Stabbings, state secrets, whores masquerading as Supreme Court justices — it’s been an especially depressing week in the news. So I’d rather focus on scarves. Specifically, Hermès, the iconic luxury brand. With $12 billion in annual revenue, Hermès now has a larger market capitalization than … Nike, which boasts $47 billion in annual revenue. I see this as a slow, yet tectonic, shift in consumer values (cue dramatic music) as awareness cedes ground to artisanship.
Awareness, via social platforms, has created a generation of empty-calorie brands — Kylie Cosmetics, Dollar Shave Club, Andrew Tate — built on sand. Over the past five years, the three biggest consumer packaged goods companies (P&G, Nestlé, and Unilever) whose competence is (building) awareness, have averaged annual stock gains of 9%, vs. 15% for the three largest luxury firms (LVMH, Kering, and Estée Lauder).
The decline of linear TV is a function of cable TV losing its oligopoly on awareness and awareness beginning to lose value as brands famous for being famous are less enduring. This trend highlights what has got to be a first-ballot-hall-of-fame strategic head-up-your-ass decision: Do away with one of the great artisanal brands of the 20th century, HBO. But that’s not what this post is about.
Key to artisanship is there being few artisans. Specifically, the existence of scarcity. Or, as is often the case, the illusion of scarcity. The strongest brands in the world — MIT, Apple, Hermès, the U.S. — are built on the artificial choking of supply via rejectionist admissions, pricing strategies, production, and visas.
Thirteen years ago I started a business intelligence firm that advised luxury (then CPG) brands. It was a successful company, predicated on a simple premise: Luxury brands would trade at higher multiples of revenue due to increasing income inequality and their ability to manufacture scarcity. That was the sermon I preached to every executive we met. We sold the company in 2017 for 8x revenue. Mirroring our client base, we were disciplined about pricing and said no to a lot of potential clients’ procurement departments (BTW, awful job). My first consulting firm, Prophet, had said yes to every client with a checkbook, and it sold for 2.8x revenue. It was the right decision at the time, as I didn’t have the capital to utter the sexiest word in the English language: no.
Want vs. Need
The richest man in the world doesn’t make cars, rockets, or enterprise software — he makes handbags. Bernard Arnault, the CEO of LVMH, is now worth more than Warren Buffett and Mark Zuckerberg combined. He’s made his fortune not selling things people need, but things they want. LVMH controls the most prestigious luxury brands in the world, from Tiffany & Co. to Loro Piana to Louis Vuitton.
When you assemble artisans and create scarcity that results in a supply/demand imbalance, you generate a cash volcano that you can cap the same way you do an oil well — and turn on/off as needed. Businesses are either supply-constrained (e.g., rare earth minerals, 1945 Château Mouton wine, etc.) or demand-constrained (pretty much everything else). The companies that trade at the greatest multiples are those that are artificially supply-constrained, where the supply/demand imbalance puts a dial on the spigot the managers control. Imagine the decision to have more revenue is just a function of when you’d like more revenue (see above: Hermès).
I wrote about scarcity six years ago. How to create it, how to sell it … why it’s so important. Today, scarcity is more important — and scarce — than ever. In sum, this post still resonates.
[The following was originally published on March 3, 2017.]
Scarcity is key to irrational prices. Beachfront property is scarce and, regardless of the economic cycle, always in demand. You can also manufacture scarcity with similar results (crazy-town prices). Spoiler alert: Hermès could produce more Birkin bags and yet decides not to. The choking of supply adds heft to the narrative that this is a special bag, and it adds credibility to the urgency — you may be shit out of luck next week if you don’t plunk down $14,000 now.
Snap Inc. stock began trading yesterday, and bankers did a masterful job of manufacturing scarcity. The triple threat of social/video/millennial is uber-fashionable, and the underwriters ensured that, after placing the bulk of shares with institutions, which implicitly commit to holding for a long(ish) time, the bankers let only 14% of the shares float (be available for trade).
So, even if a Birkin bag or Snap shares are not intrinsically worth $14,000 or $25/share, if scarcity supports the price then God bless them, no? No. Hermès can maintain scarcity. However, over the next 24 months, seven times the number of Snap shares could hit the market. The network’s artisanship/specialness is also about to become less scarce as Instagram Stories continues counterfeiting the “Snap bag.” I believe, in 2018, Snap shareholders will discover they don’t own a Birkin, not even a Kors or a Kate Spade, but an Esprit Black Brown Round Barrel Bag Purse Shoulder Small Hipster.
We’ve been reading words for several hundred years, listening to words for thousands, and learning from images for millions. We, as a species, are great with images. We can interpret/absorb an image 50 times faster than words, as we’ve had a lot more practice with visuals. Just as music is cemented into our being in our late teens, the images of our early childhood become fixed into our gray matter.
When I was 7 we lived in a house near the beach in Laguna Niguel. My dad would come home early (he was a salesman), and we’d go bodysurfing and see seals and porpoises just offshore. When there was a storm, we’d go to Newport Beach. From the end of the pier we’d look several hundred feet out and alert each other when millions of gallons, barreling toward shore, morphed into a blue-gray hemi cylinder 8, maybe 10 feet high and wait for the pier to vibrate, even shake, as the rising sea floor thrust the cylinder up and the wave crashed down on the water.
On one of four consecutive nights, beginning on the full and new moons in spring, my mom would wake me at midnight, and, armed with flashlights, we’d go down to the beach and watch what looked like hot slices of metal dancing in the shallow surf. The grunion were running.
They weren’t all images from the title sequence of The O.C. I remember, on TV, a skinny guy wearing a ski mask on a hotel balcony interrupting awe-inspiring performances from Mark Spitz and Olga Korbut. The only reason it stuck is every time this guy came on screen, my parents stood in front of the TV, visibly uncomfortable.
When my father was going on a business trip, my mom and I would go with him to Orange County Airport. More than an airport, it felt like a restaurant where people pulled up, in the back, in commercial aircraft. There was a bar with a wraparound balcony on the second floor that you could access via stairs from the street. No security. My dad would take me out on the balcony and cover my ears as aircraft engines screamed in anticipation of the pilot releasing the brakes and beginning the 5,700-foot transformation from beached seal to soaring eagle.
He taught me the difference between a 727 and a DC-9 (three jets vs. two), and between the DC-10 and the L10-11 (third jet is part of the fuselage vs. finding residence halfway up the tail). The backyard of this restaurant was dominated by two brands, Air California and Pacific Southwest Airlines. Pacific planes had a smile painted on the nose, grinning at us through the big windows.
My parents were living the American Dream. Two immigrants with an 8th-grade education, they applied hard work and talent to the greatest force of good in history, the U.S. economy. We lived close to the beach. But they (mostly my dad) fucked up, and soon we were living in two houses, neither near the beach. After the divorce, my dad would pick me up after work every other Friday in his Gran Torino, from our 800-square-foot apartment in Encino. I had to wait outside, sometimes for an hour, far from our apartment, because my mom didn’t want to risk seeing my dad, or even his car, as she hated him. I became skilled at identifying cars, from a distance, by the shape and luminosity of their headlights. AMC Pacers were easiest.
Anytime I hear sound in the air, I still look up, and, most of the time, I can identify the plane and airline. Last weekend, in South Beach, my friends pretended to be impressed with my ability to distinguish the A-380 headed to Munich (Lufthansa) from the double-decker Airbus flying to Paris (Air France). Gazing upward and cataloging air traffic is an instinct for me — look up, identify an object, and think of when we were a family and lived near the beach.
Life is so rich,
P.S. I’ll be back on Monday with a fresh look at the Markets on the Prof G Pod.
P.P.S. Watch my five-minute lecture on scarcity here. What. A. Thrill.