Oliver Petcu, managing partner of CPP Management Consultants Ltd, outlines the markets in Eastern Europe that remain the most attractive for luxury brands and explains how past emphasis on Central European and Russian markets has overexposed brands to recent volatility there.
For many years, luxury brands have ignored the potential of many Eastern European markets, focusing instead on Russia and Central Europe which have both proved to be extremely volatile during the current crisis. Major luxury brands have entered Prague and Budapest one after the other since both cities showed strong potential prior to the beginning of the crisis in mid 2008. Louis Vuitton, Cartier, Hermes and Dior are just some of the top brands that decided to open directly operated stores in Prague. The trend then continued in Budapest, with Louis Vuitton, Gucci and Burberry opening their own stores.
CPP Management Consultants Ltd, the sole Central and Eastern European consultancy specialized in luxury, warned as early as November 2006 that luxury brands in both the Czech Republic and Hungary would end up catering to foreign travellers, especially from Asia (South Korea, China and Japan), rather than local nationals. Foreign travellers have grown to represent over 60% of sales of luxury brands in these markets while locals represent less than 30%. This ratio caused vulnerability for both markets once foreign tourism numbers dropped. First, it occurred during the SARS virus outbreak, and then during the current economic crisis, which has had the most dramatic effect on luxury markets in Prague and Budapest, with sales falling by over 25% in all luxury industry sectors. The most affected sectors are hospitality, with average occupancy rates having halved in the two capitals. Luxury hotel chains rushed to open properties in both capitals and now are facing critical conditions because of this.
CPP’s in-depth analysis has shown that throughout the past five years, the Central and Eastern European markets are in fact divided in two distinct regions. On the one hand, Hungary, the Czech Republic, Poland, Croatia and Slovenia demonstrate that the majority of wealthy consumers there have comparatively low affinity and demand for luxury brands. On the other hand, the stronger luxury markets are Romania, Bulgaria, Serbia, Montenegro and Ukraine and have a very strong affinity for luxury brands among their wealthy consumers.
Sales in the strong luxury markets are driven by local consumption of over 70% while tourism represents a minority percentage. There is also an important difference between the two areas. The strong luxury markets show a very high demand for luxury branded products and services to the extent that consumers in Romania, Bulgaria, Serbia or Ukraine would even take up loans or credit to purchase luxury products or sacrifice living in a smaller residence in order to own the latest luxury car or watch. Social status is the most important kindler of luxury consumption in these markets and that is why top international labels are among the highest in demand.
During the 2006-2007 international economic boom, most of the top international luxury brands’ lack of interest in these markets was motivated by these countries not yet being members of the E.U. During this time, consumers from all these countries used to make their luxury purchases abroad, especially in Milan, Paris and Munich. The EU integration of Romania and Bulgaria came in January 2007 and suddenly most luxury brands became interested in these markets. However, the timing for expansion couldn’t have been worst, especially due to the sky high and ever increasing rates for real estate which made mono-brand franchised stores unfeasible under those conditions. That is why, for instance, Louis Vuitton compromised by choosing a hotel gallery in Bucharest at a significant distance from the centre and which is today almost empty.
According to CPP’s research, the markets with the largest number of wealthy consumers are: Ukraine (25,000), Romania (11,000), Serbia (7,000) and Bulgaria (5,000), where these figures represent the number of wealthy consumers with assets of over EUR 5 million and with a minimum yearly allocated budget for luxury products and services of EUR 100,000. With the exception of Ukraine, all other markets continue to have strong potential. This is also illustrated by a smaller rate of declining sales in luxury brands present in these markets than the rate of decline in Western Europe since the debut of the crisis in mid 2008.
In the case of Ukraine, the market was destabilized by internal political conflicts, high corruption as well as a rocky relationship with Russia especially after a diplomatic row over gas and natural resources. Currently, Ukraine’s luxury market has fallen by more than 15%, yet some sectors like luxury hospitality and SPA having grown by 10% in the past 12 months. CPP believes that Ukraine’s luxury market will see a recovery by late 2010, provided that some of the top luxury brands already present through franchising deals change their existing partners. The concentration of all luxury brands (fashion, accessories and jewellery) in the hands of four players has proven to be one of the causes of the current instability, creating a high degree of exposure to the current conditions. For instance, all Gucci Group brands are represented by one local franchisee, a company that also represents 10 other luxury brands.
Of the other three sub-markets, Romania and Serbia represent the highest potential reflected by the smallest decline in sales coupled with a very low penetration of top luxury brands. Bulgaria’s luxury market is currently experiencing decline of as much as 10-15% but the market will most likely see a revival by mid 2010. One of the segments which has been oversaturated in Bulgaria is jewellery and watches due to the fact that many top international luxury brands pushed too early for franchised, mono-brand locations.
As for Serbia, it is probably the hidden gem of luxury in the entire region. The capital city Belgrade which is a principal corporate destination has just one 5 star international chain hotel (Hyatt) and many exceptional opportunities in the form of properties ready for renovations and other projects under construction.
The luxury sectors with the highest potential for growth in the following 10 months among the strong luxury markets are:
• Ukraine – Spa, hospitality, organic concepts
• Romania – Spa, fashion, accessories, organic concepts
• Serbia – Spa, fashion, hospitality, accessories, organic concepts
• Bulgaria – Spa, fashion, accessories
The biggest challenge identified by CPP in the further growth process of the luxury industry for all of these markets is the lack of experienced and viable local partners / franchisees. That is why, in the past six months, representatives of CPP have identified major international retailers or developers with relevant experience – especially from the Middle East and Asia – which could expand their operations and invest in this region, ideally in a joint venture model with a local partner.
Furthermore, the current economic crisis presents exceptional timing for investment due to the very reasonable price of real estate especially on high streets – as well as firm interest from many European banks ready to finance luxury retail projects, particularly those under long term franchising agreements.
The top international luxury brands which have shown definite interest in Eastern Europe are: Hermès, Armani, Dior, Gucci, Ralph Lauren and also luxury department stores such as Saks Fifth Avenue and Harvey Nichols. As for the hospitality sector, chains such as Starwood or Kempinski have very limited presence in the strong luxury markets of Eastern Europe, while chains like Four Seasons and Mandarin Oriental currently have no properties in these markets.