Wednesday, May 11, 2005

The Price is Always Right for Luxury

On May 2nd, a Warburg Pincus and Texas Pacific Group acquired Neiman Marcus, a luxury goods retailer, for a handsome price of $5.1B (a price to earnings ratio over 25). How did a retail chain with only 35 namesake stores justify such a high valuation?

This question is particularly interesting given the current dynamics of the apparel retailing sector. Understanding the high-end retailing environment that Neiman Marcus operates in, and its competitive strategy compared to other players in this sector might help answer this question.

Neiman Marcus is focused on the ultra-wealthy, high-spending consumer segment. Its top 100,000 customers spend over $1.2B annually, with the average customer spending $11,000. Even more importantly, this is a growing segment in the US, with 1 in every 125 citizens being a millionaire. These customers can be notoriously fickle, desiring not only the best merchandise, but also exceptional service. The good news: they are willing to pay top dollar for it.

In the luxury segment, Neiman faces competition from two major players, Saks Fifth Avenue and Nordstrom. Neiman’s continued focus on the high-end customer base, even during the post-9/11 market downturn, has paid off while Saks’ decision to move down-market has hurt its image. Recent restructurings, budget cuts and a general lack of focus put Saks at a disadvantage against Neiman’s strong focus on merchandising and customer-service. However, Saks is turning around and a turn-around at Saks is likely to slow growth at Neiman.

Nordstrom is focused on the same customer base, but its strategy involves creating and promoting its own private brands. While there is some overlap between the store locations for Neiman and Nordstrom, their different strategies result in significant differentiation between the two companies.

Neiman also faces competition from its suppliers like Prada and Gucci, who are opening their own showrooms in the US. However, since these companies are likely to showcase their own products only, Neiman should not be significantly affected by their presence.

Hence we believe that Neiman is in a good competitive environment with room to introduce policies that lock in their customers with Neiman.

Neiman has recognized the needs of its customer base and instituted several policies that build on its competitive advantage:
Exclusivity: Over its 90-year history, it has only opened 35 stores (and 2 Bergdorf Goodman stores). By employing such selectivity, Neiman maintains its aura of exclusivity as well as sales per square foot of $555 versus $350 for Saks.
Shopping Experience: Neiman has converted mere shopping into an exclusive “experience” for its high net-worth customers. Its museum-quality art collections and lavish InCircle members-only fashion shows and events serve to emphasize its brand image.
Employee Training and autonomy: Neiman maintains best-in-class customer service through extensive training and investments in their sales representatives. New employees get 200 hours of training in the first year and 160 hours every year afterwards. Employees are encouraged to cultivate personal relationships with customers. Customers are given coupons to reward exceptional customer service.
Rewards program: The InCircle program, instituted in 1984, integrated branding, customer service and promotions into a customer loyalty strategy is still considered by some to be the best loyalty program ever. The program emphasizes the exclusiveness of shopping at Neiman, and its members account for over 50% of the company’s revenues. The program generates incremental sales, protects against competitive promotions and also encourages new-member referrals. Membership is reserved for the highest of the high-spenders, and members receive “soft” benefits like an 8-night excursion to India. These rewards in turn emphasize the “exclusive experience” image of Neiman Marcus.

Current company policies have provided strong competitive advantages in acquiring and maintaining Neiman’s high-spending customer base. However, the company does face some significant challenges moving forward:
Given its exclusive image, new store openings must be very limited. Opening too many stores may dilute its brand and strain its ability to offer best-in-class customer service and its InCircle rewards. Generating future growth in the US through new store openings will be difficult.
Considering the saturation in the US, Neiman may have to seek growth in international markets where its experience is limited. It would also have to build local operations, usually an expensive and time-consuming task.
Given its turn-around, Saks might re-emerge as a formidable competitor in this market.

Neiman sources its products from a variety of suppliers, none of whom account for a major portion of Neiman’s revenues. Its relationships are currently symbiotic; customers visit Neiman because it offers the suppliers’ brands, as well as superior customer service, and the suppliers see Neiman as a major distribution channel for their products.

Barriers to entry
While the barriers in this market are not very high, Neiman has managed to erect formidable barriers through its InCircle program, it’s well known customer service and its brand that has become synonymous with luxury. We believe that these barriers give Neiman a strong competitive advantage in this market.

Given these facts, we believe Neiman occupies a strong position in this market. By converting shopping into a luxury experience and focusing on customer service, Neiman has managed to foster loyalty in its rich, largely price-insensitive, customer base. Its future growth and success will depend on how well it can leverage its core capabilities to newer, possibly international markets.

Written by: Shatabdi Basu
Sarah Lee



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