The Irrational Economics of Luxury Goods
Surfing through the Forbes list of the top 10
billionaires, amongst the tycoons of the tech world, you’ll notice a name that
stands for something different, something surprising. Yes! I am talking about
Mr. Bernard Arnault, the chairman and CEO of LVMH Moet Hennessy, the umbrella
body of about 70 luxury fashion and cosmetic brands including Louis Vuitton and
Sephora.[1]
A brand exclusively for the privileged- a very small section of the consumer market has been successful in achieving a revenue of 64.2 billion euros in 2021 and a valuation of almost $329 Billion.[2]. This made me wonder about the curious economics that work behind these luxury brands. Are consumers really rational? Is it just utility that matters?
From the normal economic perspective, a consumer is
expected to be rational and should be buying cheaper variants of the good,
taking into consideration the utility for the same. But it is quite evident
that in today’s materialistic world, the theory doesn’t always seem to hold
true. This reminds me of Adam Smith’s example of a linen shirt. A linen shirt can’t
be considered as a necessity of life, but rather a matter of social pride, it
indicates one’s hard work and not wearing one indicates poverty, and anyone
with a dignified status in the society would still buy a linen shirt even when
it serves the same utility of a much cheaper one [3]. This theory however, has
become more complex over the course of time, for now it is not just the linen
shirt that matters, but also the brand name it comes under.
To verify the same, I interviewed a local cloth shop
(Aargee Silks, Palakkad) employee Mrs. Padmini, about the sales trends of both
branded and non-branded goods, It is noticed that people often prefer the
former when the differences in prices between them is minimal. She claimed that
when there is a brandmark on a garment, the customers seem to be indifferent
towards other factors like design or uniqueness. Mrs. Padmini also mentioned
about how the quality checks conducted by the customers are less in case of
branded goods. From these observations, we can notice that there is something
else other than just utility and pricing that drives consumers into buying
these goods. Why is it that the consumer is ready to buy a product with the
same utility at a much higher price just because it has a certain brand name
attached to it?
The question can of course be justified with various
arguments about how the production process involved in the making of a luxury
good is often different from that while making a normal good, and how luxury
goods require skilled craftmanship to facilitate its making. But at the end of
the day, even if we were to add the production cost, incidental cost and a
healthy profit margin, it will still be much lower than the ultimate price at
which the commodity is sold for. So Why? and When did all this begin?
In trial of these answers, we must look back into
history, casting a spotlight on the 19th century American economist
– Thorstein Veblen. His well-known work ‘The theory of the leisure class’ talks
about the significant change that happened in the society after the era of
industrialization [4]. Prior to industrialization, the society used to be more rigid
in its terms, where it was divided into various social classes and
everyone was restricted or even dictated upon to stay in their own class. This
classism within the society loosened up with the coming of capitalism and
industries. The focus of the society shifted to economic progression and the
people now craved for economic power. This further posed an opportunity for
everyone to move up in the society with the acquirement of economic wealth. This
gradually gave rise to the powerful new social class- the ones with abundant
wealth. These people over a period of time adapted a particular style of
consumption, often termed as conspicuous consumption. They would buy goods and services that
are exorbitantly expensive just because it is expensive in order to showcase their
prestige and power in the society. With the passage of time, other social
classes also began to imitate this style of consumption to bring themselves up
in the society and thus began the rat race behind luxury goods. This gradually grew into the present-day extravagant market for luxury goods, a market which
runs mostly on the desire of the public, not of fulfilling their necessities,
but of raising their social status.
When asked to 20 random shoppers at the Royal Meenakshi Mall, Bangalore, Why they chose luxury brands over normal ones,
many claimed that using luxury goods had a positive effect on their confidence
and mental satisfaction, others claimed that it helped them alleviate their social
status, some even claimed that they were used to using these luxury goods and
thus continued to buy them.
Q. Would you prefer a luxury good over a normal good given that both the goods have the same utility and features and Why?
Table 1.1
|
REASON |
TALLY MARK |
NUMBER |
|
Positive
Effect on their confidence and mental satisfaction |
|
7 |
|
Helped them
alleviate their social status |
|
11 |
|
Habit of using
luxury goods |
|| |
2 |
With all this mind, if we shift our spotlight onto the
conventional laws laid down by the pioneers of the subject, we will notice some
conflicts. Starting from the basic law of demand which states that a higher
price leads to a lower quantity demanded, and a lower price leads to a higher
quantity demanded [5]. This law usually becomes the foundation stone to several
business’ pricing strategies. But in case of luxury goods, it is the other way
around, the higher the price, the higher the demand. This is so because if it
were to adhere to the law, where the demand is inversely related to price, the particular commodity would lose its sense of luxury, which will ultimately dissipate its demand in the
long run. In order to create demand for these luxury goods, brands make use of
an economic technique called ‘perceived value’, which is that value which
consumers are ready to pay for a product based on their perception of the
product [6]. The marketing strategy of these brands often aims at reinforcing the
perceived value of the consumers. Luxury brands also regulate supply
artificially, even if the demand for a certain good is huge, they’ll still
limit the supply of it, so that its value of luxury embedded to the product
doesn’t depreciate in the long run.
Putting all this together, we can conclude
that the luxury goods market is an artificial market which overthrows all the
basic economic laws that work for normal goods. The negative side of this style
of consumption is that it results in unproductive allocation of the resources
within the economy. But irrespective all this, the market for luxury goods will
continue to grow at a steady pace for the consumer will continue making
irrational decisions. In fact, no matter how the theories of economics grow,
human beings can never be limited to a vague definition of being rational, the
complexity itself is what defines us human beings.
RISHABH N
1 ECOH B
2233418
REFERENCES
1. https://www.lvmh.com/group/about-lvmh/governance/executive-committee/bernard-arnault/
https://www.forbes.com/real-time-billionaires/#374cd8503d78/
2. https://www.lvmh.com/investors/profile/financial-indicators/#groupe
https://robbreport.com/lifestyle/news/lvmh-is-now-the-most-valuable-company-in-europe-1234599368/
4. http://moglen.law.columbia.edu/LCS/theoryleisureclass.pdf/ https://en.wikipedia.org/wiki/The_Theory_of_the_Leisure_Class/
OTHER REFERENCES
1. https://www.livemint.com/Home-Page/W8eexIwEwMoy6zTb1n5vGO/The-curious-economics-of-luxury-brands.html/
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