Are life's little luxuries at risk?

Is demand for luxury goods correlated with GDP growth? As a generalisation, luxury goods by their nature enjoy higher levels of demand as incomes increase and lower demand as incomes fall. Is this even truer now that the aspirational component of luxury demand has grown? Does it follow that, in times of economic downturn, the consumer will wave farewell to the Bond Street boutiques? What does this mean for the luxury sector that has enjoyed strong growth and performance in recent years?

Housing markets continue to cool, credit availability remains tight and labour markets soften. Economic conditions have, therefore, taken a turn for the worse across the developed world. We hardly need reminding of the weak equity market conditions that currently prevail. Yet despite this, global luxury companies continue to achieve healthy results.

There are very few domestically quoted UK luxury goods businesses, and one has to look overseas for the vast majority of global leaders in the sector. Nevertheless, two domestic companies with strong international sales have delivered healthy results. Burberry, which reported at the end of May, showed a 25 per cent increase in profits over the year, and Mulberry, the manufacturer and distributor of quality leather goods, reported a 14 per cent rise in revenues.

Furthermore, sector growth forecast in the region of 10 per cent for 2008 and beyond has been widely reported. Between 2003 and 2007, sales growth across the sector increased from 1-11 per cent, and many of the companies reporting lately will have seen significant follow through from these boom times.

The full impact of the credit crunch is taking time to bite, and it has been intriguing to witness consumer spending patterns in the domestic market remaining entrenched into the new year. Only more recently have overall consumer spending levels been falling significantly, with dramatic results for many general retailers. Rather than scaling back consumption in line with disposable incomes, which in the UK fell by 1 per cent during the first quarter of 2008, consumers have tended to borrow more, with the result that the UK savings ratio has now fallen to 1.1 per cent, its lowest level since 1959.

Forecasts of 10 per cent growth this year run contrary to any intuition that the economic downturn is truly biting. Why might this be? The answers arguably lie in the very international nature of the luxury market, its continuous evolution and development and the core customers who will drive demand.

In the first instance, it is probably the case that companies in the sector today are better run and better equipped, with leaner structures and stronger balance sheets than was the case in previous downturns. This does remain, however, a sector that is characterised by high fixed costs and a need to invest in brands to maintain and extend market presence, so any downturn is likely to be felt, as scaled-back production and fewer sales eat into profit margins. While larger companies, such as the sector giant Hermes, will absorb costs more easily, downside risk is inevitable to some extent as companies look to scale back investment in brands.