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Thursday, June 16, 2011

Is This the Death Knell of Salvatore Ferragamo?

Salvatore Ferragamo

Following years of discussion and rumors, Salvatore Ferragamo SpA announced they are selling 25% of the company in an Initial Public Offering (IPO) on the Milan Stock Exchange. The company planned to sell 48% in an IPO in 2006 but due to market and economic conditions the company shelved the idea.

Why is Ferragamo going public? The coming prospectus will give a number of reasons why but the real pressure is coming from within the Ferragamo family. Salvatore, who started the company in the 1920's to serve the booming Hollywood movie industry passed away in 1960. His wife, Wanda still serves as Honorary Chairwoman to the company. Aside from his wife, stakeholders in the company include his 5 children, over 20 grandchildren and other various descendents. There's an arbitrary rule in place that only 3 family members can work for the company at the same time. The limited spots for interested family members has created competition within the family and the inevitable desire of some family members to cash out of their Ferragamo stock has created a tremendous internal riff.

What was the obvious solution for Ferragamo's troubles? To go public and allow family members who wanted to sell stock the chance to do so, once and for all.  In 2010, the company reportedly had revenues of €780 million Euros ($1.1 Billion) and a net profit of €61 million Euros ($88 million). That's a net profit margin of 7.8%. For an 80-year old fashion industry company, that's extraordinary performance. There is a lot of profit available for expansion and/or dividends for shareholders (the family). Based on last year alone in a stagnant global economy, it's safe to say Salvatore Ferragamo SpA has no financial need to go from private to public. Typically companies raise money through public offerings to fund expansion and growth; Ferragamo has already been expanding and has plenty of cash to do more if they wished. The IPO decision comes back to the family pressures.

So why do we care if Salvatore Ferragamo goes public or remains private? There is a risk, a strong one at that, that the Ferragamo quality we enjoy in their superior shoes, garments, bags and accessories will vanish. Loyal Ferragamo customers know, for example, they can order a pair of shoes, the size will fit, be comfortable and last for ages with proper care. Those who count on Ferragamo for this high-quality consistency will lose confidence in a favoured brand.

In the 1920's, a talented young Salvatore Ferragamo of Florence was producing shoes in Hollywood and became known as the "Shoemaker To The Stars". His shoes were beautiful and highly sought-after. The Italian craftsman took great pride in the loved aesthetic of his shoes but young Salvatore wasn't satisfied  as they were painful to wear. Ferragamo did what was necessary to become better at his trade- even at the height of tremendous notoriety and success in Hollywood; he enrolled at the University of Southern California (USC) to study anatomy to learn how to make an attractive shoe that truly fit the foot and was comfortable to wear. His combination of art and science led to innovations in shoe-making that are still used today, including the wedge heel, shell-shaped soles and the gloved arch shoe. He took shoes to new heights with the steel reinforced stiletto (and hated for it to this day by sore-footed woman everywhere). For many years Ferragamo made arguably the most confortable woman's shoe available and exemplified Italian quality, craftsmanship and innovation.

When companies go public, the entire corporate dynamic changes. This change will ultimately effect the corporate family culture that has taken 80 years to establish. Although the Ferragamo culture may be strained internally at times, they do have a reputation of upholding Salvatore's values of superior Italian craftsmanship. With their growth, quality may have suffered a little due to higher demand but that's inevitable with growth in a quality-based business. Generally speaking, the quality is still intact. Now, there will be a block of public shareholders that own 25% of the company who care more about returns than the corporate culture of quality. This has the makings to be a textbook study in how big business is competing against quality and ultimately, the art of fashion.

The primary concern of shareholders is return on investment. These intentions are clear and understandable. They're investing to make money, period. Not if- but when, Salvatore Ferragamo goes through a period when returns are not up to shareholder expectations, investors will call for changes to be more profitable. The equation is simple: lower costs and maximized revenue. To lower costs, investors look at the cost of making goods. If the product can be made at a lower cost (and they can in this case), the new investors will call for change. Italian production will be difficult to make considerable changes to. It's evident the Ferragamo's have ensured efficient production of their core products in Italy while still maintaining qualityLabor costs of what an Italian craftsman demands compared to a worker in an emerging growth country such as China or India will easily point to moving production to these other countries. Labor costs in emerging markets is far less expensive. There's a reason so many other items- clothing and otherwise have the label "Made in China" (or India, Taiwan, Malasia, etc). A cheap labor force is appealing to shareholders to maximize returns- at least in the short term. 

Craftsmanship, quality and pride in Italy is generational and second-to-none. If an item is made in Italy, its typically very high quality. In comparison, emerging countries with large pools of unskilled workers can make that item far cheaper but don't have the experience and know-how compared the Italian culture of generational craftsmen. Moving production out of Italy will cause quality to suffer. It's not that workers in emerging markets are inept, they just don't have the experience, pride and culture that Italians have developed. When the shift from quality to lower cost takes place, the products and ultimately the brand slowly erodes. When value erodes enough, the product becomes a commodity; there is no brand premium in the pricing any longer because buyers no longer view the brand as anything more than average. A commodity can't be differentiated any longer. An average handbag is an average handbag- retail stores and discounters are full of them and the brand that produced it is irrelevant. 

It's logical that non-family involvement of shareholders will eventually demand the lowest cost solution. If and when that happens, for a period of time the Ferragamo brand would remain significant and continue to call for premium luxury pricing but erode over time due to lower quality and a loss or exclusivity. Additionally, shareholder pressure will call for capitalizing on the Ferragamo name by introducing additional royalty revenue sources through a proliferation of licensing agreements. Allowing other manufacturers to use the Ferragamo brand on a wide variety of products through licensing is an easy way for a brand to greatly enhance profitability with little effort, at least short-term. However, unless tightly controlled, a premium brand can lose its allure when everything from bedsheets to cigarette lighters flood the marketplace at lower quality than the company's core business. A primary example of this happened with Pierre Cardin. Cardin capitalized on the brand name by issuing 100's of licensing agreements for virtually every type of product conceivable. The company even had to settle a lawsuit for issuing two license agreements to make the same product- not realizing while issuing the second license they already had a licensee that made the same product. Pierre Cardin's top line haute couture remains highly regarded but the Cardin name lost its seductiveness and ability to demand premium pricing. For most, Pierre Cardin is just an average brand who's original designer used to be highly regarded.

With quality suffering and a marketplace flooded with the Ferragamo name, luxury and upscale market buyers will eventually stop buying the brand. The immediate surge of buyers of licensed products or who previously were priced out of buying the Ferragamo brand would bring higher sales while the brand erodes. Following in the footsteps of the former luxury clientele, these newer aspirational buyers will eventually no longer find value in either the product or brand. Increased licensing and moving production of the core brand out of Italy would have short term economic benefits for the shareholders but kill the Golden Goose in the long term.

Can ultimate demise be averted now the decision has been made to sell a 25% stake in a public offering? Perhaps. Selling 25% to investors has opened pandora's box. Short term, maintaining brand quality depends on the fractured Ferragamo family who still owns 75%. If they can vote in a collective majority to maintain quality in spite of investor pressure, the brand will remain intact for now. Fifty years after Salvatore Ferragamo's passing, the brand is still associated with the high quality Italian craftsmanship and care that Salvatore exemplified. The family has done a good job of sticking with their roots and demanding quality but public investor pressure will never let up. It's a matter of time before investor pressure wins and the brand suffers. When the time comes that a fractured Ferragamo family can no longer vote in plurality to maintain quality over even greater profits, the death march will begin for Ferragamo.

Michael Cress ~ The New York Sartorialist