Swiss Central Bank Sets Watch World on Edge

New York Times, March 19, 2015

GENEVA — In early February, Thierry Stern, president of the 175-year-old watchmaker Patek Philippe, sent a three-page letter to the brand’s global network of retailers that began on a sour note.

The year 2014, he wrote, “was for our industry a strange and difficult period to understand.”

He pointed to the ostensible strength of the Swiss watch industry, whose 2014 exports grew by 1.7 percent to a record-breaking 22.2 billion Swiss francs, or about $23 billion, only to cite two troubling facts about the growth.

“Good results in many markets are mainly due to Asian tourists, local clients are being more ‘discreet,”’ Mr. Stern noted. “Retailers’ inventories, pushed by a number of brands, have increased to unreasonable levels.”

Then he got to the crux of his letter. “Consequently, the whole industry started this new year with ‘mixed feelings’… until the totally unexpected announcement of the Swiss National Bank (SNB) on 15 January not to defend the 1 EUR = 1,20 CHF exchange rate any longer!”

Mr. Stern was referring to the Swiss National Bank’s abrupt decision to remove the artificial cap that kept the franc pegged to the euro for three years. In response to the move, Patek decreased its prices by 7 percent in North and South America, 5 percent in Switzerland, 7 percent in Hong Kong and 3 percent in the rest of Asia and the Pacific Rim, while increasing its prices by 7 percent in the eurozone and 5 percent in Japan. (Britain was the only market where the prices remained unchanged.)

In a statement to the news media, Mr. Stern explained his decision by citing Patek Philippe’s Ref. 5960 Annual Calendar Chronograph in platinum, a perpetually in-demand wristwatch bearing a Swiss price of 78,200 francs.

In Hong Kong on Jan. 14, the watch carried a price of 795,100 Hong Kong dollars, the equivalent of 104,000 Swiss francs at the exchange rate that day.

One day later, the franc soared by as much as 30 percent, making the watch even more expensive in Hong Kong and elsewhere, further destabilizing an already wobbly market.

Mr. Stern’s letter to retailers stressed the importance of keeping prices consistent across markets. “There is no reason why a Patek Philippe watch should be much more expensive in a given market compared to others!” he wrote. “This would not be fair to our local clients; and even more importantly, such differences would fuel the gray market!”

Patek Philippe is hardly the only brand grappling with the challenges of pricing its watches in a world beset by political and economic instability. As retailers and watchmakers gather in Switzerland this week for the Baselworld luxury watch and jewelry show, how to set prices, when to adjust them, and how downstream margins and profitability affect the final tally are sure to dominate conversations.

“This jolt comes at a time when demand in China and Europe has been subdued,” said Milton Pedraza, chief executive of The Luxury Institute research firm in New York. “For the first time in a long time, luxury Swiss watchmakers understand that economics and demand are not in their favor.”

To put modern Swiss watch pricing in context, it is helpful to recall that, for the bulk of the 20th century, Swiss watchmakers excelled at mass-producing quality mechanical timepieces. The advent of battery-powered quartz technology in the late 1960s — and the resulting flood of Japanese-made digital watches — changed things irrevocably. No longer able to lay claim to the cheapest and most reliable timepieces, watchmakers in Switzerland slowly began to gravitate to the high end, refashioning their products as handcrafted icons of status and prestige.

With that positioning came a natural, gradual increase in prices, to cover not only the research and development costs associated with building ever-more complicated movements and hiring skilled laborers to produce them, but also the marketing and advertising costs required to play in the luxury big leagues.

David Sadigh, founder and chief executive of the Digital Luxury Group, a marketing agency based in Geneva, cited a host of additional factors that drove up the cost of producing Swiss watches in recent years, from the shortage of parts and movements provided by third parties to the rise in labor and material costs — especially gold, which peaked above $1,900 an ounce in 2011 before slipping over time to around $1,200 today.

One factor he did not mention was the wave of consolidation that has washed over the industry, placing many brands under the care of publicly owned luxury groups, whose first priority is, inevitably, to their shareholders.

“They constantly have to show growth in a business that’s not easy to grow,” said Ariel Adams, founder of ABlogtoWatch, a site for watch enthusiasts. “You have two options. You produce more watches or you charge more for the same watches. What’s easier?”

Which is not to say that the steady creep upward in pricing has been arbitrary or spurious. Many watchmakers responded to the scarcity of movements and parts offered by third-party suppliers such as the Swatch Group by investing heavily in their own manufacturing capabilities, thereby increasing the cost of their products.

At Breitling, for example, the brand’s chronometer-certified chronographs ranged in retail price from 5,000 to 7,000 francs until 2009, when the introduction of its first in-house caliber prompted a price adjustment that shifted the timepieces into 6,000 to 8,000 franc territory.

“Yes, the price range of Breitling moved a little higher but in parallel with our offer,” said the company’s vice president, Jean-Paul Girardin. “We went from 40 to more than 70 power reserve hours.”

Yet “the sky is not the limit. We cannot just go up and up and up,” Mr. Girardin added. “If you increase prices, you will have less sales, so you have to be cautious.”

Lowering prices is, in many ways, more challenging. Fearful of alienating clients — not to mention retailers, whose margins get squeezed — many brands have opted against it.

“When you lower prices, the only guy you make friends with is the guy who’s about to buy your watch,” said Mike Margolis, founder of Horology Works, a North American distributor. “But you make enemies with everybody who bought your watch, including your dealer network. The first thing they want to know is, ‘Are you refunding me for all the inventory I have in stock?”’

For Patek Philippe, the price decrease was positioned as a strategic move to prevent the distribution of its timepieces through unauthorized channels. Besides wreaking havoc on a brand’s global retail network, gray market sales threaten its reputation among collectors. The gamble appears to have worked.

“While Patek entered into the rarely charted waters of price decreases, the feared backlash has not happened,” said Rüdiger Albers, president of Wempe, a retailer in New York. “A potential influx of product from other markets due to a price disparity would have inflicted far greater damage.”

The brand indicated in its letter that it would revisit prices at the end of June.

The fear, of course, is that currencies will continue to fluctuate, and disparities will linger, given that brands are not able to change prices every day or every month.

At the Baselworld fair this week, all signs suggest that most brands will stick to their current pricing, save for slight adjustments in the eurozone. But how the currency volatility will impact the business in the long term is a topic of great concern.

“It’s causing stagnation because, when people are worried and they feel concerned about pricing, they don’t put money into R&D, marketing, new products,” Mr. Adams said, referring to research and development. “So what you see is companies focusing on their top 1 percent of customers who are less sensitive to price changes.”

While the notion that the world’s biggest spenders don’t care about price increases is enticing, there’s good reason to believe that affluent people are more conscious of what things should and do cost than the luxury brands realize.

“The wealthy are take-it-or-leave-it negotiators,” Mr. Pedraza said. “This is not a time to be cavalier in the Swiss watch industry, no matter who you serve.”