How Coach Defies the Odds

Even in a time of near recession, the luxury accessory maker is going strong through a mix of high-end and outlet stores, and steady innovation

One of the hottest bags in the Coach (COH) line this spring is the Francine, a shiny, patent leather number in bright colors like teal and purple that sells for $798. It's selling well not just in flagship stores on Michigan Avenue in Chicago and Madison Avenue in New York, but in Buford, Ga. and Edina, Minn.

Coach's uncanny ability to figure out what women want—get them to buy more purses for more occasions and spend more on the ones they buy—is propelling the financial results at the $2.6 billion New York accessory maker and retailer. With average sales growth of 24% over the past three years and a 61% return on invested capital, the company is No. 1 on this year's BusinessWeek 50 ranking of top performers.

Snazzy satchels

Coach is no newcomer to the list—it was ranked No. 2 last year. Chief Executive OfficerLew Frankfort and designer Reed Krakoff have been driving the line upscale for years, from functional and sturdy to chic status symbol with the distinctive "C" logo and leather trim. Not only are the purses coveted, they are highly profitable—the company's gross margin was 77.4% for its last fiscal year, exceeding peers in the luxury goods arena such as Tiffany (TIF) (56%) and Paris-based LVMH Group (LVMH.PA) (65%.)

What's the secret to Coach's consistent success? "It's a blend of logic and magic," Frankfort says. "Logic in the rigorous analysis we use to help us make decisions and magic in the art of great design."

A native of the Bronx, the 62-year-old Frankfort was a New York City commissioner before joining the growing leather goods company in 1979 as head of business development. When Coach's founder sold out to Sara Lee Corp. (SLE) in 1985, Frankfort became president. In 2000 he led the company through its spinoff from the Chicago food and apparel conglomerate. Today, Coach's market capitalization exceeds that of its former parent.

Frankfort remains immersed in the details of the business, from the price of wallets to the location of new stores. His favorite bag: A new entry for Mother's Day called the Ergo Pleated Framed Satchel, which will retail for $458.

Outlet hedge

In recent years the company has found its customers receptive to more expensive designs such as the Francine. Bags that cost $400 or more now represent 22% of sales, compared with 13% just two years ago. Coach first tested the $798 territory in a limited number of stores last August with the Miranda bag, which did well, reaching 2% of sales in those outlets. Francine, rolled out to all Coach stores this month, ranks as the No. 5 seller, garnering 2% of overall sales.

"There is an appetite for more expensive handbags," says Terry Lundgren, chairman and CEO of Macy's Inc. (M), which is Coach's largest customer through its Macy's and Bloomingdale's locations.

Coach, of course, isn't immune to the economic downturn. Its shares have been trading in the $28 range, near a 52-week low. Citigroup analyst Kimberly Greenberger recently downgraded the stock, reasoning that a discretionary purchase like a handbag would the first to go in a recession.

But Coach, unlike most high-end retailers, has a hedge against an economic downturn. The company enjoys a diverse base with its factory outlets, which numbered 99 in North America, as compared to 282 conventional shops. For the second quarter ended Dec. 29, which reflected the holiday shopping season, same-store sales at the factory stores rose 17.7%, while sales at the company's retail shops slipped 1.1%. (Overall for the quarter, net income rose 18%, to $252 million, and sales increased 21%, to $978 million.) The company says it's on track to hit $3.15 billion in sales this year, a 20% jump.

More affordable bags

The strength of the factory stores underscores Coach's ability to serve different sectors of the market, says Steven Keith Platt, director of the Platt Retail institute, a retail research and consulting firm. "They've demonstrated an ability to manage a variety of prices and sell to consumers at various levels while maintaining its brand image," Platt says. "That's hard to do at retail."

Coach says it has no plans to scale back or realign expansion plans, which call for 40 new, full-price stores and six new outlets per year in North America. Nevertheless the company is expanding its selection of smaller and thereby more affordable bags, largely in the $200 range. They don't cut prices, but they've spent time ramping up their selections at the entry level—around $150," says Lori Wachs, vice-president of growth investing at Delaware Investments in Philadelphia, which owned Coach shares at the end of last year.

Coach says its own research suggests that the company could benefit from well-heeled customers trading down from European designers whose bags are priced out of sight by the weak dollar. And in a January study of 6,000 current and potential customers, 85% said they would spend more on handbags even though they would cut back in other areas of their life.

Innovative products

The ailing economy didn't deter shoppers at the Michigan Avenue store on a recent weekday afternoon. Kim Giordano, a 50-year-old teacher visiting from New Jersey, was purchasing a $98 cream canvas Wristlet, the compact style bag Coach popularized: "It's very secure and it's perfect for when you are out shopping and just want to grab a credit card and a cell phone." It wasn't just middle-aged women swarming over the purses, belts, and jewelry. Ryan Glisczinski, a 19-year-old from Belle Plaine, Minnesota, was planning to buy hip-looking $88 sneakers for his girlfriend: "a simple design that also could be dressed up or down."

Will Coach hit a wall at some point? With the success of the factory stores, there's a risk of hurting the exclusivity of the brand. And with Coach aiming to reach 500 stores in North America within five years, it could cannibalize department store sales. Macy's CEO Lundgren says he used to worry about the competition from Coach stores, but he has found they coexist well because department store shoppers may be comparing brands or looking to coordinate shoes and apparel. The Coach brand, he says, is far from oversaturated.

"This is a company that is very good at producing innovation," he says. "There is lots of consistency and they continue to reinvent themselves."

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