Interview Transcript

Disclaimer: This interview is for informational purposes only and should not be relied upon as a basis for investment decisions. In Practise is an independent publisher and all opinions expressed by guests are solely their own opinions and do not reflect the opinion of In Practise

Regarding the Hermès quota bags and their importance to the brand, which we discussed last time, from what I've heard, around two-thirds or three-quarters of leather goods sold are from the quota bags, like the Kelly, Birkin, and Constance. In your opinion, is this accurate?

Yes, in terms of value, I would say it's almost two-thirds.

You mentioned last time that to keep the Kelly, Birkin, and Constance bags desirable, Hermès needs to balance the offer by giving access to new clients while also tending to existing clients. In your opinion, what share of these bags are sold to customers who have purchased one before, and how many go to customers who have never purchased a Kelly, Birkin, or Constance before?

It really depends on the store, the management, and the sales personnel. For example, in Europe, especially in Paris, it's easier for French or European clients to access the Kelly, Birkin, or Constance. For Asian clients in Europe, it's challenging to have the experience of buying a quota bag there. However, in their local stores, it might be easier to access them. Most of the time, the unofficial rule is that Asian, especially Chinese clients, need to purchase another bag before gaining access to a quota bag.

Would you say, if we consider an average across global regions, which is challenging, I understand, but perhaps using Europe as an example, would you say 50% might go to a new customer who hasn't purchased one before, and the other 50% to someone who already owns one?

I would say 60% of clients purchase the quota bags as their first bag, and 40% as a second or third bag. I say this because we have a historic clientele with access, and then we have exceptional clients who also have access. So, yes, I would say 60/40.

It must be quite a lot if there's a limit of two quota bags per year, indicating many people come for a second or a third bag.

They manage to maintain the durability of the bag because it's so difficult to get one. They are willing to wait a year or a year and a half to get the second one. It takes time.

And in the meantime, they spend on other things as well.

Yes, sure. I have a good example from the Paris store. The boutique on Sèvres, not the flagship on Faubourg. A very wealthy client spent more than €45,000 on various items, but was not offered a Kelly or Birkin bag. They really choose the clients they want to offer bags to.

Yes, I've heard that. We also discussed recurring customers and their pursuit of quota bags. How relevant are customers who purchase four to five times or more per year compared to those who buy one item every couple of years?

Are you referring to small goods or all items in general? The idea is to propose something new each season. I think a good client purchases at least twice or three times a year. However, as I mentioned before, there's freedom in buying. In Shanghai and New York stores, the offers are different. A client who travels a lot and is loyal to the brand will visit stores in different locations. If they travel frequently and have a good relationship with various sales associates, they can have diverse experiences and access to many bags across different brands and stores. It depends on who your reference is, how much you travel, and where you buy most of your items. With a good relationship with your vendor, you can be offered many things. Aspirational clients might spend twice a year, while high-end clients might spend around [€500,000] per year, it depends.

How significant is the segment of clients who travel frequently and purchase three to four times a year in different stores? Are they a large part of the clientele, or just the top 1%?

I would say 10% of the clients. There is a lot of high-end clients for Hermès, especially in leather goods. To have access to these kinds of exceptional pieces, you have more aspirational clients for items like jewelry, silver, scarves, perfumes, and jewelry accessories like bracelets. It's easy and there's a lot of volume, but in leather goods, a portion of the clients are very high-end. For bags and small leather goods, it's quite a different approach.

Is that then more targeted at the aspirational customer?

Again, you have both aspirational clients and those who want a complete collection of leather goods or bags that match with leather goods. They want exceptional pieces inside their bags. For example, they might buy crocodile exotic skins in small leather goods. It's like a very precious item they want to have. It really depends on the relationships you have with small leather goods. Hermès has many Japanese and Chinese clients who love small pieces like that.

And in terms of production, we also talked a bit about production constraints last time. You mentioned that Hermès really has, as I understood, constraints and scarcity across all product categories. Did I understand that right? That these constraints are a problem or need to be considered across all métiers?

The production process for leather goods is very specific to the métier. Speaking of production, I know that shoes have the same approach with best sellers like Oran and Chypre items. These items are more linked to seasonality, so they have to stick to the production plan, which varies each time. For ready-to-wear, they are more linked with Italian factories and seasonality as well. It's not the same know-how as for ready-to-wear. Then you have jewelry and high jewelry, which are very linked to the purchase of materials. This really depends on the international market at the moment. Sometimes it's very difficult to purchase the raw materials, and then it becomes easier. They work on this.

That's another thing. Are there specific métiers or materials that Hermès is considering bringing more in-house in the future? Anything that would make sense?

Yes, it makes sense, and it really depends on the technique. Today, for example, shoes are booming. I think it's the second category for Hermès now. I'm not sure they're going to internalize it because they have all the techniques in Italy. They know how to do it, and they are quicker than if Hermès were to do it locally. They prefer to go to experts and maybe gain the expertise afterward. Or maybe the strategy is to own the business, then perhaps they can rebuy the factory just to be exclusive. At Hermès, it could be something they do. It's something they do for hardware on bags and metallic pieces in general. At Hermès, most of the time, when they have a good factory with whom they work, they gain ownership of the company. It's the same with jewelry; when they have a good relationship with the supplier, they take ownership. So it really depends on the strategy per métier and how they need to be reactive in the market.

You know, most of the time, when you have a supplier that works for other brands, the good thing is that if you have a good relationship with them, you remain competitive. When you work with a supplier who works with other brands, the costs are more aligned with the competitors, so it's easier if you want to maintain good costs.

That makes sense. I don't know if they are more flexible, maybe also in terms of production quantities. I mean, if you own the manufacturer, I would imagine that you, of course, have to manage the production quantities, and you're less flexible in that regard.

Yes, but Hermès has its own quality standards, and they really adhere to those quality standards at every step.

Another thing we spoke about last time was pricing. You mentioned that when a new item is priced, the cost of production is considered, and then the company adds a margin to derive the retail price, right? So my first question is, does this production cost include materials and labor in terms of hours worked, and then the margin is added on top?

Yes, it includes materials and labor. It depends on the line, as well as the R&D required for the product. It depends if you want to impact this on your first production or if you keep it aside. It really depends if it's a one-time thing or if it's something you want to implement in the future. For example, if you want to do an animation with a specific color and need to invest in a machine for that, is it a one-time thing and you externalize the cost, impacting your production cost, or is it something you would like to do over the next five years, which would require a different budget?

So that's usually more applicable to novelties rather than carryovers.

The second question would be, how does the company determine the margin added to the production costs, and do these margins change frequently? Would it be one margin this year and another the next year, or is it quite stable?

When calculating the margin, you work in two steps. First, you consider the cost of production, and then you apply a margin to determine your wholesale price. By wholesale, I mean the price at which you sell to staff and for resale.

Each retail store also has a margin. The margin from wholesale to retail is officially six, and it remains consistent. The margin from production cost to wholesale price has a range, and you must adhere to this range. When I was part of the team, I worked on the pricing. You have a target margin to achieve, and if you don't reach it, you need to negotiate and justify why.

It's how you balance your collection. For example, with a novelty item, it's often challenging to meet the target margin. You might decide to produce only 100 units to minimize the impact on the total margin of your collection. Alternatively, you might have a line with a very good margin that can offset what you can't achieve with another. It's about balancing everything to maintain a good overall margin.

It's not about each line individually; you have a global target to reach, and you can adjust by line. If you launch something new with a poor margin, it's acceptable for the first season. However, if you enter the market and increase volume, you risk maintaining a poor margin or needing to raise prices quickly, which can be difficult for clients to understand. As I mentioned, Hermès does not benchmark against competitors, but you do conduct an internal benchmark.

You must be very conscious of this because when you set a price for a new bag, it becomes a benchmark. In terms of value perception across your collection, this can be an issue. If you price a new launch too high, all subsequent launches will have poor margins. If you rely on poor margins initially, it can be problematic. I hope you follow me; it's crucial to balance everything because you must justify the pricing.

When creating an object, you must be transparent about the fact that it's crafted from beautiful materials in a workshop. It takes time, as one person makes the bag. If you want the quality you see, you must set the right price; otherwise, you jeopardize what you produce.

You want to maintain prices for future benchmarks, so you must consider the entire construct.

Yes, and it's important to show the true cost of things. When I was there, we had discussions about this. It's Hermès' role to demonstrate the cost of producing things correctly and maintaining luxury. This is true luxury—the real price. We aren't here to seduce customers with gimmicks or to compete on price. It's about professional integrity and setting our own price. That's how we push things forward.

Hermès has had more price increases in recent years compared to the historical average. Are there any regions where Hermès has faced more resistance from customers to these price increases?

Yes, in Europe, it's challenging to increase prices due to cultural factors. Hermès is reaching a high price point, and the wealth levels aren't the same as in China or India. We still have customers, but sometimes it's too much, especially in Europe and France, which are historical markets for Hermès. Internally, we've discussed that Hermès is traditionally a brand for French people, offering important items for key life moments. We feel we're losing that. In Japan, if the price is justified by quality, it's acceptable, but they aren't sensitive to logos. In China, price increases are accepted for "wow" pieces or small items that justify the price.

The brand image is likely very valuable there as well.

Yes.

We'll see how this develops, as prices will likely continue to rise. It remains to be seen which customers might be outpriced.

I'd be interested in your view. Three years ago, during high inflation in Europe, production costs increased, especially for Italian suppliers, which was unsuitable for clients. When everything is increasing, the cost of goods is expensive. But when luxury brands still increase prices, it's hard for customers to understand. It's difficult for customers to comprehend.

I agree. I've spoken to many customers, and for Hermès, it's not as critical as for other brands. Customers see the value and view it as the top of the luxury pyramid. They notice competitors like Chanel and Louis Vuitton increasing prices even more. They aren't happy about it but acknowledge that Hermès hasn't increased prices as much, which is acceptable to them.

It was more about the comparative price increases where customers became upset with some brands. These brands were not as good in terms of quality and craftsmanship but were still raising their prices to a level that didn't match the product's value anymore. That's what I've heard from my conversations with customers.

In terms of the market, it has been slowing down quite a bit, partly due to China. We will see what happens next year regarding price increases. I hope it won't be as aggressive. Regarding product mix per region, as we discussed, I'm interested in how Hermès tailors its product offerings in response to regional preferences. For example, are there collections mainly designed for Asian customers?

Not really. Collection teams develop their briefs explaining how China defines a bag and what they would like. However, there is no specific moment where they say, "This is for Asia, this is for Europe, this is for Japan." Some time ago, they were trying to work on something for China, but it was more focused on men's goods rather than women's. For women, we know what Chinese clients prefer, so the idea is to maintain the desired items and create good animations. If a brief is done, it's more for men's leather goods.

The specific preferences of male clients are quite different from female clients. Men tend to look for functionality but also want to have an emotional connection with the product, making the offer more challenging to set up.

Are there any other initiatives that Hermès undertakes to build brand loyalty with Chinese clients, especially given the increased competition there?

Regarding Chinese clients, they are working on specific initiatives to push the offer on small leather goods for them. It's interesting because, from my perspective outside of Hermès, in the other company I work with, China is not a strong market for small leather goods. It's more Japan.

In Hermès, I think it's the leading market because they know how to do something unconventional or very different, which becomes a unique piece for the customer. It's more challenging for Hermès to be innovative, yet it's easier to suggest a variety of items for changes. This is more my feeling, not necessarily what I know from Hermès. In Ready-to-Wear, they work more for Asian-specific needs, particularly in China and Asia in general. It's more fashion-oriented, and they focus on regional-specific needs.

Since Covid, this approach has evolved because many stores have developed their own clientele, which is larger than before. Now, they host a lot of local events like pop-ups, store openings, or events aligned with the calendar, such as Chinese New Year and Valentine's Day. When they do the buying, they focus more on local offerings for specific events. This wasn't done in the past, but now it's more emphasized. For example, certain quotas are designated for the Lunar New Year, and they aim to have exclusive lines or items. They are working on visual merchandising and store animation around these events.

That's interesting because I've heard that Chinese customers are now buying more locally in Asia rather than in Europe. So it makes sense to do that.

Previously, part of the experience was to be in France or Europe to buy because you had larger stores and the DNA of Hermès was more present there. But now, they have developed exceptional local experiences, making it easier to find something you like and have a pleasant experience locally.

You also mentioned last time about India as a potential growth market for Hermès. Are there any unique challenges or considerations that Hermès should anticipate when launching in India? Anything specific about market entry?

Not especially, but I might have mentioned that Indian customers are well attracted to high-end pieces with savoir-faire and craftsmanship. They are sensitive to that, which is something Hermès will focus on.

Additionally, there is a trend of new wealthy individuals who can access the brand. The idea is to introduce them to the brand or educate them with pieces that are not overly localized, to avoid being too new to the brand. It's important to maintain a good balance, otherwise, it could lead to an overemphasis on logos.

There are two types of customers. The ones that are very sensitive to high-end pieces, and allure of the savoir-faire and handcraft. The others are customers who have access to the brand and are seduced by the logo. It's easy for Hermès to sell to these customers but it's not the right way to promote the brand.

It's a journey and a balance, right? Something we didn't discuss last time that I'm really interested in is how you would describe the culture at Hermès and the leadership from an employee perspective.

There's a lot to say. First, speaking about the general management and spirit, it's very much a family brand. You really feel that the owner, Axel Dumas, and the artistic director, Pierre-Alexis Dumas, are deeply connected to the company. It's something from their family.

The board includes family members, and each season when you present a collection, it's not just to the market but also to the family. They are all in the same room, and they have input. It's interesting because they might say, "Oh, I like this," or "I would have done it differently," and you have to listen and consider their feedback. So, in this sense, it's really a family-oriented environment.

Many people have been working there for a long time. For example, when I was in leather goods, I worked with the sample office. The person there started when she was 16 and is now 60 years old. At Hermès, artisans tend to stay because they are key to the house, becoming experts who know everything, and everything revolves around them.

The same goes for top management. My team director was there since her internship and was 45-years-old. People are very loyal to the brand, experts in their fields, and they take their time to do things. This gives real stability to the team.

When you leave Hermès, you realize that Hermès takes its time. Every project is approached without rush because there's no seasonality. The goal is timelessness, so projects can take the time they need. People stay in their positions for an average of five to seven years, so it's okay for a project to take a year-and-a-half.

There's no stress around that. It depends on the office. In my team, for example, we were on the front line, working a lot under pressure to achieve results. But on the artisan or production side, there's a different rhythm with no stress, allowing for the time needed to complete tasks.

It really depends on where you work. One downside of Hermès is that many people spend almost their entire careers there, so salaries aren't particularly high. However, for outsiders coming from other companies, it's very interesting. Generally, people aren't well-paid, but they are passionate and very loyal to the brand. It's almost like a gift; people feel privileged to work for Hermès.

What would you say is the management's vision for Hermès in the future? You've probably met the management as well.

It's about stability and maintaining growth. Given the growth over the past five years, it's a big challenge to sustain it. Top management is under pressure to achieve this and must organize teams accordingly. However, the teams have been here for a long time, so implementing new changes can be challenging. There can be discrepancies between management's goals and Hermès' capacity to implement them. They manage it well, though. A significant issue is how to preserve and transmit the expertise of current experts. This knowledge is hands-on and intuitive, not something you can document in an Excel file. This expertise is difficult to implement within the company, and it's one of their biggest challenges.

It's this great craftsmanship that attracts people to Hermès. It's crucial to maintain and pass it on to the next generation.

Absolutely. In terms of management, it's similar across luxury brands. People have been here for a long time. It might be beneficial to diversify their top management to bring fresh perspectives and innovation. It would help them understand external practices and be more innovative.

How does Hermès support employee growth and career progression? Since many people have been there for a long time, how is that managed?

It's quite challenging for them. I'm not sure they're very strong in career management. Their HR isn't like those at L'Oréal or other companies. You often stay in the same position for a long time. As a junior, it can be difficult because you want things to move faster. Initially, I thought, "I've been in the same position for three years; maybe I want to do something else." But when you interact with artisans who've been here for 20 years, you realize the importance of being relevant. It takes time to gain expertise, which is why it often takes five to seven years. However, they don't train you to be a good manager or team player. You become more of an expert than a manager. It's good training, but if you want more, it can be quite difficult.

In terms of key management or key executives, who would you say are the key executives at Hermès, and what are their roles in terms of function? How are they perceived within the company?

Are you referring to the COMEX (executive committee)? Yes, you have Axel Dumas and then the COMEX. The COMEX is very present. You don't see them often. However, when you need to present the strategy, which is done annually, or present the collection once per season, you have some points of validation with them. Then, you have the Director of Métier who really leads their métier, and there is a coordinator for each director of each métier, who is more operational and works with the team.

Is there anyone who stands out to you? Any key executive you feel had a significant impact on the company?

There is the artistic director, but at Hermès, the artistic directors are not the strong personalities of the house. They are usually working alongside the CEO of each métier. The artistic director provides the creative impact, while the CEO provides the business impact. For example, Véronique Nichanian from Men's Ready-to-Wear has been there for about 30 years. In Women's Ready-to-Wear, the director has been there for almost 10 years. In leather goods, there is a director of the studio, but not an artistic director.

Similarly, in leather goods and other areas, there is a head of the studio, but they are not well-known artistic directors in the industry. Hermès had strong designers in the past, like Martin Margiela, Jean-Paul Gaultier, and Christophe Lemaire. However, they are not following that strategy today.

Why do you think that is?

I believe it's a way to demonstrate that they are timeless and not tied to the fashion world. However, having someone in the spotlight could help establish a real signature.

The current strategy is certainly less risky. When you look at other brands, there are no scandals, and the brand remains above the designer, right?

Yes, exactly. For instance, with exotic skins, about five years ago, Chanel faced an issue during a fashion show. Hermès decided to remove all exotic skins from their fashion shows and be cautious about displaying them in stores. They aim to maintain a low profile, and that's acceptable.

Another question, as the brand is currently very family led. How do you see the succession of the top management evolving over time?

Today, we don't have anyone in the discussion working outside Axel Dumas. We have Wilfried Guerrand, who is within the company and manages all accessories and ready-to-wear. He is the head of all departments except for small goods. He plays a significant role in the business, but he doesn't have a say in the product. For example, when it comes to a final review of the collection, he will validate it and say, "Okay, go for it." I'm not sure if everyone is doing this at Hermès.

It will be interesting to see. It's certainly not time for that yet, but I imagine it will be someone from within the brand who has been there for quite a long time and has had a similar path to Axel in the company.

Zooming out a bit and looking at the luxury industry as a whole. Since you've worked at other brands, you might have a broader perspective on the sector. Can you comment on the average gross margins of a luxury brand for the main product categories, like leather goods and ready-to-wear?

I think the most impacted today is the leather goods category because, in most companies, they lead the business and have good margins in general. However, leather goods are the category where you enter the brand, and almost everyone can access it. The major challenge today is to manage entry price lines with good quality to retain customers, as they are losing them due to increasing prices.

For ready-to-wear and fashion in general, it's quite similar. In the past two years, we focused more on luxury with beautiful materials and simple shapes. But in a luxury brand, prices are so high that when you enter, you want something different, with singularity, and you want to know why you are buying from this brand.

If you think about leather goods, for real luxury brands, the cost of a leather bag isn't like €50. That's just not the case. So, from cost to retail, considering the whole markup, for any luxury company that produces in Europe and not in China, would you say the markup range is around three, five, 10, or what?

I would say between five and 10, producing in Europe.

Is ready-to-wear and fashion accessories less, I imagine?

It's more, it's around 10. They have very high markups on ready-to-wear, especially on denim and jersey. It depends on where you do the production and how you sample it. For example, if you take a coat with a very poor lining but a beautiful exterior, this can affect the margin, sometimes by 10 or 12 times.

Perfumes have been a part of the brand, but beauty is relatively new to Hermès. Would you say this is challenging for the brand in terms of margin dilution, or does Hermès try to maintain consistent markups across categories?

I'm not sure. They have a markup strategy, but I don't know if it's linked to perfume. They need to be competitive in beauty, similar to their approach in perfume. It's more about marketing and price point.

Yes, that's what I've heard too. Development and marketing are crucial for beauty and fragrances compared to other materials, especially for leather goods at Hermès. You don't really see leather goods advertised.

That's not part of the company's strategy.