The Luxury Flywheel: Part 2

Now that we have a framework for thinking about luxury as well as a stylized luxury flywheel, I'll provide a more detailed breakdown of the industry, with a particular focus on Japan. I'll start with the overall size of the industry and the different spurts of growth and stagnation the industry has faced going as far back as Japan's emergence (1970's), Japan's boom (1980's), and Japan's bust (1990s). I focus on Japan as it is partially analogous to what is happening in China today. I believe the experience from Japan's mega bubble suggests that the current issues are a bump in the road rather than a material divergence from the 6% long-term growth the luxury industry has seen over the last 3 decades.

Total Addressable Market

If you use the broadest possible definition, the luxury industry TAM is €1.5tn but that includes €242bn of hospitality and €580bn of cars from the likes of BMW, Mercedes, and Porsche which does not meet my definition of luxury.

So let's narrow down the TAM to soft and hard goods which is €363bn of-which the breakdown is 35% accessories (mostly handbags), 20% apparel, 15% watches, and 30% everything else including jewelry and cosmetics. If you use my narrower definition of luxury as the ability to sell $3,000 handbags, the real TAM is likely <$50bn. From the table below, you can see that the industry pre-COVID was growing 6% cagr since 1996. While handbags and watches are clearly a discretionary purchase, the industry has historically been resilient to macro, growing through the tech bubble, declining just 2% from 2003-04 and declining 9% from 2007-09. Embedded in this period is a significant slowdown in Japan in the late-1990's and the subsequent rise of China in the 2010's. The COVID period was an exceptional case due to lockdowns and a halt in travel but even then, sales quickly exceeding 2019 levels by 2021.

Different Phases of Growth

Most luxury brands were founded 80+ years ago. Some brands were started from fashion designers that became famous like Coco Chanel, Cristóbal Balenciaga, Christian Dior and his assistant Yves Saint Laurent while other brands started from craftsman focused on leather goods and luggage like Louis Vuitton, Gucci, and Hermes.

1960s: European and US Expansion

By the 1960s, luxury brands were still small family-owned businesses catering to a narrow clientele of ultra-wealthy. This began changing in the 1970s as a wave of mergers took place in both the Swiss watch and French fashion and leather goods industries resulting in "professional" managers with ambitions for global expansion. Brands first started expanding via department stores then eventually mono-brand stores started opening across Europe and the US. For example, many French brands began opening their first London flagships during this period including YSL (1966) Celine (1969) and Hermes (1974). Brands also began wholesaling and in many cases licensing their brands to the US to the likes of Bergdorf's, Saks, and Nieman Marcus. While all brands including Hermes and Louis Vuitton wholesaled, some had the foresight to limit licensing (Hermes, Louis Vuitton) while others licensed aggressively (Gucci, Dior). It was common to license apparel, men's ties, sunglasses, and perfume. In the late-1960s, the primary export markets for French luxury were the US (41%) and Germany (22%), with Switzerland, Belgium, and Italy each with 10% to 11%. Asia was a non-factor.

1970s: Japan's Emergence

Luxury was selectively introduced into Japan in the 1950s and 1960s by department stores. Choichiro Motoyama, owner of a Japanese department store Seibu, first went to Europe in 1959, discovered high fashion, then tried to import these goods into Japan. Brands initially refused as Japanese customers were not viewed as wealthy enough but this gradually changed. Motoyama signed Ferragamo in 1961, Gucci in 1962, and Hermes in 1968. Other department stores opted to license rather than import. For example, Daimaru, a department store, obtained an exclusive licensing for Christian Dior in 1953 where it could manufacture clothing and even hold fashion shows. This also allowed Daimaru to tailor the clothes to Japanese preferences and proportions. Department stores that could import and license foreign products were highly successful. Dior, Gucci, and Cartier all licensed whereas Tiffany, Chanel, Loewe, and Louis Vuitton only wholesaled imported products into Japan. You can see the massive boom in department store sales per the chart below where sales roughly 20x'd between 1960 to 1990.

By the 1970s, customer sophistication increased with customers seeking "authentic" imported goods manufactured in France or Italy rather than licensed goods manufactured domestically. This led to department stores setting up dedicated shops within department stores. Louis Vuitton opened their first standalone store in Tokyo in 1981. By the mid-80's, Japan's economy was booming. The Japanese boom also touched a broader demographic to traditional wealthy clients, starting the "democratization" of luxury with even Japanese teenage girls buying Louis Vuitton purses. A highly influential magazine called Hanako (the Instagram or Xiaohongshu  of the day) which targeted younger girls helped introduce Chanel and Tiffany to Japan. Off the back of surging demand from younger consumers, luxury brands responded by moving downmarket introducing lower-priced SKUs.

1980s: Japan's Boom

By the 1980s, Japan's export-led boom drove Japan's GDP to catch-up to European and US levels.

GDP per capita in 1960 was less than half of France and roughly 1/6th of the US but by 1987 in just 27 years, Japan's GDP had exceeded both France and the US. This in turn drove a boom in luxury. One study cited Louis Vuitton growing sales from ¥1.2 billion in 1979 to ¥35.3 billion in 1990 (36% cagr) and ¥135 billion in 2002 (23% cagr). This lines up with the table below from the Yano institute which shows luxury growing from a Y200bn market in 1984 to a Y1,900bn market by the 1996 peak (21% cagr).

The table below breaks down exports by country. Pre-1970's, the US was 40%+ of exports but by the 1980's, Japan's emergence meant Japan became 35% of exports making it the largest luxury market globally. Importantly, Japan's importance continued into the late 2000's despite the popping of the bubble economy. I'm not sure what accounts for the US growth spurt from early 1980's to late-1980s but my guess is that a significant part of it was oversees spending by Japan tourists.

Post-1990s: Japan's Bust

From 1987-92, the global luxury industry saw flat exports (impressive performance considering the circumstances). We had the bursting of Japan's real estate and stock market bubbles. Stock markets and real estate peaked in 1989 but the recession started hitting disposable incomes by the early 1990s. In Japan, the market did rebound significantly after the bubble popped in the early-90s, hitting new peaks in the late-90s but the peak to trough decline from 1996 to 2010 was approximately 50%. If you use 1989 as the base year, the luxury market was flat for 22 years from 1989 to 2011 and has only recently started to recover strongly.

When you look at the details, the bust was not as bad as it looked in Japan. An important thing to point out is that despite a flat luxury market, there were some significant shifts happening within the market. My data is taken from this book.

The graph below shows Japanese leather goods sales versus men's apparel sales graphed against changes to the Nikkei, all figures on a rolling 5Y CAGR. You can see very strong correlation between the Nikkei and men's apparel with a very weak period starting around 1997 all the way to 2007. At the same time, leather goods (primarily handbags) actually grew LSD throughout this entire period and did not show any meaningful correlation to the Nikkei. It was only during the GFC, almost 20 years post the real estate crash, where demand started waning.

The table below is the same chart but shows leather goods sales (5Y CAGR) against total industry growth and growth is disposable incomes (5Y CAGR), again showing leather goods trends still growing through a period that saw lower disposable incomes.

Another important point is that the domestic data significantly understates spending by Japanese nationals. The period from 1985 to 1995 corresponded with a relatively strong yen post Plaza Accords. There was a boom in outbound travel. An analogy can be drawn with China where pre-COVID, roughly 2/3rd of luxury spending by Chinese nationals was spent oversees. Hawaii, a popular Japanese vacation spot, was a luxury shopping destination in the late-80's/early-90s. You can see from the chart below that outbound travel tripled from 1985 to 1995, so my best guess is that while handbag sales grew MSD within Japan, if you factor oversees spending, that growth may have actually been HSD or LDD.

A simple summary is handbag sales are tied to disposable incomes while other luxury sales are tied to asset prices, everything from stocks, real estate and crypto. When asset prices go down, apparel sales go down but handbag sales are resilient, still growing LSD in Japan and potentially HSD or better if you consider oversees spending. One of the interesting phenomenon that helped power handbags sales was the growth in single working women choosing to marry later. There are various newspaper articles from the time explaining this dynamic.

"Miki Takasu is 26 years old, beautiful, drives a BMW and carries a $2,800 Chanel handbag--when she isn't using her Gucci, Prada or Vuitton purses. She vacations in Switzerland, Thailand, Los Angeles, New York and Hawaii. Happily unmarried, living with her parents while working as a bank teller, she is what people here call a "parasite single." There are so many women like Takasu that they have become the focus of a heated controversy."

It sounds awfully like what is happening in China right now.

"A growing number of Chinese women have taken to social media to show that they can be older, unmarried, and still lead fabulous lives. The trend indicates changing attitudes about what it means to be a successful woman in China, which does not necessarily involve having a husband. A search on Xiaohongshu for "older single women," for example, throws up dozens of accounts from women showing off exotic vacation snapshots and expensive handbags — all with video captions highlighting that they are single."

2000s: Democratization

The 2000's are what Bain-Altagamma calls the period of "Democratization". While Japan led the way in the 1980s and early 1990s with teenagers buying Louis Vuitton purses, the 2000's marked the first time luxury became more accessible to the US and European mass-market. This was in part driven by the emergence of fashion blogs and the emergence of social media. "Regular" people could gain access to luxury styles, trends, etc. This period also corresponded with the rising popularity of Sex and the City (first season was 1998) which helped launch designer luxury brands to the mainstream.

You can see this with Louis Vuitton which started to broaden out its offerings in the mid-1990s beyond the core leather goods offerings to appeal to a wider demographic which included adjacent areas like pens (1997), travel guides (1999), prêt-a-porter, jewellery, watches and shoes (1998). Louis Vuitton also tried to segment its core leather goods portfolio by introducing different leathers to include Epi (1985), Taiga (1993) and variations of Monogram (Vernis in 1999, Mini in 2000, Multicolore in 2003).

While Japan was on its inevitable decline, the luxury industry was doing fine (including amongst the Japanese).

The chart from Bain shows that despite the weakness in Japan, luxury still grew 7% cagr from 1994-2007 (1994 being near the peak of luxury spending in Japan).

This chart specifically shows the performance of LVMH's FL&G business. While the decline of Japan led to a period of tepid growth post the tech bubble, China overtook Japan as the most important market in 2007 which in turn drove a post-GFC decade of strong growth.

In the next post, I'll describe 2008 as the turning point where China officially became most important market and growth driver for the luxury industry. Given China's sheer size, China should continue to be luxury's most important for the foreseeable future. The next post will describe this history as well as highlight some of the unique structural features of the Chinese market. These primers are intended to serve as a backdrop to better understanding luxury groups such as LVMH, Kering, Hermes, Prada, Richemont, and Moncler and provide context on the key issues facing luxury today.