As the festive season approaches a lot around us begins to change. In London the weather becomes testing, Christmas lights spring up everywhere, and a lot more drinks get drunk. Another noticeable change is the façade of London buses. For eleven months of the year they act merely as homage to the latest Hollywood blockbusters. Not in December though. For the next few weeks all we will see are advertisements to the latest gift giving ideas. In my mind, the most prominent of these is for a company called Pandora, a Danish affordable jewellery company known primarily for the charm bracelet.
Pandora operates and manages a vertically integrated business model, which begins with in-house design and production and continues through to global marketing and direct distribution in most markets.

Product development process
Figure 1. Product development process
Source: Pandora

One of Pandora’s most important assets is their crafting facility in Gemopolis, Thailand where they have over 11,000 employees. The facility allows the company to ensure a constant supply of high-quality jewellery to the market and to scale production of different pieces up or down, depending on demand. Each piece of jewellery gets handled, on average, by 25 employees, highlighting the skilled nature of production. In 2015, Pandora produced around 100 million pieces of jewellery, and to meet future demand the company are creating a new facility in Chiang Mai, Thailand, which will be fully operational in 2017. Choosing to produce the jewellery in Thailand has had a dual advantage. Firstly, the cost of labour is a lot lower than in the developed world. Secondly, they have a long-standing tax agreement with Thai authorities that contribute massively to their depressed company-average tax level of 21%. The agreement is done on a facility-by-facility basis and agreed for 8 year periods. The Gemopolis facility has the agreement in place until 2020 and the Chiang Mai facility has the agreement until 2024. Management has commented that they would be highly confident of the agreement being extended when the current contracts expire.
Pandora’s product range is diversified but ultimately centred on the charm bracelet that first came to market in 2000. Their classic collection is called Moments and offers a selection of charms and bracelets that let women customise their wrists. Campaigns are an important part of customer retention with a partnership with Disney being the most recent example. At the end of 2015 charms and bracelets made up 76% of sales with 312 new charms added to the collection and 170 discontinued throughout the year.
In terms of other products, the Pandora strategy has changed markedly since 2012. In 2010 the belief was that product diversification was going to be central to the growth of Pandora. As such, they launched into most segments, including watches, necklaces and pendants, without being ready for that expansion. The result of this was that those segments had to be discontinued due to poor execution and the strategy changed to focus on one new product at a time. The first new product of focus was rings in 2013. The operative word here is focus insomuch as rings have been produced by Pandora for many years, however only in 2013 were they the recipient of marketing campaigns, being put prominently in shops and with staff being educated as to how to sell this particular product. As of the end of 2015 rings are over 12% of total revenues. They are currently focusing on earrings which have seen good early traction in 2016 and management have commented that they will see a likely focus on necklaces and pendants in 2018 and 2019.
The Pandora product cycle is an important facet of their business. They have seven launches each year: Spring, Mother’s Day, High Summer, Pre-Autumn, Autumn, Christmas, and Valentine’s.

Pandora product cycle
Figure 2. Pandora product cycle
Source: Pandora

This calls for constant innovation into new products. A new product is first designed around one year prior to release with the production taking place around six months later. On completion, products are transferred to relevant distribution centres in Thailand, Baltimore, Hamburg, Shanghai, Toronto and Sao Paolo, before being distributed to all points of sale. All commodities, primarily gold and silver, are hedged approximately 100%, 80%, 60% and 40% of risk for the following 1-3 months, 4-6 months, 7-9 months and 10-12 months respectively.
Pandora operates a wide-reaching distribution network with various levels of branding, size and control. Shop type is split into three categories: Concept, Shop-in-shop, and multi-brand. Concept stores are defined by being larger, selling the full spectrum of products, having fully dedicated Pandora staff and Pandora designed façades and furniture. This is compared to multi-brand stores which are smaller in size and have no dedicated staff.

Retail store categories
Figure 3. Retail store categories
Source: Pandora

For the last few years there has been a push to have a higher percentage of concept and shop-in-shop stores (i.e. branded stores) at the expense of multi-brand. The idea is that customers are more likely to return to Pandora if they have experienced the full Pandora experience. Customers that enter the bright façade of a Pandora shop and that are then educated by the Pandora staff are more likely to return. This capture of repeat business obviously boosts revenues and we have therefore seen more of a growth in branded stores and a rapid decline in multi-branded. It is expected that all smaller multi-brand stores (previously called Silver or White stores) will be closed by the end of 2017.

Growing percentage of branded stores
Figure 4. Growing percentage of branded stores
Source: SPW, Bloomberg

Pandora’s store network is also categorised by ownership, as well as store type. The three types of ownership are Pandora owned (sometimes referred to as Owned and Operated (O&O)), third-party distributed, and franchised. The best way to understand the dynamics and direction of store ownership is to look at the history of Pandora’s growth. Pre-IPO in 2010 the company was essentially a distribution business borne out the private equity fund that owned them consolidating the business by buying local distributors in 2008. As such, the distribution network that Pandora has is very much a legacy position that they are working back from. In these third-party distributor markets, Pandora has no control of the network. They merely ship the products to the appropriate distributor. In recent years they have taken back control of Turkey, the Netherlands, China, Japan, Singapore and many more. The largest remaining are in Russia and Spain with the end goal being to have no third party distributors in their network.
A natural follow on from this is that the company is growing the amount of O&O stores as their third-party network reduces in size. There are pros and cons to owning your own stores but the company believe that the benefits far outweigh the drawbacks. The two primary benefits are that 1) the company receives the full revenue gain from that store and 2) they have total control of customer experience. This second point is important for similar reasons as to why Pandora wants more concept stores, i.e. they believe that a customer who is exposed to the full Pandora experience is more likely to be a returning customer. However, there are drawbacks. Firstly, there are higher costs associated with owning stores. These costs include being more capital intensive and having more risk on the books. Secondly, there may be some markets that franchisees are better at running the stores than Pandora. This may be due to better local knowledge or simply because the market is not mature enough for it to be worth their while owning a store there. The current percentage of revenue generated from O&O stores is 32%. Management want this to be more like 50% in the median term.
Lastly we have the franchisees. Pandora ships the products to these stores from Thailand and sells them to the franchisees. The mark-up that gets put on top of each product is between 2 and 2.5 times. This avenue of distribution provides Pandora with fairly risk-free / cost-free revenue generation. However, this comes with little to no control of the Pandora customer experience. However, given the cost / revenue dynamics of the franchise business model, Pandora still sees them as an important part of the business moving forward.
Market Size
According to Euromonitor, the size of the total jewellery market is $282 billion and will grow at a 7% CAGR through to 2020. Of course, the company is positioned in the affordable segment (most items priced between $25 and $150) and will therefore not compete in the whole of this market but this gives a good upper bound to think about. Pandora’s 2015 revenues were $2.5 billion.

Jewellery market CAGR estimates, 2005 - 2020
Figure 5. Jewellery market CAGR estimates, 2005 – 2020
Source: Euromonitor Research

Euromonitor also broke down the current jewellery market by country and category. It is clear that China, the US and India are the three most important jewellery markets in the world. China was initially a distribution market for Pandora but this has been changed by the company in recent years. They now have over 50 concept store and are certainly a growth engine for Pandora.
In terms of product Pandora are well established in the wrist wear segment and have either expanded, or have plans to expand, into the other three largest segments: rings, earrings and neckwear. Rings clearly provide the greatest opportunity and it is encouraging to see Pandora’s growth here since focusing on the segment in 2013.
 
Largest Jewellery Markets (USDm)
Figure 6. Largest Jewellery Markets (USDm)
Source: Euromonitor Research

Competition or lack thereof

One of Pandora’s greatest advantages is their lack of global competition in the affordable jewellery segment in which they operate. Pandora namechecked Swarovski as the only other global player operating in similar segments as themselves. However, even this is slightly questionable. Swarovski specialise in cut lead glass and produce glass sculptures, home décor, chandeliers and jewellery. The jewellery they produce is similar in price at the lower end to Pandora but they have a larger selection of higher ticket items. There is also a divergence in the scale of Swarovski compared to Pandora. Whereas Pandora have around 9000 points of sale, Swarovski only have 1000, with the vast majority not being owned by the company. Unfortunately, given that Swarovski are not listed, it is difficult to do a full financial comparison between the two companies. However, we believe it is safe to conclude that the market is easily large enough to accommodate them both.
Pandora’s main other competitors are smaller players in individual markets. Those specialising in charms include Trollbeads, Chamilia, Links of London and Thomas Sabo, but they are in a completely different league when it comes to scale. And this really is the salient point: through their size, Pandora has advantages that others cannot enjoy. These advantages are:

  • A store network of almost 9000 points of sale, significantly larger than any of the local players. This gives them unrivalled reach to the customer.
  • A brand awareness score of 73% (a number compiled by a third party, asking the question, “Do you know a brand called Pandora?”), whereas the local players have a score of around 10%. For comparison, even though they are operating in the differentiated higher end of the jewellery market, Tiffany has a brand awareness score of 71%.
  • A production facility in Thailand that can produce 100 million pieces of jewellery per year, the largest in the world. To put this into some perspective, Pandora often produces 500,000 of each piece. A local player will make around 1000. This means that they can offer more competitive pricing. Furthermore this advantage looks set to be pressed further home with the addition of a second production facility in Thailand.

Product Diversification
The cornerstone product of Pandora is the collectible charm bracelet for which the company is by far the global market leader. Most successful luxury brands have a key iconic product (see the table below). Charms and bracelets contributed 75% of the group’s total Q3 2016 revenues.

Brands and Iconic Products
Figure 7. Brands and Iconic Products
Source: JP Morgan

On top of this product diversification we are positive about the company’s central positioning in charms. To some degree charms embed a natural annuity. They are both collectible and repeat purchase products with there being the potential to have 25 beads per bracelet. As such, when a bracelet is purchased there are a certain amount of future sales that will follow on naturally from this – management believe it takes around 2 years for a customer to complete their charm bracelet. Of course, what becomes important then is for the offering that Pandora produces to remain broad and refreshed. This is clearly something that is front of mind for Pandora and the 312 new charms produced in 2015, along with partnerships with the likes of Disney, are testament to this outlook.
Shareholder Friendly
Pandora has been proactive with returning cash to shareholders. In both 2015 and 2016 they have brought back around DKK 4 billion worth of their own shares and we expect this to continue. In 2015 this corresponded to just fewer than 5.5 million shares at an average price of DKK 723.8. They also employ a progressive dividend policy where the board aim is to increase the nominal amount of dividend per share annually. In 2015 the dividend was increased to DKK 13 per share, a 44% increase on the previous year.

Pandora Dividend per Share (DKK)
Figure 8. Pandora Dividend per Share (DKK)
Source: SPW, Bloomberg