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(Bloomberg) -- For Michael Kors Holdings Ltd., the luxury fashion brand struggling with declining sales after rapid expansion, the combination of its two biggest rivals is unwelcome news.
Coach Inc.’s $2.4 billion acquisition of Kate Spade & Co. creates a New York-based powerhouse that will put pressure on London-based Michael Kors as both companies compete in a declining market for handbag sales. Kate Spade’s colorful and whimsical styles, popular with millennials, give Coach an edge in the race for younger consumers.
And the merged company’s plans to expand Kate Spade in Asia may blunt Michael Kors’s aggressive growth in the region, said Adrienne Yih, an analyst at Wolfe Research LLC.
“When you have three key players and that was reduced to two, the third one will naturally be at a disadvantage,” Yih said.
The merger comes at an especially difficult time for Michael Kors, which is staging its own turnaround plan. The retailer is trying to shed its image as a lower-priced brand that can easily be bought at off-price stores like T.J. Maxx and on the discounting racks of department stores. The company also is introducing new designs to entice customers to pay full price.
It won’t be easy to regain the glamour. Coach has the capability to improve the quality of Kate Spade’s handbags while keeping prices the same, challenging Michael Kors’s market position, said Yih.
“They will make Kate Spade product a better value for the consumer, who then will pay full price because they feel like they can get more,” she said.
A Michael Kors representative declined to comment.
Like its two main competitors, Michael Kors has been battered by heavy promotions at department stores, which face stiff online competition, slower mall traffic and a strong dollar that hurts tourist sales. But Michael Kors is also the victim of its own success. It expanded to 816 stores currently from 177 stores in 2011 as it capitalized on the popularity of its namesake designer, who has dressed celebrities from Jennifer Lawrence to Michelle Obama. By 2014, the company had overtaken Coach as the largest handbag maker in the U.S., according to the research firm Euromonitor.
With that rapid expansion, however, came overexposure. Sales at Michael Kors stores opened at least a year have dropped in seven of the past eight quarters. The stock has tumbled 24 percent in the past year through Tuesday.
The company also became too dependent on sales from department stores, outlets and off-price channels. Michael Kors gets about 46 percent of its sales from department stores and other retailers, compared with about half that percentage at Kate Spade, Yih estimated. Contribution from department stores accounts for only 4 percent of Coach’s total sales.
Read more: Coach investors see $2.4 billion Kate Spade deal as bargain
As Michael Kors merchandise became more accessible to a wider customer base and department stores began to mark down the merchandise, the brand’s cachet began to erode. Moreover, its product design became less innovative.
To regain its footing, Michael Kors announced last year that it was cutting back inventory at department stores to rein in promotions -- a strategy used by Coach and Kate Spade for several years. The company also has diversified beyond handbags and expanded its menswear business and smartwatch offerings.
“Michael Kors is trying to get away from the damage that was caused by being too ubiquitous and overexpanding,” said Neil Saunders, an analyst of retail analytics firm GlobalData Retail. “That takes some time to execute.”
Chief Executive Officer John Idol said in June 2016 that he was looking at mergers and acquisitions for expansion, prompting speculation that he was interested in Kate Spade. The Coach deal announced Monday ended the M&A talk.
The merger isn’t all bad news for Michael Kors. Coach’s plan to end Kate Spade’s reliance on the overly promotional channels of online flash sale sites and some retail partners will also reduce the rampant discounting in the handbag industry. That will aid Michael Kors’s own efforts to cut markdowns. It’s now up to Michael Kors to accelerate its transformation plan.
“They now have to make a strong comeback to differentiate themselves in very competitive commoditized market,” said Milton Pedraza, a New York-based luxury consultant. “Michael Kors has to get its own act together like Coach did.”
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