three months.
The product is a twist on something that already exists in the market with a strong narrative and distinct visual “look”. The product has broad appeal for those with at least some disposable income and an interest in culture and aesthetics.
If you were the investor, where would you put your money? Where do you think you would see a greater return on your investment, in a shorter amount of time, with a lower amount of risk? Probably Company #2.
The only company with true luxury potential is the first one. But luxury projects are capital-intensive, especially when you look at the near term returns. Which brings us to…
If your ambition is to target the Absolute Luxury segment of a product category, you are boxing yourself into a very small target market. Let’s do some quick market sizing:
There are 129 million households in the US. As a provider of Absolute Luxury, your core market is going to be the top 0.1% of household incomes, or 129,000 households. Reaching such a small segment of the population will be difficult with traditional customer acquisition tactics like targeted digital marketing.
Even more challenging: these people probably don’t want to be found. A lot of their preferences are locked in, and informed by decades of exposure to the luxury market or deep understanding of the category. And you won’t just be competing against other luxury brands for a share of attention—every brand at every price point is angling to get a piece of this market.
You’ll probably need to figure out how to place your offering in an environment where these people already are, both to build credibility and to reach them efficiently. This implies higher than average retail rent, or the challenge of breaking into an elite network of wholesalers or subject matter experts (think art advisors, top decorators or master sommeliers).
Building up a reputation for quality and craftsmanship doesn’t happen overnight. It is easier if the brand is being launched by a craftsperson who already has a reputation for excellence. For that reason, it may take years for you to build up a clientele base large enough to sustain your operation profitably, much less scale it.
Establishing the core, Absolute Luxury offering for a future luxury mega-brand is a risky, capital-intensive endeavor that takes generations. A person trained in the corporate finance system would wonder why the hell anyone would ever do this. It’s no coincidence that many founders of today’s luxury houses were artisans, not businesspeople. Which brings us to…
Louis Vuitton merged with Möet-Hennessy in 1987, and Bernard Arnault spent the next two decades maintaining a delicate balance between exposure and exclusivity while scaling these brands and acquiring new ones. The LVMH group drove turnover of 23 Billion Euro by 2011.
As soon as the broader industry caught on, there was blood in the water. Enterprising artisans saw the financial upside of a potential IPO or acqui-hire by a European luxury group, and private investors were more than happy to provide capital and “operational discipline” that would position these brands for an exit. There were some notable successes and just as many if not more failures.
But one thing was clear: all parties involved were looking to exit in five to seven years, at least when the artisans and the investors were aligned. These artisans were looking to build generational wealth, not generational transfer of savoir faire. And there is nothing wrong with that!
But it does illustrate the reason why it is so difficult for American luxury brands to come into existence, much less thrive for long enough to form a multi-brand group. There is very little overlap between the group of people who have the knowledge and desire to produce a luxury product, and the people who have the capital to finance such an expensive, risky endeavor.
What American luxury-adjacent brands have been good at is creating similar levels of desirability and status to their European counterparts, even if there is no manufacturing knowledge to back it up.
But the corporate finance system trips up American brands here again, because they inevitably choose to scale by expanding distribution, especially through outlet stores and diffusion lines.
European brands, on the other hand, pursue a pyramid strategy where broader segments of the market are addressed via product lines that have a lower prices, but are still in the top 10% of prices for the category.
Pyramid strategy is riskier and slower —you are launching the brand in a new category, and it takes time to gather the resources to do it right.
Diffusion lines are slightly less risky - you are selling the same stuff at a lower price, so the P&L has been proven out to some extent.
Off-price or outlet strategy is the least risky of all, because the customer thinks they’re buying main line product at a really good price (see: made for outlet).
The corporate finance system guides management to make the least risky decision that provides the most return.
So why can LVMH and Kering make decisions that seem to throw the laws of corporate governance out the window, while American brands and holding companies cannot?
Because LVMH and Kering are essentially publicly traded family businesses.
The Arnault Family Group owns almost 50% of LVMH stock and more than 60% of total voting rights. Groupe Artémis, a holding company owned by François-Henri Pinault, is Kering’s controlling shareholder.
So if these two individuals have a vision that involves high up-front investment for risky returns on a long time horizon, they can do it without intervention. They also have the benefit of using proceeds from the most successful brands in the group to incubate smaller upstarts unprofitably, sometimes for decades.
A publicly traded US brand or holding company is not going to be able to acquire the types of brands that LVMH acquires at the same rapid pace. And it won’t get away with investing in the same type of “lose a dollar today, make a hundred dollars in a decade (maybe)” projects that LVMH does.
Capri Holdings (Michael Kors, Jimmy Choo, Versace) already got the corporate finance vote of no-confidence by investing $2.2 billion in the purchase of Versace, a brand that once had an Absolute Luxury offering (haute couture).
And many brands launched in the early 2010’s who attempted to pursue luxury positioning have oscilated between building an Absolute Luxury core unprofitably and pursuing scale through diffusion lines and licensing, ending up in limbo. See: Proenza Schouler.
That’s why we don’t have an American luxury brands.
This isn’t a value judgement, but it is a warning to American brands attempting to pursue some component of the “luxury strategy”. The American fashion industry is in shambles right now because these brands have spent decades cribbing from the LVMH playbook without the foundation in customer and product that enables these strategies to be successful.
The pipeline for luxury crafts(wo)men poised to become tomorrow’s Gucci and Louis Vuitton has slowed to a trickle. Although European nations have a more established tradition of manufacturing luxury goods and nurturing specialized crafts, it is becoming harder to convince young people to take up these trades. This means fewer European artisan-entrepreneurs, and fewer luxury upstarts being incubated outside the existing LVMH/Kering/Richemont trifecta.
We may see the big luxury holding companies become more conservative in their strategies and investments, in the interest of preserving the cultural cache and profitability of their existing winners.
The turn toward luxury streetwear and “premium mediocre” product strategies is a reflection of this conservatism, although the epic fits above are anything but conservative. The streetwear hype cycle is a proven business model that resonates especially with men, who are an untapped growth market for the personal luxury goods sector.
The performance of these holding companies will become a lot more volatile—subject to the same taste-driven boom and bust cycles of their American counterparts. And the patriarchs of LVMH and Kering are 71 and 83, respectively. Should be an interesting decade for luxury.
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