Subcontracting at LVMH (Part 1 of 2)

Supply of raw material and production of goods for a luxury product is the key to maintaining quality and brand value of the product. The sources of supply and the level of subcontracting in SCMluxe will hence differ from the traditional retail supply chain. One difference which is obvious is the high level of subcontracting that can be envisaged in the supply chain of mass produced goods. The sources of supply are also far flung with little semblance to the country of origin. SCMluxe on the other hand would have local suppliers and lower levels of subcontracting (Refer Sourcing the Zara Way). However what surprised me was the wide difference in each of the product categories with respect to subcontracting. A study of LVMH showed the below figures

Product or Brand Category	Subcontracting as a % of Cost of Sales
Wines and Spirits	N.A
Fashion and Leather Goods	45%
Perfumes and Cosmetics	9%
Watches and Jewelry	10%

 What makes the level of subcontracting in the fashion and leather goods business so much higher than other product categories? Is it due to the larger volumes, nature of production or simply volatility of demand that makes it easier to subcontract than product from one’s own facilities? Any suggestions or answers from SCMluxe experts? Send across your thoughts and let’s incorporate it in a more detailed investigation of LVMH’s supply chain in the next few posts

Online Campaigns…..tailoring it to the audience

Though web and online portals are mainly used as channels for informing the customer and maintaining the brand of the luxury product (Refer E-Commerce for SCMluxe) , it is is an important tool of communication and the eventual buying decision. So an interesting study on the response of men and women to email campaigns by luxury goods caught my eye. The main differences between the sexes observed in the study were:



Luxury Chicks - funny or blase?

• Men click on links that are buttons or images more than on text. Whereas women tend to click on links which are “text”
• Women find “day in life” or messaging that conveyed a lifestyle. Men on the other hand preferred funny or witty messaging which was delivered in a quirky fashion
• And finally, men are more likely to open an email ad and respond to it than women would

Personalization of email campaigns especially with respect to subject, title, messaging and formatting is important to reach the target audience – hence we see Martha Stewart style images for home and fashion campaigns and Benetton features provocative messages. As to the links in the emails…do we do text or buttons …or is this all sexist nonsense in an increasingly egalitarian world?

Showrooming...what is it? and will it impact SCMluxe?

Brick and motor retailing involves not just an exchange of goods and services for a payment but providing the customer an experience of the product being sold. This is especially true in the luxury sector where the customer would like to experience the product, its values and the dream that is being propagated via the brand. Thus we see that luxury showrooms are opulent, carefully designed to provide the customer with this “experience”. This of course does not come cheap – it involves large overheads in designing, maintaining and running the showroom.

Traditional business has found online sales as a means to reduce these overheads. Once a brand is established, the e-commerce engine or web portal reduces the overheads of retailing to an almost negligible amount.  This leads to the ability to offer better prices/discounts online and hence we see the rapid growth in web sales on e-stores as compared to regular brick and motor stores. A recent phenomenon is one in which premium products where the customer would like to experience the product (fashion, watches, jewelry, high end electronics) in the showroom but avail of the better prices (due to lower overheads) offered on online e-stores. This leads to the concept of showrooming…where the customer visits the physical stores to experience and evaluate the product but buys it online. This increases footfalls in stores but with no conversion – the beneficiary being the e-store. 

Making sure window shopping is converted into actual sales?

Retailers have fought back by awarding loyalty points for in-house sales, deploying  innovative offers like mobile applications (see www.shopkick.com) which track and offer savings and points (kicks) which can be reclaimed for goodies in other stores  and in rare cases maintaining price disparity between online and offline sales channels to a minimum.

Luxury retailers have so far not been overtly affected since online sales channels are not actively used and price differences are kept artificially high (in e-stores). We also see that since experience and price is the deciding criteria for the luxury customer, we might not see customers resorting to showrooming. But in these recessionary times when even luxury is seen through the eyes of “value for money” will we see this phenomenon extending to the luxe sector as well? How will retailers react to it and what will be the impact on SCMluxe? Any thoughts or opinions?

Stock Outs and SCMluxe

Stock outs have always been used as a measure of the effectiveness and risk levels of a supply chain. This is mainly due to the retail sector wherein no stocks on the shelf mean a sale  (and revenue) lost forever to a competing product on the shelf. The manufacturing sector also uses stock out metrics to judge the risk levels of a particular inventory plan. For example, critical products like spare parts which B2B customers want on an immediate basis will have a zero stock out policy. This is since spare part non-availability or delay can mean the customer’s production line will have come to a halt. Hence these critical stocks always have very high safety stock levels vis a vis other less critical products. Generic products which can be substituted will follow a more aggressive stocking policy with lower safety stocks. What about the luxury industry? Do they segment products similarly?



IWC Exupery platinum watch. Note the serial number 01/01
limiting production to one piece to be auctioned for charity



As very nicely elaborated by Kapferer and Bastien in thier seminal  book "The Luxury Strategy" the luxury industry believes in limiting supplies to make the brand more desirable. Hence stock outs may not be viewed as entirely a lost sale (as in mass retail) but more as an addition to its brand value. Segmentation is the stock out strategy (or the tolerance towards it) is seen in the luxe industry as well. Limited edition products in absolute luxury categories are the norm. We see limited edition watches, chinaware (where the moulds are ceremoniously broken after production reaches a target volume) all the time to either commemorate a special event or simply to create a uber luxe and highly desirable product.  Similarly prestige brands are typically kept in short supply during introduction to keep interest from flagging and demand being satiated by flooding the market. Apple stores typically have long lines of eager customers camping outside stores on the eve of the launch of the new iPhone or iPad. Online sales are started much later in the sales cycle. Masstige brands on the other hand will start off with  both online and store sales with maximum volumes to ensure the market is fully exploited before competition is able to launch similar products and capture market share.

French aviator Antoine Exupery who gave us
"The Little Prince" and the inspiration for IWC



This segmentation of the stock out policy also has another important angle in SCMluxe – the ability to dispose off over stock. For uber luxe products (Refer post Disposing Overstocks) there is no channel for profitable disposal other than destruction of the product. Hence working on a tolerant zero stock policy by restricting supply also helps cut such losses from overstocking. Prestige and Masstige products on the other hand have channels for disposing excess stock in a more profitable manner and hence can afford to have less tolerant zero stock policies with more safety stocks built into the inventory plan

Roundtripping stock ... What is it? and why is it done?

Expensive inventory

Luxury goods inventories are expensive ...i.e not just the finished goods but also the raw material inventories. For most sub contractors or suppliers to luxury goods companies, this poses a peculiar problem - obtaining and managing credit lines. Though this is a problem faced by most upstream supply chain partners, in SCMluxe the problem is compounded by several factors such as:

•  higher working capital due to high cost of inventory
• seasonality in sales leading to stock pile up
• cash inflow not matching the outflow
• much longer cash cycle times

Hence SCMluxe suppliers are constrained in obtaining higher credit lines or getting them during the off-season when sales are low but production needs to be kept running to prepare for the high season.....roundtripping is one solution (albeit not entirely legal) that they adopt to manage the cash flow. This simply involves "selling" inventory to in-house units and then bringing it back after a certain period to avail higher credit lines from banks or financial institutions

An example will make this much clearer. Diamond polishers tend to have high stock of goods during lean times - especially with the current crises in the US and European markets. The hope is for the coming Christmas/holiday season or the "coming"  economic recovery to boost sales. To manage credit lines till then, these suppliers will parcel out large tranches of high value stock (large carat diamonds) to willing downstream partners (wholesalers/distributors) or in-house units. Higher credit lines are then obtained from the bank based on these higher reported sales. The stock is then bought back to the company either through returns or other such means (rework, to add further value by setting in jewellery etc). The downstream partner may or may not be compensated by a small token amount for his complicity. This process of "roundtripping" was specially predominant in Indian polishers till the government clued onto it and introduced a nominal import duty of 2% to curb such practises.

Swimming against the tide…Chinese luxe in Europe

While the stampede of western firms to sell to the seemingly insatiable Chinese market continues, a relatively unknown (atleast in Western markets)  Chinese luxury goods manufacturer is trying to forge a market in Europe.  An interesting fact is that Bosideng is not a manufacturer of typical “Chinese luxury” products such as silk or tea but is aiming at creating a global brand that is culture agnostic and appeals to the generic consumer of luxury products. With over 7579 retail stores and a market share of 36% in China, the company now seeks to move up the value chain by selling high quality clothing (with brands like Bengen, Snow flying and Kangbo) that would appeal to all well-heeled customers irrespective of their location (similar to the demographics of consumers like Christian Dior or Hugo Boss – a broadly homogenous well-travelled, mobile and high spending category of the privileged)

Red by Bosideng

Though there are some oriental touches to their fashion line, like the use of red piping on suits for instance, it is far too subtle to be plugged as “oriental”. It would be interesting to see how such a company would plan and execute its supply chain strategy while trying to move up the value chain – would it use abundantly available low cost labour and manufacturing in China? Would procurement be local or global or glocal? What would be the inventory stocking models? Let us look at some initiatives of Bosideng in SCMluxe while it is in the process of opening of its very first store in Europe in London’s trendy South Molten Street:

v  Procurement (or source) for the high end fashion line is from suppliers in Italy, Turkey and Portugal

v  Production (or make) is entirely out of Europe with only 7% being manufactured in China

v  Designers are commissioned from leading western brands such as Nick Holland and Ash Gangotra from the label Pretty Green

v  The main collection is restricted to 50 pieces at a time, so that new products are refreshed in the store on a weekly basis. This calls for a high inventory turnover and low levels of obsolete (out of fashion?) stock. Weekly refreshment of the collection will mean tighter controls over inventory and very short lead times. With manufacturing being local, logistics will be faster and simpler but demand forecasting will need to be very robust. Bosideng will have to err on the side of lower inventories risking stock outs. However in the luxury goods industry, stock outs may be a good for the brand?

South Molten Street, London

v  An all-out splurge on the retail store. With an estimated £6 million ($9 million) spent on its new property on South Molten Street, Bosideng is using a high cost sales channel instead of the cheaper option of using department stores (store in store).  This is because getting premium space for a newcomer is difficult in department stores  along with the problem of limited branding freedom

v  Alternative E-Commerce sales channel to be launched with a dedicated website for Europe. This move is to counter the twin challenges of a standalone retail store – (i) High Cost (ii) Low accessibility. The web sales model helps customers who cannot travel to the retail store locations as well as provide a cheaper option for sales

Obviously the above model of SCMluxe calls for deep pockets and staying power since the return on investments will take time. Will this high cost contra-indicative strategy of wading into a troubled market like Europe while the rest are heading East make profits? Or is it a well thought out strategy to establish a Chinese brand in the luxury market where these high costs may well be thought of as a part of the branding budget? Another interesting thought allied to this will be how the Chinese markets will be serviced with the above SCMluxe strategy? Currently Bosideng claims that for its high end suits, tweed is procured from European suppliers and shipped to China for tailoring before it comes back to Europe for the final finishing touches. Will this work for the Chinese market and will consumers want to purchase a local product at western prices? Bosideng may well provide us with an example of how the great leap East will play out…

Quick comparison of SCMluxe Retailing formats

While we have discussed retailing of distribution (Deliver) formats in posts (SCMluxe downstream part 2 and part 3), let us look at a quick comparison of the three formats in a tabular format for ready reference

Retail Sales Channel	Stand Alone Store (Boutique)	Store in Store (Department store)	Web Store (E-Commerce)
Cost	High	Medium	Low
Brand Value	High	Medium	Low
Accessibility for customer	Low	Medium	High
Flexibility in operations	High	Low	Medium
Control over operations (manage brand and communication independently	High	Low	High
Footfalls	Low	Medium	High
Footfall to order conversion rates	High (target footfall)	Medium (both targeted and accidental footfalls)	Low (mainly used to check out and compare product)

Though above is open to interpretation and in general self explanatory, if any readers want points above to be made more explicit, please write in and I'll be happy to have a more detailed post on this