Business Breakdowns
· Swetha Ramachandran
[00:00:00] S1: So the business in terms of sales, they generated about €26.5 billion last year, which if you consider the size of the global eyewear market, the fact that the company made 550 million prescription lenses last year, which is enough to provide glasses for just over 5% of the world's population, it doesn't seem like it's a huge business. And that's really because it's primarily more volume than it is value. They make a lot of very relatively inexpensive lenses and frames. There are, of course, the high-end brands that we all know, but the bread and butter is made up at the lower end. So they sell a lot of volume, which in effect means that their overall sales are “only” about €26.5 billion, even though that's hand and fist above many of their peers. I mean, if you try to consider, let's say, the average selling price—and this is very hard to do given they sell so many different things across different businesses, from prescriptive lenses to now smart glasses. But I kind of roughly used, let's say €200 as an average selling price, which is perhaps even generous. And I came up with an estimate. If you assume that the average consumer is spending at EssilorLuxottica about €200 a year, they may be reaching only 113 million consumers a year. And that's actually considering the fact that myopia is touching more than 2 billion people's lives around the world. By the year 2050, it's expected that 5 billion people, or half of the world's population, will be shortsighted. So there is this question of penetration, particularly in emerging markets, where especially younger children have a much higher rate of myopia, for example, in China and India, than they do in developed markets, and where they remain underpenetrated. So you could see that actually the relative penetration of the products of this company should continue to increase as time goes on.
· Zack Fuss
[00:00:00] S0: So I know that this is the combination of two businesses with a very rich history. Prior to the merger, they operated in somewhat of their own different verticals. What was it that precipitated the merger of Essilor and Luxottica and the stories of these two storied businesses?
· Swetha Ramachandran
[00:00:00] S1: So 2018 was the year it all happened, when Essilor merged with Luxottica. And in fact, Essilor and Luxottica themselves were heavily acquisitive companies independently prior to coming together. The story, of course, is a fascinating case study in M&A and boardroom battles. The story is one of innovation, which is primarily at the Essilor level, meeting iconization, which is at Luxottica, and its ability, for example, to take these dusty, forgotten brands like Ray-Ban and really reignite and catalyze growth for those. It's hard to remember now, but Essilor was actually, all the way back in 1959, the first manufacturer of the progressive lens, which is Varilux, which was hugely influential and was also followed by several other innovations, as well as M&A, such as Transitions, etc. Similarly, of course, Luxottica has acquired over time these iconic brands. First Ray-Ban, Oakley, and then, of course, licenses for some very coveted luxury brands such as Chanel and Prada as well. And I think what really precipitated this merger was Del Vecchio, who was the Chairman and CEO of Luxottica at the time. He was a man with a very unique vision in that he thought that integrating and controlling all aspects of the value chain in eyewear was the key to unlocking value. And of course it turns out that he was right in that this is the only company really that even today has operations across manufacturing, distribution, R&D. They have over 12,000 patents under their belt, which is again no small feat. That was a realization that prompted them. At that time, they were really only in frames and sunglasses, and the view was marrying that with lenses would be a logical next step. So this is really what brought about that merger at the time. And it clearly wasn't without its problems, as we will probably talk about later on.
· Zack Fuss
[00:00:00] S0: When you think about the combined business, one of the more interesting aspects of optical retail is the separation of the healthcare and what I'll call the fashion part of the business. And so I think when you consider the strategic motivations for a merger, but also the combined economics? Can we just talk through what it looks like in terms of where the money's being made?
· Swetha Ramachandran
[00:00:00] S1: 75% of their business today is actually from vision care. It's from corrective lenses. That is really where the bulk of the market sits. And sunglasses and frames are a much smaller 25% business overall. And the lenses business is actually much more profitable because it operates in a more concentrated market. So if we just look at the prescription lenses market, EssilorLuxottica has over 50%, almost a 55% share of this market. It tends to be much more concentrated. The other players are really Hoya and Carl Zeiss. It's almost an oligopoly. When you look at the other side of the business, which is frames and sun, that is a much more fragmented business because it's much more brand-led. And here you've got EssilorLuxottica with just over a third of the market, which is decent. It is a much smaller market. So, for example, if we look at prescription lenses, that would be basically the bulk of their sales derived from that. Frames and sunglasses are a much smaller market overall. So 75% revenue from lenses and 25% from frames and sunglasses. And here, the fragmentation is such that you don't really have a meaningful number two. Kering, which has brought back some of its brands in-house, has set up Kering Eyewear, which has roughly a 10% share of the market. Safilo, which EssilorLuxottica actually tried to buy but walked away from. I should say Luxottica, because this was pre-merger, they tried to buy it but walked away from it. That has about a 7% share of the market. But there's really not a dominant player other than EssilorLuxottica. And even here, where I would say this really differs from prescription lenses is that the other end of the market, which is a real fragmented tail, constitutes only 3% of the market for prescription lenses. But actually it makes up about 40% of the market for frames and sun.
· Zack Fuss
[00:00:00] S0: And so I think one of the popular criticisms of a business like this is that they produce a piece of plastic frames for $10, and it ends up as a $200-plus at retail product to the consumer. And I know that the truth is not exactly aligned with this infinite markup, given the gross margin profile of the business, I believe it's closer to 60%. How do the unit economics of what they sell work? What part of the business is more commoditized versus differentiated? Prescription versus luxury? How do you think about the different components and strategies?