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case teaching note 8 Coach Inc. : Is Its Advantage in Luxury Handbags Sustainable? Overview 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% and its stock price had increased by 1,400% 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% 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 U. S. with a 25% market share and was the second best-selling brand of such products in Japan with an 8% market share.
Beyond its winning combination of styling, quality, and pricing, the attractiveness of Coach retail stores and 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 companyowned stores in the U. S. 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 yearend 2006, comparable store sales in Coach factory stores had increased by 31. 9% since year-end 2005, while comparable store sales for Coach full price stores experienced a 12. 3% year-overyear increase. Coach’s dramatic growth that resulted from its strategy keyed to “accessible luxury” had not gone unnoticed by long-established luxury goods makers. In 2006, most leading designer brands had developed sub-brands 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 $600. Going into 2007, Coach Inc. executives expected to sustain the company’s impressive growth through monthly introductions of fresh new handbag designs and the addition of retail locations in the U. S. , Japan, and rapidly growing luxury goods markets in Asia.
Other growth initiatives included strategic alliances to bring the Coach brand to such additional luxury categories as women’s knitwear and fragrances. Suggestions for Using the Case Students should be highly interested in the Coach Inc. case because of their likely aspirations to own luxury goods upon completion of their degrees. Industry statistics presented in the case indicate that young professionals are among the most frequent purchasers of “accessible luxury” goods such as Coach handbags.
You’ll probably find many of the young women in your class already own Coach products. The case provides students with an excellent example of a best-cost strategy. The coupling of Coach’s differentiating features such as product quality, prestigious image, outstanding customer service, lifetime guarantee, and attractive stores with a cost-based pricing advantage has yielded a strong competitive advantage for Coach. The case also contains ample information for conducting an industry analysis and company situation analysis.
The financial statements in the case are sufficient to allow you to assign whatever “number-crunching” exercises you see fit. You should be able to generate quite a lively class discussion concerning the strategy’s capability to continue to deliver competitive advantage in the midst of new “accessible luxury” brands being brought to market by the luxury industry’s strongest brands, including Dolce & Gabbana, Giorgio Armani, and Gianni Versace. The Coach Inc. case is excellent for drilling students in the use of the analytical tools in Chapters 3 and 4.
There is ample information for students to conduct an industry analysis (dominant industry characteristics, driving forces, five competitive forces, and key success factors) and use the tools of company situation analysis (assessment of how well Coach’s strategy is working and SWOT analysis). It is also very beneficial if students have read the material in Chapter 5 since Coach’s best-cost strategy has yielded competitive advantage and given rise to a new segment within the luxury goods industry.
The information in the case is not difficult for students to understand or to analyze, so we recommend positioning the case near the beginning of your business strategy module. There is a great deal of information in the case, which allows you to structure your class discussion in a number of ways. We feel that the best way to handle the class discussion of this case is to start with an analysis of the industry – identifying the dominant characteristics, doing a five-forces analysis, assessing the impact of driving forces, and identifying the key success factors.
Then you can proceed to look at the company’s strategy, do a SWOT analysis, and conclude with recommendations. We think you will find that this case works quite nicely for a written case exercise (or oral team presentation) because of the wide range of tools in Chapters 3 and 4 that can be used. Our recommended assignment questions are as follows: 1. As Coach Inc. ‘s newest member of its Retail Division, you have been asked to prepare a report for management that evaluates the company’s strategy, analyzes the industry and competitive situation confronting the company, and assesses the company’s resources, competencies, and capabilities.
Your report should also include an analysis of the company’s recent financial performance. As part of you development, your boss has also asked that you prepare a strategic action plan that will enable the company to sustain its impressive growth rate and provide investors with above-average returns. Please limit your report to 5-6 pages, including appropriate exhibits. 2. As part of your development as a new member of Coach Inc. ‘s Retail Division, you have been charged with identifying strategic issues facing the company and recommending strategies addressing each issue.
Your list of strategic issues and proposed strategic action plan should be in executive summary format and not exceed three pages in length. Please attach all elements of your industry and company situation analysis used in identifying strategic issues. Appropriate exhibits to include as attachments include a five forces analysis, driving forces, key success factors, SWOT, and financial analysis. Assignment Questions 1. What are the defining characteristics of the luxury goods industry? What is the industry like? 2. What is competition like in the luxury goods industry?
What competitive forces seem to have the greatest effect on industry attractiveness? What are the competitive weapons that rivals are using to try to outmaneuver one another in the marketplace? Is the pace of rivalry quickening and becoming more intense? Why or why not? 3. How is the market for luxury handbags and leather accessories changing? What are the underlying drivers of change and how might those driving forces change the industry? 4. What key factors determine the success of makers of fine ladies handbags and leather accessories? 5. What is Coach’s strategy to compete in the ladies handbag and leather accessories industry?
Has the company’s competitive strategy yielded a sustainable competitive advantage? If so, has that advantage translated into superior financial and market performance? 6. What are the resource strengths and weaknesses of Coach Inc.? What competencies and capabilities does it have that its chief rivals don’t have? What new market opportunities does Coach have? What threats do you see to the company’s future well being? 7. What recommendations would you make to Lew Frankfort to improve the company’s competitive position in the industry and its financial and market performance?
Teaching Outline and Analysis 1. What are the defining characteristics of the luxury goods industry? What is the industry like? Market size and growth rate: The global luxury goods industry was expected to grow by 7% during 2006 to reach $112 billion. Scope of rivalry: The scope of rivalry in the industry was global with Italian luxury goods companies accounting for 27% of industry sales in 2005, French luxury goods companies controlling 22% of the industry, Swiss companies holding a combined market share of 19%, and U. S. ompanies accounting for 14% of industry revenues in 2005. Presence of forward/backward vertical integration: Most luxury goods manufacturers were vertically integrated into the operation of retail stores. While the signature lines offered by Armani, Versace, and other designers were handcrafted under the supervision of the designer, Coach products and diffusion lines offered by other luxury companies were produced by low-cost contract manufacturers. Consumer characteristics: Although traditional luxury consumers in the U. S. anked in the top 1% 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. 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. Degree of product differentiation: Students will easily recognize that all luxury goods companies utilize strategies that attempt to create a high degree of differentiation.
Key differentiating features include product quality, image and reputation, customer service, styling, and store ambiance. 2. What is competition like in the luxury goods industry? What competitive forces seem to have the greatest effect on industry attractiveness? What are the competitive weapons that rivals are using to try to outmaneuver one another in the marketplace? Is the pace of rivalry quickening and becoming more intense? Why or why not? The figure below illustrates the 5-forces model for the luxury goods industry.
Rivalry among competing sellers: A strong competitive force Students should have little trouble identifying interfirm rivalry as the strongest competitive force in the luxury goods industry. Luxury goods sellers were required to develop and manufacture products that were made from the finest materials, set standards for style, had reputations of quality and prestige that dated back more than 100 years in most cases, were sold in beautiful flagship stores and the finest department stores, and provide levels of customer service discriminating consumers were accustomed to.
Students should not characterize competition in the industry as fierce since there is virtually no price competition in the industry. The bargaining power and leverage of buyers: Both consumers and retailer buyers are weak competitive forces Regardless of type, buyers had little leverage in negotiating with manufacturers of luxury goods. Consumers had no ability to negotiate pricing with luxury goods manufacturers when shopping in company-operated retail stores. Coach Inc. and most luxury goods makers maintained year-round full price policies.
Department store buyers also had no ability to negotiate pricing with luxury goods makers, since exclusive department stores were defined by the luxury brands they carried. The seller-buyer relationship also favored the world’s top luxury goods makers since limited distribution promoted a feeling of scarcity among consumers. Bargaining power and leverage of suppliers: A weak competitive force Students will suggest the suppliers of fabric and leather used in the production of luxury goods had little ability to negotiate terms with luxury goods sellers.
The makers of luxury goods were committed to utilizing the finest materials available in their products, but there’s little reason for students to believe that quality leather and fabrics were not widely available. Competition from Substitutes: a moderate to strong competitive force Many substitutes existed for luxury goods in every product category. By definition, luxury goods were not necessities or even things that could improve the quality of one’s life. Luxury goods were possessions that satisfied some type of internal desire for certain consumers.
Consumers who did not aspire to own luxury goods were quite willing to purchase substitute products selling at lower price points and might actually refuse the gift of a luxury good. However, the percentage of consumers in developed countries in North America, Europe, and Asia wishing to own luxury goods was increasing in 2006. The strength of substitute products as a competitive force was more moderate for consumers aspiring to own such products. These consumers had adopted a “trade up, trade down” shopping strategy, whereby they spent little on commodity-type necessities to have more income for luxury items.
It should be difficult for students to argue that competition from substitutes is weak for even the wealthiest consumers, since very few could afford luxury goods in every product category. Threat of Entry: a weak competitive force Students will surmise that it is very difficult to establish a new luxury brand. Most exclusive brands have built their reputations over decades (if not longer) and have cultivated loyal customers. Students may also suggest entry into the industry is difficult since its likely consumers of luxury goods are hesitant to spend lavishly on unknown brands.
In addition, access to prestigious retailers is likely to be a challenge for upstart luxury brands. The most likely new entrants are existing luxury goods companies choosing to enter new product categories. The example of Dolce & Gabbana’s D&G diffusion line is an example of entry. Coach’s entry into women’s knitwear is another example of entry into a new product category by an existing firm. Overall assessment of competition: There should be little disagreement among students that the industry is highly attractive for incumbent luxury goods brands.
There is little threat of entry by startups or firms in other industries, buyers and suppliers have little leverage in negotiations with sellers, and the nature of rivalry in the industry tends to exclude price competition. The availability of substitute products does not impact industry attractiveness since luxury consumers prefer the exclusivity of luxury goods and avoid products possessed by the masses. The attractiveness of the industry is confirmed by the size of its average profit margins which approximated 40%-50% for marquee brands and 20% for diffusion brands. 3. How is the market for luxury handbags and leather accessories changing?
What are the underlying drivers of change and how might those driving forces change the industry? Students should be able to identify the following driving forces at work in the luxury handbags and leather accessories industry: Growing demand for ‘accessible luxury’ goods in developed countries. Consumer tendencies to adopt a “Trade up, trade down” shopping strategy had allowed spending on luxury goods to grow at four times the rate of overall spending in the United States. Both retailers and luxury goods manufacturers had altered their strategies in response to the changing buying preferences of middle-income consumers in the U.
S. 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. 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 sub-brands that retained the styling and quality of the marquee brand, but sold at considerably more modest price points.
Rising incomes in developing economies. In 2004, the worldwide total number of households with assets of at least $1 million increased by 7% to reach 8. 3 million. The number of millionaires was expected to increase another 23% 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%. Rising incomes and new wealth had allowed Chinese consumers to account for 11% of all luxury goods purchases in 2004. The Chinese market or luxury goods was predicted to increase to 24% of global revenues by 2014, which would make it the world’s largest market for luxury goods. Increase in counterfeiting of luxury goods. In 2006, more than $500 billion worth of counterfeit goods were sold in countries throughout the world. About two-thirds of all counterfeit goods were produced by manufacturers in China. 4. What key factors determine the success of makers of fine ladies handbags and leather accessories? We see the following as being key success factors in the luxury segment of the ladies handbag industry: Luxurious image and reputation for quality.
Luxury goods companies were required to possess adequate brand-building skills to develop and maintain an image of luxury. In addition, the procurement and production processes of luxury goods companies must ensure the company’s products were of the finest quality. Luxury goods consumers were not likely to purchase products at high price points that lacked a prestigious image and reputation for quality. Fashionable and distinctive designs. Luxury handbags manufacturers and marketers were also required to maintain a fresh lineup of distinctively-styled products.
Most luxury goods manufacturers retained their most popular items in their product lines for years (and sometimes decades). The development of distinctive and voguish handbags and leather accessories resulted from the artistic talents of developers and the ability of marketers to match creative efforts with consumer preferences. Aesthetically-pleasing store design and ambiance. Purchasers of luxury handbags expected to shop in retail stores that were aesthetically-pleasing and that provided a comfortable shopping environment.
Students are likely to suggest that the exterior and interior design elements of the store helped shape the company’s overall image. Superior customer service. As with the need for visually-pleasing store designs, luxury handbag retailers were required to maintain knowledgeable and polite sales staffs. Sales personnel were critical to consumers’ purchasing experience, since they had the ability to influence the shopper’s attitude and comfort level, recommend handbags for different occasions and apparel, and inform the customer about special order items. Luxury goods makers were also required to offer retail customers igh-quality after-the-sale service in the event a handbag or leather accessory needed to be returned or repaired. 5. What is Coach’s strategy to compete in the ladies handbag and leather accessories industry? Has the company’s competitive strategy yielded a sustainable competitive advantage? If so, has that advantage translated into superior financial and market performance? There may be an initial suggestion by students that Coach is competing in the ladies handbag and leather accessories industry with a differentiation strategy keyed to image, product quality, styling, customer service, and attractive retail stores.
These observations are correct, but Coach’s production outsourcing arrangements that allow it to price its handbags between $200 and $500 give it a best cost advantage in the industry. The company’s differentiating features compare favorably to other luxury handbag brands that carry entry-level prices of $700 – $800. Students should also see the importance of Coach’s retail strategy that includes flagship and core retail locations, department stores, and factory stores. The inclusion of discount factory stores allows the company to maintain a year-round full price policy in its full price retail stores.
The ability to offer sale priced merchandise, while maintaining exclusivity in the company’s core retail locations was essential to Coach’s growth since 80% of women’s apparel sold in the U. S. was bought on sale or in a discount store. Coach’s factory stores had outperformed full price stores in terms of comparable store sales growth during 2005 and 2006, with comparable factory store sales increasing by 31. 9% during 2006 and comparable full price store sales increasing by 12. 3% during the year.
In addition to factory stores and full price stores, Coach distributed handbags for sale to department stores in the U. S. Coach had eliminated 500 department store accounts between 2002 and 2006 as the share of the U. S. retail market held by department stores declined from about 30% in 1990 to approximately 20% in 2000. Coach’s wholesale distribution in international markets involved department stores, freestanding retail locations, shop-in-shop locations, and specialty retailers in 18 countries with Japan making up the majority of Coach’s international sales. Coach products in Japan were sold in shop-in-shop epartment store locations, full price Coach stores, and Coach factory stores. The company had 118 retail locations in Japan in 2006. Coach’s expansion plan for Japan called for at least 10 new stores annually, which would more than double its number of flagship stores to 15. Coach management believed Japan could support 180 stores and that the increase in stores would allow the company to increase its market share in Japan to 15%. As of late-2006, the company’s strategy had yielded a 1400% increase in its stock price since the October 2000 IPO—see case Exhibit 3.
Students who make calculations similar to what we have performed in Table 1 should suggest the company’s growth in revenues and earnings supports the dramatic rise in its stock price. Also, students who calculate key financial ratios such as those shown in Table 2 should be quite impressed with the company’s attractive and growing profit margins, high liquidity, low debt, and frequent inventory turns. Table 1 Compounded Annual Growth Rates for Items in Coach’s Consolidated Statements of Income, 1999 – 2006 CAGR (1999 – 2006) 21. 6% 11. 5% 26. 4% 18. 8% n. a. 45. 3% n. a. 46. 3% 50. 9% 43. 9% 37. 8% 37. 4%
Net sales Cost of sales Gross profit Selling, general and administrative expenses Reorganization costs Operating income Interest income (expense), net Income before provision for income taxes and minority interest Provision for income taxes Minority interest, net of tax Net income Net income per share Basic Diluted n. a. not applicable Calculated from case Exhibit 1. Table 2 Selected Financial Ratios for Coach Inc. , 1999 – 2006 Profitability ratios Gross profit margin Operating profit 2006 77. 6% 2005 76. 6% 2004 74. 9% 2003 71. 1% 2002 67. 2% 2001 63. 6% 2000 59. 1% 1999 54. 8% margin Net profit margin 36. 2% 23. 4% 3. 5% 21. 0% 30. 7% 18. 0% 22. 9% 13. 7% 16. 4% 10. 5% 16. 9% 10. 7% 10. 4% 7. 2% 3. 9% 3. 3% Other profitability ratios Return on assets Return on equity Liquidity ratios Current ratio Working capital Leverage ratios Debt-to-assets Debt-to-equity Times interest earned Activity ratios Inventory turnover 2006 30. 4% 41. 6% 2005 26. 2% 34. 0% 2. 9 $632,658 2. 7 $443,699 0. 2% 0. 3% 0. 2% 0. 3% 9. 0 9. 3 Days of inventory 40. 36 39. 4 Calculated from case Exhibits 1 and 2. 6. What are the resource strengths and weaknesses of Coach Inc.? What competencies and capabilities does it have that its chief rivals don’t have?
What new market opportunities does Coach have? What threats do you see to the company’s future well being? This is a good case in which to drill students in SWOT analysis and in carefully assessing a company’s competitive assets and competitive liabilities. Coach’s resource strengths/competencies/capabilities Design process that developed new products based upon market research rather than artistic preferences of an individual designer. Procurement contracts that guaranteed the company access to the highest quality leathers. Offshore production contracts that delivered high product quality and low manufacturing costs.
Licensing agreement with the Movado Group to make Coach-branded watches available in Coach retail stores. Licensing agreement with Jimlar Corporation that gave Jimlar the right to manufacturer and market Coach-branded ladies footwear. In 2006, Coach footwear was available in 500 locations in the U. S. , including department stores and Coach retail stores. Licensing agreement with Marchon Eyewear that made Coach-branded eyewear and sunglasses available in Coach retail stores, department stores, and specialty eyewear stores. Coach frames for prescription glasses were sold through Marchon’s network of optical retailers.
Strategic alliance with Lutz & Patmos to make women’s knitwear available in Coach stores. Licensing agreement with Estee Lauder Company to develop a Coach-branded fragrance. In-house architectural group that created designs for Coach retail stores. Attractive store designs that were rated 10th among luxury brands in a 2006 Luxury Group survey of 2,000 wealthy shoppers. Direct-to-consumer channels in the U. S. that included 218 full price stores, 86 factory stores, Internet sales, and catalog sales. Wholesale accounts with approximately 900 department stores in the U. S. 18 retail stores in Japan 108 wholesale locations in international markets outside Japan Largest seller of luxury handbags in the U. S. with a 25% market share Second largest seller of luxury handbags in Japan with an 8% market share Coach’s resource weaknesses/competitive deficiencies and liabilities Coach is not present in Europe Products for men accounted for only 2% of the company’s 2006 sales Business cases accounted for only 1% of sales in 2006 Luggage accounted for only 1% of sales in 2006 Coach’s market opportunities Pursue growth in rapidly growing international markets for luxury goods such as India and China.
Further expansion into additional product categories to leverage the Coach brand name. Develop retail locations in Europe Develop new product lines targeted to men External threats to Coach’s future well being Consumers may find diffusion lines offered by more prestigious luxury goods makers more appealing than Coach products. Any recessionary effects in the U. S. or Japan may cause middle-income consumers to abandon aspirations for luxury goods. Consumers may begin to view Coach as an inferior brand because of the company’s factory stores. This assessment confirms that Coach Inc. is in strong position.
Its resource strengths are considerable and it currently enjoys a position of leadership in the luxury handbags industry. 7. What recommendations would you make to Lew Frankfort to improve the company’s competitive position in the industry and its financial and market performance? Students’ analysis of the luxury goods industry and Coach’s competitive position in the industry should lead them to the development of a strategic action plan containing the following items: The company should continue to develop distinctive and fashionable handbags since rivalry includes an important focus on the distinctiveness and quality of products.
It’s important that Coach continue to launch a steady stream of the best-looking and most fashionable handbags every month or more often. The company’s design teams should also develop new lines and new models of existing lines to sustain growth in sales. Coach must ensure its designs don’t fall behind those of other luxury handbags manufacturers. Coach should pursue its plans to double the number of stores in North America. The U. S. market should be able to support 500 or more Coach stores because of the company’s pricing strategy.
Coach handbags are priced so that consumers in most any city are able to afford the product. Students are likely to recommend that Coach managers pursue any local market where a large enough population exists to meet sales volume expectations. There should also be little disagreement with the company’s plans to increase factory stores by a third. An increase of approximately 30 factory stores would bring the total count of factory stores to about 120. An average of just over two factory stores per state should not damage the company’s brand image.
In addition, students should firmly support the company’s policy of locating its factory stores no closer than 50 miles from full price stores. The company should definitely pursue its expansion plans in Japan and emerging markets in Asia. It’s essential that the company sustain its growth in Japan, since it’s the world’s largest market for luxury goods. The company should also add to its planned opening of 10 stores in China since that country was projected to become the world’s largest market for luxury goods by 2014. Growth in income and wealth in India also make it a strong candidate for international expansion.
Coach should also develop new business cases designed for women business professionals. The addition of a broader line of business cases tailored to women should help improve the company’s sales of such products. Students may suggest it will be more difficult to increase sales of products for men since many men may not want to shop in a “ladies handbag” store. The company may have to expect sales of men’s items to be in the form of gifts purchased by women for the near future. There is reason for the company to try to protect against counterfeiting by placing tight controls on contract manufacturers.
The theft of handbag patterns or fabrics would make it easy for illegally operated shops to turn out very authentic-looking fakes. The company should also aggressively pursue the sellers of knockoffs in the U. S. and Asia. It can be argued either way whether coach should expand its product line to include branded products that are not closely related to ladies handbags. For example, footwear is a clear example of a product that is able to benefit from the Coach brand, but knitwear and fragrances may prove to be a stretch. Product categories that seem to be able to benefit from the Coach brand are ladies leather jackets and gloves.
Epilogue Coach Inc. recorded net sales of $1. 4 billion during the first six months of fiscal 2007, which was a 26% increase over the same period in fiscal 2006. Net income for the six month period ending December 31, 2006 increased 32% from the same period in fiscal 2006 to reach $353 million. In January 2007, the total number of Coach retail stores in the U. S. stood at 237 and the total number of U. S. factory stores stood at 90. The company expected to open a total of 40 additional retail stores in North America during fiscal 2007.
Some of Coach’s new locations to be opened in fiscal 2007 would be Coach Legacy Boutiques. The Legacy Boutiques were a new store concept that showcased the company’s most innovative items in an intimate store design that had a residential feel. The company expected to open 20 new stores in Japan during fiscal 2007. For the very latest information, we urge that you visit the company’s website and review Coach’s press releases and investor relations section (which has recent financial performance data); Coach’s website address is www. coach. com.