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Old 19 February 2020, 10:32 PM   #91
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Originally Posted by cgaites View Post
First, to address the question, "Why does Omega allow this to happen?" The answer is simple, because they make more money this way. It is business school 101 that profit is maximized when marginal revenue and the marginal cost of production are equal. As long as Omega can sell another unit for a price above the marginal cost to produce that unit (inclusive of all overhead, transportation costs, etc.) then they should if their interest is maximizing profitability and share holder value. As Omega the brand is owned by the publicly traded Swatch Group, their interest is undoubtedly the maximization of profit / shareholder value, and the time horizon for that maximization is likely on the order of quarters or a small number of years at the longest.

It is no different for ADs. As long as the "after discounts" revenue associated with the marginal sale is greater than the marginal cost of the watch to the AD, then they should make the sale. Obviously there is some art to determining what the minimum discount is that will get the deal done. However, as long as the sale contributes margin then the profit maximizing decision is to make the sale.

Secondly, there are two reasons a buyer normally sees the value of a watch, whatever the brand, drop when they walk out of an AD. The first reason is that the price they paid is greater than the prevailing market price in their chosen sales channel. Said another way, the buyer failed to negotiate their best price within their preferred channel. Say they received only a 5% discount at the AD when average buyer receives a 15% discount. In this case the buyer will see a immediate 10% drop in value associated with their below average negotiation ability. The second reason is that the level of trust is higher in the AD channel then in either the grey market or private party channels. Perceived risk on the part of the buyer is lower in the AD channel. Lower perceived risk on the part of the buyer is associated with a higher willingness to pay. For this reason market prices tend to be highest in the lowest risk channels. For watches this means AD market price is normally greater than grey market price, and grey market price is higher than private party sales price. Even among grey market and private party sales, some sellers with long track records of reliable transactions can command higher prices than other sellers in the same channel.

How all of that relates to value retention of Omegas is simple. MSRP in the AD channel is normally higher than the market clearing price because Omega is setting its production at the level that it believes will maximize profitability in the short to medium run. They know that there is still much profit to be realized when selling watches at a discount to MSRP, so they make more. Consumers who buy their watch in the AD channel (or grey market channel) are then faced with selling it in higher risk / lower price private party channel. The loss associate with having to move to a higher risk channel when selling are compounded by losses associated with any discount "left on the table" during the negotiation at the time of purchase in the AD channel.

The current situation with Rolex's SS watches is the result of a market inefficiency in the AD channel. For whatever reason, be it intentional or not, Rolex has set production of SS watches at a level below the profit maximizing level. Because Rolex has simultaneously artificially capped pricing in the AD channel at MSRP, it has created an arbitrage opportunity for those buyers able to secure a SS watch through an AD. If Rolex decided to either a) increase production to the profit maximizing level, or b) allow ADs to sell at the actual market clearing price within the channel, then you would see the same value retention behavior for Rolex watches as for Omega watches - only at a higher average price level across the various sales channels.

Sorry for the novel of a post. I hope folks find it interesting.
This is a terrific post! What is your background if I can ask?

BTW I bolded the section above that explains the key difference between Rolex and Omega. As a publicly held company, Omega (Swatch) puts more emphasis on profits and revenue while a privately held company like Rolex has more leeway to restrict supply and think long term. Omega has to decide if their shareholders can take the short term pinch for long term gain if they decide to cut back production and restructure. So far no sign of that.
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