Coach Inc: Is Its Advantage in Luxury Handbags Sustainable 1

Case Report 1

Coach Inc: Is its Advantage in Luxury Handbags Sustainable

Coach Inc: Is Its Advantage in Luxury Handbags Sustainable 2

Coach Inc: Is its Advantage in Luxury Handbags Sustainable

Introduction

Coach is a specialty retailer focused on providing premium everyday accessories

in an assortment of styles and materials. Its products include handbags, wallets,

watches, footwear, glasses, scarves and other leather accessories. Although nearly

60% of sales come from its roughly 300 U.S. retail stores and more than 100 outlets

stores, Coach also sells its products through department stores, international shops, the

interned and its catalog (http://www.morningstar.com/).

Coach, Inc. sells its products through company operated stores in North America,

Japan, Hong Kong, and Macau; the internet, and the Coach catalog as well as through

indirect channels, such as department stores in North America, international department

stores, freestanding retail locations and specialty retailers. As of December 27 2008,

the company operated 324 retail stores and 106 factory stores in North America, and

155 locations in Japan as of December 27, 2008 (http://www.morningstar.com/).

Coach, Inc has experienced tremendous growth with annual revenues increasing

28% on average during the last five years. Despite its fast track to over $3 billion in

sales, future growth opportunities remain for Coach. Even though the company is

slowing down the growth of its stores in the near term in an effort to be prudent in this

weak economic environment, plans still exists to expand its stores base in North

America over the long term, with a target market of around 500 stores

(http://www.morningstar.com/) .
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Coach has carved out a niche in the fast growing premium accessories market

with its accessible luxury handbags. Coach fills a void between moderate brands and

designer label with its high-quality, smartly priced goods. Coach’s brand positioning

differentiated product offerings, and controlled distribution provides comfort that the

company will weather this difficult retail environment. This challenging economic

environment will pressure near-term sales and profitability, expansion abroad and

continued product innovation will be key drivers of future long-term success for Coach

(http://www.morningstar.com/).

Coach’s channels of distribution include direct-to-consumer channels and indirect

channels. Direct-to-consumer channels include full-priced and factory stores in the

United States (U.S.), internet sales, catalog sales and stores in Japan. Wholesale

accounts with department stores in the United States and in international markets

outside Japan represent the company’s indirect sales. The company’s wholesale

distribution in international markets involved department stores, freestanding retail

locations, shop-in-shop locations, and specialty retailers in 18 countries (Thompson, et

al pp C-110).

Financial Analysis: 1999 to 2006

Income Statement

From 1999 through 2006, Coach experienced tremendous revenue growth. In

1999, the company generated $501 million in revenues which rapidly grew to $2.112

billion by 2006 (Thompson, et al pp C-101). Coach’s rapid growth during this period can

be attributed to the design process developed by Creative Director, Reed Krofoff who
Coach Inc: Is Its Advantage in Luxury Handbags Sustainable 4

believed that new products should be based on market research rather than instinct. To

this end, Coach began conducting extensive consumer surveys which resulted in the

launch of new collections every month rather than only two collections per year

previously. In addition, the company revamped the look of their stores to a brighter,

airier ambience which proved more appealing to customers

(http://www.morningstar.com/).

Gross and operating margins have widened over the years. The company’s

gross profit margin has widened from 55% in 1999 to 78% in 2006 from outsourcing

production which resulted in lower cost of goods sold. Operating profit margin improved

from 3% in 1999 to 46% in 2006 as well benefiting from lower COGS and greater

operating efficiencies. Netting revenues and expenses, the company achieved $494

million in net income in 2006 from $16.7 million in 1999 (Thompson, et al pp C-102).

Balance sheet

As of July 1, 2006, Coach had a solid balance sheet with low leverage and strong

liquidity. Cash and short-term investments were $537 million, bank debt was under $32

million and working capital was $633 million. Beside cash, the bulk of the $1.6 billion of

total assets were A/Rs 84 million; inventory $233 million; fixed assets $299 million; and

goodwill $228,000. The company had total liabilities of $438 million and shareholder’s

equity of 41.19 billion (Thompson, et al pp C-103).

Coach Inc: Is Its Advantage in Luxury Handbags Sustainable 5

Competitive Strategy

Despite its historical track record of double digit profit, growth is not expected

over for now. The company is reducing its prices 10 – 15 % and sales volumes remain

under pressure as consumers curb their spending on high-end discretionary goods.

This could lower profit margins in the near term as lower sales volumes persist and

pricing pressures remain in this economic environment (http://www.morningstar.com/).

In addition to domestic expansion, Coach has great potential in international

markets. In Coach’ fiscal 2008, around 20% of its sales were from Japan despite

weakness in the Japanese economy in recent months. Even though consumers are

pulling back on their purchases of high end goods, it is believed that Coach’s affordable

luxury positioning will continue to pay off in the long term. Additionally, it is also

believed that expansion into China is key. As Chinese consumers’ disposable income

increases and they become aware of the brand, Coach’s sales in the Chinese market

are expected to accelerate at a rapid pace (http://www.morningstar.com/).

Strategic Options

In 2007, Lew Frankfort’s (the company’s manager) key growth initiative involved

expansion in the United States, Japan, Hong Kong and mainland China, increasing

sales to existing customers to drive comparable store growth, and creating alliances to

exploit the Coach brand in additional luxury categories. Frankfort believed that

opportunity exists to double the number of full-price retail stores in North America and

increase the number of North American stores by a third. It was also believed that

Japan could support approximately 70 additional Coach stores. Licensed distributors in

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Hong Kong operated 13 locations there and planned to open at least 10 locations on

mainland China by 2007 (Thompson, et al pp C-111).

The second growth initiative was to increase same-store sales through continued

development of new styles, the development of new usage collections, and the

exploitation of gift-giving opportunities (Thompson, et al pp C-111).

Competitive Landscape

Demand is largely determined by consumer tastes and the comparative costs of

manufacture in the US and overseas. The profitability of individual companies depends

on operation efficiency and the ability to secure contracts with clothing marketers

(http://www.morningstar.com/).

Competitive Advantage

Coach maintains a sizable pricing advantage relative to other luxury brands.

Coach handbags are priced from $200 to $500, well below the $700 to $800 prices from

other luxury brands Thompson Jr. et al, pp C-100).

Strengths

Coach is positioned as a fashion forward lifestyle brand. Its trendy, high-quality

products continue to be popular with consumers seeking affordable luxury. With its

operating margins in the high 30% range, Coach ranks as one of the best performing

specialty retailers. With little debt on the balance sheet and solid free cash flow, Coach

is in excellent financial health and is well positioned to fund growth. Coach continues to

expand through new product categories, such as perfume and jewelry, and is evaluating
Coach Inc: Is Its Advantage in Luxury Handbags Sustainable 7

another distribution with its Coach Legacy boutique. In addition, Coach’s growth

strategy relies heavily on strong international markets, particularly Japan and China.

Coach products are being well received abroad, particularly in Japan. Expansion in the

new Japanese markets should fuel growth. The company recorded revenues of

$3,180.8 million during the financial year (FY) ended June 2008, an increase of 21.8%

over 2007. The operating profit of the company during FY ‘08 was$1,147.1 million, an

increase of 15.5% from ‘07. The net profit was $783.1 million in FY ‘08, an increase of

18% over FY ’07 (http://www.companiesandmarkets.com/Summary-Company-

Profile/coach,-inc.-swot-analysis-80423.asp).

Weaknesses and Risk

Consumers are cutting back on discretionary goods in light of a challenging economic

environment, which is likely to pressure near-term sales and profitability for Coach.

Sales are projected in the low single digits in 2009 and 2010 versus historical single

digit growth. These modest projections are driven by decreased distribution to stores as

a result of a decline in customer demand. After 2010, annual sales growth of around

5% is expected, driven by new store openings, both domestically and abroad. While the

company’s strategy to lower prices 10%-15% in its handbag category should help drive

sales and contribute to operating and net profits, this may not be sufficient to offset

weak sales volumes in this retail environment which is likely to result in both operating

margin and profit contraction in the near term. Also if Coach adds higher-priced novelty

bags to its handbag collection, as an expansion into the higher priced market, it risks

tarnishing its image as an affordable luxury brand (http://www.morningstar.com/).

Coach Inc: Is Its Advantage in Luxury Handbags Sustainable 8

U.S. retail stores, factory stores, the interned, and the catalog is expected to

continue to make up the majority of Coach’s revenue. However, international sales is

expected to increase as a percentage of total revenue over the next 10 years as the

company ramps up its expansion into China. This projection assumes that Coach will

succeed in its expansion efforts both domestically and internationally

(http://www.morningstar.com/).

Opportunities & Treats

Coach is riding in style, thanks to the company's leather items and some savvy

licensing deals. The firm designs and manufactures (mostly through third parties) high-

end leather goods and accessories, including purses, wallets, outwear, and luggage.

Coach, founded in 1941, also licenses its name for watches, eyewear, fragrances, and

footwear. The company sells its wares through department and outlet stores (in the US

and about 20 other countries), catalogs, and its web site. It also runs about 550 retail

and factory outlet stores in North America (with plans to add more by 2009) as well as in

Japan. The firm got into selling scents in late 2006 (http://www.hoovers.com/coach,-

inc./--ID__101101--/free-co-competitors.xhtml).

Competitors

The three top major competitors of Coach are: Dooney & Burke, kate spade and

michael kors. Dooney & Bourke makes high-end handbags and accessories, mostly for

women but also for men. They're sold in department stores (such as Macy's and

Nordstrom), online, and by catalog. The company operates about 10 of its own stores

internationally, including seven locations in a handful of US states and a flagship shop

in Manhattan. Best-known for its distinctive initial-covered purses, Dooney & Bourke
Coach Inc: Is Its Advantage in Luxury Handbags Sustainable 9

also makes cell phones and iPod cases, as well as jewelry, luggage, apparel, shoes,

totes, wallets, and assorted accessories http://www.hoovers.com/coach,-inc./--

ID__101101--/free-co-competitors.xhtml).

kate spade's story is one of simplicity, like the bags it peddles. Begun by

designer Kate Spade and her husband, Andy, in 1993, signature kate spade bags were

an instant success because of their uncomplicated design. Since then, the company

has expanded into stationery, various functional bags, and licensing -- with a line of

home ware, including sheets, tableware, and wallpaper, as well as beauty products,

eyewear, and shoes. kate spade's products are distributed in Asia and sold in the US

through about 25 of its own stores and in upscale department stores, including those of

its previous owner, Neiman Marcus. Neiman's sold the company to Liz Claiborne for

about $124 million (http://www.hoovers.com/coach,-inc./--ID__101101--/free-co-

competitors.xhtml).

Michael Kors dresses the stars, both real and imagined. The company designs

and distributes high-fashion apparel and footwear for men and women. It has expanded

its products portfolio through the years by inking several licensing agreements, such as

timepieces with Fossil, eyewear with Marchon Eyewear, swimwear with Warnaco

Swimwear, and socks with American Essentials. The firm's collections include such

brands as Michael Kors, KORS Michael Kors, and MICHAEL Michael Kors. Michael

Kors, himself, owns about 15% of the company, while Sportswear Holdings, the holding

company owned by fashion investors Silas Chou and Lawrence Stroll, bought some

85% of the company in 2003 (http://www.hoovers.com/coach,-inc./--ID__101101--/free-

co-competitors.xhtml).
Coach Inc: Is Its Advantage in Luxury Handbags Sustainable 10

Counterfeiting has become so prevalent that the Global Congress on Combating

Counterfeiting estimated that 9 percent of all goods sold worldwide were not genuine.

The European Union’s trade commission categorized the problem as nothing short of an

economic crisis. About two-third of all counterfeit goods were produced by

manufacturers in China (Thompson et al, pp C-106).

One of the problem in combating counterfeiting is the demand for knockoffs. In

the U.S., China and Europe, vendors and consumers who trade in outdoor street

markets knowingly brought and sold fakes and had few reservations about doing so.

Even with all the many steps taken to combat counterfeiting, many piracy and

counterfeiting experts believe the problem would not subside until the Chinese

government adopted a zero tolerance policy against fakes (Thompson et al, pp C-105).

Conclusion

Consumers are cutting back on discretionary goods in light of a challenging economic

environment, which is likely to pressure near-term sales and profitability for Coach. The

number of millionaires is expected to increase by 23% by 2009, to reach 12 million, with

much of the increase in new wealth occurring in Asia and Europe, demand for luxury

goods in emerging markets are projected to grow at annual rates approaching 10%

(Thompson et al, pp C-105). Luxury goods producers are opening retail stores in India,

which is another rapidly growing market for luxury goods. Sales are projected in the low

single digits in 2009 and 2010 versus historical single digit growth. These modest

projections are driven by decreased distribution to stores as a result of a decline in

customer demand. After 210, annual sales growth of around 5% is expected, driven by
Coach Inc: Is Its Advantage in Luxury Handbags Sustainable 11

new store openings, both domestically and abroad. While the company’s strategy to

lower prices 10%-15% in its handbag category should help drive sales and contribute to

operating and net profits, this may not be sufficient to offset weak sales volumes in this

retail environment which is likely to result in both operating margin and profit contraction

in the near term. Also if Coach adds higher-priced novelty bags to its handbag

collection, as an expansion into the higher priced market, it risks tarnishing its image as

an affordable luxury brand (http://www.morningstar.com/).

U.S. retail stores, factory stores, the internet, and the catalog is expected to

continue to make up the majority of Coach’s revenue. However, international sales is

expected to increase as a percentage of total revenue over the next 10 years as the

company ramps up its expansion into China. With the growing demand for luxury goods

in emerging markets this projection assumes that Coach will succeed in its expansion

efforts both domestically and internationally (.http://www.morningstar.com/).

Coach Inc: Is Its Advantage in Luxury Handbags Sustainable 12

References

Electronic reference formats recommended by the American Psychological Association.

(2008). Retrieved July 08, 2008 from http://www.hoovers.com/coach,-inc./--
ID__101101--/free-co-competitors.xhtml

Electronic reference formats recommended by the American Psychological Association.

(2008). Retrieved July 08, 2008 from
http://www.companiesandmarkets.com/Summary-Company-Profile/coach,-inc.-
swot-analysis-80423.asp

Electronic reference formats recommended by the American Psychological Association.

(2008). Retrieved July 08, 2008 from http://www.morningstar.com/

Jarrar, Y., & Schiuma, G. (2007), Measuring performance in the public sector:
challenges and trends. Measuring Business Excellence Journal, 11(11), 4-8.
Emerald Group Publishing Limited.

Thompson Jr, A.A., Strickland III, A. J. Gamble, J. E., (2008), Crafting & Executing
Strategy: The Quest for Competitive Advantage Concepts and Cases, (16th ed)
McGraw-Hill/ Irwin: The McGraw-Hill Companies, Inc.