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Burberry’s profit warning: A sign of global austerity or bad strategy?

Last month’s profit warning by the British fashion brand Burberry, which reduced by about 20 percent the value of the stock, was widely interpreted as a reflection of China’s economic slowdown and the arrival of an austere era in Europe that would reduce sales for luxury goods.

That reaction was strongly suggested by Burberry itself. The company’s CEO, Angela Ahrendts, issued a statement blaming the more challenging “external environment” for a year-over-year sales slowdown in the second quarter. Most news coverage picked up the same theme: The 156-year-old maker of plaid-lined trench coats was hurt by “a slowdown in China and Europe’s debt crisis [which is] bringing a nearly three-year boom in demand for luxury goods to an end,” Reuters reported.

Because of how Burberry’s profit warning was interpreted, many other companies selling luxury products saw their stock prices drop. The day after Burberry’s announcement, LVMH, makers of products bearing the Louis Vuitton brand, lost 4 percent and PPR, which owns Gucci and Yves Saint Laurent, also lost 4 percent. Ralph Lauren fell 3.5 percent, Tiffany was off by 1.4 percent, Michael Kors dropped 1.9 percent, and Coach was down 1.1 percent.

The fact that other luxury brands got caught in Burberry’s downdraft bothered a writer for Seeking Alpha, a stock analysis website that is popular among financial professionals. The writer, who posts as “Helix Investment Management,” a firm owned by Ivan Deryugin, wrote a lengthy analysis of the luxury sector, in which he disputed the notion that all luxury brands were in the same kind of trouble Burberry was in. (In a disclosure, he said he owned none of the stocks covered in his analysis.)

Burberry, he said, had erred in “pruning its product lines, cutting low-priced goods, especially in the United States, in an effort to move up in the marketplace and make Burberry a more ‘elite’ brand.” In a time of retrenchment, this strategy “backfired” by eliminating a way for customers to associate with the Burberry brand without spending a lot of money.

He contrasted Burberry’s strategy with Tiffany’s longtime approach of selling a line of products that carried the Tiffany name, and gained from presentation in the luxurious environment of a Tiffany store, but were more affordable. But Tiffany was not the only company that Helix Investment Management judged to have been caught unfairly in Burberry’s bad news. He also reviewed recent results for LVMH, Richemont and Salavatore Ferragamo, all of which had positive economic news – with LVMH, the largest luxury goods company, seeing a 28 percent increase in profits in the first half of 2012.

“Many companies blame macroeconomic conditions when their results fail to meet expectations, and that may be the case here,” he concluded.

Other analyses of Burberry’s announcement concurred with the company’s assessment of the changing luxury market, but several contended that it’s not just a matter of austerity making the wealthy more cost-conscious. The real problem is that the wealthy are feeling social pressure not to display what their wealth can buy them.

John Stepek, editor of the British publication MoneyWeek, said he has been “negative on the luxury goods sector for a while now.” He blamed the politics of austerity, writing, “These days, flaunting your expensive lifestyle choices is the equivalent of pinning a ‘tax me’ sign on your own back. European tax collectors, for example, have come up with the crafty wheeze of using ostentatious displays of wealth to work out who has been fiddling (with) their returns.”

But the more ominous signs for luxury brands and their investors, Stepek said, come from China, where “the fabled Chinese consumer is finally running out of steam.” In addition, taxes on business are going up, and because of downturns in mining, real estate and other industries, “China looks increasingly panicky” in its moves to stimulate its economy. But, he added, the next stimulus is unlikely to be as large as the one in 2008 – the one that Stepek and other observers believe paid for a lot of luxury spending in China.

Zoe Williams, a leftist political commentator for the UK Guardian, believes the luxury market’s China crisis is due in part to the leveling effects of social media.

The wardrobes of wealthy people and high government officials can scarcely be kept secret at a time when every mobile phone has a camera, and every image snapped with that camera is likely to be mass distributed on the web.

When officials preach austerity, exposure of their purchasing habits is a threat to their power. In China, still nominally a Communist country, some party officials are widely believed to be padding their low official salaries by misappropriating public funds for personal gain, according to Dali Yang, a political scientist at the University of Chicago. At the National People’s Congress, according to The Guardian, “sharp-eyed observers drew attention to the designer brands on parade,” and commented about them online.

Such ostentation “chips at the credibility of the party,” Yang said.

One high official suffered the indignity of having photos of five expensive watches he allegedly owned posted on Weibo, a Chinese microblogging site like Twitter, including a Vacheron Constantin model worth more than $60,000. That official’s posted salary is less than $20,000 per year. According to NewPopulationBomb blogger and author Jack A. Goldstone, the government has traditionally looked the other way at officials enriching themselves by “using their positions” as “a way of keeping down the official costs of government while relying on the judgment of local officials to manage their community’s (and their own) finances.”

But, according to Williams, all that’s changing. The changes will hurt companies like Burberry, because “sales were driven by the Chinese super-rich who, being mostly in the Communist party, could never afford even a snazzy dog coat or neckerchief on their posted salaries. A combination of the economic slowdown in China and a sudden surge of connectivity whereby anyone who identifies your fancy timepiece can now blog about it means that ostentatious wealth has become as dangerous to the party high command as it would be for the perpetrators of a recent heist.”

To be sure, as in Europe and the United States, there will always be Chinese businesspeople who can legitimately afford a pricey coat, watch or car. But in a country whose ideology is dedicated to equality but where the vast majority of its people live on $2 per day, the pressure against ostentatious displays in the biggest market in the world would surely cut into sales.

John Stodder Jr. is The Dolan Company’s national affairs correspondent and web-editor-at-large.

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