Luxury commodities:changes in consumption during the economic downturn

December 12, 2008

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Introduction

•Russians haven't got used to sparing money; every second one* doesn't have any savings at all. On the other hand the credit market flourished – almost every second Russian did the shopping on credit

•Every third Russian (31%) considers the global economy's status unstable

•21% suppose it's plunging into crisis

•41% believe that global financial crisis will threaten their welfare

•People will be changing their views on life. The shock will be followed by revision of values including lifestyle and luxury consumption patterns

* Source: VCIOM, October 2008

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How the money is saved

51% of Russians consider real estate to be the

most reliable way to save the money

19%prefer gold and jewelry

17% believe that

lodging their money in Sberbank is the only way to save them

Source: VCIOM, October 2008

4Source: Synovate Russia

Expenses to be cut

26% are ready to cancel

family vacations abroad

19% may quit

visiting cafés and restaurants

17% may cancel

buying a new car

11% – buying household appliances

10% each – weekends in country

clubs and New Year celebration abroad

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• True financial elite – approx. 153.000 people

• Those are the families with annual income above $1 mil.

• 86% of them live in Moscow, 11% – in St. Pete

• Even the most expensive purchases have little effect on their budgets and these people will remain real luxury consumers no matter what

* Source: Quans Research, excerpts from "Millionaires' Lifestyle" research report

Luxury consumers

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• "Mass elite" consists of major businessmen, bureaucrats and large capital heirs

• Numbers approx. 1,2 mil. people

• Many of these people invest in real estate, speculate on stock exchange and thus may start to face financial troubles

• They show mature consumption patterns, many of them prefer to avoid public attention

Luxury consumers

* Source: Quans Research, excerpts from "Millionaires' Lifestyle" research report

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• Those who will really suffer from the crisis are "semi-luxury" consumers

• They buy cars for $150.000, Swiss watch for $30.000, use exclusive services, etc.

• In most cases such purchases are financed by borrowing using big salary

• The consumption patterns of these people are 80% ostentatious – it is precisely they who create the idea of rich people's lifestyle for masses

Luxury consumers

* Source: Quans Research, excerpts from "Millionaires' Lifestyle" research report

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At the same time…

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Millionaire Fair is a luxury goods exhibition which ran November 27-30; almost all the stands were sold out

in the beginning of October, there were no cancellations and a vast number of visitors was

observed.

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Price of a Moscow hotel stay may be 40% higher

than the price of a similar hotel in London (a night at Ritz-Carlton costs $5000), a cup of coffee in a posh café costs $10, and taxes

on European leather goods make a Louis Vuitton bag

the most expensive except Dubai*.

Russian luxury market is overpriced by 50% which means it has room for a

drastic downfall.

* Source: Forbes

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Clothes

"Right now we're dealing with several rich customers which continue to buy luxury goods despite the financial crisis, but a serious slump in sales volumes is observed." – Alexander Reebok, Mercury CEO on sales in TSUM and some boutiques.

Annual increase of the market totaled 20% before the crisis; Russians spent 2-3 times more on new clothes than Americans and Europeans; the market's volume made $40 bil. in 2007.

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Clothes

"As a result of the crisis we'll have to think about clothes in a more simple and ironic manner and thus change the attitude towards ourselves.

Difficult paradox lies in the fact that we'll be longing for inaccessible things much stronger than ever: we won't be able to say 'if I want it, I'll

earn for it' or 'if I feel an urge, I'll take a credit."

"Concepts of 'looking good' and 'being well-dressed' will often mean inventiveness, thoroughness and aptness of the dress rather than belonging of its elements to the list of expensive brands." – Linor Goralik, writer and journalist

"Two major separate trends are going to be pronounced in people's look. The first one is tendency towards practicalness, affordable versatility, simplicity and unisex aesthetics of the outfit. This trend could be called 'the humble fashion' as it's based on acceptance of the mood imposed by the crisis.

Another trend, on the contrary, is going to incline us towards stressed sophisticatedness, complexness of the look – it could be called 'the

resistance fashion' due to its willingness to oppose difficult times and general dullness of outfits."

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Travelling

"Speaking of luxury segment, wealthy people have been and will be travelling. This

segment is going to develop at the same pace as of the previous seasons.” – CEO, Capital

Tour travel agency

5 mil. tours abroad were made by Russians in the first half of 2008*; the market has grown up by 30% for the

last year.

"Concerning Russian market, our partners agree on that it's going to suffer less than other markets. … Most probably this has to do with the fact we're working in the luxury travel segment. … It turns out people are not sparing money and plan their vacations. … This is the current situation and it fills me with optimism." – CFO, Sodis travel agency

Experts predict the downfall in sales of long distance journeys areas, such as South East, Thai and Caribbean. This has to do with the sharp increase of ticket prices which told upon the consumer's abilities.

* source: Newsweek

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Travelling

Tatyana Vand, Vand International Tour CEO, confirmed the 10-15% downfall occurred during the last fortnight of October:

there's sluggish demand for long distance tours (Vand's company deals with expensive exotic destinations) in middle-price segment (3000-4000 Euro per person), especially India, Thailand, Cuba and Bali. Only very expensive individual tours

(which cost more than 5000 Euro per person) are much in demand.

According to the survey conducted at LJ community www.community.livejournal.com/ru_travel:• 54% responded that the crisis hasn't affected their plans for foreign tours• 25.8% found difficulty in replying• only 20% admitted their plans has been affected

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Restaurants

Restaurants already feel the client outflow. Nobody's got exact figures, but "it's clear from conversations with

restaurant owners", says Andrey Petrakov, Restkon executive director.

"The crisis couldn't have failed to affect the market. Firstly, large suppliers are already changing the terms of working with restaurants. … I think we should anticipate increase in price on certain products. … Secondly, there're some difficulties in working with banks. The real troubles will begin as soon as our customers feel it's time to tighten one's belt. Corporate clients are going to be the first to suffer." – Oleg Kondrashov, head of Nizhny Novgorod restaurant holding PIR.

Muscovites have started to choose restaurants more carefully – "if I spend the

money, it's better be something interesting". Yet the most expensive places are hardly

going to suffer.

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Restaurants

Restaurant owners are waiting for February when the New Year's revenue analysis will show how much money people are ready to spend on entertainment. Many will make the final decisions around the end of winter and the beginning of spring. "At present we've had to cancel everything associated with development." – Mikhail Zelman, Arpikom CEO.

"Sure, we've had to revise the investment plans. We planned to open four restaurants a year prior to the crisis,

not one or two. … We observe real downfall in demand, first of all in the upscale segment of the market. Situation

is stable for inexpensive restaurants yet. … Many have started to think about changing their lifestyle and cutting

the budgets for posh places. … Fortunately we have some reserve at least: we can build 15% profit from the wine into

the budget instead of 300%.” – Roman Rozhnikovskiy, Nostalgy restaurant co-owner.

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Jewelry

Inflation increased by 0.8% in September and due to the discounts on gold the price of the metal

increased by 7.8%.

Increase of the prices on gold and silver, negative dynamics on stock exchange and inflation urge people on buying jewelry and other luxury goods.

According to the data of Smolenskie Brilliyanti jewelry group, demand for investment gems increased in October: large diamonds, sapphires and emeralds.

"Volumes of sales of gold and jewelry have increased multifold." – Viktor Konteev, vice-mayor of Yekaterinburg on goods market.

According to RBC Daily, jewelry retail chains have been registering unprecedented growth of sales by 40-70% in the last two months.

"Psychological factor is working: today people are eager to buy things they've been dreaming of, and after all gold is

always gold.” – Pavel Sidorenko, marketing director, Adamas jewelry retail chain.

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Foreign real estate

During the crisis Russians are showing interest in real estate in Eastern European countries which are relatively easy to

come to and have huge potential, such as Bulgaria.

"Irish, British and Scandinavians are selling their realty in Bulgaria because of the financial crisis. This vacuum is fulfilled by Russia's citizens more and more." — Milen Keremedchiev, deputy chief of Bulgarian Ministry of Foreign Affairs.

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Yachts

Monaco Yacht Show, one of the major international yacht exhibitions which took place in September, displayed a

significant slowdown in demand.

But at the International Boat Show, which ran October 30 through November 4 in Florida, majority of exhibitors reported keen interest from qualified buyers and a healthy number of repeat viewings. There was a strong international presence, with potential customers flrying in from Europe, Russia, Mexico and the Middle East. Ticket sales were up by 15% from 2007.

Sales of smaller vessels, typically financed by borrowing, have contracted sharply, and sales of preowned yachts are plummeting. But demand for new superyachts, costing upward of $20 mil., remains robust.

"Demand from India and the Middle East remains strong, but all eyes are on

Russia, where a collapse in demand would have serious repercussions for the industry." — Tim Wiltshire, a spokesman

for international yacht broker Burgess, worries about the global sell-off in

equities which made the 25 richest Russians' combined wealth fall by 68%

thus jeopardizing the market that accounts for 15-20% of new superyacht

commissions.

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Art

In October Mercury acquired control of Phillips de Pury & Co auction house which was until recently owned by LVMH group.

"I think that art market has huge potential… especially the contemporary art market." – Alexander Reebok, who admits the fact that the financial crisis has made art even more attractive investment object.

"The most important thing about this deal is that it went off with a disastrous downfall of stock markets in the background. It means

that Mercury and its clientele from the Forbes list estimate the Russian art market's potential very high, are interested in it and want to add

to the existing line-up of luxury goods the most luxurious one called 'art'." – Mikhail Kamenskiy, Sotheby's CIS director.

Despite the fact that art is traditionally seen as an easily dispensable luxury and thus a good bargain, contemporary art is widely held to be at greater risk than any other area.

However the recent auctions disproved pessimistic forecasts: Sotheby's and Christie's sold contemporary art worth more than $238 mil. in just two sessions – the market has

avoided the collapse and still commanded enormous prices, even if these were lower 40-50% compared with the spring sales.

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"Fine art classics won't become cheaper because of the crisis. On the other hand, the overrated prices for contemporary art

may burst like soap-bubbles." – Iosif Bakstein, Moscow Contemporary Art Biennale commissioner.

Russian market isn't integrated into transparent global art market system, at the same time there're huge amounts of money changing hands here – as a result nobody in the West knows Russian art, and our customers buy classics which serve as identification codes here for crazy prices abroad: "Why invest money into unknown Russian painter when's there's Pollock?" – Evgeniy Barabanov, art historian from the State Center of Contemporary Art. He presumes that the amount of big-scale purchases may increase while the overall turnover of the art market will decline.

Art

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"Demand for luxury goods is still quite high. According to our forecast, serious changes on Russia's luxury market as well as expensive services market are unlikely to happen in the near future."– Christopher Skirrow, PriceWaterhouseCoopers

Nevertheless consultants remain optimistic…

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At the moment spokespersons of companies from different segments of luxury market give rather controversial commentary on changes in the consumer's behavior.

Anyway, revision of the system of values has already started; even those who haven't been affected by the crisis yet, may substantially reconsider their shopping priorities in Q1 2009.

Irrational – if not panic – behavior is already occurring (e.g., in different price segments of jewelry market).

Conservative investments, like foreign estate with relatively stable forecasts and works of art, may turn out to be more preferable purchases than a new prestigious car.

At the same time there's no visible prerequisites yet for the consumer's switching over to more affordable luxury goods, e.g. changing Jaguar XF for Jaguar X-Type.

Quick summary

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How consumer behavior will change?We have two hypotheses

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Types of consumer behavior

Gambler:tends to maximize the pleasure

under crisis conditions prefers to display individuality

clothing: will face difficult situation, when creating one's image will require

great effort and inventiveness, while the glamour's value will definitely

increase

travelling: may reduce the frequency of travelling abroad considerably while

trying not to drop the level of resorts and choosing the closest ones in terms

of geography

restaurants: while refusing to quit visiting status places which he got used to, will probably try to reduce the bills,

e.g. at the expense of wine

Thinker:tends to cut the costsunder crisis conditions prefers to comply with the norms

clothing: may seek inspiration in classical and semi-classical style due to its elements' compatibility, comfort and ability to conceal the lag with fashion trends

travelling: will prefer Eastern Europe or Turkey to vacations in the Pacific

restaurants: will start visiting restaurants only on weekends trying to cook at home for the most of time

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Gambler:tends to maximize the pleasure

under crisis conditions prefers to display individuality

jewelry: will abandon the category in favor of more ostentatious types of

luxury

foreign realty: under conditions of unstable domestic market may decide

to invest accumulated money into something exotic

art: owner's identification function of really expensive art can boost the

auction sales thanks to such people

Thinker:tends to cut the costsunder crisis conditions prefers to comply with the norms

jewelry: will spend money only on precious metals and raw gems if spending anything at all

foreign realty: may acquire underrated realty in Eastern Europe, only as an investment object

art: consumption of this type of goods is possible solely from investment standpoint but will doubtfully gain large scale as these people will be worried about other things

Types of consumer behavior