"This is the publication I recommend
when people ask me what I read"

— Norbert Lou

LVMH will buy Loro Piana

Luxury conglomerate LVMH will buy Loro Piana for $2.6 billion, the New York Times reports.

One of these days I hope to read (or write) the definitive investment case study of LVMH and Bernard Arnault. How did the son of a French provincial construction company owner  compound a relatively modest sum of initial capital into the largest luxury company on earth and a personal fortune close to $30 billion? It’s one of the greatest capital allocation records of the modern era.

LVMH is in some of the most glamorous businesses in the world. But I believe its spiritual ancestor is one of the least glamorous companies ever—Standard Oil. Both companies mastered the repeatable process of establishing and growing economies of scale through acquisitions, bringing their unit costs ever lower until no one could compete with them. The story goes that John D. Rockefeller used to visit his competitors with a copy of his company’s books and say, “Here’s what I pay per barrel for transportation, here’s what I pay for cooperage, etc. You can either sell to me or compete with me.” They usually sold.

With LVMH it’s basically the same thing. No one in the fashion industry likes to pay attention to unit costs, but it turns out they matter a lot. LVMH’s 2012 income statement looks like this:


Revenue                                   28,103  (million euro)

Cost of sales                              9,917

Marketing and selling         10,101

G&A expense                            2,164

Other expense                             182

Operating income                  5,739


The combination of cost of sales and marketing and selling expense adds up to over 71 percent of the company’s sales, so any efficiencies that can be extracted from them will create a lot of extra operating margin. Arnault’s genius was to recognize early on that both categories were subject to cost economies of scale. Leather and other raw materials can be bought in bulk, saving on unit costs. Advertising can be bought in bulk, real estate can be leased in bulk, etc. All of these vendors (tanneries, magazine, landlords) are high fixed-cost businesses, so they will tend to be willing to offer volume discounts, the better to amortize those fixed costs (advertising is especially interesting, because as a given brand grows its per-unit advertising costs tend to go down on their own. A full-page ad in Vogue costs the same whether you sell 10,000 units or 1,000,000 units).

Unit cost savings can either be invested in price reductions, invested elsewhere on the income statement (eg $10 million saved on leather purchases could be spent securing the best retail real estate in a given city) or allowed to fall to the bottom line as cash flow.

LVMH has used the extra cash flow it generated from economies of scale to buy other companies, thereby strengthening economies of scale even further. Over decades the process added up to the company you see today, with over 60 brands in the family. Now LVMH is one of the few buyers that can absorb a company the size of Loro Piana, so that’s yet another economy of scale. It’s also capable of extracting the most economies of scale per dollar of revenue acquired, which means it can pay more than anyone else for acquisitions and still earn a good return.

Here is more.