From the Knowledge@Wharton today blog.

When Burberry recently reported that sales at stores open a year or more were flat, and suggested that profits are likely to be on the disappointing side, some people began to wonder if Burberry might be the canary in the coal mine – a harbinger of lower sales in the luxury sector over the coming months.

A Wall Street Journal article today supports that theory, noting that diamond sales in China are expected to grow more slowly this year than last, while Daimler AG has announced that its Mercedes-Benz division would miss its profit target in China and expects lower sales for its Porsche division.

Is London-based Burberry indeed an example of what we will see in the luxury goods market? What are the implications for the global economy and, equally important, for the upcoming holiday season?  

Burberry suggests that its slowdown is “a sign of an upcoming trend in the luxury segment,” says Wharton marketing professor Barbara Kahn. “Although it is hard to know for sure, there is some indication that this might be a correct analysis.”

Much of the ability of the luxury segment to maintain steady growth has been due to strong performance in China, she adds, and “recently, this growth has slowed down for several reasons. First, as the Chinese luxury consumer gets more sophisticated, [his or her] need for purchasing high-end visible status symbols slows down. Many of Burberry’s products are high status — and visibly so, due to the famous ‘check’ [design].” Now that consumers are gaining more confidence “in their own positions of wealth, these types of purchases may decrease.”

In addition, Kahn says, China’s economy is slowing down, “and there are indications that the government will not provide substantial stimulus mechanisms, as they have in the past, to keep up the growth levels.”

Burberry, a luxury fashion house that sells accessories and clothing for men, women and children, has approximately 235 stores and outlets, and can be found in more than 200 upper-end department stores worldwide.

An article in The New York Times noted that Burberry’s main customers, “known in the industry as traveling luxury consumers, [include] just over a third in Asia, a quarter in the Americas and a little less than a third in Europe.”  The article, published shortly after the disappointing figures were announced by the company, quotes Burberry CEO Angela Ahrendts acknowledging that “the external environment is becoming more challenging,” and suggesting that Chinese consumers may be slowing down their luxury purchases only temporarily, waiting to see how the upcoming leadership changeover in China affects their purchasing power. 

Wharton marketing professor Z. John Zhang has a slightly different take. “I don’t believe that the overall consumption of luxury goods in China is going down, and even if it is, it will not last for long,” he says, adding that economic downturns typically do not affect many luxury goods consumers, “especially in a country where the income disparity is huge. If anything, in a downturn, you need to look even better to impress your peers.”

Burberry’s lower sales could be due to a number of reasons, according to Zhang. “First, more and more people in China are going abroad for shopping. The people who could afford to travel abroad are those who could afford to buy luxury goods, and there will be a substitution effect. Second, there may be more fake luxury goods in the Chinese market. After all, during a downturn, you do what you must to survive. The supply of fake goods may have increased considerably now that the economy is getting tougher.”

The worst outcome for Burberry in China, he adds, is that “it is no longer on the top of the Chinese customer’s list of luxury goods [to purchase]. These consumers are constantly looking for new ways to distinguish themselves and to stand out in a crowd. It is an arms race [among] luxury brands to find new ways to provide exclusivity to their customers.” The disappointing news from Burberry could reflect the fact that the company “is losing favor with exacting Chinese consumers.”

So what’s ahead for Burberry and other luxury goods retailers?

“The luxury retail sector was the first to recover after the recession, partly due to strong demand from China,” says marketing professor Stephen Hoch. “Maybe they are now at a pausing point.” Any weakness that is evident, he adds, “would be due to Europe and China rather than the U.S., where the rich seem to be doing just fine relative to everyone else.” In China, if the new stores — where you would expect the biggest increase in same store sales since they are new — showed any weakness, “then this could be a big contributor,” he points out. “It is hard to predict whether Burberry is a harbinger of anything else. I tend to doubt it, but we will see.”

Kahn notes that the continuing uncertainty in Europe is definitely a factor in lower luxury goods purchasing. In addition, she has read reports suggesting that the new Chinese leadership team – expected to begin transitioning as early as next month – “is not likely to provide as much stimulus to the economy as they have in the past.”  Finally, if Burberry’s slowdown is indeed a general trend, and not unique to Burberry, “I would expect to see similar slowdowns in other highly visible status luxury purchases, such as LVMH and Chanel.”

And the outlook for the luxury goods sector during the all important holidays? “As usual, it is hard to predict the upcoming holiday season,” Kahn says. “The back-to-school season was reasonably strong — relative to our new, more moderated expectations — so people are cautiously optimistic. I think the current thought is that we should see a holiday season fairly similar to last year – which is reflecting the slow but steady growth patterns.”

This post was previously posted in Knowledge@Wharton today blog: Is Burberry the Canary in the Luxury Coal Mine?