Burberry and the Big Bag Test

The Burberry results released yesterday were confusing to some investors. Why, if top-line growth has accelerated so dramatically and the brand is doing so well in its attempts to diversify, weren't margins better? ( EBIT margin ex-one time costs went from 22.3% in March '06 to19.9% in March '07). Last March the new CEO Angela Ahrendts launched a collection called Icons that debuted last fall. Sold to the press as a celebration of the company's 150-year heritage, it was also a test to see how far the brand could move away from that iconic and chav-assoicated check. One of the key pieces in the Icons test was a leather handbag called the Manor bag. Whereas previous Burberry bags were made of nylon and sold on functionality, this one was leather and pretty pricey, 795uk pounds or about $1680. That's a threshold price in luxury bags -- a way to determine if a brand is perceived as designer like Prada or a more functional like Coach.

Beaton, left, and Manor Bags

Burberry stores ordered 2 ,000 bags when it was introduced. The company decided to double production to 4 ,000. Delivered last August, they were sold out by mid-September. The brand had passed the test, but the company faced a dilemma. Do they meet demand for more by rushing an estimated 10,000 into production whatever the cost or do they plan they next year more carefully?

When Louis Vuitton found itself in a similar position in 2003 with the bags produced in conjunction with Japanese artist Takashi Murakami bag, Chairman Bernard Arnault decided to preserve his margins and use the limited availability as a PR tool, bragging about the exclusivity and the 7,000 names on the waiting list. But since the Burberry bags were a move into new territory, Ahrendts decided to grab the market share while she could. New factories were found, rush orders were placed and the margins took the hit -- luxury bags should bring in 25 percent margins, but in the results released yesterday the bags achieved well below that (an estimated 10 percent ).

This spring another threshold was tested. The new patent-leather Beaton bag, which went into stores in late February or early March, costs uk pounds 1095 (or $1975). Including the Beaton, Manor and other Icons luxury handbags, a total of 200,000 orders were collected for Fall/Winter '07. And the Spring/Summer shipment of Icons bags also seems to be performing very well. Redburn partners Lisa Rachal did a call around to 18 stores last week asking about availability of the signature black patent leather Beaton . One-third of the biggest stores in the US were sold out (or nearly). Another third said they were very low. Although Burberry took a margin hit on the last round of bags, it looks as though these will make their mark.