The Deloitte Swiss Watch Industry StudyTiming the future

November 2012

The Deloitte Swiss Watch Industry Study Timing the future 1

Contents

Foreword 2

Key features of the Swiss watch industry 4

Industry outlook 8

• Continued optimism despite economic uncertainty

• Asia still dominates growth expectations

Challenges and risks 10

• External risks dominate

• Exchange rate risks a major concern

• Labour and supply side concerns

Business strategies 14

• New products to drive the market

• Verticalisation a growing trend

• Social media getting popular

Contacts 17

About the Deloitte Watch Industry StudyThe Deloitte Swiss Watch Industry Study 2012 is based on personal interviews with executives and an online survey. The personal interviews were conducted from June to September 2012. The online survey was conducted in September 2012. A total of 50 watch executives participated. Some 52 per cent of participants work for component manufacturers, 30 per cent for a brand and 18 per cent for companies across the value chain. Two thirds of participant’s companies sell watches at a retail price of over CHF 5,000, one third below.

Deloitte in SwitzerlandDeloitte is a leading accounting and consulting company in Switzerland and provides industry-specifi c services in the areas of audit, tax, consulting and corporate fi nance. With approximately 1,100 employees at six locations in Basel, Berne, Geneva, Lausanne, Lugano and Zurich (headquarters) Deloitte serves companies and institutions of all legal forms and sizes in all industry sectors. Deloitte AG is a subsidiary of Deloitte LLP, the UK member fi rm of Deloitte Touche Tohmatsu Limited (DTTL). DTTL member fi rms comprise of approximately 200,000 employees in more than 150 countries around the world.

2

ForewordThe Deloitte Swiss Watch Industry Study 2012

Welcome to the fi rst Deloitte Swiss Watch Industry Study. It focuses on industry trends, risks and opportunities, and also examines future strategies. The study is based on personal interviews and an online survey with 50 senior industry executives.

The Swiss watch industry has recently enjoyed extraordinary success. Exports hit a record CHF19.3 billon in 2011 and a monthly record of CHF1.97 billion in July 2012, despite the impact of a rising Swiss franc.

However, there are signs the outlook may be weakening. Export volumes plateaued in recent months, leaving rising prices and stronger demand for high-end watches as the primary drivers of growth. In September 2012 the value of Swiss exports declined for the fi rst time in 30 months, down by 2.7% compared to the previous year.

The industry faces the risk that if growth in key export markets slows, fl at volumes may become entrenched, raising questions over how well the industry is prepared for a potential slowdown.

The biggest potential risk in the medium term may be the global economic outlook. In the United States, a sclerotic recovery shows little sign of imminent improvement. Consensus forecasts put economic growth at 2.1 per cent in 2012 and 1.9 per cent in 2013. Europe is still in the grip of the sovereign debt crisis, causing economic uncertainty and rising taxes. Consensus forecasts see the eurozone in recession in 2012 (-0.5 per cent) and growing only 0.1 per cent in 2013.

Among global markets, one country in particular has fi red the engines of demand: China. Averaging a growth rate of 10.2 per cent since 2000, China has emerged as one of the biggest consumer markets, with an insatiable appetite for prestigious and expensive brands. It has become by far the most important export market for Swiss watches, accounting for about a third of exports.

While Chinese economic growth is expected to slow this year to around 7.8 per cent, the consensus forecast is for 8.6 per cent growth for 2013. However, downside risks persist. Can China avoid the middle income trap seen previously in other fast-growing markets? Given these concerns it is hardly surprising that China is seen not only as an opportunity, but also as a risk to the future growth of the Swiss watch industry.

The rising importance of the Chinese market prompts two further observations. First, the market has not been exploited to the fullest extent. Many Swiss watch brands are only just beginning to expand beyond the entry points of Hong Kong, Shanghai and Beijing. Second, demand from other developing markets is also growing and will represent a signifi cant opportunity in future.

Overall sentiment among watch executives remains fairly positive, despite the concern over the economic outlook in the industry’s main export markets.

The appreciation of the Swiss franc also presents a challenge. A Switzerland-based industry like watchmaking cannot escape the impact of an appreciating currency, and a large majority of respondents see a strong franc hurting margins. On the other hand, many component manufacturers sell in the Swiss market, and big brands are often powerful enough to share exchange rate risks with distributors and consumers. Therefore the extent to which a company is impacted by the strong franc depends therefore on its products, customers and brand power.

While the Swiss watch industry has demonstrated remarkable resistance to exchange rate pressure, there is a limit. Watch executives view EUR/CHF 1.20 and USD/CHF 0.90 as decisive thresholds for currency appreciation, beyond which problems would mount.

With the industry growing strongly, supply side risks deserve special attention. Of particular concern is a shortage of skilled labour. More than half of watch companies are experiencing recruitment diffi culties, according to employment statistics (JOBSTAT) from the Swiss Statistical Offi ce. More than a third of survey respondents plan to increase staff in Switzerland over the next year, and only 11 per cent plan to cut.

The Deloitte Swiss Watch Industry Study Timing the future 3

Another supply side risk is the availability of third-party parts and movements, which can be infl uenced by government or regulatory decisions (such as the COMCO ruling allowing the Swatch Group to reduce output, or “Swiss Made” legislation aimed at protecting the Swiss brand). The COMCO decision gets a mixed reception in our survey, while the “Swiss Made” legislation is widely supported.

Swiss watches have in recent years made the transition from simply being high quality timekeepers to desirable fashion accessories. As a result the importance of marketing and sales strategies (and corresponding risks) have become more important. While optimising sales channels is a priority for survey respondents, many also recognise the increasing potential of social media. Several executives indicated plans for online distribution through e-boutiques. The big sales trend of recent years – mono-brand stores – is still going strong, with new openings planned around the world.

Though times are tough, the range and depth of business strategies remain formidable. The Swiss watch industry has managed the ups and downs of fate and fortune for more than 400 years and shows every sign of continuing to do so.

I wish you an interesting read and welcome your feedback and comments.

Howard da SilvaConsumer Business Leader

The Deloitte Swiss Watch Industry Study Timing the future 3

Chart 9. ... rising exports ...

Swiss finished watch exports by value and volume

0

5

10

15

20

25

30

Jan-Aug2012

Jan-Aug2011

20112010200920082007200620052004

Exports by value (CHF bn)

Exports by volume (million pieces)

Round the clock – 12 key features of Record sales interspersed by crises, such as the technological challenge of quartz watches in the 1970s and the fi nancial crisis of 2008/09. Success, crisis, success; the development of the Swiss watch industry might resemble the regular tick-tock of its product – only with more “success-ticks” than “crisis-tocks”.

From one to twelve, in clockwise direction, the key features of the Swiss watch industry and its success.

Chart 11. ... sold to the world ...

Export destinations

China/Hong Kong30%

US10%

France7%Singapore

6%

Italy5%

Japan5%

Germany5%

UAE4%

UK3%

South Korea2%

Other countries24%

201120102009200820072006

Chart 7. ... highly valuable ...

Average price of an exported Swiss watch in CHF

512

571608

569 580608

Food industry

Paper products, publishing

Rubber and plastics products

Metal products

Electrical andoptical equipment

Machinery and equipment

Transport equipment

Watch industry

Chemical industry

Textile products

Chart 8. ... high export orientation ...

Export share of production in %, including re-exports

104

102

95

91

83

67

54

53

26

21

Chart 10. ... outperforming many other Swiss exports...

Sector comparisons of export performance

0 20 40 60 80 100 120

Watch industry

Precision instruments, jewellery

Chemical industry

Food, beverages and tobacco

Total Swiss exports

Metal industry

Machine and electronic industry

Leather, plastics

Motor verhicles

Textiles and clothing

Paper and graphic industry

Index 2008 = 100

0

5

10

15

20

25

Chart 12. ... from the leading watch export nation (by value)

Leading export nations in terms of volume and value

Export value in billion USD

Export units in million

0 100 200 300 400 500 600 700 800

Switzerland

Hong KongGermany

FranceChina

4

Chart 6. ... preferences for movements...

Share of mechanical watches in the Swiss watch industry exports

40%

45%

50%

55%

60%

65%

70%

75%

80%

2012

2011

2010

2009

2008

2007

2006

2005

2004

2003

2002

2001

2000

10%

12%

14%

16%

18%

20%

22%

24%

26%

Share of mechanical watches as a % of total exports (value)

Share of mechanical watches as a % of total exports (volume)

Value Volume

20,000

30,000

40,000

50,000

60,000

2011

2009

2007

2005

2003

2001

1999

1997

1995

1993

1991

1989

1987

1985

1983

1981

Chart 1. Built by a few ...

Number of employees in Switzerland

0

100

200

300

400

500

600

700

800

900

1,000

2011

2009

2007

2005

2003

2001

1999

1997

1995

1993

1991

1989

1987

1985

1983

1981

Chart 2. ... growing, vertically-integrating companies ...

Number of companies and number of employees per company

0

10

20

30

40

50

60

70

80

90

100

Companies (left hand scale)

Employees per company (right hand scale)

Chart 3. ... geographically concentrated ...

Location of employees and companies, % of total

NeuchâtelBernGeneva

SolothurnJuraVaud

TicinoOthers

31%

28%

20%

24%11%

17%

7%5%

15%10%

9%

6%3%

5%

5%4%

CompaniesEmployees

Chart 5. ... suiting all tastes in materials...

Material distribution of Swiss watches by value and volume, % of total

SteelPrecious metalsGold-steel

Other metalsOther materials

39%

5%2%

52%

2%

4%

16%

26%

37%

17%

UnitsValue

Paper and graphic industry

Metal industry

Leather, plastics

All Swiss exports

Chemical industry

Machine and electronicindustry

Precision instruments

Medical technology

Watch industry

Chart 4. ... high quality ...

Unit value (CHF / kg) 2011

10,096

480

270

43

40

12

7

5

1

the Swiss watch industry

Sources: Federation of the Swiss Watch Industry, Swiss Customs Offi ce, Convention patronale de l’industrie horlogère suisse (CP), Swiss Federal Statistical Offi ce, OECD

The Deloitte Swiss Watch Industry Study Timing the future 5

Chart 1. Built by a few … After reaching a maximum 90,000 in the 1950s and a minimum 30,000 in 1987, employment in the Swiss watch industry has risen again in recent years. However, at around 53,000 in 2011 it remains a relatively small sector, accounting for around 1 per cent of the Swiss work force. Watch companies fi nd it diffi cult to fi nd skilled employees. To alleviate staff shortages, they are increasingly training internally.

Chart 2. … growing, vertically-integrating companies … The number of companies in the watch sector has fallen over the past few decades, resulting in a rise in the average number of employees per company. Still, 20 per cent of companies have four employees or less, while 60 per cent employ more than 5 and less than 100 people. Some 78 per cent of employees in the sector work for companies with more than 100 employees. A major trend is the verticalisation of the industry, with brands acquiring suppliers (details on page 15).

Chart 3. … geographically concentrated …The fi rst Swiss watch companies were founded in Geneva in the 16th century, and expansion to the neighbouring Jura mountain area and Canton du Vaud (Valée de Joux) began 100 years later. Today Neuchatel has the highest number of watch companies and employees; about a third of the total, Bern and Geneva are second and third.

Round the clock – 12 key features – explanatory text to the charts

Chart 4. … high quality …Swiss watches are a synonym for quality, and their reputation is supported by statistics. One measure is value divided by weight, the so called unit value – the idea being that more processing leads to higher quality. By this measure the watch industry comes out top among Swiss export goods. Quality and reputation for quality (and thus brand value) increase price setting ability. Tradition, quality and brand value are major differentiators.

Chart 5. … suiting all tastes in materials … As a fashion accessory watches must suit many tastes, and Swiss watches are made from a wide range of materials. By volume, steel dominates, with non-metallic materials second. Not surprisingly, when measured by value precious metals are more important. Gold watches registered above-average growth in 2011 (27 per cent), as did watches made from both gold and steel (25 per cent), resulting in the average value of Swiss watches rising. This trend continued over the fi rst eight months of 2012.

Chart 6. … preferences for movements … Technological innovation has allowed mechanical watches to stage a comeback, after the challenge of quartz watches in the 1970s. Mechanical watches dominate production by value, accounting for about 75 per cent (but only 20 per cent by volume). Mechanical watches have gradually increased their share of total exports over the past 10 years. In 2011 mechanical watch sales grew faster than quartz in terms of value (20.8 per cent) and volume (24.5 per cent). That trend continued over the fi rst half of 2012 and is likely to persist in the coming years. As mechanical watches are usually more expensive than quartz watches, their rising share of exports has contributed to rising export values.

6

Chart 7. … highly valuable … While Swiss watches can be found in most price segments, a large part constitutes luxury watches. The average value of Swiss watches has risen by nearly 20 per cent since 2006, refl ecting the higher value of materials used, increased proportion of mechanical movements and the price setting ability of the industry. Upward price pressure has also been exerted by the strengthening Swiss franc.

Chart 8. … high export orientation … Approximately 95 per cent of Swiss watch production is exported. Offi cial export statistics capture commercial exports, not purchases by foreign private visitors in Switzerland, and a proportion of the remaining 5 per cent is likely also to be exported.

Chart 9. … rising exports … Swiss watch exports have risen fast in recent years, reaching CHF19.3 billion in 2011 (up 19.4 per cent year-on-year), of which CHF18.1 billion were fi nished watches. Over the past fi ve years they grew by 8.5 per cent on average and twice as much when excluding the steep fall in 2009 (-22.2 per cent). The fi rst eight months of 2012 saw a 16.5 per cent rise in export value. However, the volume increase in this period was just 0.4 per cent, suggesting the fi rst signs of a slowdown, particularly in steel watches. Growth in value was driven by watches costing more than CHF 3,000 and particularly gold and platinum watches, which saw growth in export value and volume. In a challenging economic environment, the short term outlook for watch exports remains uncertain.

Chart 10. … outperforming many other Swiss exports … Excellent growth over the past few years has resulted in Swiss watch exports signifi cantly outperforming total exports. Against an average yearly growth rate in watches of 8.5 per cent, total exports grew 2.6 per cent on average. The 2011 fi gures were 19.4 per cent and 2.1 per cent respectively. Watch exports in 2011

surpassed their 2008 level, while total exports lagged.

Chart 11. … sold to the world … The excellent performance of watch exports was driven by broad geographical diversifi cation, but in particular high demand from Asia. While about 60 per cent of overall Swiss exports go to the EU, only about 30 per cent of watch exports are to Europe. About 30 per cent of watch exports are shipped to China and Hong Kong, against less than 8 per cent of overall exports. Watch makers are optimally placed to profi t from wealth creation in developing economies.

Chart 12. … from the leading watch export nation (by value)The biggest worldwide watch exporter by volume is China, shipping 682 million units in 2011 (export numbers in this section include re-exports). In second place is Hong Kong, adding another 403 million units. Hong Kong is less of a direct competitor to Switzerland, however, since it functions mainly as a distribution hub for re-exports. In third place was Switzerland, at close to 30 million units. However, the ranking order reverses when measured in value terms. Here Switzerland exports about twice as much as second-placed Hong Kong (USD 22 bn. versus USD 9 bn. in 2011), which again exports twice as much as third-placed China (USD 4 bn.). Export growth in the two leading countries moved almost in lockstep in 2011 (19.4 per cent in Switzerland versus 19.5 per cent in HK). China’s export growth was 15.5 per cent in 2011.

The Deloitte Swiss Watch Industry Study Timing the future 7

Industry outlookContinued optimism despite economic uncertainty

Swiss watch company executives remain fairly optimistic despite global economic uncertainties and mediocre growth outlooks in many countries, including Switzerland. Optimism is most pronounced in respect of their own industry. A net balance of 31 per cent is optimistic for the next 12 months, although they are slightly less optimistic for the Swiss economy and the watch industry’s exports markets. Worries about a possible growth slowdown in the watch industry’s main export markets is a persistent worry.

The watch industry has outperformed during the crisis, posting record fi gures in 2011, as new orders rose. Exports by volume reached a plateau in the fi rst eight months of 2012 (Chart 9), and the short-term outlook is uncertain.

The Swiss watch industry has a strong competitive advantage, particularly in the mid- and high-end price segments. Watch executives see more competition in the low-end price segment, where some 81 per cent said competition is a large or medium threat, compared with 30 per cent in the mid- and high-end price segments. Respondents are unanimous in saying the international promotion and protection of the “Swiss Made” label by Swiss luxury watch companies and the Federation of the Swiss Watch Industry is essential in maintaining Switzerland’s position in the luxury watch market.

Chart 13. Outlook for Swiss economy, export markets and the Swiss watch industryHow do you judge the outlook for the next 12 months for the …

Negative Net balancePositive

Swiss Economy

44%

-27%

Export markets ofSwiss watch industry

41%

-27%

Swiss watch industry

49%

-18%

17%14%

31%

Chart 14. Strongly outgrowing the crisis

Production, revenues and new orders, quarterly index Q1 1995 =100

0

50

100

150

200

250

300

350

Q12008

Q22008

Q32008

Q42008

Q12009

Q22009

Q32009

Q42009

Q12010

Q22010

Q32010

Q42010

Q12011

Q22011

Q32011

Q42011

Source: Swiss Federal Statistical Office(New statistics from 2012 onwards do not show watch industry separately)

Production New orders Revenues

0

20

40

60

80

100

Above 1,000 CHFBelow 1,000 CHF

Chart 15. Competitive situation

How would you rate the threat of foreign competition to Swiss made products below CHF 1,000 (low-end price segment) / above CHF 1,000 (mid-range and high-end segment)?

32%15%

15%

57%

13%

49%

17%2%

Small threat Medium threat Large threatNo threat

8

Industry outlookAsia still dominates growth expectations

Asia has been a particularly fast-growing market in the recent period, and US markets are increasingly important. Survey participants expect these two regions to retain their importance over the next 12 months, with 58 percent expecting the strongest growth in Asia. While China / Hong Kong are the dominant Asian markets, Singapore, Japan and South Korea are in the top-10. The United States started recovering in 2011 and 2012. Germany and France remain the two biggest European markets. Italy, which was previously a strong European market, has not shown signs of recovery and is likely to underperform in the short term.

The economic environment has grown more challenging. In two of the top-10 markets (the United States and Japan) a GDP-growth slowdown is expected in 2013. In Italy a recession is forecast. For the others growth acceleration is expected, including the most important market, China.

However downside risks persist. The risk of growth slowdown in exports markets is a persistent theme in the interviews we conducted, as is also evident from Charts 13 and 18.

A major reversal of recent growth patterns seems unlikely, and GDP growth in China is predicted to stay above 7.5 per cent. But demand risks are clearly higher than before. China, because of its high market share in premium watches, is seen as a potential growth risk.

13%

58%

Europe

Asia

Americas

Chart 16. Asia most important growth region

From which geographical region do you expect the strongest growth in sales in the next 12 months? Answers only from brands

9%

Africa and Oceania 0%

Chart 17. GDP growth outlook of top-10 foreign markets of the Swiss watch industry

China/HK GDP growth is given as mainland China figures only Share of Swiss watchexports 2011

Source: Swiss Customs Office, The Economist, Economist Intelligence Unit, as of October 2012

South Korea

UK

United Arab Emirates

Germany

Japan

Italy

Singapore

France

US

China/HK

GDP forecast 2012 GDP forecast 2013

30%

10%

7%

6%

5%

5%

5%

4%

3%

2%

7.8%8.6%

2.1%1.9%

0.1%0.4%

2.4%4.0%

2.2%2.1%

0.8%0.9%

3.0%3.5%

2.7%3.7%

1.1%

-2.4%-0.7%

-0.2%

The Deloitte Swiss Watch Industry Study Timing the future 9

64%

68%

32%32%

14%18%

14%

5%9%

0%

0%

*

*18%

18%

14%

5%5%

5%9%

5%5%

27%

14%

36%

45%32%

59%

64%

82%

Rising prices for parts and movements from third-party manufacturers

Insufficient supply of parts and movements from third-party manufacturers

Counterfeiting/theft/fraud

Corruption

Rising labour costs

Insufficient supply of gold

Insufficient inhouse production capacity to meet demand

Insufficient supply of other raw materials

Weaker domestic demand

Rising prices for other raw materials

Rising gold price

Shortage of qualified labour

Strength of the Swiss franc

Weaker foreign demand

Chart 18. External risks dominate

Which of the following factors are likely to pose a significant risk to your businessover the next 12 months (multiple answers possible)?

Component manufacturers

* Answers from brands only

Brands

Chart 19. Swiss franc: Stable at a high level

EUR/CHF exchange rate and exchange rate volatility

1.0

1.1

1.2

1.3

1.4

1.5

1.6

1.7

CHF

%

0

5

10

15

20

25SNB interventionsince 06.09.2011

20122011201020092008

EUR/CHF exchange rate, left hand scale

Source: Thomson Reuters Datastream (as of 28.09.2012)

EUR/CHF 3m volatility, right hand scale

10

Challenges and risksExternal risks dominate

The most signifi cant risks for the Swiss watch industry over the next 12 months are seen as weaker foreign demand and the strength of the Swiss franc. External risks are of most concern for brands, but they also rank highly for component manufacturers.

A shortage of qualifi ed labour is a risk for components manufacturers who are concerned about vertical integration.

Also mentioned are supply side risks such as rising gold and raw material prices, insuffi cient supply and/or high prices of third-party parts or movements. In an industry with high growth rates over the past few years, the management of the supply chain to accommodate rising volumes is an important factor. The increase in demand for watches has led to bottlenecks in movements and other strategic components, and the further vertical integration of large brands and authorisation granted by the competition watchdog to the Swatch Group to reduce supply represent increasing external risks to smaller brands.

The strengthening of the Swiss franc has been one of the biggest challenges for Swiss exporters in recent years, with the biggest impacts felt during the period of extraordinary volatility before the introduction of the exchange rate fl oor against the euro in September 2011. The appreciation of the Swiss franc against the euro has been most pronounced, but the Swiss franc also appreciated markedly against the US dollar.

The “Swiss Made” label is a crucial differentiator of the Swiss watch industry, and means production must be concentrated in Switzerland. That gives the industry less room to offset a strengthening Swiss franc by moving costs abroad. It must therefore rely to a large degree on its strong brand and price setting ability. This can manifest itself in rising retail prices. It can also be seen in relationships with distributors, who may be prepared to take some exchange rate risk. Some Swiss watch exports are billed in Swiss francs. However, this is not always possible and often depends on the value of a particular brand.

Challenges and risksExchange rate risks a major concern

Asked about the impact of the strong Swiss franc on margins over the past 12 months, 62 per cent of respondents say it was negative. These were mainly small brands less able to pass on the exchange rate impact to their distributors and clients, who are also sourcing parts from Asia or other countries. Only one respondent states the impact is positive. About one third say it has no infl uence, refl ecting suppliers who sell to the Swiss market or top-tier brands which can bill in Swiss francs.

The negative impact could worsen if the Swiss franc/euro exchange rate fl oor is abandoned. Some 7 per cent of respondents felt the exchange rate impact at EUR/CHF 1.40, and another 20 per cent felt it at EUR/CHF 1.30. That means 27 per cent feel pressure at current levels. The most important barrier is EUR/CHF 1.20, the current exchange rate fl oor. The majority of our survey respondents see major problems below that level. Just 7 per cent consider major problems would only start if the exchange rate falls below parity to the euro.

With regard to the US dollar, a majority of respondents see serious problems for the industry from an exchange rate of USD/CHF 0.90 upwards.

As the export numbers show, the watch industry has proven to be relatively resilient, not least because of its brand power and ability to shift exchange rate risk to distributors and consumers. But should the Swiss franc appreciate further, this ability is likely to decrease. Executives are aware that neither the resilience of producers and distributors nor the spending power of consumers are limitless.

Chart 22. ... and below USD/CHF 0.90

From which level do you consider the USD/CHF exchange rate to be a major problem for the Swiss watch industry?

0.70 and below 0.80 0.90 1.00 1.10

2%

19%

40%

28%

12%

Chart 21. Major problems would start below the exchange rate floor of EUR/CHF 1.20 ...

From which level do you consider the EUR/CHF exchange rate to be a major problem for the Swiss watch industry?

1.401.301.201.101.00 and below

7%

30%

36%

20%

7%

Chart 20. Strong Swiss franc hurts margins

How would you judge the impact of the strong Swiss franc on your operating margins in the last12 months?

PositiveNeither positive nor negative

Rather negativeVery negative

2%

40%

22%

36%

The Deloitte Swiss Watch Industry Study Timing the future 11

Chart 23. Recruiting to continue

Do you plan to change the number of Swiss-based staff/staff based outside of Switzerland in the next 12 months?

35%

-11%

18%

-5%

Increase Decrease

Switzerland Abroad

Chart 24. Controversial COMCO decision

How do you judge the decision of the COMCO to allow the Swatch Group to reduce the provision of movements and parts to third parties?

NegativeNeither positive nor negativePositive

30%

74%

26%

17%

43%

9%

Brands Component manufacturers

12

Challenges and risksLabour and supply side concerns

With the industry growing fast, supply side risks deserve special attention. Of particular concern is the shortage of skilled labour, as shown in Chart 18. More than half of watch companies are experiencing recruitment diffi culties, according to employment statistics (JOBSTAT) of the Swiss Statistical Offi ce. Unsurprisingly, watch companies are looking to recruit, with more than a third of survey respondents planning to increase staff in Switzerland over the next year, and only 11 per cent planning to cut staff. Numbers abroad are lower, but still positive. With the recent construction of new factories by large brands/groups and the planned construction of numerous new sites in the Geneva area, the need for qualifi ed labour is likely to increase further in the short term.

Another concern is the availability of third party parts and movements. Availability gets a mixed rating, with slightly more respondents rating it as a high risk than low. Availability is seen as highly impacted by government and regulatory intervention.

One such intervention, the decision of the Swiss competition watchdog (COMCO) to allow the Swatch group to restrict supply of movements and parts, could increase supply concerns. Correspondingly that decision is differently rated by brands and component manufacturers. About a third of brand respondents and more than 70 per cent of suppliers rate that decision as positive. Watch brands may fi nd other suppliers or establish their own production capacity. The COMCO decision is likely to increase vertical integration.

For small brands that cannot build production capacity, especially in the low to mid-range, a switch to other suppliers may be a problem due to cost, supply and reliability issues.

The Deloitte Swiss Watch Industry Study Timing the future 13

Consumers might value a “manufactured” movement more than a generic ETA (or other standard movement), so there may be benefi ts in replacing generic movements with in-house “manufactured” movements, although that requires high levels of R&D and human resource investment, as well as time. The main objectives of brands that can afford to develop “manufactured” movements are better differentiation versus competition, a rise in legitimacy and greater independence. Slightly less than 50 per cent of respondents state they believe consumers would pay a premium of more than 25 per cent for “manufactured” movements.

The vast majority of respondents state that higher standards for the “Swiss Made” label would be benefi cial for the Swiss watch industry. The “Swiss Made” label is a valuable brand for Swiss producers in general, but especially for watch producers. Executives surveyed state that they expect higher “Swiss Made” standards to increase supply problems in third party parts and movements. However, the fact that higher standards are overwhelmingly supported indicates that the brand value of the “Swiss Made “label outweighs the disadvantages of a worsening supply situation.

78%

11%

Beneficial

Neutral

Detrimental

Chart 25. Industry overwhelmingly supports Swiss Made legislation

To what extend will the proposed increase in the thresholds to obtain the Swiss Made designation be beneficial for the Swiss watch industry?

11%

0 10 20 30 40 50 60 70 80

Expanding by acquisition abroad

Increasing production capacity abroad

Expanding acquisition in Switzerland

Reducing currency exposure

Increasing capital expenditure

Increasing production capacity in Switzerland

Organic growth

Expanding into new markets

Stronger focus on Research & Development

Reducing costs

Increasing cash flow

Introducing new products

Chart 26. Business strategies

To what extent is each of the following business strategies likely to be a priority for your business over the next 12 months? (multiple answers possible)

83%

78%

74%

66%

62%

61%

61%

53%

41%

21%

10%

3%

Chart 27. Focus on design and complications

In what area will you place the most important focus regarding product development in the next 12 months? Answers only from brands

OtherMovementsMaterialsComplicationsDesign

36%

32%

18%

9%

5%

Chart 28. Strongest material growth in gold

In which material did you see the strongest growth in the last 12 months?

OtherPlatinumSteel-goldCeramicSteelGold

44%

23%

15%

8%5%5%

Business strategiesNew products to drive the market

Defensive strategies such as looking to increase cash fl ow or reduce costs are high on the agenda. The most important business strategy, however, is introducing new products. Some 83 per cent state this is a priority over the next 12 months, in conjunction with a focus on design, materials and complications. Recent years have seen a growing trend toward introducing new products more frequently, mainly due to changes in the consumers’ tastes but also to the growing trend of limited editions.

Other areas of focus include increasing production capacity in Switzerland and more R&D. The former is likely to be motivated by production bottlenecks seen in the recent growth periods and the proposed increase in the “Swiss Made” threshold. The latter is a result of the introduction of new materials and the need for companies to develop in-house movements for better differentiation of products.

The biggest focus in respect of product development is on design, followed by complications. Despite the continuing importance of technical excellence, the mechanics of a watch are not suffi cient to guarantee success. Watches, especially higher priced ones, are luxury accessories, and design is a key element.

In terms of materials, most respondents saw strongest growth over the past 12 months in gold watches, followed by steel. Ceramic watches also became an important growth area. The strong growth in gold watches over the past year is in line with export statistics and is one of the primary contributors to export growth by value (versus volume).

14

The Deloitte Swiss Watch Industry Study Timing the future 15

Business strategiesVerticalisation a growing trend

The growth cycle in 2004-2008 led to a number of acquisitions of suppliers by large groups and brands, with the objective of securing production capacity to reduce bottlenecks in movements and other strategic components. These acquisitions were also aimed at securing skilled labour and know-how.

The post-crisis recovery was particularly vigorous in 2010 and 2011 as brands ramped up inventories that had been reduced during the slowdown and met growing demand in Asia and developed markets. To alleviate sourcing problems (in production and skilled labour), large groups and brands have focused on vertical integration, and the years 2011 and 2012 saw 13 acquisitions so far. Executives expect this trend to continue. Almost two thirds of respondents expect M&A levels to rise in the next 12 months, with about one third expecting them to remain stable.

Asked about the type of acquisitions expected, many believe the focus will be on supplier acquisitions. Increased verticalisation is having a profound impact on the industry, not least on suppliers. In a separate question two thirds of respondents say they expect the formation of large supplier groups.

Some 48 per cent of respondents say acquisition of suppliers by suppliers is the most likely outcome going forward.

The supplier market remains fragmented and most are small companies with low investment capacity, making them vulnerable to downturns. These characteristics led to the formation of a number of supplier groups in the past decade and this trend is likely to be reinvigorated by the vertical integration of brands.

Some 70 per cent of component manufacturers and 61 per cent of brands say increased verticalisation is a threat to the supplier market.

As many larger producers are acquired by brands, it leaves the remaining suppliers more dependent on smaller brands, which have lower production volumes and are often less resilient to downturns.

64%

34%

Increase

No change

Decrease

Chart 29. M&A activity set to continue, ...

How do you expect levels of M&A activity in your industry to change over the next 12 months?

2%

Chart 30. ... leading to vertical integration

In your view, which type of acquisitions are most likely to happen? (please choose up to 3)

Brandsacquiringbrands

Brandsacquiringsuppliers

Suppliersacquiring

other suppliers

Suppliersacquiringbrands

Acquisition ofcompany outsidewatch industry

Financialacquisition

14%

25%

98%

41%

2%

48%

Chart 31. Implications for suppliers’ market

How do you rate the effect of the increasing verticalisation of large brands/groups on the suppliers' market?

Threat Neutral Opportunity

22%26%

70%

61%

4%

17%

Brands Component manufacturers

16

Business strategiesSocial media getting popular

The dominant sales and marketing strategy over the next 12 months is likely to be optimisation of sales channels, which has been a consistent theme over many years. However respondents also say social media is a priority. Product placement and the use of brand ambassadors also score highly. Brand association is regarded as important in the consumer decision-making process. The globalisation of social media provides an opportunity for Swiss watch companies to monitor and infl uence international “chatter” about their products.

Some 76 per cent of respondents say authorised dealers will be their primary distribution channel over the next 12 months. But mono-brand stores are identifi ed as increasingly important, with almost a fi fth of respondents stating they want to put most emphasis on this channel. This confi rms the trend seen in the past few years and which is still strong. The main advantages of mono-brand stores are better inventory control, better tracking of sales, better control of pricing, an elimination to a certain extent of the grey market and capitalisation on brand image. Mono-brand stores are also a means for brands to build a better client experience, with universes dedicated to product lines and sales teams that are better informed about products. The highest number of mono-brand or fl agship stores are planned in Asia and Europe, followed by the United States.

In a seperate question, some 20 per cent of respondents say they want to open an e-boutique in the next 12 months as an auxiliary strategy. In recent years, several large brands have opened e-boutiques or are running pilot projects. This however will likely remain a secondary focus due to the specifi cities and high-price of luxury watches.

The biggest risk in online marketing and distribution remains the grey market, according to 57 per cent of survey respondents. Counterfeiting, another traditional risk for valuable and desirable brands, is mentioned by about a quarter of executives. Reputational risk associated with social media is also a concern. The high share of reputational risk identifi ed in social media might on fi rst glance be surprising, but use of social media as a marketing tool has now become a huge phenomenon, affecting how consumers research and select products, and where they buy them, across all international markets (see chart 32). The online environment is less manageable, posing new challenges for marketing.

Social media (reputational risk) 19%

Grey market (reputationaland financial risk) 57%

Counterfeit (reputationaland financial risk) 24%

Chart 34. Grey market seen as biggest online risk

In what area of online marketing and distribution do you see the biggest risk exposure? Answers only from brands

Chart 32. Marketing and sales strategies

To what extent is each of the following business strategies likely to be a priority for your business over the next 12 months? Answers only from brands (multiple answers possible)

35%

86%

39%

59%Using social media as a marketing/

sales strategy

Use product placement asa marketing strategy

Use Brand Ambassadors as a marketing strategy

Optimisation of sales channels

Chart 33. Traditional sales channel remains dominant

On what sales channels will you be putting the most emphasis in the next 12 months? Answers only from brands

Authorized dealers Mono-brand stores Online resellers Own e-boutique

0%

76%

5%

19%

The Deloitte Swiss Watch Industry Study Timing the future 17

Contacts

Howard da SilvaPartner, ZurichTel: +41 58 279 62 05hdasilva@deloitte.ch

Karine SzegediPartner, GenevaTel: +41 58 279 82 58kszegedi@deloitte.ch

Dr. Michael GramppChief EconomistTel: +41 58 279 68 17mgrampp@deloitte.ch

Jean-François LagasséPartner, GenevaTel: +41 58 279 81 70jlagasse@deloitte.ch

Jules BoudrandManager, GenevaTel: +41 58 279 80 37 jboudrand@deloitte.ch

Dennis BrandesResearch EconomistTel: +41 58 279 65 37dbrandes@deloitte.ch

Contributors

AcknowledgementWe would like to thank all participating executives for their support in completing the survey and conducting interviews with us.

A note on methodologySome of the charts in the survey show the results in the form of a net balance. This is the percentage of respondents reporting, for instance, that the outlook for the watch industry is positive, minus the percentage that state it is negative. This is a standard method of presenting survey data. Due to rounding, percentages may not add up to 100.

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Deloitte AG is a subsidiary of Deloitte LLP, the United Kingdom member fi rm of DTTL.

Deloitte AG is recognised as auditor by the Federal Audit Oversight Authority and the Swiss Financial Market Supervisory Authority.

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