How far can luxury brands travel? Avoiding the pitfalls of luxury brand extension

Business Horizons (2009) 52, 187—197 www.elsevier.com/locate/bushor How far can luxury brands travel? Avoiding the pitfalls of luxury brand extensio...
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Business Horizons (2009) 52, 187—197

www.elsevier.com/locate/bushor

How far can luxury brands travel? Avoiding the pitfalls of luxury brand extension Mergen Reddy a, Nic Terblanche b, Leyland Pitt c,*, Michael Parent c a

Capgemini Consulting, P.O. Box 785827, Sandton, 2146, South Africa Stellenbosch University, Private Bag X1, Matieland, 7602, South Africa c Segal Graduate School of Business, Simon Fraser University, 500 Granville Street, Vancouver, BC V6C 1W6, Canada b

KEYWORDS Luxury brands; Brand extensions; Degree of adjacency; Premium adjacency matrix

Abstract Brand extensions are always tempting to marketers, and in the case of luxury brands the allure is particularly strong. While the path to luxury brand success may be partly paved with extensions, there are even more examples of brand extension disasters that litter the way. Brand extensions continue to be among the most researched and studied phenomena in marketing. When it comes to luxury brands, however, the factors that lead to successful extension have received far less attention. In this article, we consider the notion of perceived premium degree of the brand as a function of its category, and what we term the degree of adjacency between its product categories. Building on our research, which found that a luxury brand’s perceived premium degree has a different impact on profitability depending on whether or not the brand is spread across adjacent product categories, we demonstrate when luxury brand extensions work–—and when they fail. Perhaps most importantly, we herein introduce the premium adjacency matrix as a tool for luxury brand managers to consider in formulating extension strategies. # 2008 Kelley School of Business, Indiana University. All rights reserved.

1. The temptation of luxury brand extension While there are almost as many opinions on fine wines as there are wines and wine critics, most * Corresponding author. E-mail addresses: [email protected] (M. Reddy), [email protected] (N. Terblanche), [email protected] (L. Pitt), [email protected] (M. Parent).

would agree that Cha ˆteau Margaux, the famous Bordeaux first growth, is up there with the very best. It is a wine of which author William Styron (1992) wrote, in the novel Sophie’s Choice, ‘‘when you live a good life like a saint and die, that must be what they make you to drink in paradise’’ (p. 151). It would be a marketer’s dream to extend the Cha ˆteau Margaux brand. It could perhaps be broadened to less rare, more readily available early drinking wines. Or, partnerships with wineries in other countries

0007-6813/$ — see front matter # 2008 Kelley School of Business, Indiana University. All rights reserved. doi:10.1016/j.bushor.2008.11.001

188 could be formed. It might even be extended to other beverages, or to a range of gourmet food products. It could even encompass hospitality offerings or a selection of durable luxury goods. So far, though, Cha ˆteau Margaux has resisted the temptation to extend the legendary brand to anything other than great wines–—and only three, at that (Deighton et al., 2006). In contrast, first growth competitors such as Cha ˆteau Haut-Brion and Cha ˆteau Mouton-Rothschild have extended their brands in a number of ways. Haut-Brion markets a wine called Clarendelle at around $20 a bottle. Mouton-Rothschild, through alliance with Mondavi in California, produces and markets Opus One for about $250 a bottle; partnered with Vin ˜a Concha y Toro in Chile, it produces and markets Almaviva for around $75 a bottle. While these are premium priced wines, they never reach the heady price levels of first growths; for example, a 2000 Cha ˆteau Margaux will sell for approximately $900 per bottle. MoutonRothschild also mass markets red and white wines, at a price point less than $20 per bottle, under the Mouton Cadet label. Even the legendary Cha ˆteau Pe trus has a brand of merlot associated with it which ´ sells for under $20 a bottle. While estimates of its size vary from forecaster to forecaster based on their assessment of segments and customer behavior, and also on the classification schema used, the simple truth is that the international market for luxury brands is immense (Allen, 2007; Cohen, 2007). Its size has been further accelerated in recent years as the number of affluent consumers in countries such as China and India increase, as those nations exhibit stellar economic growth. In the developed world, the rich are indeed getting richer. Rising stock prices, increased disposable incomes, consumer confidence, and a double-digit upsurge in international travel have proven to be a boon to luxury brands. Unfortunately, all of this has not made the management of luxury brands any easier. What Nueno and Quelch (1998) pointed out a decade ago is just as true today: Growth in luxury brands has raised the competitive wagers that need to be made. Managers of luxury brands can be led into temptation by growing consumer affluence, making it difficult to resist the pull that could be so easily acquiesced to by endless brand extensions. So, is it possible to answer the most important questions facing luxury brand managers? Might it be possible to predict which brand extension alternatives might be successful, and which might not? Is it feasible to foresee which extension strategies will be profitable, and which will not? Based on our research and experience, we believe the answer is yes.

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2. Extensions can work, but just how far can a luxury brand travel? Brand extensions are one of the most heavily-researched and influential areas in marketing (Czellar, 2003). The considerable attention given by marketing scholars to issues regarding brand extensions, and their findings in general, support the conclusions of our research and the recommendations that we will make here; for instance, Vo ¨lckner and Sattler (2006) found that fit between the parent brand and an extension product is the most important driver of brand extension success. From a luxury branding perspective, however, much of the extant research does have particular limitations. First, the majority of brand extension research has focused on non-luxury brands. For example, while Keller and Sood’s (2003) research found brands to be far less vulnerable to the vagaries of extension than generally feared, the brand environments considered were those of beverages and health and beauty aids. Second, in many of the studies considering the impact of brand extensions, the main dependent variable has been the impact on quality perceptions of the parent brand. Keller and Sood (2003) found that these were unaffected when the proposed extension was in a dissimilar product category. While this is mildly reassuring, in the case of luxury brands we contend that there is probably a more fundamental and compelling outcome criterion: profitability. Third, the settings for much of the research on brand extensions are far removed from the real context of luxury brands. For example, noting that the most successful extensions involve brands that are associated with benefits that are valued in the extension category, Meyvis and Janiszewski (2004) proposed that brand extension success also depends on the accessibility of benefit associations. Accessibility, in turn, depends on the amount of interference from competing brand associations (e.g., category associations). They argue that broad brands (i.e., brands offering a portfolio of diverse products) will tend to have more accessible benefit associations than narrow brands (i.e., brands offering a portfolio of similar products). It is therefore easier for broad brands to extend than narrow brands, even when the narrow brands are more similar to the extension category. While these findings make welcome sense, and are heartening, this research was not carried out in a luxury brands context or with the target customers of luxury brands. Similarly, contrasting the commonly advanced rationale for the proliferation of brand extensions that a firm’s motivation was to leverage the equity

How far can luxury brands travel? Avoiding the pitfalls of luxury brand extension in established brands, Balachander and Ghose (2003) investigated whether extensions would favorably affect the image of the parent brand and thereby influence its choice. They established the existence of a positive reciprocal spillover effect emanating from the advertising of a brand extension. However, the research used scanner panel data (of consumer brands) and the researchers point out that their findings were earlier contradicted by those of Sullivan (1990), who considered a luxury brand (Jaguar) more like those discussed in this article. Research such as that conducted under the PIMS studies has long demonstrated a positive link between a brand’s profitability and its relative market share (Buzzell, 2004; Buzzell & Gale, 1987; Szymanski, Bharadwaj, & Varadarajan, 1993). An equally important finding from this line of research was that relative product quality had a significant impact on profitability, either because of quality management’s effect on lowering costs or the fact that customers were willing to pay more for premium quality, or–—synergistically–—both (Anderson, Fornell, & Lehmann, 1994; Jacobson & Aaker, 1987). In a similar way, CEOs of luxury brands might expect to grow their profitability by increasing the perceived premium degree of the brand as a function of its category. In simple terms, the premium degree of a brand is the extent to which customers perceive it to offer more quality than comparable offerings, and are willing to pay a premium price (Reddy & Terblanche, 2005; for an alternative analysis, see Anthony & Christensen, 2003). A familiar example of this is Harley-Davidson motorcycles. The brand commands a premium price and extreme Figure 1.

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brand loyalty, despite the fact that in terms of technical product performance and features it is easily surpassed by the majority of its Japanese and European competitors (Helyar, 2002). In the luxury brands arena, there is evidence that marks like Tiffany, Bose, Rolex, and Louis Vuitton all showed increased profitability as the consumer perception of the brand increased. We wanted to test, more broadly, the applicability of the degree premium phenomenon in the case of luxury brands: would degree premium fully explain brand profitability? In order to do this, we studied 150 luxury brands (see Table 1), conducted interviews with 300 executives (two from each company), and analyzed a decade’s worth of financial data for each of these luxury brands (see Appendix for details).

3. When premium degree works Our research yielded surprising results. Of the 150 luxury brands we studied, the link between customers’ perceived premium degree of the brand and increasing profitability simply wasn’t there, as illustrated in Figure 1A. Furthermore, our analysis showed this pattern–—or, indeed, lack thereof–— was not confined to select product categories; it seemed to be a general phenomenon. While some brands like Bose (the leader in high quality audio systems) achieved margins far superior to their traditionally commoditized category, other luxury brands in premium categories did not. Perceived premium degree turned out to be a necessary but not sufficient driver of a luxury

Luxury brand profitability: The effect of adjacency

190 Table 1.

M. Reddy et al. Brands studied

Alessi Alexander McQueen Anthon Berg Aquascutum Armani Aston Martin B&O Balenciaga Baume et Mercier Bedat & Co. Belvedere Bentley Berluti BMW Bollinger Bose Bottega Veneta Boucheron Breguet Breitling Bugatti Bulgari Burberry Canali Cartier Cerruti Chanel Cha ˆteau d’Yquem Chloe Christian Dior Cranchi Cristal Dassault Falcon Davidoff De Beers Diane von Furstenberg Dolce and Gabbana Dom Perignon Donna Karan Dries van Noten Ducati Dunhill Eos Airlines Ermenegildo Zegna Escada Evian Faberge ´ Fendi Ferrari Ferretti Yachts

R F C F F A S F W W C A F A C S F W W W A F F F W F F C F F A C A C W F F C F F A F A F F C W F A A

French Connection Gianfranco Lotti Gilan Givenchy Godiva Gucci Guerlain Harrods Harry Rosen Hennessey Herme `s Hugo Boss Issey Miyake Jaeger-LeCoultre Jaguar Jean Paul Gaultier Jimmy Choo John Bartlett Johnnie Walker Blue Josie Natori juwelry Kenneth Cole Kenzo Kiton Krug Kurt Geiger La Perla Lacoste Lamborghini Lancome Lear Lexus Liberty of London Lindt & Spru ¨ngli Lladro ´ Loewe Longines Loris Azzaro Louis Vuitton Manolo Blahnik Marantz Marc Jacobs Marcel Rochas Maserati Maurice Lacroix Maxwells Maybach Mercedes-Benz Michel Herbelin Miu Miu

F F W F C F F R F C F F F W A F F F C F W F F F C F F F A F A A F F W F W F F F S F F A W F A A W F

Moe ¨t et Chandon Montblanc Movado Muji NAD Nina Ricci Omega Orient-Express Hotels Oscar de la Renta Paco Rabanne Pal Zileri Panerai Patek Philippe Paul Smith Perrier Piaget Porsche Prada Princess Yachts Rado Raffles Ralph Lauren Richard James Savile Row Rolex Rolls Royce Salvatore Ferragamo Sergio Rossi Stella McCartney Swarovski Tag Heuer Tannoy The Four Seasons Thomas Pink Tiffany Tissot Tods Tom Ford Turnbull & Asser Vacheron Constantin Valentino Van Cleef & Arpels Versace Vertu Veuve Clicquot Viktor & Rolf Vivienne Westwood Wally Yachts Waterman YSL Zenith

C W W R S F W R F F F W W F C W A F A W R F F W A F F F W W S R F W W F F F W F W F W C F F A W F W

Legend: A - Automotive, Transportation; R - Retail (specialty); C - Consumables; S - Audio Equipment; F - Fashion; W - Watches, Jewelry

brand’s success. We examined a small number of the brands in Figure 1A at the extreme ends of the spectrum, and observed that the mix of products in the portfolios of the most profitable brands (the top right-hand side of the spectrum) demonstrated

far more logical consistency than did the less-profitable brands. In simple terms, these more-profitable products under a brand umbrella had more in common with each other. The products in the brand portfolios represented in the bottom-left of the

How far can luxury brands travel? Avoiding the pitfalls of luxury brand extension Figure were not as cohesive. For example, a cohesive brand portfolio might consist of products such as leather shoes, belts, bags, and wallets: all small leather goods. A less cohesive portfolio would consist, for example, of leather shoes, baseball caps, cotton shirts, and pens: items that are all worn on the person, but without the logical consistency displayed by the former portfolio. We termed this cohesion ‘‘brand adjacency.’’ We found that a luxury brand’s profitability (as measured by gross margins) is driven by its perceived premium degree and its degree of adjacency. A luxury brand’s profitability will rise as the perceived premium degree increases only if the brand is extended along adjacent product categories. If a premium luxury brand extends itself into a nonadjacent product category, there will be a general decline in profits, irrespective of the strength of the brand in its core category. This is demonstrated in Figure 1B.

4. Brand adjacency We define brand adjacency as the extent to which a particular brand extension is consistent with the values embodied by the core brand. The more symbolically consistent the extension, the greater the degree of adjacency. For example, Louis Vuitton and Cartier respectively have gross margins in excess of 70%. When considered against their peers, these brands are also rated at the highest end of the premium scale. What’s more, these brands have extended their names into product categories that are closely adjacent to their core products. In the case of Cartier, the brand was extended from jewelry to watches, perfumes, and accessories. Louis Vuitton went from handbags to clothing, jewelry, perfumes, and accessories. Considering each brand extension, the equity of the brand in its core category carried through into the new category because all the new categories were very close to the core category in terms of key values and perceived attributes. The once-venerable Pierre Cardin brand was among 21 early elite members of the Chambre Syndicale de la Couture Parisienne, the trade association for haute couture brands. To boost flagging revenues in the 1960s, the company licensed its name to perfumes and cosmetics which were manufactured by transnationals such as Unilever, L’Ore ´al, and Este ´e Lauder. The approach was initially very successful, which encouraged management to extend licenses across a vast range of product categories, seemingly in an indiscriminate fashion. By 1988 more than 800 licenses had been

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issued across 94 countries, generating a turnover of approximately $1 billion. The first Pierre Cardin brand extensions, into the perfumes and cosmetics categories, were successful since the premium degree of the brand transferred itself into the new categories without losing image. Rather than attribute this to proper fit between the product categories, the owners of Pierre Cardin saw it as a testimony to the strength of their brand. Believing this to be true, margins dropped markedly after the Pierre Cardin name began appearing on unrelated items–—everything from cigarettes to baseball caps. There was even a table wine launched under the Pierre Cardin label, which sold dismally (Ries & Trout, 1982). In the end, the adjacency of the extensions–—or, their consistency–—is what made the difference.

5. A growing affluenza While the market for luxury brands is one of growth, there is no reason to believe that it is limitless, and certainly no cause to assume that lines can be extended indefinitely or brands extended as broadly as marketers’ fancies take them. Evidence also suggests that the luxury brands market will be more, not less, competitive (Allen, 2007; Cohen, 2007). On the one hand, the size and growth of the primary target market is still fairly limited. On the other, while one might expect growth to come from increases in middle income markets, luxury brand marketers are faced here by what has been termed the mainstreaming of affluence phenomenon: consumers expect more than what they deserve. If a product does not feature a luxury look and feel, it will not pass muster (Smith, 2003). Under such conditions, when every product is expected to meet this standard, nothing can command a premium price just because it provides a luxury look and feel. The point is this: luxury brands cannot simply rely on heritage to retain their cachet. As such, managers of luxury brands need to consider growing by either expanding into adjacent product categories or by moving into new markets. The latter option will lead to incrementally limited growth if key markets have already been entered, despite the fact that there is growth in markets such as India, China, and the United States. The adjacent category option is therefore a strategy that merits serious consideration. Developing the most profitable strategy for a luxury brand entails more than spending millions of dollars creating the best marketing strategy; it is not enough to merely consider the brand’s equity in the market. Our analysis, as described, suggests

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that both premium degree and brand adjacency need to be simultaneously contemplated: First, to what degree is a particular luxury brand considered premium by the market, relative to its peers? Second, to what degree can brand extensions be made along adjacent product categories?

6. The premium adjacency matrix To aid in our analysis, we developed a two-dimensional matrix whereby any luxury brand may be mapped onto one of four quadrants. Each quadrant will have different implications for a luxury brand’s potential, and how it can and should be managed. This is illustrated in Figure 2. Inevitably, a portfolio of luxury brands will occupy more than one quadrant. It is therefore important for managers to understand the implication for managing individual luxury brands in these portfolios. Since brand dilution and the subsequent profit erosion exhibits a lag effect, it is also important for managers to carefully consider the longer-term impacts of their decisions. Given the quadrant a luxury brand occupies, managers might ask themselves: ‘‘What can I do to avoid a painful lesson like Pierre Cardin’s?’’ A luxury brand manager can use this matrix to consider future expansion opportunities, and to avoid disasters.

6.1. Star brand We call a luxury brand that is considered premium to its peer group, and extended along adjacent product categories, a star brand. Our research shows that star brands typically have gross margins in excess of 70% while generating strong revenue growth. For any CEO on the watch of a star brand, the mantra must be ‘‘creativity, quality, Figure 2.

Luxury brands: The premium adjacency grid*

and exclusivity.’’ Customers of star brands pay a steep premium to acquire a good or service from a brand that is of the highest quality, which incorporates the latest design or production trends, and which has an aura of exclusivity; the brand is aspirational. Louis Vuitton is a good example of a star brand. The brand has maintained gross margins in excess of 70% and average sales growth over 10% for many years, peaking at 16% in 2004. While rivals have struggled through economic slowdowns and the vicissitudes of the international business environment, Louis Vuitton has ceaselessly focused on quality, distribution, and marketing. To maintain a firm control on quality, 11 of Vuitton’s 13 production sites are in France, which is one of the most expensive labor markets in the world. Moreover, these sites are continuously upgraded to manage costs and quality. Each step of the production sequence is meticulously mapped by trained craftspeople and engineers; teams of crafts workers are trained months–—sometimes a year–—before a product will be launched. This intense focus on quality and cost reduction in operations makes sense, considering the costs of managing the customer interface. Louis Vuitton spends approximately 12% of revenues on advertising versus an average of 6.3% by its major competitor, Gucci. Distribution is under a tight rein via company-controlled stores. Louis Vuitton also uses product primers to manage the paradox of maintaining exclusivity while satisfying consumer demand for its special collections. For example, the Murakami line and Marc Jacobs Graffiti line of handbags were only released in limited batches. These limited collections act as primers in that the waiting list extends for months, which encourages the typical consumer to buy a standard Louis Vuitton handbag representing a scaled-down version of the

How far can luxury brands travel? Avoiding the pitfalls of luxury brand extension limited edition design. This has allowed the brand to maintain exclusivity while still posting strong growth, driven by sales of the adapted standard lines: an average of 30% of sales originates from new lines. Louis Vuitton’s joint venture with diamond giant De Beers is an example of brand extension into an adjacent category, inasmuch as luxury apparel items and luxury jewelry are discretionary purchases and allow for a display of affluence. Louis Vuitton would benefit from moving into the branded diamond jewelry market with a premium partner, without over-exposing itself in an industry in which it has limited experience. Another example of a star brand is Cartier. Once dubbed the ‘‘king of jewelers,’’ the brand was founded in 1847 and built its reputation by outfitting European royalty. In the jewelry category–—which accounts for half of Cartier’s business–—the firm tended to lose momentum in the late ‘90s and early 2000s, with no new lines being launched. During this time, complacency, lack of innovation, and limited investment in original designs caused a decline of 10% in sales from new products. Cartier responded by launching novel lines of women’s watches and jewelry. This re-focus on innovation and quality led to new product launches, accounting for approximately 27% of new sales by the turn of the century. The brand has shrewdly raised profit margins by expanding into adjacent categories and not by the indiscriminate granting of licenses. A third example of a star brand is Herme `s. With price points of $8,800 for crocodile skin handbags and $400 for cotton poplin shirts, Herme `s has limited competition from a pricing perspective. The brand has built its reputation through not only a relentless focus on quality, but also marketing to a well-understood core client base. Quality has been maintained by integrating a large proportion of its production and retail operations: Herme `s has even been willing to take over key suppliers just to ensure superior quality of inputs for the end product. Approximately 75% of the products sold are manufactured in-house, and of the 23 production sites in Europe, 21 are located in France. Unlike Louis Vuitton, however, which has a broader target market, Herme `s has a more established market and, hence, significantly lower customer interfacing costs. Approximately 6% of sales are spent on advertising, and the company even goes so far as to buy back selected franchises to maintain quality. This dedicated focus on quality, creativity, and marketing has seen new business sales increase overall sales by an average 25% annually. In our opinion, only 10 luxury brands in the world can lay claim to the title of star brand. Here, unlike in the case of most consumer

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products categories, profitability is not driven by market share. While it might be tempting for managers of star brands to trade down and target the mass market of middle- to lower-income consumers that crave their brands, this should be approached with caution. They would be well advised to think carefully before deciding to lower price points in order to exploit this market. Significant profits can still be generated by expanding into adjacent categories or new markets. Simply lowering prices in order to gain market share might erode a brand’s long-term earning potential, and ultimately destroy profits.

6.2. Aspiring star brand Characteristically, an aspiring star brand is one which is high on premium in its core product category, but not as strong in other categories; moreover, they typically have gross margins between 50% and 70%. Managers of aspiring star brands usually have two strategic choices: Invest resources to develop the brand in non-adjacent categories, or exit non-adjacent categories to focus on the core category and only then expand into adjacent categories. Porsche, the specialist sports car manufacturer, is a good example of an aspiring star brand. Having made the decision to move into the fast-growing and traditionally profitable SUV category, Porsche launched its Cayenne model in 2002. The company posted a 9.39% increase in operating revenue until 2006, but gross margins only increased by 3.65% over the same 4-year period following the Cayenne’s launch. Rather than exit the category, Porsche responded by introducing an ultra-premium SUV which retails for around $100,000. SUV sales now account for 58% of the company’s total sales, and profits are at their highest levels in many years. Porsche has clearly elected to invest resources to develop the brand into non-adjacent categories, since at first glance, there appears to be limited adjacency between the luxury sports car and SUV categories. Porsche nevertheless managed to transfer its symbolic characteristics onto the segment rather than its functional characteristics, and subsequently raised the strength of its brand in the category. The aspiring star quadrant is transitory, and really a way-station. Aspiring luxury brands move through this quadrant as they become more profitable or less profitable. When considering brands in this quadrant, managers need to reassess their strategy and ensure that in the long-term the brand is given sufficient resources to reach the star quadrant.

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6.3. Waning luxury brand When a luxury brand is perceived to be of lower premium than its peers, yet extended along adjacent product categories, we refer to it as a waning luxury brand. Luxury brands in this quadrant usually have gross margins of between 30% and 50%. Over half the brands we studied fell into this category, which may be disconcerting to luxury brand managers, given our observation that the luxury brand market internationally seems set to grow. This observation emphasizes two fundamental requirements for astute luxury brand management: first, that market growth alone will never drive brand profitability; and second, that indiscriminate brand extension can severely affect brand profitability. The automobile industry provides several good examples of waning luxury brands. Consider Mercedes-Benz, which has consistently been regarded as a luxury automotive brand with numerous models in its portfolio. The Mercedes brand has been extended into adjacent product categories which reflect its focus on comfort and luxury–—the latest being SUVs, which now account for 12% of the company’s sales. However, Mercedes’ profitability has suffered at the hand of an expansion strategy that negatively impacted product quality and, hence, the perceived premium degree of the brand. Both of Mercedes’ main competitors, BMW and Audi, have moved into adjacent categories, where they have also improved their design and quality ratings. While these two auto makers have consistently moved up the J.D. Power & Associates ranking (www.jdpower.com/ autos), Mercedes-Benz has slipped. Lapses in quality have hurt Mercedes’ profits, as evidenced by the expensive 2005 product recall of 1.3 million vehicles to fix an electronics problem in luxury E, SL, and CLS Coupe models. To emphasize the enormity of this situation, consider that the size of the recall exceeded Mercedes’ annual output. A waning luxury brand which improved its image is Bottega Veneta. In the 1970s, this leather goods house was famous for its woven bags and the slogan, ‘‘When your initials are enough.’’ The brand was subsequently extended into adjacent categories such as clothing, whereby it unfortunately produced items of poor quality and image (e.g., black catsuits with ‘‘BV’’ in neon lettering). Following this downturn, Herme `s designer Tomas Maier was lured away to introduce a line of high-fashion Bottega Veneta clothing and handbags; as a result, Bottega’s gross margin rose by 12%. Can a brand successfully exist in this quadrant? When managers of waning luxury brands decide to pursue revenue growth over profitability, these brands usually post strong initial growth. Over time,

M. Reddy et al. however, the brand starts to erode and profits begin to decrease. In this age of increasing shareholder expectations, it is rare for management to consistently condone revenue growth at the expense of profitability. Increased expansion costs and lower profitability create a vicious cycle wherein not enough funds are available to build the brand, and brand erosion cannot be halted. Managers of waning luxury brands therefore need to employ what we call an island-hopping strategy. This term is derived from a practice first employed by the U.S. Navy in the Pacific Theater of World War II; generally, it refers to crossing an ocean via a series of shorter journeys between islands, as opposed to a single direct stretch to the end destination (Weigley, 1973). In a luxury branding situation, managers should extend the brand to one adjacent category (e.g., from a line of wallets to a line of briefcases) at a time and deploy the required investment to build the brand until it is as strong in this category as it is in the core category. They should not move on to the next category until this has been achieved. Initially, this will ensure sufficient capital is available to grow the brand, and later that the category generates profits to fund itself, thereby freeing capital for expansion into other adjacent categories–—or, in Navy terms, hopping to the next island.

6.4. Dying stars When a luxury brand is extended along non-adjacent product categories and is perceived as significantly less premium than its peer group, we refer to it as a dying star. Luxury brands in this quadrant typically have gross margins of less than 30%. Brands in this quadrant could either be star brands which have since lost their luster, or brands on their way up which have not yet succeeded, or will not. Managers of dying stars have two strategic options. The first is to make the necessary investments to reinvigorate the brand, boost it, and turn it into a star brand. Obviously, this will depend on the funds available. Given that the average gross margin is still between 20% and 30%, this might be possible in some cases. Gucci is one example. Executives at Gucci diluted the brand’s luxury cachet in the 1980s by broadly licensing it to everything from sunglasses, to apparel, to cigarette lighters, much like Yves Saint Laurent (YSL) did earlier. With concomitant drops in sales and perceptions of the brand as luxury, management took back control of the brand, restricted extensions, and imposed stringent quality control on all products. As a result, the brand has since rejuvenated and regained its cachet.

How far can luxury brands travel? Avoiding the pitfalls of luxury brand extension Choosing a turnaround strategy like Gucci’s will result in a significant initial drop in sales as distribution, licensing, and product categories are streamlined. Costs will simultaneously increase as the investment in innovation, design, quality, and production increases. The second alternative is to go down-market and reposition the brand as a premium, not luxury, brand. This might be the only alternative when sufficient funds to reinvigorate are not available, or when the gross margins being enjoyed do not merit further investment. It would be wise to review the difference between these two strategies. Opting to take the brand to star status will require reducing distribution and heightening exclusivity. Quality is increased irrespective of the cost, even if this entails moving to expensive manufacturing centers such as France. Licensing is restricted and the brand is positioned alongside carefully selected celebrities using meticulously chosen media campaigns. Luxury brands usually have a strong, long-lived heritage, and this legacy is a key asset in repositioning the flagging brand. On the other hand, electing to make the brand a premium brand will require increasing distribution and reducing exclusivity to increase sales. Quality is important, but since the brand is at a lower price point, the product is positioned for more frequent purchases to drive revenue growth. Manufacturing does not require craftsworker skills and is usually done in the lowest cost location. Advertising delivers the largest exposure at the lowest cost. Premium brands can quickly increase sales without the asset of a strong heritage. Managers need to judiciously consider the last differentiator before selecting their strategy for this quadrant. Brands with a long and established heritage have a greater chance of making it to star status. Brands without the birthright would need to acquire this characteristic before reaching star status; this takes time, since a small group of customers need to learn to trust the brand.

7. The best medicine The case of the von Furstenberg brand and its evolution serves well as a final reminder of the principles we expound in this article, and puts forth a set of prescriptions for luxury brand managers. During the 2002 ‘‘7th on Yale’’ lecture series, Diane von Furstenberg regaled the audience with her story, one of triumphs and tribulations faced by a princess who founded a luxury brand in New York. Given her candor, energy, experience, and shining personality, one would be remiss in forgetting that she, too, learned

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a painful lesson that no luxury brand manager would want to experience first-hand. In 1972, at the age of 26, von Furstenberg designed the dress that shaped a generation. By 1976, she had sold over 5 million of the all-purpose daywear-to-disco frock, and was hailed by Newsweek as ‘‘the most marketable female in fashion since Coco Chanel’’ (Francke, Whitman, & Gilbert, 1976, p. 52).

 Prescription 1: Never forget that a luxury brand has history, tradition, and–—above all–—a ‘‘story’’ that resonates with its target customers. Brand extensions which deny this narrative are perilous. By this time, a single mother of two and an A-List VIP at Studio 54, von Furstenberg continued her success with a line of beauty products and fragrances. Based on this triumph, the von Furstenberg name was splashed across such diverse product categories as luggage, eyewear, jeans, and books, to name but a few. The strategy initially worked, as the von Furstenberg name generated higher margins onto every product to which it was introduced, irrespective of the category. Profits and revenues were up. A few years into this period of heady growth, however, these non-adjacent brand extensions diluted the core brand, and the company saw a plunge in revenue and profit. The situation reached a critical point when the design and cosmetics houses were sold off to pay looming debt. How could such a luxurious and royally-anointed brand have failed?

 Prescription 2: Luxury brand managers should not be anesthetized by initial successes. Markets may be wooed but not ultimately seduced by nonadjacent brand extensions, perhaps for curiosity’s sake without any real long-term commitment to products that do not make sense to them. Von Furstenberg erred by emphasizing the mechanical aspects of the non-adjacent products the firm branded (such as the shapes and finishes of its eyeglasses frames), rather than accentuating their symbolic worth as related to the original brand. While the brand originally enjoyed a high perceived premium degree, this was eventually eroded by its extension into non-adjacent product categories. The general decline in gross margins–—despite the strength of the brand in its core category–—turned it first into a waning, and then into a dying, star.

 Prescription 3: Luxury brand managers must remember that, more than anything else, brands are symbols (Stern, 2006). When managers want to extend luxury brands into non-adjacent cate-

196 gories, they should first consider whether the brands have appropriate symbolic muscle to traverse categories. They should also consider whether the symbolism can be consistently promoted in the new categories. Using our premium adjacency matrix, they can avoid extending into categories that are not sufficiently adjacent.

8. The lap of luxury Luxury brands excite and entertain us. When Coco Chanel uttered her famous line, ‘‘Luxury must be comfortable, otherwise it is not luxury’’ (Barry, 1964, p. 31), she had the consumer in mind, not the management of luxury brands. Yet the line is as apposite to the management of luxury brands as it is to the dictates of consumer wellbeing. Luxury brands are most comfortable in a portfolio that makes sense, where the perceived premium degree fits closely with adjacent extended categories.

Appendix: The study Our study began by identifying the top luxury brands. To do so, we hired a U.S.-based consumer research firm, and asked it to construct and administer a questionnaire to a representative group of consumers that would identify and rank luxury brands against each other. The panel did so for 150 luxury brands, which we then sorted into six broad categories (see Table 1). As expected, the majority of brands (71 out of 150) fell into the Fashion category. Watches and Jewelry were second, with 32 brands. Automotive and Transport (jets and yachts) were third, with 21 brands. The remaining categories consisted of Consumables (wine, liquor, chocolate, tobacco — 15 brands), Audio Equipment (5 brands), and Specialty Retail and Hotels (6 brands). We calculated premium degree first by using the brand’s price elasticity (the less elastic, the greater the premium degree). Secondly, we force-ranked the brands relative to each other based on the questionnaire results. Adjacency was defined as the ability of a brand to leverage its core competency into a new category where that same competency was essential for the brand to exist and succeed in the new category. This competency was, in turn, defined as the core attribute for the brand’s success and the one characteristic it would not compromise in any way. We determined each brand’s core competency/ capability using a Delphi method, whereby we as-

M. Reddy et al. sessed the extent to which this core competency was essential for the brand to exist in the new category. The more essential the characteristic, the greater the degree of adjacency. In sum, adjacency was a broad concept that extended beyond the product itself to include skills, management structures, financing arrangements, manufacturing, supply chains, and the like. In order to determine brand success, we conducted focus interviews with 300 executives at the companies that owned the brands (two from each company). Interviews were structured as face-to-face, with follow-up telephone calls and emails as necessary. We also collected 10 years’ worth of financial data for each of these 150 brands. For listed firms, we used disclosed data. However, most financials do not disclose data at the brand level. To obtain this information, we conducted follow-up interviews, as needed, with the executives. We checked our data two ways: first against third-party industry trade data, and second with models developed by industry analysts. Finally, we verified our results with executives at the companies. All of the 300 executives save 22 confirmed the accuracy of our models. Fortunately, we had at least one executive from each of the 150 brands confirm.

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