Episode 2 How the Swiss ended up as the predominant watchmakers has been the result of a series of choices and fate throughout history. However, contrary to common belief, the Swiss have not always been the dominant force in the watch industry. It has only been post-1877 that the Swiss transformed their methods and were able to compete with the rising American watch producing titans Waltham, Elgin, Hamilton, and others.
This may seem shocking and not true. In fact, in an 1876 secret (at the time) Swiss watch industry document published by the Swiss watchmakers talks about how much better the American watches are than Swiss watches at the time. The report concludes:
“Let us put to one side the bad council of our offended self-esteem and engage in the fight, benefiting from all the advantages which we still have and from the methods that [the Americans] have discovered. Let us take their tools, imitate their workmen and their methods, but especially let us group together to obtain the kind of progress that the individual industrialist, in his tiny room with his own efforts, cannot achieve” (source: “American and Swiss Watchmaking in 1876,” David, Jacques translated by Richard Watkins (2003) pg 82)
The question grappling Swiss leaders today is: what choices can they make? What choices will others make? What role will fate play in determining the future of the luxury watch industry?
- First, we will examine current Swiss watch market sales data to demonstrate the industry is experiencing a slump (or perhaps, a disruption?)
- Second, we will address the question “are watches a dying item?”
- Lastly, we will look at the choices and potential turns of fate that have potential to reshape the industry for better or worse.
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“Sales and profits for the six-month period ended 30 September 2016 were significantly below the prior year’s level, reflecting the difficult global environment, the exceptional inventory buybacks and challenging comparative figures in the first half of the previous financial year.” -Richemont Group 2016 Annual Report
Sales in Swiss watches peaked in 2015, and are now back to 2012 sales levels. One could explain this as normal with the cyclical nature of the market (any market), which could very well be true, but it presents a problem because of the lead times that Swiss watch companies must schedule and coordinate their production. Last week, I met with one of the top executives of the top Swiss watch companies who explained the challenge arises because they have to coordinate their production schedule 2-3 years out, and as a result their factories are able to produce a lot more right now but they don’t have enough customers willing to buy their watches (also known as excess capacity). In fact, in Richemont’s 2016 annual report, the head of the group states “Concerning watches, we will look to deal with overcapacity issues, adapting manufacturing structures to the level of demand.” In other words, they are set up to produce too many watches and need to figure out how to scale this back without losing too much money.
Let me translate how badly the decreasing sales are affecting Swatch Group, one of the major conglomerates that make Omega, Blancpain, Breguet, Harry Winston, Longines, etc. (Here is a link to Swatch’s semi-annual letter to Shareholders which I base this on).
- A share of Swatch stock is now worth -25% from a year ago. In 2015, the company was worth 19.9B Swiss Francs. Now it is worth 15.6B Francs (as of 30 June 2016).
- Swatch used to generate 10.3% ROE on every dollar the company is worth (return on equity – ROE). Now, they earn 4.8%; in other words, they are 50% less efficient at generating returns. (see their 2016 letter to shareholders)
- Swatch’s income is down -52%, despite revenues being down only -11%. This is because fixed costs (such as paying the mortgage or paying pensions to retired workers) must be paid regardless of sales. Think of income as the money you get to keep after you pay your taxes, mortgage, car payment, etc. Even if you get paid less this month, your mortgage and car payment still cost the same, meaning you walk away with less money. (see their 2016 letter to shareholders)
Swatch Group is not the only one suffering. Richemont Group (who owns Jaeger LeCoultre, Vacheron Constantin, Baume & Mercier, and many others) reported their sales were down -14% with a -51% decrease in net profits (again, slight decrease in sales, massive decrease in profit). They also reported they spent €-211M to buy back unsold inventory. Had they not done inventory buybacks, their sales would have gone from -14% to -25%! For further reading on “the slump”, read this article and also this one on the Richemont and Swatch downgrade by Barclay’s.
Overall, these companies are still very financially healthy, but these statistics show an industry that has unexpectedly found themselves in a slump they did not anticipate. I will not devote extensive attention to the macroeconomic factors playing into the Swiss industry’s troubles, though they are significantly at fault. Many other analyses have already been devoted to these topics, which I will leave to those authors to present.
- Exchange rate / cost of a watch to buy
- Decreasing sales in booming markets such as Hong Kong
- Fewer travelers to Europe due to terrorism concerns
WATCHES ARE NOT A DYING SECTOR
Despite the advent of the smartwatch cannibalizing the watch industry and people implying that watches are a thing of the past, these are simply not true. I argue that watches are perhaps more popular now than they were 10 years ago as culture continues to emphasize chic fashion, for which watches have become a mainstay for men and women who want to emphasize their identity or success. Smart watches are not killing the mechanical watch industry (read my previous article on this thesis here). While watch companies got a late start to social media marketing, their growth is astronomical. As a proxy, I will use Instagram to demonstrate this point. Rolex gains approximately 18,000 followers a day (went from 1M users in late July to 2.3M in early November); Audemars Piguet gains approximately 3,000 a day. Rolex has over 2.3M followers and AP has over 1M; Omega has over 830K followers. The rate of growth of followers for these companies is staggering if they are “part of a dying industry” and people “don’t care about watches anymore.” Watch blogs are also in high demand with WatchUSeek getting over 3.5M views per month (one of the top watch blogs), Hodinkee getting 1.4M views a month, and aBlogtoWatch (also another leading watch blog) getting over 1.65M views per month (all data according to estimates by similarweb.com). People still aspire to own luxury watches or at least enjoy looking at and reading about them even with the advent of smartphones and smartwatches, which tell time while providing added functionality. If the purpose of a watch was only to tell time, Swiss watches would have faded away by now. As an anecdotal case-in-point, I met a guy over the weekend wearing a Breitling Emergency whose battery had died and the watch wasn’t telling time, yet he wears it anyway until he can get it fixed because he “loves the watch”.
ROLE OF CHOICES & FATE IN THE FUTURE
Throughout this series, I will emphasize the role of fate and the role of choices in shaping the watch industry throughout history and today. You must abandon the idea that the Swiss have always been the premier watchmakers. That is not historically accurate and has been the uninterrupted case since only ~1900. Prior to this, many other countries’ watchmakers were considered superior. Therefore, Switzerland has a series of choices they can make to continue to be the epicenter of watchmaking, but fate also gets a vote; their predominance is not a guarantee.
- Improve Marketing. The Swiss industry is not the most forward-looking marketing engine. They have continued to demonstrate a marketing lens that is about 10 years behind, but are quickly playing catch-up. They rely heavily on billboards, event sponsorships, and brand ambassadors to communicate their brand’s image and message, while other industries have moved heavily into the use of social media. The Swiss executive I spoke with cited this as a major problem for the industry as a whole. Many in the luxury industry viewed social media marketing as cheapening the brand until very recently. However, social media makes watches aspirational for a whole new generation of potential buyers. Luxury watch companies like to ensure their products appear exclusive, which is difficult when they are appearing on everyone’s newsfeed. According to L2 Inc, a well-respected digital consulting firm, some companies like Rolex and Cartier do a standard-setting job in using modern marketing to reach their customers. However, some companies like A. Lange & Sohne have chosen to remain largely absent from social media and modern uses of the web to drive sales. This is a barrier they have to embrace. If the younger generation does not see it on their newsfeed, they will not aspire to it or even be aware of it, and luxury watches will become the stodgy item of their grandparents.
- Improve transparency. The Swiss have maintained an aura of exclusivity through minimal product information for many years. As noted in L2’s industry report (available for purchase on their website), very few companies post their prices online. Advertisements are limited to ambiguous celebrity figures flashing watches in existential scenes, but little product information is shown.
We live in an era that demands transparency. When we want to know how much something costs, we demand google answer the question. When we want to know how something is made or determine which is better, we ask google. The Swiss companies have provided very little information on this, leaving third party sites to either report or estimate prices, resulting in inaccurate information or gray market sales on the internet (such as eBay, google shops, or amazon) where prices are clearly displayed and a customer can find the best deal. The Swiss must be willing to improve transparency to survive in today’s era that demands it.
- Innovation. While smartwatches won’t kill the industry, they have forced the industry to realize that they must continue to innovate. Companies like Audemars Piguet and Rolex continue to innovate their movements and materials to demonstrate the Swiss watch is not the same it was 20 years ago, rather it is improving. Luxury watch companies have to distinguish themselves from their competitors by not only innovating but ensuring customers view them as innovative. This is true in almost every industry where innovation is viewed as the kingmaker and customers want to associate themselves with the companies they view will be on top in 5-10 years. Just take the history of Apple, Tesla, SpaceX, Uber — all companies that are viewed as innovators, whose sales have tracked not only their record of innovation but people’s’ perception of the company. Watch companies must also market themselves as innovators. As Ira Kalb of the Marshall School of Business said “We should be most concerned about companies that are currently successful that do not have innovation ingrained in the fabric of their businesses.”
- De-fragmentation of the industry. There are too many watch companies competing with each other and little to no differentiation between the watches they produce — they use the same base movement and have very similar case and dial. This is expected within the affordable range of $100-700, but this is also the case for watches in the $1000-10,000 range. There are watch brands that continue to exist as part of major conglomerates despite their brands carrying little weight in today’s market. This turns these finely crafted watches into commodities, where it doesn’t matter if I buy a Zenith or Longines. They are all equal as far as high quality, mid-tier price, and good brand recognition, therefore there is little distinguishing factor. Each brand that the conglomerates maintain costs them money in management and marketing. The industry does not need 30 brands operating within the same price segment to drive competition. This fragments the industry, which makes it ripe for consolidation and disruption. The industry could find itself being disrupted and consolidated from the outside (such as the UK, America, or Japan).
- Dealing with competition. The Swiss have chosen to largely ignore competition arising outside of Switzerland. They are demonstrating this by increasing the requirements to call something Swiss Made starting in 2017. This means they are doubling down on the brand equity of Swiss Made, which means they think consumers will care about this going into the future despite the increased production costs due to the implementation of the new law. This may not necessarily be true. Other non-Swiss competitors have rose and performed including companies in Germany, the United Kingdom, and the US showing that Swiss made might not be as important to younger generations.
- Generational preferences. The younger generations have demonstrated they like watches just as much as past generations, but with less expensive brands. Daniel Wellington and Shinola are great examples of watches that are considered “cool to have” among young people, maybe even more so than owning a much nicer Rolex. That is a reversal of fate nobody predicted. The remaining question for fate to determine: will the interest in David Wellington or Shinola translate to more expensive luxury sales as those customers grow older or will they always desire less expensive trendy watches?
- New entrants to the market. Apart from Daniel Wellington and Shinola, new entrants are entering the market everyday (literally, on kickstarter). Sure, these are startups, but how many of them entering the market does it take before they take a collective toll on the Swiss industry sales? Are they taking sales away that would have gone to existing companies? But perhaps they also benefit the market by interesting new people in watches that previously didn’t care.
Many of these new watches being produced are junk, but some companies such as TiMe22 are innovating good watches, and while their first design might not become the next mass-market chic watch to own, they have demonstrated an ability to innovate new ideas backed by better materials (grade 5 titanium) and better (forever) warranty commitments at affordable prices (~$600). It is companies like them that could become a future threat; they call it “disruptive innovation” because nobody sees it coming until it has disrupted the industry (this sounds crazy, but billboards were the premier way to advertise up until 2010 (now we have social media), and taxis had zero competition until about 2011 and now Uber is a way of life for many people). Up-market, competitors such as Bremont and Niall are making watches in the UK and US that are very well made and selling at rapid paces.
Some limited edition Bremont pieces command 200% on the secondary market, while Niall reported in October that they were sold out and having troubling keeping up with demand. US luxury watch company Vortic has a 6-8 backlog for orders; these are all in sharp contrast to the Swiss who are buying back their own inventory.
- Economic conditions. The future of the global economy also gets a vote. Countries are becoming more protectionist which could lead to more trade barriers, meaning more tariffs, meaning more expensive watches. Additionally, exchange rates could continue to benefit the Swiss, but also discourage foreign sales as it becomes more expensive for non-Swiss customers to buy a watch due to their currency being weaker. Finally, another global recession would badly damage luxury sales.
- Growing inequality. As inequality continues to grow around the world, but particularly in the US (one of the major markets), there are people that are very wealthy, but fewer middle class. This creates a smaller customer base able and willing to buy watches. The last recession caused the inequality gap to widen as more money congregated with fewer people coming out of the recession. If this trend continues, the luxury watch market might find itself selling fewer watches for very high dollar amounts to a relatively few wealthy people.
WHO ARE THE POTENTIAL COMPETITORS TO THE SWISS?
We will investigate this topic across the remainder of this series. Next, we look at Raymond Weil, a luxury Swiss company who is innovating and growing in market share despite the tough industry. FEATURING AN EXCLUSIVE INTERVIEW WITH RAYMOND WEIL CEO ELIE BERNHEIM.
Correction: an earlier version of this article incorrectly stated that Rolex gains 30,000 Instagram followers a day. This has been corrected.