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Analysis: Burberry smells a chance in fragrance business

By Astrid Wendlandt

PARIS (Reuters) - Burberry hopes it can gain better control over its brand and eventually a bigger slice of profits by running its own perfume business, a big gamble that could change the structure of the luxury goods industry if others follow suit.

Like most luxury firms, the British brand licenses its perfume business, in this case to Interparfums, which also sells scents for an array of other names, from shoemaker Jimmy Choo to penmaker Montblanc.

Burberry announced on Thursday that it was taking the business in house, becoming the first big luxury brand in at least a decade to do so. Many analysts reckon it will be a difficult task.

"Fashion and beauty are different industries," says Thomas Chauvet, luxury analyst at Citi, who sees the move as potentially costly and a management distraction at a time when the luxury industry is entering a potential global slowdown.

Burberry said it saw big potential in the perfume and cosmetics sector, and was inspired by market leaders Dior and Chanel, long among the few to run their own perfume businesses.

If it succeeds, it could be copied by rivals such as Prada, whose scents are made by Spain's Puig, and Gucci, whose fragrances come from Procter & Gamble.

"Burberry's move will be closely watched," said Fflur Roberts, global head of luxury goods at Euromonitor. "Rivals might do the same if they have the capability to do it."

That could potentially change the structure of the industry, reducing the influence of specialist fragrance companies like Interparfums, Coty and L'Oreal, which pay royalties to brands while logging the sales of branded scents on their own books.

Firms will be eager to see if Burberry can handle the business itself. There are already signs that it may have underestimated the challenge: it has extended its contract with Interparfums to March 31 from its initial end date of December 31.

The 156-year-old British company, known for raincoats lined with a distinctive camel, red and black check pattern, said on Thursday it would give more financial details on the impact of the perfume move when it publishes interim results on November 7. It issued an unrelated profit warning last month.

Citi estimates the perfumes move could dilute earnings by about 3-5 percent in 2013 and 2014, but says that if Burberry is able to achieve best-in-class operating margins of 20 percent in fragrances then it would largely offset the start-up costs.

LEVERAGE CONTROL

Burberry thinks it can beat Interparfums and speed up growth of a perfume business that currently generates about 210 million euros a year in sales for Interparfums, an amount equivalent to about 9 percent of Burberry's revenues.

It could also expand beyond perfumes into cosmetics, an area in which it has only a small presence but says it has big ambitions. The overall global fragrance and cosmetics industry is huge - $95 billion in sales in 2012, set to reach $106 billion in 2016, according to Euromonitor.

Control over its perfumes can also be leveraged to help the brand sell other products. In ads for its Body perfume during its biggest-ever fragrance launch last year, for example, Burberry dressed model Rosie Huntington-Whitely in a trenchcoat.

Burberry is following an industry-wide trend of buying back licenses to gain more control over brands. Last year it completed the purchase of its menswear licence and took steps to reduce the number of licence agreements it has in Japan.

Dior bought back many of its licences in the 1990s, including its perfume business, acquired in the late 1990s thanks to Bernard Arnault when he started building up LVMH, now the world's No.1 luxury group.

But fashion brands have generally been reluctant to buy back licences for products like perfumes, cosmetics or eyewear, which require specialised expertise and distribution networks.

"One key to success in luxury is control of your image," says Christian Blanckaert, professor of luxury management at Paris ESCP business school. "This is why many brands, such as Yves Saint Laurent, have bought back their licences to reposition themselves at the high end of the luxury spectrum."

Yves Saint Laurent used to have more than 160 licences around the world and spent much the past decade buying them back. Now it has two: one with Safilo for eyewear, and another with L'Oreal for perfumes and cosmetics.

Even now, it has no plans to go into the perfume business. Parent firm PPR said it was happy with with L'Oreal.

"We are not planning any licence buyback because we do not have the expertise they (L'Oreal) have," Jean-Francois Palus, PPR managing director told Reuters this month. "We do not have the distribution network they have nor the infrastructure in terms of research and development."

Buying back a licence can sometimes go wrong, even in the same industry. Italian fashion brand Dolce & Gabbana bought back the licence for their D&G clothing line from Italy's Ittierre but had to shut it down a few years later in 2011, lacking the scale and manufacturing base to keep profit margins healthy.

NOT FROM SCRATCH

Burberry already does the marketing and design for its fragrances and cosmetics, and says it will not be turning itself into a full-blown perfume company overnight.

Finance Director Stacey Cartwright said it was not going to create a laboratory and would rely in part on Interparfums' current suppliers for logistics, production and distribution.

"This is not about inventing a new business from scratch," she told reporters in a conference call on Thursday. "It is about getting into the shoes of an existing partner who has a number of third party relationships."

Interparfums already uses outside suppliers for things like glass bottles and flower extracts, and relies on a network of distributors such as department stores and duty-free shops.

But Burberry will still have to create a new division, hiring scientists, artistic directors and lawyers to deal with red tape which has increased in the perfume industry.

In practice, it is likely that Burberry will operate like Salvatore Ferragamo, which manages its perfume business directly but outsources many operations to Milan-based manufacturer ICR Industrie Cosmetiche Riunite.

(Additional reporting by Antonella Ciancio; Editing by Peter Graff)

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