Case
5
Coach Inc.: Is Its
Advantage in Luxury
Handbags Sustainable?
John
E.
Gamble University of South Alabama
In the six years following its October 2000 initial public offering (IPO), Coach Inc.s net
sales had grown at a compounded annual rate of 26 percent and its stock price had
increased by 1,400 percent as a result of a strategy keyed to "accessible" luxury. Coach
created the "accessible" luxury category in ladies' handbags and leather accessories by
matching key luxury rivals on quality and styling, while beating them on price by 50 percent
or more. Not only did Coach's $200-$500 handbags appeal to middle-income consumers
wanting a taste of luxury, but affluent consumers with the means to spend $2,000 or more
on a handbag regularly snapped up its products as well. By 2006, Coach had become the
best-selling brand of ladies' luxury handbags and leather accessories in the United States
with a 25 percent market share and was the second best-selling brand of such products in
Japan with an 8 percent market share. Beyond its winning combination of styling, quality,
and pricing, the attractiveness of Coach retail stores and the high levels of customer service provided by its employees contributed to its competitive advantage.
Much of the company's growth in net sales was attributable to its rapid growth in
company-owned stores in the United States and Japan. Coach stores ranged from prominent
flagship stores on Rodeo Drive and Madison Avenue to factory outlet stores. In fact,
Coach's factory stores had achieved higher comparable store growth during 2005 and 2006
than its full-price stores. At year-end 2006, comparable store sales in Coach factory stores
had increased by 31.9 percent since year-end 2005, while comparable store sales for Coach
full price stores experienced a 12.3 percent year-over-year increase. In 2006, Coach products
were sold in 218 full-price company-owned stores, 86 factory stores, 900 U.S. department
stores, 118 locations in Japan, and 108 international locations outside Japan.
Going into 2007, the company's executives expected to sustain its impressive growth
through monthly introductions of fresh new handbag designs and the addition of retail
locations in the United States, Japan, and rapidly growing luxury goods markets in Asia.
The company planned to add three to five factory stores per year to eventually reach 105
Copyright
2006 by John
E.
Gamble. All rights reserved.
283
284 Case Group A Market Opportunity Analysis
stores in the United States, add 30 full-price stores per year in the United States to reach
300, and add at least 10 stores per year in Japan to reach as many as 180 stores. The company
also expected its licensed international distributors to open new locations in Hong Kong
and mainland China. Other growth initiatives included strategic alliances to bring the
Coach brand to such additional luxury categories as women's knitwear and fragrances
Only time would tell if Coach's growth could be sustained and its advantage would hold in
the face of new accessible luxury lines recently launched by such industry elites as Giorgio
Armani, Dolce & Gabbana, and Gianni Versace.
COMPANY HISTORY
Coach was founded in 1941 when Miles Cahn, a New York City leather artisan, began
producing ladies' handbags. The handbags crafted by Cahn and his family in their SoHo loft
were simple in style and extremely resilient to wear and tear. Coach's classic styling and
sturdy construction proved popular with discriminating consumers and the company's initial
line of 12 unlined leather bags soon developed a loyal following. Over the next 40 years,
Coach was able to grow at a steady rate by setting prices about 50 percent lower than those of
more luxurious brands, adding new models, and establishing accounts with retailers such as
Bloomingdale's and Saks Fifth Avenue. The Cahn family also opened company-owned stores
that sold Coach handbags and leather accessories. After 44 years of family management,
Coach was sold to the diversified food and consumer goods producer, Sara Lee.
Sara Lee's 1985 acquisition of Coach left the handbag manufacturer's strategy and
approach to operations more or less intact. The company continued to build a strong rep
utation for long-lasting, classic handbags. However, by the mid-1990s, the company's per.
formance began to decline as consumers developed a stronger preference for stylish
French and Italian designer brands such as Gucci, Prada, Louis Vuitton, Dolce & Gabbana,
and Ferragamo. By 1995, annual sales growth in Coach's best-performing stores fell
from 40 percent to 5 percent as the company 's traditional leather bags fell out of favor
with consumers.
In 1996, Sara Lee made 18-year Coach veteran Lew Frankfort head of its listless handbag
division. Frankfort's first move was to hire Reed Krakoff, a top Tommy Hilfiger designer.
as Coach's new creative director. Krakoff believed new products should be basedupon
market research rather than designers' instincts about what would sell. Under Krakoff, Coach
conducted extensive consumer surveys and held focus groups to ask customers aboul
styling, comfort, and functionality preferences. The company's research found consumers
were looking for edgier styling, softer leathers, and leather-trimmed fabric handbags. Once
prototypes had been developed by a team of designers, merchandisers, and sourcing
specialists, hundreds of previous customers were asked to rate prototype designs against
existing handbags. The prototypes that made it to production were then tested in selected
Coach stores for six months before a launch was announced. The design process developed
by Krakoff also allowed Coach to launch new collections every month. Prior to his arrival,
Coach introduced only two collections per year
Frankfort's turnaround plan also included a redesign of the company's flagship stores t0
complement Coach's contemporary new designs. Frankfort abandoned the stores' previous
dark, wood paneled interiors in favor of minimalist architectural features that provided a
bright and airy ambiance. The company also improved the appearance of its factory stores
which carried test models, discontinued models, and special lines that sold at discounts
ranging from 15 percent to 50 percent. Such discounts were made possible by the companys
policy of outsourcing production to 40 suppliers in 15 countries. The outsourcing agret
ments allowed Coach to maintain a sizeable pricing advantage relative to other luxur
Case Five Coach Inc.: Is lis Advantage in Luxury Handbags Sustainable?
285
handbag brands in its full price stores as well. Handbags sold in Coach full-price stores
ranged from $200-$500, which was well below the $700-S800 entry-level price charged by
other luxury brands.
Coach's attractive pricing enabled it to appeal to consumers who would not normally
consider luxury brands, while the quality and styling of its products were sufficient to
satisfy traditional luxury consumers. In fact, a Women's Wear Daily survey found that
Coach's quality, styling, and value mix was so powerful that affluent women in the United
States ranked Coach ahead of much more expensive luxury brands such as Hermes, Ralph
Lauren, Prada, and Fendi. By 2000, the changes to Coach's strategy and operations
allowed the brand to build a sizable lead in the "accessible luxury" segment of the leather
handbags and accessories industry and made it a solid performer in Sara Lee's business
lineup. With the turnaround sucessfully executed, Sara Lee management elected to spin
off Coach through an IPO in October 2000 as part of a restructuring initiative designed to
focus the corporation on food and beverages.
Coach Inc.'s performance proved to be stellar as an independent, public company. The
company's annual sales had increased from $500 million in 1999 to more than $2.1 billion
in 2006. Its earnings over the same timeframe improved from approximately S16.7 million
to $494 million. By late 2006, Coach Inc.'s share price had increased nearly 15 times from
the 2000 IPO price. Exhibit presents income statements for Coach Inc. for fiscal 1999
through fiscal 2006. Its balance sheets for fiscal 2005 and fiscal 2006 are presented in
Exhibit 2. Coach's market performance between its October 2000 IPO date and December
2006 is presented in Exhibit 3.
1
OVERVIEW OF THE
GLOBAL LUXURY GOODS INDUSTRY IN 2006
The world's most well-to-do consumers spent more than $105 billion on luxury goods
such as designer apparel, fine watches and writing instruments, jewelry, and select quality
leather goods in 2005. The global luxury goods industry was expected to grow by 7 percent
during 2006 to reach $112 billion. Italian luxury goods companies accounted for 27 percent
of industry sales in 2005, while French luxury goods companies held a 22 percent share of
the market, Swiss companies owned a 19 percent share, and U.S. companies accounted for
14 percent of the luxury goods industry.
Growth in the luxury goods industry had been attributed to increasing incomes and
wealth in developing countries in Eastern Europe and Asia and changing buying habits in
the United States. Although traditional luxury consumers in the United States ranked in the
top 1 percent of wage earners with household incomes of $300,000 or better, a growing
percentage of luxury goods consumers earned substantially less, but still aspired to own
products with higher levels of quality and styling. The growing desire for luxury goods by
middle-income consumers was thought to be a result of a wide range of factors, including
effective advertising and television programming that glorified conspicuous consumption.
The demanding day-to-day rigor of a two-income household was another suggested factor
because it led middle-income consumers to reward themselves with luxuries.
An additional factor contributing to rising sales of luxury goods was the growth of big
box discounters such as Wal-Mart and Target. Discounters' low prices on everyday items
had facilitated a "Trade up, trade down"2 shopping strategy, whereby consumers could buy
necessities at very low prices and then splurge on indulgences ranging from premium
vodka to S4,000 Viking stoves. The combined effect of such factors had allowed spending
on luxury goods to grow at four times the rate of overall spending in the United States.
1How Coach Got Hot," Fortune, 146, no. 8 (October 28, 2002).
As quoted in "Stores Dancing Chic to Chic," Houston Chronicle, May 6, 2006.
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Case Five
Coach Inc.: Is ls Advantage in Lurury Handbags Sustainable?
287
Coach Inc.'s Balance Sheets, Fiscal 2005-Fiscal 2006 (in thousands)
YHIBIT 2
ASSETS
equivalents
Cash and cash
Short-term investments
receivable, less allowances
of S6,000 and $4,124, respectively
July 1, 2006
July 2, 2005
$143,388
$154,566
394,177
228,485
84,361
65,399
Trade accounts
Inventories
Deferred
income taxes
and other current assets
Total current assets
Prepaid expenses
233,494
78,019
41,043
974,482
Long-term investments
184,419
50,820
25,671
709,360
122,065
298,531
227,811
12,007
203,862
income taxes
84,077
Other
noncurrent assets
29,612
Total
assets
54,545
29,526
$1,370,157
Property and
equipment, net
Goodwill
Inde nite life
Deferred
intangibles
LIABILITIES
Accounts
Accrued
$1,626,520
payable
$79,819
261,835
credit facility
Current portion
of long-term debt
170
Total current liabilities
Deferred income taxes
341,824
31,655
3,100
61,207
S437,786
Long-term debt
Other liabilities
Total
12,088
AND STOCKHOLDERS' EQUITY
liabilities
Revolving
238,711
liabilities
$64,985
188,234
12,292
150
265,661
4,512
3,270
40,794
$314,237
equity
Preferred stock: (authorized 25,000,000
shares; $0.01 par value) none issued
Common stock: (authorized 1,000,000,000
shares; $O.01 par value) issued
and outstanding 369,830,906 and 378,429,710
Stockholders'
shares,
$3,698
775,209
417,087
respectively
Additional paid-in-capital
Retained
earnings
Accumulated other comprehensive (loss) income
Total stockholders' equity
Total liabilities and stockholders'
fi
Source: Coach Inc.
2006 10-K.
equity
(7,260)
$1,188,734
$1,626,520
$3,784
566,262
484,971
903
$1,055,920
31,370,157
288 Case Group A Market Opportunity
Analysis
EXHIBIT 3
Performance of Coach Inc.'s Stock Price, 2000-2006
(a) Trend in Coach's Common Stock Price
45
COH Monthly
35
30
25
20
Stock Price
in dollars)
15
10
01
02
03
5
04
Year
06
(b) Performance of Coach's Stock Price Versus the S&P 500 Index
+1,400%
COH Monthly
sp500
AA
Coach's Stock
Price
+1,200%
+1,000%
+800%
+600%
+400%
S&P 500
+200%
+0%
-200%
01
02
03
04
Year
05
06
Percent Change
(2000
0)
Case Five
Coach
Inc.: Is
lis Advaniage in Luxury Handbags Sustainable?
289
Both retailers and luxury goods manufacturers had altered their strategies in response to
the changing buying preferences of middle-income consumers in the United States. Much
of Target's success was linked to its merchandising strategy that focused on relationships
with designers such as Philippe Starck, Todd Oldham, Michael Graves, and Isaac Mizrahi.
Target's growth had not gone unnoticed by Wal-Mart, which in 2004 began to closely watch
haute couture fashion trends for inspiration for new apparel lines. Wal-Mart hosted fashion
shows in Manhattan and Miami's South Beach to launch its Metro 7 collection of women's
apparel in fall 2005. Exsto was a designer-inspired menswear line that Wal-Mart introduced
in summer 2006.
Wal-Mart also had begun to evaluate new store concepts that might appeal to upscale
consumers. In 2006, the company was testing a stylish new Supercenter store in Plano,
Texas, that stocked gourmet cheeses, organic produce, and 1,200 different wines. The new
store also included a Wi-Fi coffee shop and a sushi bar. A Wal-Mart spokesperson
explained the company's experimentation by commenting, "We've always been a top choice
for the budget-minded customers. What we're trying to do now is expand our product line,
and sell products more relevant to folks who are more discerning in their shopping."3 Like
Wal-Mart, other middle market retailers had altered their merchandising strategies to
accommodate consumers' desires for luxury. During the 2006 Christmas shopping season,
J.Crew offered S1,400 cashmere overcoats and Home Depot stocked $2,800 HDTVs for
consumers looking for extraordinary gifts.
Manufacturers of the finest luxury goods sought to exploit middle-income consumers'
desire for such products by launching "diffusion lines" that offered "affordable" or "accessible" luxury In 2006, most leading designer brands had developed subbrands that
retained the styling and quality of the marquee brand, but sold at considerably more modest price points. For example, while Dolce & Gabbana dresses might sell at price points
between $1,000 and $1,500, very similar appearing dresses under Dolce & Gabbana's
affordable luxury'" brand-D&G-were priced at $400 to S600. Giorgio Armani's
Emporio Armani line and Gianni Versace's Versus lines typically sold at price points
about 50 percent less than similar-looking items carrying the marquee labels. Profit
margins on marquee brands approximated 40 percent-50 percent, while most diffusion
brands carried profit margins of about 20 percent. Luxury goods manufacturers believed
diffusion brands' lower profit margins were offset by the growing size of the "accessible
luxury" market and protected margins on such products by sourcing production to lowwage countries.
Growing Demand for Luxury Goods in Emerging Markets
In 2004, the worldwide total number of households with assets of at least SI million
increased by 7 percent to reach 8.3 million. The number of millionaires was expected to
increase another 23 percent by 2009 to reach 10.2 million. With much of the increase in
new wealth occurring in Asia and the Eastern Europe, demand for luxury goods in emerging
markets was projected to grow at annual rates approaching 10 percent. Rising incomes and
new wealth had allowed Chinese consumers to account for 11 percent of all luxury goods
purchases in 2004. The Chinese market for luxury goods was predicted to increase to
24 percent of global revenues by 2014, which would make it the world's largest market for
luxury goods. In 2006, a number of prestigious Western retailers such as Saks Fifth Avenue
had opened retail stores in China to build a first mover advantage in the growing market.
Similarly, most luxury goods companies had opened stores in China's largest cities with
Louis Vuitton operating 12 stores in 10 cities in 2006.
3bid.
4"Some Fashion Houses Bolster Lower Priced Lines,"
The Wall Street Journal, September 25,
2006.
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