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The Luxury Goods Gray Market

In 2021, Bernstein valued the gray market at ~8% of the total ~$250bn luxury goods market. It's a significantly higher percentage in China. The ‘gray’ market, also called the parallel market, is notoriously opaque. It’s the unwritten rule in the industry. If you have overstock, which is likely every season, gray market operators will sell it for you.

A wholesaler typically acquires products from manufacturers at 40% of the RRP. If the product doesn’t sell, gray market operators buy it for 20% of RRP, at least a 50% discount from wholesalers.  

Selling through the gray market is technically a breach of wholesale contract. Wholeslaers can only sell product in their own stores. But brands seem to turn a blind eye. The manufacturers need the wholesalers to place orders for the new season. Without clearing overstock, wholesalers won’t have the capital to place new orders. 

Their contracts stipulate they can only sell in their store and on their websites. However, the brands know they have too much inventory. If I'm a wholesaler and I purchase from you, let's say, you have Gucci, and I buy five million for this season. Next season, if I ask for seven million, there's a high chance you'll say no unless I can show proof. The brand itself will say no because they know that extra two million might be wholesaled at a margin to a third party. This is a common occurrence in the luxury fashion system. - Founder of Cettire Competitor

Brands like Gucci and Dolce & Gabbana seem to be frequent indirect, and sometimes direct, users of the gray market channel. 

Bottega Veneta and Gucci, part of Kering, engage significantly with the gray market, which they refer to as J2 internally. It's something not only done by wholesalers or Australian companies but also internally within the brand and externally. This is why Gucci, for example, has grown so rapidly. However, when I worked at Gucci, the parallel market was very dangerous. I think the problem with Gucci is that they saturated the gray market. They sold too much to the gray market, which is the danger. When you saturate the gray market, you lose the image and the luxury perception. - Former Kering Executive

While tempting, stuffing the gray market with overstock doesn’t protect brand equity. But it seems to be a crucial cog to recycle capital and drive new order growth throughout the luxury system. These two interviews are the first in a series on how the luxury gray market functions. We’re exploring how the brands are approaching distribution, the durability of the gray market, business models like Cettire, and the principles of quality luxury goods distribution. We plan to publish our learnings in more detail over the coming weeks. 

Fever Tree vs Q Mixers: Off-Premise Sales & Distribution

The premium mixer retail category is odd. It’s non-alcoholic but not a soda. It’s paired with spirits but can’t sit together with spirits on the shelf. US liquor laws are also different by state; some states allow liquor in grocery stores, others don’t. This causes retail shelf placement to be different across the US. The volume and rate of sale doesn't drive enough gross profit dollars for retailers to pay attention. For Kroger, premium mixers is the second smallest category:

The velocity is low, meaning the number of units sold per store, per week is small. Mixers are almost an afterthought in the grand scheme of grocery store sales. It's not a very big category. I believe it was the second smallest category that Kroger plans for. In the overall scope, it's tiny and doesn't have much impact. - Former Sales VP at Q Mixers

The low gross profit per unit means retailers don’t look to promote items on display. This dampens customer activation which pressures volume growth. If you can’t pair the mixer with the spirit on the shelf, and you can’t activate customers via displays, how does the customer know how to buy and use the product?  

It's really challenging. For example, sampling is an obvious method. If you're trying to get people to try something new, you do sampling. However, sampling now is very diluted because every state's different. Implementing it in big national chains that operate in multiple states is complex. The effort to tailor the program for each store in each state isn't worth the results. Another challenge with sampling is that unless a retailer builds a display to support your sampling, you typically run out of what you're selling in the first 30 to 60 minutes of a demo. If you have a four-hour demo without a display and rely on the shelf supply, you've incentivized people who can't purchase the product for most of your demo. Coordinating displays is tactical, not strategic, but it makes a huge difference in how much product you actually sell because you can't convert it. - Former Sales VP at Q Mixers

All these variables compound to make premium mixers a tricky retail category. But this is the hypothesis of why FEVR may have an edge. Its distributed differently than Q; Southern Glazer's has the power and distribution model to merchandise Fever-Tree in-store:

Fever-Tree is different because they are with Southern Wine and Spirits, the largest distributor in the US. They can cross-merchandise since all brands come from the same delivery truck. Fever-Tree has a portfolio, whereas Q Mixers is its own company with three main distributors, unlike Fever-Tree. - Former Sales VP at Q Mixers

This interview with a Former Q-Mixers off-premise sales executive walks through how to sell premium mixers to Kroger and Walmart and the difference between FEVR and Q off-premise distribution. How this translates into long-term US organic growth will be critical to get Fever-Tree off its 8-year lows.

Hermes: New Collections & European vs Asian Customer

Hermes is one of the most desirable brands globally. It's Kelly and Birkin bags have stood the test of time. However, according to a former Hermes Merchandising Executive, this level of desirability is running the risk of going too far...

I believe that for many people, owning an iconic bag from Hermès is a significant goal. In terms of brand value and public perception, Hermès is very aspirational. Even though the number of clients has decreased, the desire to own the bag remains strong. However, the issue today is that many European clients feel it's too expensive and difficult to obtain. This lack of accessibility could be dangerous for the brand because people dream of it, but it's becoming too much of a challenge to acquire and too costly. This could potentially alter the image of Hermès as a familiar, French brand known for doing things right, and shift it towards being seen as too luxurious and edgy, losing accessibility. I think this poses a risk for the aspirational customer. - Former Hermes Merchandising Executive

Industrial Holdcos: Danaher, Lifco, Perimeter, Diploma, Halma, B&B, Lagercrantz, Addtech, Judges

Over the last five years, a core area of our research has focused on industrial holding companies that have built incredible track records creating shareholder value. Our research is built from over 200 hours of interview material on our platform covering industrial acquirers. These acquirers are companies that conduct programmatic acquisitions of durable, niche industrial assets with high returns on capital and low-single digit organic growth. The combination of ~5% organic growth plus 5-7% of inorganic growth leads to a diversified and durable earnings stream that can compound for decades. 

But M&A is risky. As we all know, on average, it destroys capital. So how do companies like Danaher, Lifco, Halma, Judges Scientific, and the Bergman & Bergman spins create so much value? 

We've focused on understanding how acquirers are organized to scale, what makes an effective M&A framework, the post-acquisition operational playbook, and incentive structures throughout the groups. Each company follows a similar corporate strategy but operates in a slightly different way. This IP Research Roundup curates some of our learnings on industrial acquirers over the last five years.

Tesla: Gigacasting Manufacturing Fundamentals

For the past several months, we have been studying Tesla's vertically integrated approach to its repair network to better understand how it could lower the average cost of repair, leading to lower insurance premiums and lower cost of vehicle ownership.

Tesla's gigacasting method of manufacturing cars, while very efficient for production, potentially introduces some repair challenges. In this interview, a former Project Specialist at ŠKODA takes us through the fundamentals of the gigacasting method for manufacturing cars using aluminum and helps us uncover the challenges it introduces throughout the lifecycle of the vehicle.

If you use a different metal, you get the disadvantages of that metal, such as high weight. Because metal is less liquid, you would need to use higher forces, balancing all the pros and cons. In the end, you will likely end up using aluminum anyway. It's not about casting. Even if you have an aluminum sheet and a metal sheet, when bending, you can nicely bend a metal sheet of some thickness. However, if you do the same with an aluminum sheet, it will crack at some point. - Former Gigacasting Project Specialist at ŠKODA 

ADESA: Power Dynamics Post-Carvana Acquisition

Even though Carvana purchases most of its cars from retail customers, auctions remain a useful channel to get access to low mileage, high quality, and newer vehicles. Large fleet owners like banks and car leasing companies can dispose of vehicles at scale and speed and without transporting them large distances like when using local auction locations.

In this interview, a former Director at KAR Global sheds light on the negative effect the ADESA acquisition had on Carvana.

"Then they bought ADESA for however many billion—was it three billion or something like that? I forget the exact number. Instantly, everyone was questioning their decision. There had to be a mass exodus. I know it was starting, and I can't imagine they didn't lose a lot of their business because the auction is driven not just by small independents who might not care about Carvana, but on the dealer side, they really rely on ADESA. They depend on them to buy their factory sale cars, their frontline stuff, and sell from there." - Former Director at KAR Global

Manhattan Associates: WMS Customer Switching Costs

In this interview, a former Senior Executive at GXO Logistics sheds light on the challenges the company faced in developing and maintaining its in-house warehouse management software and how alternative off-the-shelf solutions are prone to dominate the market.

"Let's say you launch, and then there are small changes. I'll use inbound receipts as an example. We get a new vendor and realize we need to adjust how they send us stuff. Someone locally, either on the OMS side and/or the WMS side, might make a small tweak to account for that. It's only in that version and that specific instance. Now, if I do a mass upgrade because I've tested it and it should work for everything, it might miss these individual instances where adjustments were made over the years - Former Executive at GXO, a Manhattan Customer

Vitrolife: Igenomix Economics & Insourcing Risks

Vitrolife spent EUR 1.25 billion, more than 10x sales for Igenomix, a genetic laboratory services company. Almost a third of the purchase price was written off in January 2024. We interviewed a former Igenomix executive to understand the business, its fit within the Vitrolife portfolio and the potential risks.

Those were the prizes. If you could land them, it would be amazing. I'm quite surprised we did as well as we did in the UK. You could translate this success across other territories as well. I'm surprised we did as well as we did, considering we struggled to get the big groups. TFG was another one. Fertility Group was pretty much Coopers, and then a little bit Juno towards the end. So we were sort of picking off the other non-networked ones.- Former Commercial Executive at Igenomix

As PE consolidates IVF clinics globally, Igenomix is dealing with larger and larger customers.

"But actually, as time has evolved in the UK, the number of those independent ones has reduced. CRGH, which was a very large IVF provider and pretty much doing all the different genetic tests, got acquired by Future Life. Future Life has its own laboratory. - Former Commercial Executive at Igenomix

However, consolidated clinic groups are in-housing PGT-A testing, which is ~50% of Igenomix revenue.

However, the downside is that some, like IVIRMA, do their own in-house testing. It's a question whether Juno Genetics is in-house, but it's essentially a spin-out, making it a closed shop except for certain tests. Another group in the UK, the Care Group, seems to work almost exclusively with Cooper, making it hard to break in. It wasn't even pricing that was the issue; it was multi-layered. - Former Commercial Executive at Igenomix

We are planning on publishing a written piece of research on the in-housing risk Vitrolife faces across its portfolio later this year.

Kinsale Capital: Culture

In this interview with a former Senior Executive at Kinsale Insurance, the culture, management and source of the cost advantage are discussed in more detail.

Kinsale and Brian have a habit of hiring many employees straight out of college. I would say 50% to 60% of their employees have less than five years of experience. This keeps salaries low, and along with commissions, helps maintain a low expense ratio. - Former Senior Executive at Kinsale Capital

These less experienced employees and IT infrastructure are the main drivers of the lower expense ratio. The strict underwriting policy & targeting new markets like cannabis drive the superior loss ratio.

They're rather restrictive on the casualty side. On large property accounts that I've underwritten, you try to align with the terms and conditions of the primary insurer. If company A is writing the primary $10 million, and you're writing excess above $10 million, you have to follow the terms and conditions of that primary, or you won't be used. So that's the big difference between property and casualty. Casually, it's take it or leave it. Goodbye. For property, you have to do a lot more negotiating on terms and conditions, exclusions, endorsements, etc., to partake in the layered insured business up to whatever hundreds of millions they're limited to buying. - Former Senior Executive at Kinsale Capital

Westwing: EU Online Furniture Market Opportunity

In this interview, a former Senior Executive at Westwing sheds light on the furniture retail market in Europe and how the company is navigating the logistical challenges of succeeding online.

"The downside is that they have closed some warehouses. In terms of cost, it's a good decision, but now they only have two big warehouses between Germany and Poland. The larger one is in Poland, and the smaller one is in Germany. Previously, we had warehouses in Spain and Italy. The downside is the logistics timing. Now, when you buy a sofa, for example, you have to wait more than four weeks to receive it. They're starting to get negative feedback because of this. Previously, products were delivered faster. - Former Senior Executive at Westwing