Why Coach Should Upgrade Its Prices

In its last quarter, Coach (NYSE: COH  ) disappointed the market with weak sales and poor performance in its North American business. Once a growing entity in the luxury handbags and accessories category, Coach saw its market share fall from 19% in 2011 to 17.5% in 2012 to competitors like Michael Kors Holdings (NYSE: KORS  ) .

During its earnings conference call, Coach stated that it would be increasing the prices of its products further. Average Coach prices rose 7% in 2013 alone. Ralph Lauren's (NYSE: RL  ) most recent earnings suggest that luxury sales are still strong despite the economy.

Given Ralph Lauren's continued success in the luxury market and Coach's current position in the handbags category, Coach's decision to raise prices again may be the best decision for the long term.

By Eightinc, via Wikimedia Commons

Why higher prices may work for Coach
Before we consider why raising prices is the best move, we should first examine what happens when you start lowering prices.

Whether it is Coach, another luxury brand, or any company for that matter, customers generally keep a running tally in their minds of how much things should cost and how little things can cost. When prices are reduced, what you've done is lower the brand's perception for the price-conscious customer. This trend started hurting popular teen retail brands in recent quarters.

Status symbol is important to consider. Unlike clothing, where you can wear multiple items simultaneously, you can realistically only carry one handbag at a time.

Higher prices, therefore, could be management's bet that customers are willing to save and spend more for individual handbags than spend the same amount for several cheaper items.

Coach's $400-plus bags generated higher sales last quarter, representing 22% of handbag sales. Additionally, Coach indicated during the conference call that products at the $600-plus price point had the strongest sales performance.

Furthermore, Coach prices remain well below higher-end European brands at $1,500-plus. This gives Coach significant margin to raise prices even though it may be losing sales in lower-priced items to less-expensive options like Michael Kors.

Lastly, higher prices may work because shopping malls are evolving in favor of luxury brands like Coach. Regional shopping centers that contain big-box stores decreased as a proportion of all shopping centers by 7% from 2009-2013. However, higher-end shopping centers are doing just fine and made up 15% of all shopping malls in 2013, up from just 9% in 2008.

Credit: Coach

Potential drawbacks from higher prices
The biggest drawbacks for Coach and higher prices surround its strategy and the competition.

First, Coach stated that it plans to open 15 more factory stores in 2014. For investors, this contradicts Coach's strategy to raise prices. It makes no sense for customers to pay full price at retail locations when cheaper alternatives exist at factory stores.

Second, there is the fear that Coach will continue to shed market share to cheaper alternatives like Michael Kors.

In recent quarters, Michael Kors has built up strength in the $200 price range for handbags. As a result revenue increased 59% to $1 billion last quarter, while Coach's revenue fell 5.6% to $1.4 billion.

With Michael Kors' recent plans to grow the men's side of its business, higher prices at Coach could be a double whammy. If customers are already avoiding Coach for its increasingly expensive handbags, an expanded men's business at Michael Kors may give customers another reason to avoid Coach altogether.

Coach had $700 million in sales last year in its men's business, while Michael Kors generated $150 million in sales.

Finally, counterfeiting may become worse for Coach as prices continue to rise. Handbags are currently the most counterfeited item in America. At 40% of all seized counterfeit goods, handbags are targeted the most because of their perceived value.

However, this works the other way too. As Coach and other luxury handbag brands are counterfeited more frequently, customers are forced to go to the actual retail stores to buy items at retail prices for fear of buying something fake elsewhere or online.

Credit: Coach

Coach's next earnings date is April 29
Both revenue and net income fell for Coach last quarter. Most significant, though, was the 13.6% plunge in North American same-store sales. Investors should observe these three indicators. Additionally, investors should notice what management says about higher prices and if customers have bought into the new strategy.

It would also be beneficial to observe other luxury brands, even those outside the luxury-handbag segment like Ralph Lauren. If both Michael Kors and Ralph Lauren experience revenue and net income growth again while Coach continues to falter, it might signal that an underlying shift is occurring among customers in the luxury space.

Bottom line
In the past 12 months, Coach saw its share price fall slightly more than 1% while Michael Kors shares increased more than 63%.

However, Coach's strategy to increase prices may be the best move considering 1.) the strength in other luxury brands, and 2.) since 2009, spending by the top 5% of earners increased 17%. In contrast, the bottom 95% of earners increased spending just 1%.

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