Ralph Lauren Betting On High End Luxury and Direct-To-Consumer Model To Boost Its Margins

Luxury lifestyle company Ralph Lauren (NYSE:RL) has seen its stock fall by about 10% on a year-to-date basis. The fall can be mostly be attributed to the decline in operating margins in the previous quarters. In the recently concluded quarter, operating margin was 240 basis points below last year’s at 14.3%, due to the timing of payments related to incremental investments in growth initiatives, which was somewhat offset by operational discipline and the favorable impact of currency fluctuations. ^[1] The company issued guidance of further decline in margins in the upcoming quarters.

Ralph Lauren is facing a challenging market environment as it tries to transition from a wholesale dominated business model to one based on direct sales. Consumers are now showing a preference for shopping at retail stores and online instead of department stores. Ralph Lauren, which used to be a staple of department stores like Bloomingdale’s and Macy’s, has suffered because of this change in consumer preferences. As a result, the company is now trying to derive more of its sales from company owned stores and the e-commerce channel. The other step taken by the company to boost its margins has been to increase the penetration of luxury accessories, like expensive watches and bags, in its stores.

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Direct Sales May Boost Revenues

According to figures from the U.S. Department of Commerce, department store sales peaked in the early 2000’s and have been declining ever since. Adjusted to 2013 dollars, department store sales have declined from nearly $27 billion in 1999 to just over $14 billion in 2013. ^[2] The gap in sales from department store sales has been filled by sales from internet retailer and specialized, non-department stores. In the January 2013-January 2014 period, department store sales fell by 6.5%, while sales from internet retailers increased by 5.7% and sales from specialized, non-department stores rose by 1.2%. ^[2] In response to these trends, companies like Ralph Lauren have decided to switch from a majority wholesale model to a majority retail model supported by significant investments in e-commerce.

In order to give its retail sales a boost, the company has intensified the development of its Polo brand. Currently, 60% of the sales made by the company are in its men’s business, the reverse of the usual industry trend where sales are skewed towards women. During fiscal 2014, the company created Polo for women, which it expects to replace the existing Blue Label line for women. Therefore, the sales made from this switch will not be completely incremental. However, in the longer term the company expects the Polo brand to address a much broader market than the Blue Label line. Additionally, the retailer is still in the early stages of executing the expansion of its Polo stores worldwide. It operates 13 Polo stores currently, with plans of opening 15 to 20 more in fiscal 2015. Over the long term, the company believes there is an opportunity to have between 100 and 200 Polo stores worldwide, with significant concentration in international markets. ^[3]

Additionally, the company is working hard on the development of its e-commerce segment. In fiscal 2014, e-commerce brought $500 million in revenues. Based on the high growth and the profit creative dynamics of the channel, the retailer will continue investing in this space. At present, the company’s e-commerce operations behave very differently in different geographies. In the U.S., the management pointed out that if a consumer switches from shopping at a brick-and-mortar store to online, it is profitable for the company. However, the company’s e-commerce operations are only starting to achieve scale in Europe. RL will need to make further investments in its European e-commerce business to reach the same level of profitability as in the U.S. Meanwhile, it’s only just launched the e-commerce business in Asia. The company currently operates in Japan and Korea, with investments still ongoing to bring operations online in Greater China and Southeast Asia. ^[4]

Betting On High-End Luxury

Ralph Lauren converted footwear from a licensed to owned segment in 2006 and re-opened operations in 2008. At the same time, the company gained direct control of its licensed handbags and small leather goods business. Since then, the leather goods category has grown at an average of 20% annually. Currently, handbags, footwear and leather goods represent less than 10% of total consolidated sales. The company has stated that it wants to grow this category to about 20% of the top-line, which should favor margins as it is a higher margin category than apparel.

To this end, RL is now changing the look and feel of its stores. Earlier, a visitor to the store was more likely to spot Polo staples on display, but now those have been replaced by luxury goods and luxury accessories. The company is taking serious steps to draw a sharp distinction between its Polo based lineage and its aspirations as a serious competitor in the high-end luxury space. ^[5] With the launch of the Ricky handbag, which starts at a price of $2,500 and extends to $18,000, the company is entering into direct competition with the likes of Hermes, Dior, Valentino and Louis Vuitton. Early signs are not entirely positive- the Ricky handbag is being outsold by the cheaper Celine Trapeze, but the shift in strategy is clear. ^[6]

The motivation behind the shift towards the higher reaches of luxury seems to be higher margins, but an alternate explanation is possible. It could be that the company is trying to re-engineer its brand image in anticipation of higher sales from Asia, especially China. Asia only forms about 12% of the company’s current sales but expectations from this market in the future are high. ^[5] China contributed nearly 47% of the worldwide spending on luxury goods in 2013- the majority of this spending was directed towards watches, personal care goods, perfumes and leather hand bags. ^[7] The Ralph Lauren brand is new to Chinese consumers and this provides considerable leeway to the company in terms of how it wants to sell its brand image. As a result, the company is using this time frame to gain a firmer foothold in the luxury goods market.

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1. Ralph Lauren Q1 FY15  Earnings Call Transcript, Seeking Alpha, August 2014 [↩]
2. The Decline of Department Store Sales, US News, February 2014 [↩] [↩]
3. Ralph Lauren’s Q4 2014 Results Earnings Call, Seeking Alpha, May 2014 [↩]
4. Ralph Lauren Q1 FY15  Earnings Call Transcript, Seeking Alpha, August 2014 [↩]
5. Ralph Lauren Is Pushing Higher Into Luxury With New Stores, Accessories, Wall Street Journal, August 2014 [↩] [↩]
6. Ralph Lauren’s Sales May Rise on Direct Retail, Bloomberg, August 2014 [↩]
7. China’s Domestic Consumer Market in 2020, China Briefing, August 2014 [↩]