Since Kate Spade was said to be on the market, speculation swirled about which suitor would be the best fit. Two emerged as likely buyers: Michael Kors and Coach. And while it was the latter that eventually stepped up with an offer, the two companies have been intertwined in a fight for leader of the affordable luxury handbag space that Coach initially pioneered.
Over the years, each have had their struggles—when Coach faltered during the recession, Kors surpassed it with its new accessories-focused business model, and now with the Coach company overhaul, it is now positioned to reclaim the top spot. In fact, the challenges that Kors faces today mirror those that Coach has recently overcome. And now with the acquisition of Kate Spade, Coach is set to prove that its transformation wasn’t a one-off but rather a successful formula that will catapult it into a multi-brand fashion conglomerate.
The global handbag and small leather goods market is worth about $41 billion, according to industry experts. For retailers and brands, the handbag category is close to ideal. It drives store traffic, yields great margins and is far less complex than apparel since there are no sizes and little seasonality. For consumers, it’s a personal purchase, reflecting tastes, style and lifestyle. It’s the perfect pick-me-up and wardrobe refresher—and it never makes you feel fat.
These attractive retail economics, combined with the importance of a handbag to consumers, has resulted in an increasingly crowded marketplace. When Coach went public in 2000, the market was dominated by French mega-luxury brands like Chanel, Hermes and Louis Vuitton, Italian brands with global recognition such as Fendi, Gucci and Prada as well as a few more accessibly priced labels, including Kate Spade, Dooney & Burke, Furla and Longchamp. By the time Michael Kors went public in 2012, the market had witnessed an influx of new entrants at contemporary prices such as Rebecca Minkoff, Mansur Gavriel, MZ Wallace, Tory Burch along with a slew of pricey purses from Saint Laurent, Lanvin, Celine, Jimmy Choo, Valentino and many more.
The Coach brand and Michael Kors, which both generate sales greater than $2 billion in handbags and small leather goods in North America, are fighting for the lion’s share of the market. Kors is likely in the lead but with 40 percent of its business coming from wholesale operations, it faces poor margins and brand erosion. (The comparison is further blurred because Kors’ apparel business is 30 percent of brand revenues compared to the small single digit clothing accounts for at Coach).
Kate Spade, the company over which they were both vying, is the third billion dollar plus North American handbag brand. The company has had an erratic operating history with less than stellar profit performance, but until recently, it achieved superior sales growth ($1.4 billion in 2016 up from $803 million in 2013 for a 16.9% three-year CAGR). That potential plus the brand’s whimsical and differentiated positioning is what made it appealing. Coach Inc.’s $2.4 billion acquisition of Kate Spade announced in May could catapult the combined businesses to the lead and is a win-win, if its successful in providing the company sound strategic, operating and financial acumen.
Coach is confident it can boost Kate Spade profits by undertaking many of the same steps it took to revive its own brand over the last three years. Following years of double-digit sales and earnings growth, Coach hit a wall in 2014. The highly promotional environment coupled with deep discounts at the outlet tier and a reliance on e-commerce flash sales sent sales down 5.5% and EBIT margin contracted 510 basis points, to 25 percent of sales and the trends were deteriorating. While still the leader in the U.S. handbag market, its position was tenuous.
In June 2014, the company announced it was walking away from an estimated $300 million of flash sales, rightsizing distribution, increasing emotional/lifestyle context with complementary categories and elevating product. The company raised fashion visibility by showing in NY and London fashion weeks and capturing valuable fashion editorial praise for Coach’s executive designer, Stuart Vevers and the Coach 1941 collections.
Three years later, Coach can claim success. Coach has reported four consecutive quarters of same store sales growth in North America, sales of $400+ handbags are increasing and margins are expanding. The company is expected to follow the same blueprint for Kate Spade, reducing online flash sales and wholesale distribution, which near term will reduce the brand’s sales and profits but better position it for sustainable long-term growth and profitability. By connecting with millennials via the Kate Spade brand, Coach has the potential to create a halo effect across the Coach organization.
While Coach was pulling back to reassess its business, Michael Kors seemed oblivious to the increasingly possible pitfalls in the promotional handbag market. The company expanded aggressively in both the wholesale and retail channels, doubling its owned store base from 405 to 827 since 2014. (Coach operates approximately 1,000 retail locations and has roughly 38 percent more retail square footage). Its jet-set lifestyle positioning benefitted from designer Michael Kors’ stint on Project Runway and the brand’s huge social media following. But you had to question the hubris of the company’s rapid expansion considering Coach’s experience and the significant disruption in retail. No surprise that as Coach repositioning began to achieve traction, and the North American business stabilized and began to grow, the Michael Kors business declined. The tea leaves were there for the reading.
Kors held its investor meeting on June 9 during which it laid out its own three-year plan, which looks a lot like the Coach plan: refresh product, rationalize and renovate the store fleet, and reduce promotional activity. Near term, sales and margins will continue to suffer with these brand enhancing moves. Sales declined 4.6% in the most recent fiscal year ended March 2017, and in the most recent quarter, same store sales were off 14.1%. The company is guiding to an approximate $250 million sales decline this year along with an approximate 400 basis point EBIT margin contraction to 16 percent. Up to 125 stores are set to close.
Part aspirational, part functional, the handbag market can grow at a mid-single digit global pace for the next 10 years. Which brand will be the beneficiary of that growth will depend on which offers designs that resonate most. From today’s vantage point, Coach is in the leading position in terms of product newness and covetable products, while the product at Michael Kors seems derivative of past successes and higher-end designer copycat renditions.
Marie Driscoll, CFA is an industry analyst focusing on apparel brands, retailers and luxury goods and providing consulting services to academia, industry, investors and non-profits through her firm, Driscoll Advisors. She can be reached at email@example.com.