(FORTUNE Magazine) – In the conference room of an exquisite townhouse off Hanover Square in London, two dozen executives of luxury powerhouse LVMH are contemplating a critical question: Who should be the new women's wear designer of Givenchy? The label is like a school kid with lots of potential but lousy grades. It has languished since chairman and CEO Bernard Arnault acquired it in 1988 as part of his 20-year drive to become the king of luxury.

Around the table are managers of LVMH brands from four continents, including some from leather-goods maker Louis Vuitton. That's not an accident. The whole point of this London conference is to apply the magic of Vuitton to Givenchy and much of the rest of LVMH's stable. While LVMH's Dom Perignon champagne brand has higher operating-profit margins than Vuitton--50%, vs. about 45%--Vuitton brings in 25% of LVMH's $13.5 billion in revenues and a whopping 60% of its $2.47 billion in operating profits. That's a dangerous level of reliance on one brand for a company that owns more than 50 others (see chart). "Our strategy is to bring this star status [of Vuitton] to other brands," says Arnault. "We have to build for the future."

Brand building in the luxury business is trickier than in, say, the cereal business. You need to create desire for things that no one really needs. The formula, devised by Arnault, goes something like this: Sharply define the brand identity--or "DNA," as he puts it--by mining the brand's history and finding the right designer to express it; tightly control quality and distribution; and create masterful marketing buzz. That worked so well for Vuitton that LVMH last year posted operating profits higher than in the boom year of 2000. Competitors Gucci, Richemont, and Prada can't say the same. "Within the company, [Arnault] is God," says new Givenchy men's wear designer Ozwald Boateng, a Brit born of Ghanaian immigrants who measured Arnault for a $7,000 custom-made suit at their first meeting, last December. (Single-breasted, two-button, gray, with turquoise lining. Plus an extra pair of pants.)

The elegant Arnault, 55, got his start in luxury 20 years ago. At 35, using a combination of family money and loans, he bought Boussac, a bankrupt French textile group that had financed Christian Dior's original fashion house in 1946. Arnault stripped Boussac down to Dior and used it as a vehicle to create LVMH, which was born out of the 1987 merger between Louis Vuitton and Moet Hennessy. Once in control, Arnault fired executives of both companies, put in his own team, then spent the '90s snatching up still more luxury brands, including shirtmaker Thomas Pink, Chaumet jewelry, Fendi leather goods, the Pucci and Donna Karan fashion lines, Krug champagne, and TAG Heuer watches. With his father, Jean, he still controls 47% of LVMH's stock and 63% of its voting rights, while separately owning 68% of Christian Dior Couture, the fashion side of Dior.

If you want to know how Arnault plans to fix his lagging brands, a brief history of Vuitton will help. The brand has a storied past. It was created in 1854 by a Paris craftsman who developed the first flat trunks covered by waterproof canvas. Later, in 1896, he invented the famous LV logo by printing his initials on the canvas. His business flourished with the growth of travel by rail and ship. By the late 1980s, though, Louis Vuitton had become the bag your mother bought. Expensive and well made, but boring.

That began to change in 1990 when Arnault brought in Yves Carcelle to run Louis Vuitton. Then, in 1997, Arnault hired Marc Jacobs, a young, hip designer from New York, as creative director. Jacobs studied Vuitton's history and developed a series of modern twists on it. The first was the graffiti bag, which bore a scrawled Louis Vuitton signature. The second was the Murakami bag, designed in collaboration with Japanese artist Takashi Murakami, who rendered the famous LV initials in a kaleidoscope of colors on a white background. "Marc brought that zest of modernity to the products," says Arnault. But he kept the brand's intense focus on quality. At the rear of Vuitton's factory in Ducey, France, sits a shredding machine for destroying bags that aren't up to snuff. Inspectors tally the number of stitches on a handbag strap. If it is off by even one stitch, into the shredder it goes. "The Japanese count the stitches," says factory director Stephen Fallon. "If they count four on one side and five on the other, they bring the bag back."

As the bags got edgier, Carcelle worked to create crucial buzz via a combination of PR stunts, celebrity endorsements, and, most effectively, artificial scarcity. Only LVMH, says Marvin Traub, the former chairman of Bloomingdale's in New York, would spend $1.5 million erecting scaffolding in the shape of two giant Vuitton suitcases around the renovation of Louis Vuitton's Paris store. The scaffolding effectively became a giant advertisement. Vuitton spent $20 million on a party celebrating the opening of its Fifth Avenue store last February, complete with an Eiffel Tower made of luggage rising from the stage as gospel singers belted out "Oh Happy Day." And at the height of her affair with Ben Affleck last year, spokesmodel Jennifer Lopez appeared in huge Vuitton ads that surrounded construction of the Fifth Avenue store. In paparazzi shots, too, she always carried her Louis Vuitton bag.

The best buzzmakers, though, are the highly priced, limited-edition products Vuitton creates each season. This year it's the $5,550 Theda bag, originally available in the States only at Vuitton's Fifth Avenue store in turquoise ostrich and satin. LVMH allocated just ten such bags for all of Britain. By March, a few weeks after the bag was introduced, the waiting list was months long in both London and New York. "The aim of the fashion bags isn't to make money," explains Fallon at the factory in Ducey, "but to make envy." Because if you can't get a Theda bag, chances are you'll plunk down money for one of the 180 other standard bags Louis Vuitton makes every year--and since they're cheap by comparison, it'll feel like a bargain. Or how about a wallet or a pair of shoes?

That's the Vuitton formula. But extending it to LVMH's other brands is daunting. Since 2000, Arnault and his management team have sold a bunch of them rather than try. Gone are Bliss spa and cosmetics, Michael Kors fashion, Ebel watches, Pommery champagne, the Tajan auction house, and Hine cognac. (LVMH may sell another half-dozen brands, but executives won't name them.) Instead, Arnault has been focusing on his most promising underperformers, which include women's wear line Celine, Zenith watches, Pucci fashion, and Ruinart champagne. And he's had some notable successes so far.

Perhaps the best example is Celine. Four years ago, Celine's sales were falling, and losses stood at $16 million. So Arnault named Jean-Marc Loubier, the No. 2 at Louis Vuitton, to head Celine. Loubier mined the brand's past, as Jacobs had done at Vuitton. He discovered that it had begun as a high-class shoe merchant in 1945 in Paris. "I thought we could use this date as an asset, allowing us to present Celine as one of the first modern luxury brands, a symbol of Paris and Europe's revival," Loubier says. So, with designer Michael Kors--like Jacobs a talented American--he remade Celine into the image of the street-smart, cosmopolitan Parisian woman. The offerings--including such things as ladylike scarlet-boucle sheath dresses, double-faced camel's-hair pencil skirts, and mink scarves--appealed to shoppers from Chicago to Tokyo.

Loubier also changed the product mix. The Celine he inherited had produced mostly clothing and just a few bags. But he knew that bags were the big profitmakers at Louis Vuitton. So Kors went to work creating more bags, such as the Boogie, a classic square-shaped bag with double-rolled leather handles, available in five colors and exotic skins such as crocodile. The bag was an instant hit: Madonna, Gwyneth Paltrow, and Sarah Jessica Parker all wound up carrying it. (Celine sent some celebrities the bags for free, but didn't pay any to carry them.) Loubier took another cue from Vuitton by pricing the initial bags at a steep $1,150 for the calfskin model. Celine later came out with $580 versions in denim, a carefully calculated move: Shoppers who had seen the $1,150 model thought they seemed like a deal.

Meanwhile, Loubier improved product quality and shortened delivery times from months to weeks--making both merchants and customers happy. The result of all those changes: Celine's sales last year were up 40% from 2000, to $203 million, and profits rolled in for the first time in ten years. This year profits will be ten times what they were in 2003, predicts Loubier. Celine's fall 2004 line, arriving at stores now, looks strong. But there is a question mark ahead: That season was the last for Kors, who departed this past spring to focus on his eponymous line. Arnault selected Roberto Menichetti, formerly at Burberry, to replace him--but it's too soon to tell what he may do. Matching the right designer with the right manager and brand "is a long and fragile process," says Arnault. "It can take years. It's why this business is quite difficult."

At Zenith watches, Arnault did another talent transplant. In 2001 he brought over Thierry Nataf, who once managed Veuve Clicquot, one of LVMH's most successful champagne brands. There Nataf has redesigned the watches, exposing the mechanism and using hand-stitched bands to highlight the brand's history of quality Swiss movements. "This company had 120 years of great glory and then was forgotten in the last 30 years," says Nataf. "It is really a diamond in the rough." For the first time in 30 years, the brand also is selling women's watches in pink, lime green, baby blue, bright red, and pearl gray, as well as black. And there's now a logo, just like at Louis Vuitton: a star on the crown of the watch. Zenith sales were growing by single digits when Nataf arrived; now they're growing by double digits.

Pucci, too, has benefited from the Vuitton treatment. The Italian clothing line known for its vibrant '60s mod prints was going nowhere until Arnault asked Christian Lacroix to redesign it in early 2002. Lacroix extended Pucci's iconic prints to everything from shoes to rugs and furniture. In a particularly Vuittonesque example of synergy, Lacroix has designed a Pucci box for a limited edition of $200-a-bottle, 1996 Veuve Clicquot champagne. Pucci celebrated it at celebrity-studded parties from Florence to L.A. And like Louis Vuitton, Pucci opened a flagship store on Manhattan's Fifth Avenue, the mecca of luxury shopping. Sales have more than doubled since 2002.

Even in champagne, the formula seems to work. At Ruinart, an exclusive champagne priced just below Dom Perignon, Arnault is constructing a history-rich story to sell, as he did for Louis Vuitton. To do that, he hired historians to ferret out small facts about the brand's background. They found that Ruinart was developed in 1729, drunk by Marie Antoinette, and exported to other European royalty. Ruinart's identity was elitist, aristocratic, global. So, borrowing a buzz technique from Vuitton, in spring 2004 LVMH embarked on a series of promotions, such as $220 champagne dinners at the Ritz Hotel in London, to position Ruinart that way. It's too soon to see how well the new positioning worked.

Arnault is still struggling with certain labels. Four months after that London meeting, for example, he still hasn't found a new women's wear designer for Givenchy. Donna Karan, Loewe, and Kenzo are works in progress. But with fat profits rolling in from Louis Vuitton, Hennessy, and Dom Perignon, Arnault has the luxury of time. "If you go too fast, you can lose money," he says. "We push on the accelerator only when everything is in place. Only when we have the magic formula."

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