Vertical Integration in Luxury Companies: Objectives and Effects

Franck Delpal

During the last twenty years, the tremendous development of the luxury markets has had consequences on companies’ organizations and models. Facing several changes in their economic environment (deregulation, globalization, fast expanding demand, weakened suppliers) some of the most emblematic players of the sector (couture houses, leather goods makers, shoemakers) decided to switch to a more integrated model. This strategy took two majors forms: firstly most of the companies started to develop their directly-owned stores network (downstream integration), and secondly some of them built their production capacities or bought back subcontractors (upstream integration). Others cases of hybrid forms of control are also often observed (vertical restrictions for distributors, quasi-integration of suppliers). Based on a series of French and Italian case studies and using a game-theoretic framework, this paper deals with two main issues. First, we examine the motivations to proceed to such vertical control. The economic theory of industrial organization provides us a first approach of the cases in which vertical integration is necessary and efficient. A specific analysis of some luxury sectors (apparel, shoes and leather goods) shows that the motives usually declared by the companies to explain their choice to “make” rather than “buy” and to distribute the major part of their product by themselves are not the only reasons. If the necessity to maintain a certain level of quality through the production process, to guarantee a certain consistence in the brand image around the world and an equal service to customers is no doubt a factor, we show that this strategy also has an economic foundation. Concerning the downstream integration, the benefit of a double margin as a producer and a retailer is obvious. And even for the wholesale part of their business, luxury companies’ use of vertical restrictions allows them to sell under very favorable conditions. In terms of upstream integration, economic and strategic motivations are once again central in the choice of the integration policy and its form (full integration, quasi-integration…).

This general movement of vertical integration has led to diverse consequences. At a microeconomic level, it has clearly improved the companies’ performances. Moreover, using the tools of the game theory, we show that this strategy led to the settling of strong entry barriers at a sector level. In addition with their strong brand identity and in certain cases specific know-how and assets, the “insiders” now have a bigger market power on their environment, whether they are suppliers or distributors. Potential new competitors have to cope with many disadvantages: important initial investment, worse selling conditions, more expensive or slower deliveries from manufacturers. These evolutions can explain the structure of the luxury industry on many consumer goods: a few big companies whose supremacy can hardly be compromised by their smaller scale competitors.