Is Cubitusgate a Financial Nothingburger?

Let's get some preliminaries out of the way: I don't particularly admire or respect how Patek CEO Thierry Stern responded to criticism of Cubitus, the brand's newest release.

Three pocket watches on display during the 2017 Patek Philippe Grand Exhibition in NYC.

Here's what he said: “The haters are mostly people who have never had a Patek and never will, so that doesn’t bother me.” Does this remark seem filled with hubris and disrespect for potential buyers? Yes. Will it matter for Patek financially? I don't think so. Let me explain.

In order to understand the financial side of watch brands, we should never forget that retail buyers are not their customers (with some rare exceptions). I know that sounds crazy, but it is 5,000% true. For a brand like Patek, the primary watch market is financially mediated. There is a third party standing between brands in Switzerland and collectors. Namely, Patek sells to authorized dealers, they don't sell to collectors. Brands like Patek are, financially, reliant on business-to-business relationships. Patek is not a business-to-consumer operation. The chart below presents my view of how Patek and other AD-reliant brands operate. The watches go to an intermediary and the money comes from the intermediary in exchange. The intermediary, ie authorized dealer, is the brand's actual customer when it comes to revenue.

It can be easy to lose track of this fact because brands are business-to-consumer when it comes to information and advertising. In the chart, I show collector-targeted information coming from the brand. Because public information is non-excludable, ADs also see collector-targeted information. As I detailed in my book on Rolex, some of the most important functions handled by "brand headquarters" in Switzerland are marketing and promotion. Brands fund and design advertising for their product in markets around the world. Brands will also sometimes collaborate with local authorized dealers in advertising strategy. Patek has an account on Instagram and they promote their products there. They run a very important, and presumably expensive, "Grand Exhibition" every two years. This is a "touring" event in which historical and new products are on display for the public. Patek's own museum in Switzerland plays a similar role.

So that is the terrain for Patek (and many watch brands): information is disintermediated (the brand "speaks" directly to the public) while money is mediated through authorized dealers. In addition, Patek sends private information (covered by NDA) to authorized dealers. I show this in the chart with the arrow marked by an envelope. The key to understanding why Stern said what he said is to ask, which information channel was he using: collector or AD? The answer will probably help us understand why, financially, Stern's "hot take" might have been the right thing to say, although the jury is out on that one.

I think Stern was speaking to authorized dealers when he proferred his quote about Cubitus and haters. It, obviously, wasn't covered by NDA, so his statement was also observed by collectors (see the dashed line in the chart). Stern's interview was published in a biweekly business magazine out of Zurich, though, so he could have intended to speak to the business audience that matters most to Patek in terms of revenue. It's likely or possible that authorized dealers would see his quote there (particularly if they operate out of a German speaking market). Sure, it's also possible that collectors would see the quote (I'd say many have), but the math is: does the financial upside in terms of authorized dealer reaction exceed the financial downside in terms of negative collector reaction? Strictly speaking, Patek is removed from any financial downside because that would accrue to dealers if they keep their order book unchanged. I don't know the answer on the net financial effect from the interview, but I understand why Stern would roll the dice in order to find out.

Times are not good in the watch industry and keeping cashflow alive is key to surviving with as little pain as possible.

A photo montage of Lake Geneva from the 2017 Grand Exhibition in NYC.

Stern needs to get Cubitus on the order book with authorized dealers if he wants to make payroll in Switzerland without dipping into his own family's assets. Plain and simple. Patek authorized dealers, and their sales staff, do not typically operate in the population center of any given country (the population center is the location at the center of where people live in a country). In the United States, the population center is Hartville, Missouri, population 594. The nearest Patek dealer is 210 miles (338 km) away from Hartville. The geographic center of UK is Leicester, I believe, and that is also quite a distance from the Bond Street luxury shopping district in London (105 miles or 169km).

The point is that Stern's quote is a signal to authorized dealers that in the markets where they operate, away from population centers, and with the clientelle who buy in those markets, ADs need not worry about a negative reaction to Cubitus. He didn't use those words, but I think that was his intent. And, the whole point of this is to make sure ADs accept their Cubitus deliveries and pay Patek.

A Patek Philippe Star Caliber 2000 featuring 21 complications.

It is up to sales staff to handle any grumbling about Stern's quote (in fact, I wouldn't be surprised if "trainers" are preparing a special script for their upcoming sessions with sales personnel). Also remember that selling lesser-known Patek models isn't exactly the hardest thing for authorized dealers. They have that wait list they can wave around and remind everyone about how important it is to "build relationship" in order to access application pieces, scarce models, etc etc.

More than anything, I think this whole episode illustrates the difficulty of speaking to financial intermediaries, such as authorized dealers, when so much information is disintermediated and not covered by NDA. You may intend to send a message to sales staff, but the whole world will likely hear what you say. "Goodwill" exercises like the Grand Exhibition can help a great deal if the wrong message gets out. Memories and attention spans are short in the modern era. By the end of November and early December, when the watch industry is in the most important part of the sales season, I think a lot of people will have forgetten about this whole episode. I could be wrong. We'll find out soon enough. Update A number of readers reached out and mentioned that Patek does operate its own boutiques and is not necessarily 100% "AD" dependent. Based upon my own understanding, watch brand boutiques sometimes have silent partners who are, effectively, authorized dealers. For this reason I decided not to go into this branch of things in the main body of the post.

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