For companies, their "brand" can be a tricky thing to define. A founding father of modern advertising referred to it as "the intangible sum of a product's attributes." Others have said it is simply what prospective customers think about when they hear the name of your product or company.
Either way, the goal is to establish a positive emotional connection between what you are selling and the people you are trying to sell it to.
Some companies are viewed as a great value; others want to be seen as high quality. Both are rooted in something practical. On the other end of the spectrum are luxury brands. A luxury brand has nothing to do with being practical. It's about status.
These brands are seen as rare, exclusive, and typically steeped in tradition. Sometimes brands once considered a luxury slip to having mass-market appeal. The fall is usually an effect of chasing growth.
However, it's hard to think of a brand that was able to make the climb from mass market to luxury. That's exactly what home furnishings company RH (RH +0.18%) is trying to do. And it's all-in on the strategy.
Stores aren't just for selling
One of the more underappreciated elements of RH's bid to become a bona fide luxury brand is its move to turn physical locations into more of an experience than a store. They call them galleries for good reason. They feel more like a large hall in a museum than a store at the mall. Compared to Williams-Sonoma's (WSM 0.72%) Pottery Barn, an RH gallery is expansive and serene. That's intentional.
While the legacy galleries average about 7,400 square feet, the newer design galleries are closer to 34,000. The chart below shows the mix shifting to the larger footprint in the past few years.
Data source: RH; chart by author.
RH is going even bigger in the future. The new prototype is for a site to average a massive 38,000 square feet. That includes hospitality space (e.g., restaurants and wine bars), as well as areas for designers and their clients.
Furthermore, major metropolitan areas will get unique galleries that serve as brand statements, as will geographies favorited by the affluent. Examples are the company's locations in New York and Aspen, Colorado. RH will also be testing smaller galleries in secondary markets and anticipates a payback of no more than two years on those expenditures. Investors will be keen to see the results.
Getting back to normal
The transformation toward luxury comes amid a tough backdrop as the COVID-induced transition to a work-from-home economy led to a boom in demand for home improvements and furnishings. That demand has waned in the face of capital expenditures nearly doubling since the beginning of 2020.
Over that same period, trailing-12-month sales are only up 27%. That has pressured returns, as shown by RH's return on invested capital. It has fallen all the way back below pre-pandemic levels.
RH return on invested capital data by YCharts.
Full speed ahead
When management reported earnings for the quarter ending in April, it projected continued markdowns to clear older inventory. That might boost sales, but it will hurt profit margins. And add to it the cost of the transformation -- RH isn't letting the gloomy forecast slow its investments. That's partly why shares are 55% off their highs.
Despite the drop, CEO Gary Friedman is confident in the strategy. He has said times like now are when long-term thinkers make investments that will separate them from the competition.
Friedman has earned the benefit of the doubt. And he has plenty of skin in the game. His vision has produced a roughly 340% gain over the past decade -- nearly doubling the S&P 500. He also owns a whopping 20% of the shares outstanding.
In his own words, Friedman thinks it could get worse before it gets better. It's a bold strategy that could be the birth of the next great luxury brand, or a self-indulgent gambit that doesn't move the needle in terms of RH's relevance.
For now, I'm waiting to see if the approach takes hold. I'll be listening for the performance of its new galleries -- both domestic and international -- as an early indicator of success.
