Originally Posted by thereminjames
Hi.
Longtime lurker here - so I’m taking a risk by courting controversy in my first post! But as a lover of business history I’ve been fascinated by the grey market dynamics in new Rolex watches and the opinion that this is all bad for Rolex’s brand, and I’ve given it some thought.
My thesis would be that Rolex has effectively created a stealth two-step distribution model for some products (Steel watches) whereby the ADs are effectively now wholesalers, and the greys are retailers. Setting aside questions of ethics relative to consumer expectations, I’d argue this is a highly rational strategy from a purely economic standpoint, to Rolex.
What are the benefits of turning AD’s into a stealth wholesaler channel?
1.) It reduces inventory risk to Rolex and their critical partners (AD/Wholesalers). Let’s say demand drops due to COVID-19. The greys will be stuck with the most excess inventory in these models, followed by AD’s. Rolex, the manufacturer now has two layers of buffer and a retail presence that protects their most important partners.
In supply chain terminology, this lengthens the bullwhip by adding a new party at the tail - one Rolex won’t mind throwing under the bus every once in a while, when necessary.
2.) A wholesale layer preserves Rolex’s pricing power. If Rolex wants to raise the price of SS Daytona on the AD (wholesaler) by 5% they can do that - how that gets absorbed is a function of dynamics between the consumer, the grey market, and the AD/wholesaler.
I’m not up on current retail pricing or retailer gross margins, but let’s say Rolex sells BLNR to AD for $5000 and list is $10,000. ADs, acting as wholesalers, sell to greys who sell for $15,000. People complain, but they also buy, keeping greys in business.
Now Rolex wants to put in a 10% price increase of $500 and tell ADs they can raise list to $10,500 to recoup that. Most likely greys see some gross margin degradation, but even if they pass through 100% of the increase the “consumer” ultimately sees a 3% price increase ($500 on $15,000).
Even better for Rolex, they get no bad press for a 10% price increase - instead the narrative is about greys in cahoots with AD’s fleecing the consumer.
What does all of this mean? If Rolex has less inventory risk and more pricing power they effectively have a lower cost of capital which means they can invest more in R&D, manufacturing, and marketing. Best of all as the price increase example shows, they can get all of this in a way where the complaints are directed at grey market dealers (who are effectively the “real” retailers when ADs are operating as wholesalers).
From a pure economic, profit-maximizing perspective allowing this to happen is very smart strategy. Making it happen through non-enforcement is very smart PR. If you look at things this way (from Rolex perspective), it leads to some unconventional conclusions that are not going to be popular in this group:
First, it would suggest that the grey market prices in SS models are in fact the “true” retail prices - the market seems to bear these prices. Second, while this sours some people on the brand, it allows more investment in the brand that may more than offset the negatives.
I believe this is all intentional because tracing the provenance of brand new watches has to be among the cheapest and easiest things to do. If Rolex was a public company it would have a higher multiple because of this, and the board would approve of it.
For these reasons, I fully expect this dynamic to continue.
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