Wednesday, July 15, 2009

The Impact of the current economic crisis

In his 1958 classic, The Affluent Society, Harvard Economist John Kenneth Galbraith made the argument that society as a whole had become affluent – after all most all families had tremendous modern conveniences previously known to be luxuries such as plumbing and heating, washing machines, electric stoves and refrigerators and two cars. He argued that as society becomes relatively more affluent, private business must “create” consumer wants through advertising to create an artificial demand for products beyond the individual’s basic needs. Given today’s economic crisis, it is hard to argue with this principle which he wrote about 50 years ago. This is a particularly relevant concept for luxury goods – especially if we accept the notion that luxury goods are by definition unnecessary and extremely expensive.

My review of the historical context of luxury suggests, in many respects the notion of what is luxury has not changed so much over time. However, the affluence that Galbraith wrote about has continued to increase across society. Affluent luxuries such as heating, plumbing and electricity have been augmented by air conditioning, color (and then cable and then satellite) TVs, computers and the internet. But in addition to this utilitarian affluence, over the past 50 years the Affluent Society really has become very affluent in wealth and in the number of wealthy.

Despite the fact that there is a growing gap between rich and poor, there has been enormous wealth created in this country and around the world over the past 50 years. There are nearly three million households in the US alone with a liquid net worth of over $1 million and there are literally tens of millions of households that have the buying power to purchase luxury goods from $500 – $5000. The disposable income households have to spend has been greatly enhanced by huge gains in the stock market and huge gains in the value of houses. But disposable income is not limited to gains in the stock market or house prices, it is also the result of the enormous growth in the American service economy and can also be attributed to the advent of dual income families. The result is that the majority of luxury goods products have become affordable to a much larger segment of the population. Louis Vuitton or Gucci hand bags are still relatively very expensive but never the less very affordable for millions of consumers.

One of the phenomenon’s (and attractions) of marketing luxury goods is the relative ease luxury brands have in convincing consumers to spend vast sums of money on things they simply don’t need! No matter how high the price, luxury consumers are typically very happy with their purchases even though they logically know that the cost of the item is far too high for its utilitarian worth. Luxury brands appeal to the visceral side of consumers. Advertising and promotional hype from the red carpet of Hollywood or the pages of glossy magazines are indisputably creating the demand or “wants” for these products much as Galbraith suggested. In the case of most consumer products, advertising creates a relative desire for a given product but that product typically has a utilitarian function such as cleaning your teeth or washing your clothes. The price paid is generally a market price that reflects the cost and value of the product.

Luxury goods, while sometimes having a utilitarian function such as clothes or shoes do not have a price which reflects their intrinsic cost or added value they provide – certainly not in comparison to an ordinary pair of shoes or an inexpensive handbag. The mark-ups on some luxury products is sometimes eight to ten fold. The price is irrational and is justified based on its uniqueness or creativity and its rarity. Luxury goods are typically of exceptional quality, but the prices charged to consumers are at a huge premium over cost.

As luxury brands have dramatically
increased their production quantities and sent manufacturing for many items to the Orient, the prices have been reduced in some cases. The combination of greater availability, greater affordability and in some cases diminished quality threatens the luxury status of many brands. If the notion of being extremely expensive is a defining component of being a luxury good, then affordability is another measure of a luxury good. If a brand becomes affordable to a large market then it brings into question its status as a luxury brand. If a luxury brand is too broadly available then it no longer is rare, which is one of the defining components of a luxury brand. In other words the tremendous success and expansion of some luxury brands may threaten their own status as a luxury brand.

Over the past 15-20 years the market for luxury goods has exploded due to the global expansion of luxury brands and the dramatic increase in consumer wealth. The current economic crisis is unlike anything we have ever experienced and will have profound effects on the luxury business. In the past, recessions did not dramatically affect the consumption patterns for luxury goods. The reason was because the truly wealthy were unaffected by the recession and so it did not have a dramatic affect on their luxury goods consumption. The last significant recession was in the early 90’s. In fact it was a pretty mild recession. The difference at the time was it was the first white collar recession. This was more a reflection of how much the economy had changed from manufacturing to services. At the time the global luxury goods business was just beginning its huge phase of growth. The luxury goods business grew tremendously throughout the nineties and was then hurt dramatically by a series of events at the arrival of the new millennium including the bursting of the dot com bubble, 9/11 and SARS. Nevertheless the market for luxury goods quickly recovered as stock markets recovered, the run up in housing prices began and the arrival of new luxury markets emerged in Russia, China,India, Brazil and the Middle East

The impact of the recession and the loss of wealth will have severe and profound affects on the luxury business. Essentially all luxury goods purchases are by definition unnecessary and therefore can be eliminated. In addition the luxury goods business has a huge travel component not only from sales of travel or duty free retail stores in airports, but also because major luxury goods boutiques are found in the major cities around the world. Unlike regular retail stores, luxury stores garner a significant portion of sales from tourists. Since travel is another discretionary purchase that consumers are cutting back on, it will be another drag on luxury sales.

by Dale Dewey

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