Fashion arbitrage: The US Dollar conundrum

In economics,

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is the practice of taking advantage of a price differential between two or more markets by buying something for a lower price in one market and selling it for a higher price in another market, preferably instantaneously, to avoid the risk that price gap will close.

With the plummeting US dollar, many European brands have decided to take a hit on margins instead of lifting prices to reflect the current exchange rate. They want to stay competitive with their American counterparts and don't want to turn off American consumers with astronomical prices.  But the resulting lower US prices have led to an opportunity for some seriously lucrative fashion arbitrage. For example, a New York Times

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published this week reveals that the Yves

Downtown bag costs $1495 at Bergdorf Goodman in New York, but costs £910, about $1796, at Harvey Nichols in London.

Savvy consumers can make money by buying bags and other fashion products in the US and then flogging them in Europe and Asia -- at prices higher than in the US, but lower than the International price.

To plug the arbitrage opportunity created by lower US prices, brands like Prada and Gucci have  put in place policies which limit the number of designer handbags that a customer can buy. They are rightfully concerned that their products will end up in the so-called grey market of back-of-the-truck deals, eBay auctions, and suitcase import techniques --  definitely not the ideal environments for upholding luxury images.

However, the purchase limit solution may only work in the short-term and could in turn lead to other kinds of damage to the brands.

First, as consumers and professional networks of fashion arbitrageurs get more creative about how they exploit the price gap, the leak of product into the grey market will be increasingly difficult to control.

Second, consumers everywhere are getting more savvy and value-conscious, even in the luxury market. They travel more. They compare prices on Internet sites. And they wonder, why should the exact same product be 20-40% more expensive in Europe than in the US?  Some consumers may feel insulted when they discover the discrepancies, and be turned-off from the brand for good. Others may choose to restrict their purchases to the US, where they get the lower prices. Neither of these reactions is ideal for the brands for whom international markets are the fastest growing portions of their business.

And third, the recent devaluation of the US dollar does not look to be going away any time soon. How long can prices in the US  be kept artificially low without affecting margins? The US tends to represent between 10-20% of luxury brands' revenues and over time, the impact of lower margins in the US will show up on the bottom line.