Victor Luis, Coach’s CEO, has told investors about his brand transformation plans. In practice however, many aspects of his brand transformation plan have not panned out. Coach has succeeded in discouraging its fans from shopping at retail/mainline stores without actually reducing the discounting of the brand.
First, some background on what consumers look for and how they perceive pricing strategies.
A lot of retailers such as department stores follow a “mark stuff up so that you can mark it down later” strategy. I refer to this as the “fake sales” strategy. The way I would look at it is this: often, perception is more important than the truth. Whether or not the consumer is actually getting good value is largely irrelevant. They rarely calculate the actual markup on a handbag or its actual value. What matters is the consumer’s perception of the situation. Consider this hypothetical case of a handbag retailing at $200:
- Viewpoint A: It’s absolutely ridiculous to pay $200 for a handbag.
- Viewpoint B: It’s absolutely ridiculous to pay $400 for a handbag. But I got it on sale for $200.
Many consumers do think that paying $200 for a handbag is a little much. (The reality is that many handbag manufacturers make 70% gross margins before overhead. Not a good deal if you look at it that way.) But when the consumer sees something that they perceive is a deal according to viewpoint B, their anchoring biases can cause them to be more likely to buy.
The value of a handbag
The value of a handbag is an ephemeral concept that is inside the consumer’s head. People buy handbags for different reasons.
- Quality. Some people like buying quality products that last a long time. More sophisticated consumers will look for quality materials such as leather over fabric. Thanks to the Internet, some consumers pay attention to the serial numbers on a handbag and may avoid “made for factory/outlet” products since they may be of lower quality.
- Logo. A handbag tells other people about who its owner is. Somebody with a handbag with a logo plastered all over it may like the attention and compliments that they get from others. Unsophisticated people (such as myself) need logos to understand that a particular handbag is a status symbol. Without logos, it is difficult to figure out the value of a handbag by simply looking at it. The logo buyer likely does not care whether they paid $200 at an outlet store or $800 at a mainline store. Most people can’t tell the difference between a $200 handbag and a $800 handbag.
Technically, many handbag manufacturers do segregate their lines. The “diffusion” brand may be specifically marked as such, even if it’s an intentionally confusing brand like MICHAEL Michael Kors (which is not the same as the Michael Kors brand). While Coach does not have a diffusion brand, its outlet products are specifically made for outlet and offer different styles. Coach store employees can tell the difference… but most people do not work at a Coach store where they are familiar with the latest styles that are unavailable at outlets. There are also buyers who specifically do not want a logo bag because they don’t want to be a walking billboard. That’s just not who they are as a person, much like how some people have a lot of tattoos covering their body while other people have none.
- Style / image. Some handbag buyers want to buy very expensive handbags, sometimes from obscure designer brands, because it tells their sophisticated peers about their sophisticated tastes. There’s a minority of people in the world who can identify a $4,000 hand bag (to see people who can’t, see this Buzzfeed viralbait video). There are groups of people who understand the latest fashions and understand this game. Partly, a handbag tells other people that its wearer has good taste; these buyers generally do not want logos.
- Function. Yes, apparently handbags hold stuff too.
- Gifts. People will buy their loved ones nice things as a present. Sometimes it is (clueless) men buying gifts for women. That buyer will not see the world the same way as other consumers do.
- Men buying handbags for themselves. There is a niche market of men who would like to buy high-end fashionable items.
- Hot fashion items. Some handbags turn into hot fashion items whenever supply is limited.
What Coach is doing well
Coach has hot products with its Rogue bag and its Coach X Peanuts line. Initially, distribution on the Coach X Peanuts line was artificially limited to a portion of Coach’s mainline stores. The supply/demand imbalance caused those products to run out of stock and to become coveted items. Coach has slowly introduced the product back onto the market but with wider and wider distribution. It has quietly sold larger quantities of the Coach X Peanuts line in its outlet stores.
By intentionally making product scarce, Coach helps build its brand since some consumers will associate Coach as a brand that does have some hot items. This should have a bit of a halo effect on other Coach products.
Coach’s scale is an advantage when it comes to marketing. Whether it pays celebrities to carry their bag in public, runs fashion shows, or operates flagship stores… these costs can be spread out over a larger base.
Popular online blog sites like Purse Blog might also give Coach favorable coverage because the site is supported by affiliate links from the manufacturer. Affiliate links allow website owners to receive a commission for every sale generated through special links on their site. Unfortunately, Purse Blog does not (prominently) disclose its affiliate links. The Purse Blog website has written far more about Coach than it does about Michael Kors; Purse Blog uses affiliate links to department stores that sell Kors product but does not have affiliate links to Kors’ website itself. Some brands may not want to associate themselves with shill marketing from undisclosed affiliate links. However, I don’t believe that Coach suffers any brand damage from allowing affiliate marketing. If anything, it has likely helped Coach build brand awareness among shoppers who spend a lot of time online reading about handbags. To be fair to the Purse Blog site, it likely writes about Coach more than Michael Kors because Coach is coming out with innovative new designs that are fashion forward whereas Michael Kors’ lineup is not as fashion forward.
Where I have reservations about Coach’s current strategy
(*Disclosure: I have a short position in Coach so you should assume I’m biased.)
Coach’s CEO Victor Luis wants to mimic the promotional strategy of higher-end brands, such as running only 2 sales a year. Coach currently runs 4 sales a year at mainline stores. The problem is that Coach has already let the cat out of the bag. Many Coach customers have been taught that there are various ways to get discounts on Coach product:
- Department stores often run friends and family promotions at a much higher frequency than 4 sales a year.
- PCE. Coach issues coupons for Preferred Customer Events at mainline/full-price stores for 30% off. Other customers get 25% off during these sale periods.
- Outlet stores.
- Secondary markets like eBay. (Unfortunately there are many fakes online.)
By reducing promotions at mainline full-price stores to only 4 sales a year, the Coach customer can turn to other channels to get a deal. There is not much of a reason to shop at a mainline store when you can get the same product at a department store for a lower price. Or, the customer can wait months until Coach eventually releases the product at outlet stores for a 50%+ discount.
In theory, Coach could get department stores to match the promotional cadence of Coach mainline stores. There are two issues:
- Coach allows its product to be discounted during department stores’ sales. Coach is often not on the department store’s exclusions list (whereas Michael Kors is).
- The department store business model is built upon fake sales. Department store customers expect sales and will shun full-price items because they have been taught that sales are frequent. JC Penney tried to drop the fake sale promotional strategy and it did not work out too well for them.
In practice, customers have shunned Coach mainline stores because those stores don’t run sales as frequently as department stores do. Or, they might check out the latest Coach product at a mainline store before figuring out where to buy it cheap (e.g. on a department store website or at a Coach outlet). Other shoppers simply go straight to a Coach outlet and see what full-price product has landed there.
The numbers tell a interesting story about the health of Coach’s mainline business. Under Victor Luis’ tenure, Coach has been closing mainline stores while opening outlet stores in North America. Outlet store square footage has increased from 0.982M sqft to 1.189M sqft from 2013 to 2015.
Now it seems that Coach is trying to get department stores to match the promotional cadence of mainline stores. Coach’s earnings press release (8-K) states that there will be fewer department stores distributing Coach’s product:
the strategic decision to elevate the Coach brand’s positioning in the North American wholesale channel, including the closure of about 25% of doors and a reduction in markdown allowances
In my opinion, it seems that Coach’s strategy is incoherent. If it really wants to avoid promotions on full-price product, Coach needs to stop making knockoffs of its own products for outlet stores on top of curtailing department store discounts. Then, it needs its own network of full-price stores to make up for the lost volumes from fewer department store doors. Such as the stores it has closed in the past few years.
Brand issues with the outlet channel
Coach’s outlet stores go against Luis’ vision of a higher-end retailer. For example, they are highly promotional. Here is a series of emails from April 22 to May 5 for the online outlet store:
Every single email in that timeframe highlighted a “50% off everything” promotion. Coach Outlet is engaging in all sorts of activities that Victor Luis is trying to steer the company away from: constant promotions, big logo bags, blinged-out bags (and ‘tackier’ styles), and saturating the market with trendy product.
Another brand issue with outlet stores is that made-for-outlet products have an inferior brand among savvier shoppers. Rightly or wrongly, savvier shoppers tend to look down upon made-for-outlet (MFO) versions of bags even if the MFO version is occasionally superior to the full-price version. Coach regularly does MFO knockoffs of mainline/full-price product.
The alleged brand transformation
Victor Luis is telling investors that Coach is undergoing a “brand transformation”. While big changes have occurred at Coach, the outlet channel has seen the least transformation. While the coach.com website shows very few logo bags, the coachoutlet.com website has a few sections that look like this:
The big C monogram pattern in the bottom right of the image above is more in line with what Coach has done historically. That style is not available at mainline stores and coach.com. We can see that Coach is still selling logo product to consumers. This is consistent with management’s comments on conference calls:
After several years of decline in global penetration and gains and leather our North American logo business has stabilized at less than 5% in retail [full-price/mainline] and about 25% in our outlet channel similar to the prior year. We will continue to monitor consumer preferences and fine tune this balance [as] needed.
COH – Transcript: Q3 2016 Coach Inc Earnings Call, Tu 04.26.16 8:30 AM http://snt.io/1o2CcR2tG
Frequency of online flash sales
On the Q4 2014 conference call back in August 2014, Victor Luis talked about his efforts to bring down promotions at its online factory site. He said that the frequency of promotions would drop to “approximately one event per month”.
[…] it’s the decrease in the cadence of events is really being phased in throughout the year and it will start — has started this quarter, where we’re right now at approximately four events per week. That then decreases further in the second quarter, and by the second half of the year we will be at approximately one event per month. EOS or our e-outlet business was over 15% of North American sales at about $0.5 billion.
COH – Transcript: Q4 2014 Coach Inc Earnings Call, Tu 08.05.14 8:30 AM http://snt.io/iL2CbkwjN
What actually happened is this:
- The site is still running frequent promotions, in the ballpark of 1 event per week. Current discounts range from 50-70%.
- Coach has limited who can access the coachoutlet.com website. Yes, Coach intentionally makes it difficult for consumers to buy their products. Signing up for the website does not grant the consumer entry into the website. (The website’s design is very confusing and users can easily miss the FAQ.) Some accounts are activated via random draw. Coach also gives out activated accounts to Coach Outlet customers, though I’m not sure if that practice continues. If you want to browse the CoachOutlet.com website, try the username firstname.lastname@example.org and the password asdfasdf
- The CoachOutlet.com website does not appear on Google’s search results. The coach.com website does not link to the online outlet site. The website is intentionally difficult to find.
Here’s a comparison between similar items on the CoachOutlet.com website and the Coach.com website:
- The made-for-outlet version of the bag at CoachOutlet.com is 56% cheaper than the full-price version at coach.com.
- Similarly, style 36026 (Coach Nomad Hobo in Glovetanned Leather) sells for $495 on coach.com while the made-for-outlet style F36026 sells for 50% off on coachoutlet.com under different colours.
Coach Outlet is selling discounted versions of items currently in its full-price assortment. Coach is discounting itself.
The issue with this practice is that savvier buyers (e.g. those who frequent online forums) will be hesitant about buying anything for full price at a mainline store knowing that Coach may quickly put identical or similar product in its offline/online outlet channel. Devaluing full price purchases teaches customers not to pay full price. This thread on the PurseBlog forum talks about how hot product may show up in the outlet channel. Some Coach fans are annoyed that the company makes knock-offs of its full-price (FP) products.
While Victor Luis talks about making the brand less promotional, what Coach actually does in practice is a completely different story. The blurred lines between outlet and mainline product makes shopping at mainline stores less attractive. Coach does not have a clear message about how its mainline product is differentiated from outlet product. Savvier consumers have grown to expect discounts via PCE (preferred customer event discounts), department store sales, outlet stores, and CoachOutlet.com sales.
What the numbers are saying
As far as the brand transformation goes, it largely seems to be a bad idea. Coach has been closing down mainline stores and will see its product distributed at fewer wholesale doors. The outlet channel is doing well judging from the growth in square footage and store count. Ironically, Coach seems to have found more success at lower price points than higher price points.
China is doing well, while Hong Kong and Macau are seeing an unspecified drop in same store sales. Europe is a small business at the moment but growing.
One of the annoying things about Coach is that investor transparency has gone down. Coach no longer breaks out direct versus indirect sales. This is likely a sign that management is trying to obscure the facts so that investors don’t realize that management has been doing a bad job. Management has started to report silly non-GAAP numbers to make itself look better. I would expect that the non-GAAP numbers going forward will have “one-time” adjustments every year that will cause non-GAAP earnings to be inflated.
The company largely does not seem to be playing games with its GAAP accounting. The company did change the estimated useful life assumption of furniture and fixtures in the 10-K filed in 2015 from 3-5 years to 3-10 years. “Furniture and fixtures” is one the two biggest line items on Coach’s balance sheet. Coach’s “furniture and fixtures” line item has gone up dramatically due to the new headquarters spending. To be fair, the change in the accounting estimates could be reasonable.
The company is likely doing a poor job at keep costs contained. It is moving into new headquarters whose market value is 5.6X that of its old headquarters ($707M versus $125M). The cost of the capex improvements in the new headquarters outside of the Hudson Yards joint venture will exceed the sale price of the old headquarters (the 2013 10-K put the cost of these improvements at $24.8M + $190M, which is higher than $125M). Both headquarter buildings are literally on the same block in New York City.
The decline in operating income (excluding the Stuart Weitzman acquisiton) has slowed dramatically. Comparing the 9 months ended March 2016 versus the 9 months ended March 2015, operating income ex-Stuart Weitzman fell from $579.2M to $506.0-$536.7M.
The old formula works
In my opinion, the reason why Coach continues to be profitable is that the old formula (before Victor Luis became CEO) still works.
- Fake sales work.
- The flash sale model works because it pushes consumers into making impulse purchases.
- The outlet shopper generally doesn’t know or doesn’t care about the differences between made-for-outlet and full-price products.
- The consumer that wants fashion-forward handbags and more expensive handbags often doesn’t care whether Coach sells logo bags or not. For example, most Louis Vuitton fans aren’t turned off on the brand because LV sells its signature logo products. The buyer who does care is the woman who spends $800 on a logo bag only to see other women walk around with $100-$200 logo bags. The logo buyer mostly cares about the logo and will feel ripped off if she thinks that she overpaid for the logo. But I don’t think that particular customer type is that important.
- Coach still has a strong brand. In the “affordable luxury” price point in the ballpark of $200-300, there are really only two big brands with wide distribution: Coach and Michael Kors. Coach has one of the strongest brands at “affordable luxury” price points.
Where Coach could make improvements is in its full-price stores and full-price product lines. Problems that it could try to solve are:
- Full price handbags are devalued by made-for-outlet knockoffs. When a shopper buys a handbag from a high-end luxury retailer like Louis Vuitton, they will have the perception that the bag is an “investment” and holds its value over time. LV offers promotions too so sales and promotions are not the issue. The problem is that Coach makes knock-off versions of full-price products that dramatically reduce the price of the bag. If you buy a bag for $800 and see other people buy very similar looking bags for $100, you will not feel that great about your past purchase.
- Communicating the full-price brand to consumers. Perhaps Coach could copy Michael Kors, which delineates its brand into Michael Kors and the diffusion brand MICHAEL Michael Kors. Coach needs to communicate to the full-price shoppers that its full-price products won’t be devalued by made-for-outlet knockoffs. This should have little effect on the outlet channel since most diffusion brand buyers don’t know or don’t care that they are buying the diffusion brand.
- Getting a good deal on Coach product can be time-consuming and confusing, which can be frustrating for some consumers. Having to look for department store sales and figuring out CoachOutlet.com is somewhat complicated. A simpler promotional environment may (or may not) be beneficial in driving sales.
What styles do customers want?
I don’t have great data on this. However, you can do a Google search for queries like Coach outlet and see what counterfeit products are being made. It does seem like the big C bags are popular among counterfeit products.
This does not paint the most accurate picture of what consumers want, since consumers who would want to buy counterfeit Coach bags likely gravitate towards logo bags more than normal Coach customers.
However, I think the reason why Coach had a significant amount of logo product is because it resonated with customers and worked in the past.
Where this stock is headed
I really don’t know.
I think that Victor Luis lacks the right instincts. He wants to make Coach more upscale. But instead of reducing promotions, what actually happened is that he discouraged Coach shoppers from buying at mainline/full-price stores. He did not actually get rid of the promotions and heavy discounting, so the execution did not make a lot of sense. Coach continues to engage in behaviours that devalue full-price products, such as the made-for-outlet knockoffs.
Recently, it seems that Coach has stemmed a lot of the bleeding. The deterioration in the business has slowed dramatically. However, it does seem like Victor Luis is still pushing the company into doing things that don’t make that much sense. It seems that Luis would like department stores to stop discounting Coach product. If so, all channels need to be aligned on the same promotional strategy and cadence. Department stores won’t be enthusiastic about devoting store space to Coach product if consumers learn that they should look for discounts at Coach outlet stores or online factory sales. It doesn’t seem like Victor Luis has really thought about how the consumer would react to how Coach product is sold and discounted.
Whether Coach will continue to decline -and how fast- remains to be seen.
Coach: Victor Luis could be the next Ron Johnson – My original short thesis on Coach from May 2, 2014. While the stock has fallen around 15% since then, my short thesis largely did not play out. Unlike JC Penney, the CEO did not push the company into losing money and was not fired.