Salvatore Ferragamo & Luxury Retail Unit Economics

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.

Ugo, can you provide some context to when you joined Ferragamo and the luxury industry a few years ago?

I joined the luxury industry from a background in high-end retail, with the leader in the hearing aid market. We worked with an average selling price that’s possibly higher than the average selling price of the luxury world, in the region of €3,000 to €5,000 per transaction. I had a lot of knowledge of the retail experience.

At that time, Ferragamo was repositioning the brand with a managerial change because the CEO had just been replaced by gentlemen coming from the industry; younger ones with a desire to move the company toward a younger target population and refresh the brand. They wanted to get into the digital arena by relaunching a brand with a lot of history but was not as cool as it had been in the past. It seemed to be a very exciting experience; not a turnaround, but a significant improvement for the brand when I joined. I would say it's still a valid description of the situation because it’s a long process that hasn’t completely come to fruition, even now.

What are the core challenges in turning around a luxury brand in that situation?

It's a matter of working on many fronts. You need to refresh the company internally, accelerate the generation of newness and color, of excitement in the design arena to make the procedure faster. You need to put tools in place for monitoring the inventory, monitoring the sell-through, monitoring the open-to-buy in a much more structured way. It’s also a matter of getting new customers by creating a different image that is perceived by the customers in communicating about the products. This product has to be explained to a new target. It’s a matter of generating a new product and putting it into the windows and shops and getting people to stop and look into the windows. A 360-degree turnaround is needed.

How exactly does the open-to-buy work at luxury brands?

I would take one step back and think, how is the collection produced. A luxury brand makes the collection 100% internally. There is no buying from third parties. You don't buy products; you make products. You start with a designer that makes sketches, then you have the prototype, and you start industrializing the product. What you buy is, in fact, the raw materials. In the case of a company like Ferragamo, it's leather. Leather goes into shoes and bags and belts at the beginning of the business for all of Ferragamo. You then have third parties, labs that make the products on your behalf and all of this starts when you release the collection to the market. You present your prototypes, your collection, to the potential buyers, who are a combination of internal buyers, the representatives of the various countries in which there are DOS (direct-operated stores) and third party stores. The third parties are department stores, franchisees and the big online players that buy part of the collection. You create an order book, which usually happens 10 to 12 months before the products hit the stores. At this point, you know which of your products are liked and requested by the market. You launch production, issue orders to your labs and make that given quantity of a pair of shoes or a type of bag.

You will have pre-bought the leather. Leather is usually a bottleneck. You need to do the sourcing even 18 months before or you work with some stock you already have on hand. Then the production is made based on the orders you have received. When I was there, a big theme was to create a global core collection that was defined centrally so as not to leave full independence to the buyers – whether it was our own subsidiaries or third parties – to cherry-pick what they want. We would say that the 2022 collection contains at least 50% of the core products we, from central merchandising, define as representing our image. The balance is localization. The lifestyle and taste of our consumers are also a factor. If you go from very hot to very cold places – Chicago is not Hong Kong – you need to allow leave space for personalization.

The big challenge was to create commonality and try to have the right balance between the initial order and what is open-to-buy, which is the balance you buy during the course of a season, depending on how sales are evolving. I would say the right balance would be 50% on the upfront set of the collection and 50% bought during the evolution of the sale, depending on what sells more and what sells less and to rebalance from market to market.

So 10 to 12 months before the products hit the stores, you’re going to store managers and third-party department store buyers to see if they want to place an order based on the prototype?

Yes, pretty much. The old or pre-COVID way of doing things was you present the collection in your internal showrooms, normally in conjunction with the main show with the media and buyers viewing the new collection on the runway. This way, you have the prototypes, the buyers are coming over, in our case, to either Milan or Florence. There are two weeks of excitement as people see, touch and try on the products. They could be thinking this is a great product for my end-user, or this might not be the right one for my market. This process involved a lot of manual interaction between buyers and sellers for the company.

Now, all of this has disappeared. It's done online. We have the product presentation online and maybe we send some samples of the fabric or the leather so the buyers can get a feeling for the product, but the image is something you see. There has been a proliferation of digital tools that allow you to see the collection in 3D, with someone wearing it and in different environments. Frankly, I don't know what the future will be like. It will probably be a combination of online and physical. I don't think we will be getting back to full physical as it used to be, but I also feel that there will be some physical interaction again as soon as possible. It's needed to get a full understanding of the product.

How has digital buying changed the dynamic for brands' risk and how buyers are looking at taking a risk on a product?

At the end of a day, it's in the hands of the end-users. The end-users drive everything because the buyers are just trying to get an interpretation of their preference. Right now, the formal part of life is diminishing dramatically. Now there is much more of a casual approach to life. It’s more about being comfortable, being green, being mindful of the environmental impact. There are different values in the consumer's mind and, as we speak, this is happening in a messy way. To what extent it's temporary or stable, I think the answer is again a balance. I think we will go back to what it used to be, but it will not be exactly the same as before.

What are the biggest challenges in getting the raw material in line to produce a collection? Is it less on the actual sourcing and buying side, or is it more on the design and getting the product correct for the market?

The big challenge, especially in a luxury brand, is to be a transcender, invent something that is liked by the consumer, something in which you can be different from the other. To have the right interpretation of what we want and gain market share vis-à-vis the others is something you see cyclically. A brand comes up with something different and is cool for a moment. They get leadership, then someone else comes with another idea, everybody kind of piggybacks on it and then someone else comes in with something new. Some brands are more fashion and are more exposed to these cycles and some other brands represent a more permanent perception of luxury. If you think about Hermès, it's stable, it doesn't fly, but on the other hand, it doesn't come down. But Dolce & Gabbana had a very strong moment and then it lost momentum for a bit, then it might regain. Versace was a very top brand for a moment, then lost a little bit of edge. It depends on how fashion or traditional luxury you are.

Ferragamo was more traditional luxury. Still, it was gradually fading away and fading away, so he is trying to inject some newness to have the right balance between this fading stability and some acceleration. The important thing is to find the right balance. If you do too aggressive a collection, you might alienate your traditional, loyal customers. If you don't put in any newness, you run the risk of all your customers gradually fading away.

As luxury brands see the revenue mix shift to more wholesale compared to direct retail, how does this change the way you incremental margins for brands?

Normally, the highest margin is the one that you're able to generate through your own stores. To the extent that you have a well-established network with the right balance of local cost, the incremental units generated through your own stores are giving you a higher margin because you can get the full 80% to 90% gross margin when you sell in your own direct store. So incremental sales there are significantly more profitable. Decreasing sales impact your P&L much more because when you sell to wholesale, whether it's a traditional wholesaler like a department store or an online wholesaler, you have roughly half of the marginality that you would get selling to the end-user. To the extent that you have quantities moving online through wholesalers, you put your margin at risk unless you can, at the same moment, decrease your fixed cost in the retail shops by shutting them down or closing. Once the shift of units becomes a gradual movement, the stores' closure means, all of a sudden, you lose both the margin and the cost, so you usually are reluctant and this shift puts pressure on your margins.