Thursday, May 14, 2015

The Gathering Storm

With the watch world's eyes squarely resting on China we wait, and we watch - and if the big dogs in Switzerland have the good sense that God gave them, they will start living in the reality of the world today.

I read a very good article on Watches by SJX - the link is here if you'd like to take a moment:
http://www.watchesbysjx.com/2015/05/watch-retailers-in-hong-kong-band.html


The basics are this - watch retailers in Hong Kong are sitting on a LOT of inventory owing to decreasing demand.  In addition, several of Hong Kong's watch retail leaders have joined together to request rebates owing to poor sales so far this quarter - reported to be some 40% down in the first quarter.

It is important to understand that this is not down to smart watches.  Moreover, it is not solely due to clamp-downs on anti-corruption in China, nor is it solely due to the currency fluctuation that the Swiss Franc created earlier this year.  These are all factors, but the problem is perhaps a little more basic and a little more "predictable" than that because it is one that has existed for quite some time.

So allow me to reintroduce my 2 favorite characters in the watch business -
Cause and Effect.  Or as I sometimes say: "Why the watch you paid full-price for back in November is now available for 35% off through the grey-market "new in box with papers".

The watch business is not entirely unlike many others - you make a product, you market it, you (hopefully) sell it, and then you (hopefully) offer service.  The core, basic, KNOWABLE reason why watches are being treated like "expired baked goods" is, if we are honest, the fault of the brand.
Why would a brand knowingly sabotage itself?  Well, as with pretty much every other endeavor, we all start out with good intentions.

Step 1.  Budgets are vetted by the board via the CEO and approved.  It is important to understand that these budgets are based on PROJECTIONS, not ACTUALS (because, of course, we have no way of knowing what the actuals will be until December 31st).  These budgets dictate production, sales, etc.  Production numbers are therefore tailored to accommodate the projections.

Step 2.  Watches then run through assembly, and new watches are "prototyped" for SIHH and BaselWorld.  And orders (hopefully) are taken.

Step 3.  Watches start to be delivered - for a well-established retailer this is not unlike using a very flexible credit card - the agreement says that the retailer will pay 1/3 within 30 days, another 1/3 after 60 days, and complete the transaction within 90 days.  This, in turn, motivates the retail partner to sell at least 55 - 60% of their stock within that time frame.

If the watch brand manager is new, desperate (or both)  the retail store may receive that magical thing known as "memo" - meaning the store does not pay anything for the watches until they have sold them.  And it then becomes even more expensive for the brand to work with the retail partner because the ONLY way that the brand can know whether or not the store has sold any watches is to spend the money for a ticket, rental car and hotel and come and "count" the watches in the store's safe.  It might be that the store sold the watches 3 months ago, but because the safe count comes 3 months after the fact it is only then that an invoice will be generated at HQ.  The retailer will receive it in about 14 days, which their accounts receivable office will typically "age" for 30 days before paying, by check which will then take (likely) another 14 days for the brand to receive and deposit in their bank.  This then means that the brand has waited nearly half a year to get paid.

Now multiply that 1 example by, I don't know...25!  As you can imagine that creates more than a bit of a cash-flow crunch for a brand's US distributor or office.

Step 4.  Several retail stores are slow to pay, and several of the "new" accounts from SIHH and BaselWorld are not selling through, and the brand manager can just forget about them re-ordering.  The brand starts to realize as September looms, that it is becoming abundantly clear to the folks back in "the factory" that they are nowhere near their numbers.  Action has to be taken, and the senior sales managers are then dispatched to places like, I don't know, Hong Kong where great volumes of watches are dumped.  The brand takes a small hit, but not nearly the hit they would take if the watches were still sitting at HQ.  And in most cases, the "grey market purge" has already been accounted for as a line item on the spreadsheet.

Step 5.  That watch you spent $5,000 (full price, mind you) is now available via the grey market for 35 - 50% off.

Step 6.  This was still not enough to stem the tide and brand managers and sales directors are let go.  You can truly set your calendar to this - September - February is traditional.  New brand managers and sales directors are brought it - and the dance begins again.  And inevitably the cycle repeats itself.

So getting back to China -Steps 1 - 6 have always existed, but with China buying up boatloads of discounted watches there was always a place to "sweep" your excess inventory "under the rug".  That option is now becoming less and less possible and the brands are going to have to do some serious "soul searching" to see if they can find a more practical way to go forward.

It is ironic that the lessons of the 30s, the 70s and even 2008 are slow to sink in with many brands.  First class travel, ridiculously expensive press junkets and downright waste seem to go hand in hand with brand management.  Over production, panic and an unwillingness to wait it out rather than blow out a collection, create a brand new one for next year and go through exactly the same pain 12 months later.  Only now the realities are a little bit starker.

The storm is coming, let's hope at least some of the brands have enough sense to close the windows and bring the dog in.

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