I recently read an article on aBlogtoWatch (ABTW) on this topic, and it was thoroughly detailed and interesting enough for me to want to write this. The post was inspired by a Morgan Stanley publication entitled “DTC and the Bullwhip Effect” which you can read in full here. It is a broker report, covering Richemont and Swatch – two listed companies – and the executive summary is as follows:
We are downgrading Swatch to Underweight and Richemont to Equal-weight due
to a combination of factors: 1) inventory management challenges at Swatch in the
past few semesters, likely a symptom of inefficiencies in the supply chain; 2) more
difficult than anticipated transition from wholesale to direct to consumer (DTC); 3)
increased evidence that smartwatches are impacting the below CHF3,000
segment (wholesale value), which is 80% of Swatch Group sales; 4) weaker end
demand YTD and a more cautious outlook, particularly when it comes to Chinese
Our previous thesis was built on the margin benefits of the Swiss watch industry
undergoing a transformational channel shift from wholesale to retail. While our
view of the long-term benefits of this shift remains unchanged, we now think that
it will be a highly disruptive process in the short to mid term (3-5 years). We expect
the shift to present the watch brands with a dilemma: to either buy out inventory
of third party retailers (thus leading to pressure on cash flows and ROIC) or allow the inventory to be sold at discount on third party online platforms (thus potentially damaging brand equity long term and sales short term).
I am paraphrasing, but ABTW has suggested that the oversupply is simply a result of the push for in-house movements where: … “the watch industry made itself too large (needing to sell too many watches to support itself) by building up a series of unnecessary and redundant factories to produce products no one wanted”.
So what does that mean? Well, ABTW says: “when you have a large volume of watches listed online with published discounts, it can have a direct negative impact on all watch sales online, even for those models and brands which do not have published discounts. The reason is because mass discounting of just a few name-brands can lead consumers to believe that the entire product category is over-priced and thus most retail prices in that category cannot be trusted. Such mass discounting of watches occurs in such a widespread manner as to become the norm”.
And here is a wrap-up of the report from ABTW – this isn’t a detailed summary per se, and the report covers a lot of other topics such as smart watches and China, but the essence of the oversupply argument is summarized here:
To summarize the outcome of the Morgan Stanley report, they suggest that the problem of over-inventory of watches, the cleaning up thereof, as well as the cost and stress of transitioning to a more direct-to-consumer distribution sales platform will be “significantly disruptive” to the Swiss watch industry. Outlook for the next three to five years are bleak with regards to profits, with likely losses coming as necessary sacrifices in order to build a foundation for a solid Swiss watch industry future. Brands unable to stomach the cost of disruption will be part of the fallout, but with disruption comes innovation and the promise of new talent and creativity in the watch industry.
In conclusion, ABTW ends with this:
What I see as the biggest challenge isn’t the eventual discovery of effective means to produce, market, and sell watches in the future. This will also come as a natural result of trial and error by players in the market. My worry is that brands will predictably disagree about when changes must occur and thus all proceed to the future at different paces. In other words, a few stubborn brands not wanting to get with the times can effectively hold back the entire industry. As I discussed above, the industry’s ability to earn profits is being damaged by there being too few willing consumers interested in paying retail prices. Just a few brands with widely published discounted prices has a very deleterious effect on consumer confidence and thus buying behavior.
If any part of the bullwhip effect is true, then it is related to poor communication across various regions of the watch industry. Poor communication will lead to differing ideas about how to proceed according to the prescriptive advice given by Morgan Stanley. Not only that, but some brands could “get the message” years too late. What is needed sooner than later is an industry-wide consensus on what they want the future of the watch industry landscape to look like. Without a unified agreement about smoothly transitioning to the next era of the watch industry, the next several years will be fraught with avoidable conflict and resource waste. If the collected watch industry manages it, then effective consensus about strategy and diplomacy will lead the watch industry forward. Hey, and aren’t those qualities what Switzerland is supposed to be known for? They won’t even break a sweat on the road to recovery.
My thoughts on the above are as follows:
- I agree with the sentiment that there will need to be a reversal of the oversupply, which will come at a huge cost… and unless this is done collectively by all the brands, the transition will be arduous for the industry.
- I agree with Morgan Stanley that reducing the number of brand-specific offerings (reducing SKU count) will go a long way to helping the oversupply issue.
- I disagree that supply chain management is a huge hurdle, and DTC selling will go a long way to overcoming this – however, although it may decline, I am certain that 3rd party selling is not going to go away altogether.
- There is an inherent problem with the optimal solution to collectively reach an agreement to unify the industry thinking on the future of the watch industry – that problem is anti-competition law. If the leaders of all the behemoth entities in the watch world got together to decide something – you can bet your last penny someone will take them to court!
In conclusion then, I think this is a fascinating topic, and one to watch as it unfolds.
What do you think?
PS. Link to the full article on ABTW is here.