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Geneva -- Who makes that Swiss watch you’re wearing? Chances are high that it belongs to one of the 19 brands owned by the Swatch Group. If so, you possess an iconic object that symbolizes Europe's ability to compete in the globalized free market. While sales from the Swiss watch industry dropped by 25% last year, the Swatch Group recorded its third most profitable year in history. True, sales were down 6.3% from 2008, but of the roughly $11.4 billion sales in Swiss Watches in 2009, more than $5 billion belonged to the Swatch Group.

Swatch also profited from the fact that espite the enormous proliferation of brand names and models, the watch movements—the inner workings that make a watch actually tell time—are with a few exceptions mostly manufactured by Swatch and then dispatched to different companies who market them as their brand names. Late last year, the Swatch Group’s founder, Nicolas Hayek, hinted that Swatch might decide to stop selling movements to other companies that have little more to do with the industry than marketing and branding.

Nicolas Hayek is generally credited with saving the Swiss Watch industry in the early 1980s when just about everyone seemed to think that the business was doomed. The trouble trouble had started with the 1967 invention of the Beta 21, the world’s first quartz watch, developed by the Centre Electronique Horloger, a Swiss company based in Neuchatel. Instead of taking advantage of the new technology the major Swiss watchmakers decided to stick with established mechanical watches with higher profit margins. It didn’t take long for Japanese and Hong Kong manufacturers to flood the market with cheap electronic watches that kept just as good time. By the early 1980s, the Swiss global share of the watch industry, roughly 50% in terms of value in the 1950s, had declined to 20%. Industry analysts predicted that labor costs in Switzerland were simply too high to compete with production in Asia.

The extent of the damage became clear when SSIH (Societé Suisse de l’Industrie Horloger), the most important manufacturer in French-speaking Switzerland, found itself in debt to 30 banks and a number of pension funds. With the banks fast running out of patience, UBS eventually took control and asked Nicolas Hayek, who was running Zurich-based consulting firm, to do a quick assessment. Hayek, who was born to a Greek Orthodox family in Beirut, Lebanon, and later educated in France, had a reputation for doing brilliant feasibility studies for a number of heavy industries, and he had attracted attention by advising the Swiss military on how to make substantial savings in its purchases of its tanks. Asked to analyze the watch industry, he quickly recommended merging SSIH with the largest German-speaking manufacturer of watch movements, ASUAG (Allgemeine Schweizerische Uhrenindustrie AG). ASUAG resisted at first, but by 1982, it too had encountered financial difficulties and Hayek’s firm was called back to make a new assessment.

In late 1983, SSIH and AUSAG merged, and Hayek became CEO and chairman of the board of the new company in 1986. It was initially called SMH (Societé Suisse de Microélectronique et d’Horlogerie) but eventually changed its name to the Swatch Group. In order to wrest 51% control of the new company, Hayek had put up roughly a third of his personal wealth and had convinced several wealthy private Swiss investors to back him.

Hayek realized early on that the real problem was not cheap Asian manufacturing as much as it was the fact that the Swiss companies had fallen behind in strategy, structure and management. AUSAG owned a few notable brands, including Longines and Rado, but its main business was producing watch movements for other companies to be assembled into finished watches. As these mostly family-owned companies encountered financial difficulties of their own, AUSAG took them over, but left the floundering management teams on their own. By 1982, AUSAG owned more than 100 separate companies. Most of them did their own marketing, assembly and R&D.

SSIH, which owned the Omega brand, was in nearly as bad shape. Omega’s success had led SSIH to dilute the brand by selling too many watches at too low a price. Quality suffered, and Omega was losing nearly $50 million a year. The company clearly lacked discipline and strategy.

After the merger, Hayek’s first move was to take on the Asian competition by competing at the low end of the market. The model he chose to spearhead the campaign was a new ‘slimline’ watch that AUSAG had been developing. AUSAG had intended to market it to watch resellers like Timex, but Hayek decided instead to produce a finished watch and to have the company handle its own marketing.

Hayek’s reasoning was that the low end of the market needed to be controlled, and that the new company needed to resource its capacity for innovation. Even more important, getting into the trenches with mass manufacturing allowed Hayek to avoid firing employees by maintaining production volume and keeping his factories busy. Hayek was convinced that building trust and loyalty among his employees was an essential key to long term success. Retaining their skills and knowledge-base was a critical element in shaping the company’s future. When the Japanese offered to sell him integrated circuits at half the cost of manufacturing them himself, he refused. Initial estimates were that the Swatch would sell five to six million units a year. Sales actually came in at 20 to 25 million units a year.

The development of the Swatch also provided Hayek insight into what was actually driving the market. Previously, Swiss manufacturers had emphasized complexity, which implied greater accuracy at a premium price. But quartz watches were cheap and accurate enough for most people. Hayek realized that a watch had to offer something more than simply telling time. While fashion projects an image, he sensed that the decision to buy a watch was often an emotional one. Hayek believed that emotional products are about a message that tells people who you really are and why you do what you do. Swatch’s message was high quality at a low price and an affordable stylishness, as well as to a certain extent thumbing one’s nose at social convention. A Swatch watch projected a message about the values of the people who wore it.

Hayek’s next step was to develop the marketing side of the business. He felt that the company had focused too heavily on manufacturing while neglecting to think of why it was that people actually wanted to buy a watch. A sorting exercise according to image and price revealed that most brands did not have a clear position in the market. In the case of Omega, it soon became apparent that 80% of the sales came from only 15% of the models. The number of models was reduced from 2,000 to 130. Hayek soon made sure that each brand had a clear and understandable message that customers could identify. Omega was positioned around precision, sportiness and intelligence. Swatch maintained its market momentum by constantly adding new model lines. The best selling watches, Swatch, Omega, Breguet and Léon Hatot moved into selling jewelry in addition to watches. To stay on top of trends, Hayek installed the latest information technology which linked some 440 reporting units whose job was to report market changes and adapt accordingly.

Having stabilized the company, Hayek began moving higher in the luxury market. Breguet, which had been a favorite of Napoleon, had a price coming out of the factory that was in multiples of $10,000. Blancpain sold from $10,000 to $12,000. By the time the watch reached a retail sales outlet, it might cost three to four times that amount.

In retrospect, Hayek’s gamble has clearly paid off. Today, China manufactures around one billion watches a year, but those watches sell for roughly $2 a piece. Switzerland exports around 26 million watches a year, but according to the Federation of the Swiss Watch Industry, the average price is more than $563 per watch. In terms of value, Switzerland holds 55% of the world’s market. By 2008, Asia was absorbing 46% of Switzerland’s watch exports. China exported $2.7 billion worth of watches. Switzerland’s share of the market was $15.8 billion.

In an interview with the French newsmagazine l’Express last summer, Hayek admitted that the Swatch Group’s sales had fallen off by 12% to 14% due to the recession, but the Swatch Group had resisted laying off its 25,000 employees in keeping with one of Hayek’s most important management principles, which is to avoid firing staff for economic reasons if there is any other alternative. “When a manager wants to save money, his first thought is to let go of personnel, because that is the easiest,” Hayek explained. “He doesn’t think first about how to improve his revenues, his purchases or his logistics.” As the recession fades, the Swatch Group intends to be ready to face new market opportunities with its personnel in tact and at maximum strength. The gamble paid off and in January Swatch Group confirmed that its sales were already rebounding in the latter half of the year. As for Hayek, ever the entrepreneur at 81, his new company, Belenos, named after a Celtic sun god, aims to produce clean energy motors that provide mobility without contributing to global warming.