Watch Opinion : 5 Things Killing The Watch Industry

  

I own a company that makes watches, NTH. Call it a microbrand, a boutique brand, or something else, it won’t change the fact that my business has to contend with the same challenges facing all my competitors, both large and small. 

Sometime between mid-year and Christmas 2019, I started to feel the onset of a funk, a lingering sense of something being generally “wrong” in my world, without being able to precisely identify what it was that was bothering me. 

But, as the calendar turned over to a new year, with news of Swatch Group vs Comco, then with the blockbuster, worldwide release of Coronavirus, to rave reviews – “This thing is a killer! Everyone’s getting it!” -I started to put my finger on it. What’s been bothering me are all the things I see which are “wrong” with this industry I work in, but worse, my general inability to do f**k-all about them. 

Because people, particularly watch geeks, seem to love top 5 lists, here’s my list of the top 5 things killing this business

Scottish Watches and Moritz Grossmann

 

  1.     Limited choice of reliable sources for movements.
Image from https://www.swatchgroup.com/

 

Let’s start with the obvious – movements. Every brand needs them. But scarcely few brands have the resources to make their own movement in-house. It takes an enormous scale to rationalize the investment in R&D, plant & equipment, set-up, and tooling costs. Because of this, most of the industry is using off-the-shelf movements from a handful of suppliers. The three largest of which are owned by behemoth companies with their own retail watch brands – ETA (part of Swatch Group), Seiko, and Miyota (Citizen).

But as we all know, Swatch Group, after rolling up the vast majority of Swiss production in the wake of the quartz crisis, now seems to be cutting many independent brands off from using ETA movements. And while I have great admiration for Seiko and Miyota movements, it would be wonderful if those two companies came to the table with more and better calibre choices, and if they could increase their production numbers more readily than it appears they can.

After those big three, the choices become a bit more dubious.

  • Selitta is the next largest Swiss manufacturer, but many in the industry (myself included) don’t think their quality is as good as ETA’s, and at least as of 2014, they couldn’t make any movements without some ETA components. It’s still not clear if they’re completely independent, and either way, their annual production capacity is reported to be much lower than ETA’s.
  • Soprod’s annual capacity is much, much less (~100k units/year), their movement prices are much higher, and they’ve had some reliability issues with which to contend. Ronda’s R150 calibre has yet to prove itself or be produced in any real volume. In 2018, a Ronda representative told me their annual capacity for 2019 would only be between 5,000 and 10,000 units.
  • Fossil-owned STP’s capacity seems to be greater, but I and the owners of many other independent brands know that their defect rate is unacceptably high.
  • Eterna’s capacity seems very low, their prices are very high, and their defect rate is likewise unacceptable.

 Independent brands need more and better choices. In a perfect world, the movement manufacturing arms of ETA, Seiko and Miyota would be independent companies, which only produced movements, separate from the companies producing branded watches. In this perfect world, we’d also have access to movements from Orient (whose movement operations would likewise be separate from Orient’s branded watches operations), and Chinese movement suppliers would be producing and delivering with greater reliability.

     The cost to scale.

 As I said above, the reason we don’t all have in-house movements is the enormous cost involved with making them. Even with automated production of parts and assembly – the damned machines and robots to run them cost hundreds of thousands of dollars. A single high-end CNC machine and a robot to run it could easily total $400,000 or more.

Image From bwcmg.org

 

What’s even more problematic are the set-up costs involved in programming the robots and creating the tooling for the machines to produce each part. Those tooling and programming costs can add tens of thousands of dollars for each part being made. 

For the sake of discussion, let’s say a small company launches, and has one high-end CNC machine, and one robot to run it, purchased for $400,000. A 5-year term loan at 6% interest would require monthly payments of almost $8,000. Rent and utilities on the reasonably small industrial space needed might add another $2,000, for a total overhead of $10,000 per month, not counting the cost of any employees. That’s not too bad, is it? 

But wait – each part they produce using those machines could require more than $50,000 in tooling and programming. If their movement has 75 parts to it, they’ll have almost $4 million in tooling and programming costs, regardless of how many of each part they make. It doesn’t matter if they make 100 pieces or each part, or 1 million pieces per part – it’s $50k per part. 

Remember – they only have one machine and robot running it. That’s not going to give them much production capacity. If they can only make and sell 1,000 movements, their total cost per movement would be over $4,000 – not counting the cost of raw materials, or doing assembly, or paying the electric bill to run the machines and keep the lights on. At 1,000 movements per year, it will be 80 years before they can get their unit costs down far enough that they compete head-to-head with the likes of ETA. 

This is why ETA, Selitta, Seiko, and Miyota have the tremendous advantage they do. They’ve been producing the same parts, in huge numbers, for years. It’s estimated that ETA produces 5 million movements per year. Their cost per part in all those movements has dropped down to become next to nothing. 

To put that another way – if our small startup has $4 million in costs associated with equipment, tooling, and programming, they’ll have to make 4 million movements before they can get those costs down to $1 per part, or $75 per movement, before raw materials and assembly. In order to make that work within 5 years, they’ll have to produce and sell 1.6 million movements per year. That’s the sort of scale they’ll need to have if they want to compete with the likes of ETA and Selitta. 

And that’s just the movement. A watch company still needs to produce all the other parts which go into making a watch – case, dial, hands, strap, buckle, crystal, crown, all the little gaskets, etc – assemble them all, do testing and quality control, and of course, produce some sort of box, and package it all for shipping to a customer. 

This is why small brands turn to outsourced manufacturing. But of course, that brings with it a new set of challenges, including but not limited to ensuring quality, protecting intellectual property, production delays, and other supply chain issues.

     Overproduction/Overpricing.

A recent report by stock analysts at Morgan Stanley revealed the shockingly high production costs for Swatch Group and Richemont. What was somewhat less shocking (at least to me), was the revelation that these large luxury groups are working off a 6x markup of costs to retail.

 To put that as clearly as I can, if it costs them $1,000 to produce a watch (including the cost of the box, freight, customs, and any other costs associated with creating a unit ready for sale), they price it at $6,000. To be blunt – that’s a very generous markup. And it’s likely the reason why Swatch Group has almost 2 years of assembled inventory on hand (720 days), but almost 5 years (1,396 days) of total inventory, which would include unassembled components and work in progress, whereas a healthy business wouldn’t have more than 3 months’ worth of inventory on hand at any given time. 

Again, let me put that as clearly as I can – any accountant will tell you an inventory-based business should turn their inventory over every 90 days, or 3 months, on average, so there should rarely be more than 3 months’ worth of inventory on hand. Swatch Group has 8 times that in assembled inventory, and 15.5 times that in total inventory. Richemont’s numbers were better, however, they still have 379 days of assembled inventory (4.2x what they should), and 471 days of total inventory (5.2x). 

Most people would look at that and say they’re simply producing inventory faster than they can sell it – i.e., over-producing. But I say overproduction is really just the flip side of overpricing. If they were working off a lower multiple of their costs, no doubt they’d be selling through that inventory at a faster pace, all other things being equal. 

Inevitably, when they have so much money tied up in unsold inventory, the luxury brands are forced to routinely dump that inventory at a deep discount, fueling the growth of the gray market, and undermining their customers’ perception of their brand value.

     Overproduction/Underpricing. 

I know, if I just got done tying overproduction and overpricing together, in a cause-and-effect sort of way, how can I now seemingly do the exact opposite, in tying overproduction to underpricing? Bear with me, as I’ll explain… 

As I’ve alluded to already, scale is one of the persistent challenges for watch brands. The problem doesn’t simply disappear when we outsource production or purchase off-the-shelf components. We still have to contend with MOQ’s (minimum order quantities) from our vendors. 

The numbers aren’t huge – 50 pieces per dial variation, 300 pieces per strap or bracelet, 500 pieces per case, etc. But when you start attaching dollar figures to those numbers, they become huge, for small, independent brands producing and selling in low volume. 

Remember that an inventory-based business is supposed to turn over its inventory every 90 days, on average. Many independent brands, particularly startups, would struggle to sell 300-500 pieces per year, much less in three months, especially if they try to work off the markups they need in order to grow the business and be sustainable. 

Having all that money tied up in inventory for sale, and the ongoing cost of overhead in running the business, often forces small brands to underprice their watches, out of necessity, just to accelerate their sales pace. But underpricing, while it can initially accelerate sales and inventory turnover, it can also, and paradoxically lead to slower sales (because customers become accustomed to only buying when a brand is discounting).

Photo by McGoo84FreeImages

 

Whether a brand habitually or only periodically underprices, it really makes no difference, as underpricing makes it nearly impossible to grow the business to the point of being sustainable. Smaller, independent brands are often trapped in a vicious, self-perpetuating cycle of forced overproduction, which forces brands into underpricing.

 5.    The cost of quality.

 This is always the unacknowledged elephant in the room. Like most brand owners, I want to feel like I’m delivering a quality product to my customers. That feeling largely comes from customers saying I deliver a quality product. But customers who say that are generally going to be making those sorts of assessments about our quality while taking *price* into account.

But, as I just got done explaining, the big luxury brands routinely dump their unsold inventory at a discount, and many smaller, independent brands are forced to underprice. As a result, customers are absolutely spoiled for choice when it comes to getting amazing quality for their hard-earned and carefully spent dollar. 

Compounding matters for smaller brands is that most don’t have an extensive network of physical storefronts stocking their wares, forcing customers to make their purchasing decisions based on a mix of online pictures, reviews, lists of specs and features, and digital word-of-mouth. 

What’s more, there are rapidly diminishing returns with manufacturing quality, which make it increasingly difficult for customers to feel they’re getting good value for their money as prices go up. The difficulty in seeing and feeling the small differences in quality, which come at large differences in cost, leads many customers to become obsessed with specs and features for the price.

Am I blaming customers, and calling them all cheapskates, who are unable to notice or appreciate differences in quality? Not exactly. I’m just acknowledging what is and has long been the elephant in the room – for most small brands, it’s easier to sell a feature-rich spec-monster of low quality, at a lower price, and offer minimal support, than it is to sell a lower-spec watch with fewer features, but of higher quality, and at a higher price, with outstanding support.

 All brand owners or managers have to contend with this same set of challenges. Because we’re often forced to overproduce, and because we need to turn our inventory over fast enough to keep the business going, we’re often challenged to deliver the product quality and high touch support we want to give our customers. The net result is a lowering of the industry bar, a lowest-common-denominator approach to the business, which is ultimately bad for both brand owners and our customers.

What’s the upshot of all the above? Honestly, I see both large and small brands continuing to struggle to deliver what customers want, how they want it, when they want it. The old ways of doing business – the ways by which the watch industry still operates – are increasingly out of sync with what modern consumers expect from the businesses they support. But I don’t see that changing unless and until we see some sort of industry cataclysm occur, one which forces the industry to adapt, or die.

What sort of changes do we need to see? Swiss authorities forcing Swatch Group to divest itself of all production operations, so that those units could freely support independent brands would be a good start. Decreasing costs of automation, improvements in 3D-printing or on-demand manufacturing, or anything that dramatically lowers the cost to scale, and/or serves to lower the minimum order quantities for small brands, would be a huge help. Until we see some of these changes, the industry will continue to fall out of step with the market.