Recently, an associate in Shanghai bought a Hermès handbag for about $15,000. She said she fell in love with the brand and that specific bag, and her dream was to own it (and she would have done anything to get it). Luxury is like love, and once consumers fall, prices no longer matter to some extent.
Today, most luxury brands price benchmark their products with the products of their competitors, or else they use production costs as their pricing measure. This is the wrong idea, and I’ll explain why. Many people think “luxury” is the equivalent of “an expensive price point,” and many brands price that way. They use the price as a marker of luxury, which may work in the short-term but won’t in the long term. That’s because a high price point is a result of luxury; it isn’t the driver. This is an important distinction. To sell luxury means to create extreme value. Once that value is created, a brand can price for it, but if the brand prices high without creating underlying value, it will not succeed over time.
Normal to premium brands have two value drivers: functions and basic emotions. Both create the value that people pay prices for. If you think about Starbucks, a cup of coffee may cost between $3 and $5. You pay a bit more for the larger size and less for the smaller size. Hence, the price is — to some degree — the result of a logical, linear pricing structure. The more you get, the more you pay. On top of that, a more premium brand will charge a few percentage points more than a less premium brand. Everything makes logical sense. There are no surprises. This is the world of normal to premium brands.
Luxury is different. Suddenly we are in a world where prices are detached from features or emotions. Think about a Lamborghini: It has a small cabin, isn’t overly comfortable, only seats two, doesn’t have a trunk, and is very loud inside. While it may be fast, a 7-seating Tesla Model X will outperform it in a sprint. In terms of functional features, the car should be priced at the lower end, However, at price points of $300,000 and up, the brand has a non-linear value jump, especially compared to the value-heavy Mercedes S Class or a BMW 5 Series. This is why: When we measure the value of a luxury brand, we find an added value component that normal or premium products don’t have that I call Added Luxury Value (ALV).
Added Luxury Value is comprised of some more obvious dimensions: social dominance, being an ultimate treat, adding self-esteem, and more, but it also has hidden dimensions like adding attractiveness, giving the aura of expertise, and signaling high-quality decision-making. Extensive research studies show that these are the real drivers of luxuriousness, and that produced ALV is also typically a multiplier of other value components. In other words: Added Luxury Value, is worth dramatically more than the functional or basic emotional value of a brand when it comes to luxury product, and this value is, ironically, created by the brand (branding) and not by the product itself.
This is a remarkable insight. If you take a Lamborghini, the value of the car — excluding ALV — would be maybe around $50-100,000. But with ALV, it sells for $300,000 or above. Take a handbag: Without ALV, people may pay $50-100. Adding ALV makes a brand like Louis Vuitton sell for $2,000 and above, while Hermès achieves price points of $10,000 or higher. Most of that value is due to ALV.
If ALV is detached from the product (for instance, the design or the features), but connected to the brand and its story, then comparing one product to the other across brands makes no sense. However, most managers do exactly that. When they create prices, they look at what the competition is doing with the product and ignore the ALV they create. But it’s important to estimate the ALV for both for the category and the brand, so a company can make pricing decisions in a data-driven way instead of simply “doing what everyone else is doing.”
Why is this important? What if, in the case of the Lamborghini, every company in a category is using gut feeling (in other words, benchmarking prices without factoring in ALV)? In this instance, there’s a high likelihood that the pricing will be wrong. This is called a ‘category bias,’ and many brands fall in its trap.
As an example, despite what experts and the media thought, all of the most expensive cars were too cheap ten years ago. In fact, I was considered crazy to suggest that a million-dollar car was too cheap. But today, Bugatti just sold their first new car for over $10 million, and new cars with price points between $2 and $5 million have become more “normal.” They may still even be too cheap! Back then, the problem was that every competitor was too low at its highest price tier. Because every company observed each other and priced their products in line with the others, all the top luxury brands were too cheap. The difference in results after a price hike is dramatic. If a car company that sells 10,000 units per year could have sold their cars for an average of 100,000 U.S. dollars more than they did, the profit impact is $1 billion per year. That’s a lot of money left on the table.
It is remarkable how in many categories, limited editions sell out in no time: in fashion, jewelry, watches, handbags, and cars. Hermès just sold out a limited-edition “China” Birkin bag for more than $200,000 — practically the moment the bag was presented. If consumers pay this price without any hesitation, it’s a sign that the price was far too low, and that a profit opportunity wasn’t realized.
Millennials and Gen Zers are the most active and avid luxury consumers ever. Together, they are also the most important consumer group today, accounting for over 40 percent of luxury sales worldwide and more than 80 percent in China. They love luxury and their sociographic and psychographic profiles make them long for luxury like no other group before them. Different from older target groups, they want instant gratification and will pay almost anything to get the “must-have” item others don’t have as a way of using the most desired product of the time as “social currency.” Hong Kong and Shanghai are among the top-ten cities in billionaire density and own the highest concentration of golden Audemars Piguets, Bugattis, and Birkin bags. Pricing a luxury brand by gut feeling is a cardinal mistake. Our research shows that many of the most iconic brands are priced too low.
While you may not be charging enough for your luxury, the precondition to charging more is creating more Added Luxury Value. One path toward extreme value creation is telling the brand story more coherently and straightforwardly. A brand audit will help validate competitive brand positioning and storytelling and is advisable at least every two years. This brand story needs to be reflected along each customer journey touchpoint, and digital tools that generate real-time insights from around the world are needed to monitor and adjust that content. When ALV is created, companies should be ready to price for it.
Premiumization is a major revenue and profit driver but still isn’t utilized enough. Applying a different pricing approach to luxury is not only a major opportunity for luxury managers, but it’s also one of the most important tools for differentiating and accelerating growth and securing a leadership position for luxury brands.
Daniel Langer is CEO of the luxury, lifestyle and consumer brand strategy firm Équité. He consults some of the leading luxury brands in the world, is the author of several luxury management books, a regular keynote speaker, and holds management seminars in Europe, the USA, and Asia. Follow @drlanger