The Louis Vuitton money machine

Thunk. Thunk. Thunk. Behind a locked door in the basement of Louis Vuitton's elegant Paris headquarters, a mechanical arm hoists a brown-and-tan handbag a half-metre off the floor, then drops it. The bag, loaded with a 3.5kg weight, will be lifted and dropped, over and over again, for four days. This is Vuitton's test laboratory, a hi-tech torture chamber for its fabled luxury goods. Another piece of laboratory equipment bombards handbags with ultraviolet rays to test resistance to fading. Still another tests zippers by tugging them open and shutting them 5,000 times. There's even a mechanised mannequin hand, with a Vuitton charm bracelet around its wrist, being shaken vigorously to make sure none of the charms falls off.

Thunk. Thunk. Thunk. Behind a locked door in the basement of Louis Vuitton's elegant Paris headquarters, a mechanical arm hoists a brown-and-tan handbag a half-metre off the floor, then drops it. The bag, loaded with a 3.5kg weight, will be lifted and dropped, over and over again, for four days. This is Vuitton's test laboratory, a hi-tech torture chamber for its fabled luxury goods. Another piece of laboratory equipment bombards handbags with ultraviolet rays to test resistance to fading. Still another tests zippers by tugging them open and shutting them 5,000 times. There's even a mechanised mannequin hand, with a Vuitton charm bracelet around its wrist, being shaken vigorously to make sure none of the charms falls off.

Think Louis Vuitton, and what comes to mind? Certainly not some robot that batters bags all day. Most likely, it's those glossy ads - you know, the ones with supermodels draping their lithe frames over Vuitton luggage against a striking gold-and-turquoise desert landscape. Or the crowd of Hollywood celebrities, fashionistas, and even former New York mayor Rudy Giuliani, partying at a champagne-soaked 150th birthday party for Vuitton in a tent next to Lincoln Center in New York last month. Or the sleek new Vuitton retail temples, from Fifth Avenue to Tokyo's fashionable Omotesando district, where shoppers plunk down $1,000 and up for a handbag in the new Murakami line.

Vuitton trades brilliantly in the stuff of desire and ego. Yet creating a buzz is the stock in trade of every fashion and luxury house. Flip through Vogue, Vanity Fair or Elle, and you'll find pages and pages of half-naked models, legs splayed, dangling handbags from Vuitton and rivals Gucci, Prada and Hermès. In the glamour department, Vuitton is great but not alone.

You have to peek behind the glittery facade to see what makes Vuitton unique - what makes it the most profitable luxury brand on the planet. There's the relentless focus on quality. (That robot makes sure Vuitton rarely has to make good on its lifetime repair guarantee.) There's the rigidly controlled distribution network. (No Vuitton bag is ever marked down, ever.) Above all, it is a money-making machine, finely tuned to deliver rising productivity in design and manufacturing - and, as Vuitton grows bigger, the ability to step up advertising and global expansion without denting the bottom line. "Their operating metrics are second to none," says Lew Frankfort, the chief executive of US handbag maker Coach, who wants to surpass Vuitton's success some day.

Good luck, Lew. The Vuitton machine is running smoothly right now. With $3.8bn (£2.1bn) in annual sales, it's about twice the size of runners-up Prada and Gucci group's Gucci division. Vuitton has maintained double-digit sales growth and the industry's fattest operating margins as rivals have staggered through a global downturn in the past two years. That power was underscored anew on 3 March, when parent LVMH (Moët Hennessy Louis Vuitton) reported a 30 per cent earnings increase for 2003, fuelled by a record-high 45 per cent operating margin at Vuitton. The average margin in the luxury accessories business is 25 per cent. "The sky's the limit," says Yves Carcelle, the charismatic former textiles executive who has run Vuitton since 1990 and is widely credited with masterminding its turbo-charged growth.

Levitating act

LVMH chairman Bernard Arnault says the brand will keep roaring ahead, even though it has already quintupled sales and raised margins sixfold since he bought the company in 1989: "Of all the luxury brands, Vuitton has the greatest potential for growth." Although LVMH doesn't disclose sales for Vuitton alone, analysts reckon they grew at least 16 per cent worldwide last year and are likely to repeat that feat in 2004. Thanks to Vuitton's levitating act, LVMH's Paris-traded shares have almost doubled in the past 12 months to more than €60 (£41).

Compare that with Gucci, which not only posted disappointing sales and reduced advertising spending last year but was also rocked by the announcement that designer Tom Ford was departing. And whereas Ford had reshaped Gucci in his own rock-star-inspired image, the power of Vuitton extends beyond the persona of well-regarded chief designer Marc Jacobs.

Does Vuitton, which started as a maker of steamer trunks during the reign of Napoleon III, have its best days ahead of it? It still needs to wean itself from Japanese customers, who account for an estimated 55 per cent of sales. Vuitton must build sales in the US while tapping into rising affluence in China and India. It also needs to fight sophisticated global counterfeiting rings. Most of all, because Vuitton markets itself as an arbiter of style, it needs to keep convincing customers that they're members of an exclusive club.

Carcelle dismisses suggestions that Vuitton has limited growth potential. Yet it's a crucial question for LVMH, which draws an estimated 80 per cent of its profits from Vuitton, thus propping up less-successful units, from the DFS Duty Free retail chain to couturiers Christian Lacroix and Givenchy. "If LVMH didn't have Louis Vuitton, it would be a disaster," says Armando Branchini of InterCorporate, a Milan luxury consulting group. The touchiness of this issue was underscored recently when LVMH won a ruling in France that a Morgan Stanley analyst, who had cited Vuitton's "maturity", had downgraded LVMH's shares unfairly. Morgan Stanley is appealing the decision, which awarded LVMH at least $39m in damages.

These are serious concerns. But Vuitton has some serious strengths. One is the loyalty of its clients, shoppers who think one Vuitton bag in the closet just looks too lonely. "I save up for a while, and then I spend a lot on one item," says Elizabeth Hanny, an Indonesian civil servant leaving Vuitton's boutique on Paris's Avenue Montaigne with a cylinder-shaped, Papillon-monogrammed toile bag that she just bought for $665. Hanny, 35, has shopped at Vuitton since she was 20. Vuitton's strategy is to move such shoppers up from the classic tan-and-brown monogrammed bags to newer lines such as Murakami, which starts at around $1,000, and Suhali, a line of goatskin bags that average more than $2,000.

Women aren't the only Vuitton addicts. Meet Jean-François Bardonnet, 51, an independently wealthy Frenchman who's a sucker for Vuitton briefcases, wallets, even eyeglass cases. "You buy into the dream of Louis Vuitton," he says. "We're part of a sect, and the more they put their prices up, the more we come back. They pull the wool over our eyes, but we love it."

Vuitton was already the world's biggest luxury brand when Arnault acquired it in 1989. But the previous owner, France's Racamier family, had focused mainly on building a Japanese clientele that accounted for 75 per cent of sales. Then, in the late 1990s, luxury accessories became red-hot, with long waiting lists for bags such as the Kate Spade tote and the Fendi "baguette". Vuitton's classic brown bags, still renowned for their quality, looked dumpy by comparison.

Enter Jacobs, a streetwise New York designer associated with the grunge look. He seemed a risky choice for Vuitton when Arnault hired him in 1998. But Jacobs' fresh, unfussy aesthetic was a perfect fit, and the new ready-to-wear and shoe lines that he has introduced - though they account for less than 15 per cent of Vuitton sales - draw younger customers in the door. Last spring, Jacobs teamed up with Japanese artist Takashi Murakami on a multicoloured line of bags, incorporating images such as cherry blossoms and eyes into the traditional LV monogram and adding shiny metal trim. Vuitton sold more than $300m of them last year. "Vuitton is a status symbol, always has been," Jacobs says. "But now it's sexier, bolder." While the Jacobs touch has attracted younger buyers, Vuitton continues to attract older clients with its quality and lifetime of free repairs.

Vuitton owes much to Jacobs. But it owes just as much to executives such as Emmanuel Mathieu, a former factory manager at food and beverage giant Danone, who has headed Vuitton's industrial operations since 2000. On Mathieu's watch, Vuitton has boosted manufacturing productivity 5 per cent a year, with improvements ranging from more efficient leather-cutting equipment to a new teamwork structure in factories loosely modelled on the quality circles pioneered by Japan's auto makers. Five years ago, Mathieu says, it took 12 months from the time Vuitton decided to launch a new product until the item hit stores. Now it takes about six months. "We're always looking for ways to improve'" he says.

Managers such as Emmanuel Mathieu have helped transform Vuitton from an overgrown cottage industry into a 21st-century business. Vuitton's manufacturing is still labour-intensive, with a team of 24 workers producing about 120 handbags a day. But, says Andrew Gowen, a London-based analyst who until recently covered LVMH for Lehman Brothers: "They've achieved pretty close to the perfect balance between mechanisation and handmade." Gowen, who has visited the factories of Vuitton and its competitor Hermès, says they are "worlds apart. At Hermès, it looks like you stepped into the 14th century, just rows and rows of people stitching." Hermès bags cost more, but its operating margins are only about 25 per cent.

To see how the Vuitton machine works, consider the Boulogne Multicolor, a new shoulder bag that went on sale this month in Vuitton stores worldwide for about $1,500. With the success of the Murakami line last year, Vuitton marketing executives quickly began looking for a way to capitalise on it. Canvassing store managers, they learnt that customers were asking for a Murakami shoulder bag. In a workshop attached to the marketing department, technicians took a classic bag, the Boulogne, reworked it in multicoloured toile, added metal studs and other touches, and dubbed it the Boulogne Multicolor. "We wanted to have some elements that were striking, while retaining the history," marketing chief Pascale Le Poivre explains. The prototype went directly from the marketing department to top executives, who approved the bag without any involvement by Jacobs' high-profile design team. Moving to production was easy: factories could use existing templates.

Teamwork pays off

By June, the prototype was on its way to Vuitton's factory in Ducey, an airy, glass-sheathed building near the Normandy coast. On the factory floor, workers feed canvas and leather into precision equipment that cuts out the pieces of each bag, cookie-cutter style. Other workers sit at sewing machines, each performing a different task such as stitching in lining.

As at all Vuitton factories, employees at Ducey work in teams of 20 to 30. Each team works on one product at a time, and team members are not only encouraged to suggest improvements in manufacturing but are also briefed on details about the product, such as its retail price and how well it is selling, says Stéphane Fallon, a former manager for Michelin, who runs the Ducey factory. "Our goal is to make everyone as multiskilled and autonomous as possible," says Thierry Nogues, a team leader.

The teamwork pays off. When the Boulogne Multicolor prototype arrived at Ducey last summer, workers who were asked to make a test production run quickly discovered that the decorative metal studs were causing the zipper to bunch up, adding time and effort to the assembly process. The team alerted factory managers, and within a day or two, technicians had moved the studs a few millimetres away from the zipper. Problem solved.

Such efficiency helps compensate Vuitton for its decision to keep most manufacturing in France, one of the world's most expensive labour markets. Of the 13 factories that make Vuitton bags, 11 are in France and the other two are across the border in Spain. Why not manufacture someplace cheaper? "The question gets raised all the time, but we feel more confident of quality control in France," says Mathieu.

Productivity alone won't sustain growth. So while most luxury groups cut their advertising budgets last year, Vuitton boosted spending an estimated 20 per cent, including a global campaign featuring Jennifer Lopez. This year's campaign, shot in the Dubai desert, features supermodels including Naomi Campbell and Kate Moss. "We used to be modest, too modest," Carcelle says of Vuitton's advertising strategy. "Now we've taken it to a new level." Even so, Vuitton is so big that analysts reckon it spends only about 5 per cent of revenues on advertising, half the industry average.

Other companies are trying hard to emulate Vuitton's success. Coach has repositioned its once-utilitarian bag as a snazzy accessory, widening margins to 29 per cent. Venerable Hermès is expanding its retail network and recently hired designer Jean Paul Gaultier to freshen its image. Vuitton will try to outpace these rivals as it carefully opens boutiques around the world. Bernard Arnault is especially pleased that the US stores, which once posted 75 per cent of their sales to Japanese tourists, are now thronged with local shoppers, who account for 85 per cent of sales. That's helping Vuitton reduce its risky dependence on Japanese customers. Vuitton's sales in Japan grew 12 per cent last year - respectable, but lower than companywide sales growth. "Almost every grown-up Japanese woman already owns at least one Louis Vuitton item," says Akira Miura, chief editor of WWD Japan, a fashion paper.

As Vuitton expands, other hazards appear. Counterfeiting has risen sharply in the past five years, largely because of China. Interestingly, the Chinese spurn the fake bags, which are mainly exported to Europe and the US or sold to tourists. Pressed by Vuitton, Chinese authorities closed one factory in Guangzhou last July. "It's a menace we take seriously," says Bertrand Stalla Bourdillon, the director of intellectual property.

Another menace would be the departure of key personnel. Early this year, there was speculation that Jacobs might leave unless LVMH gave more backing to his clothing line. But his contract runs until 2008, and Arnault has recently been singling out Jacobs' label within LVMH's portfolio.

For Vuitton, the biggest challenge may be to keep this powerful machine under control. The company opened 18 stores last year, about twice the rate of store openings a decade ago. "The temptation with a lot of brands is to immediately find new outlets, new sources of distribution, and price points," says Marc Gobé, a New York-based principal in the brand consulting group Desgrippes Gobé. Not Vuitton. "They are extremely disciplined," Gobé says. Bernard Arnault promises that Vuitton will never lose its discipline or its focus on quality. "That's what differentiates Louis Vuitton," he says.

The message seems to be getting across. Just ask Ariella Cohen, 24, a Manhattan legal assistant who already owns a Vuitton messenger bag and several Vuitton accessories, and now covets high-heeled Vuitton sandals - even though she'll have to put her name on a waiting list. "Louis Vuitton never goes out of style," she says as she leaves Vuitton's Fifth Avenue store. With luck, the Louis Vuitton machine will never run out of steam.

Attention to detail... and cost

Price tag

Forget bargains: Vuitton never holds sales, and prices rose by 10 per cent to 12 per cent in the US and Japan last year as the euro strengthened.

(Data: company, BusinessWeek)

Production

Manufacturing methods adopted from car makers and other industries are boosting productivity by 5 per cent a year.

Leather trim

Vuitton uses hides from northern European cattle, which have relatively few blemishes from insect bites.

Zipper

Laboratory equipment randomly tests zippers by opening and closing them 5,000 times.

With Diane Brady in New York, Robert Berner in Chicago, Rachel Tiplady in Paris, and Hiroko Tashiro in Tokyo. This article was sourced from BusinessWeek's latest European edition. For further information, go to www.businessweek.com