If you can buy a pair of Levi's for $68, why pay $11,300 for a pair of Earnest Sewn and Van Cleef & Arpels Alhambra jeans?
It's not fit, it's feelings.
Companies pricing luxury items "are not selling goods, they are selling an emotion," says Jens Baumgarten, head of financial services at Simon Kucher & Partners, a strategy and marketing consulting firm.
A high-priced item can convey prestige and a sense of belonging to an elite group. Particularly when given as a gift, Professor Jagmohan Raju of the Wharton School at the University of Pennsylvania, says, the luxury item can serve as a "demonstration of affection."
Whether executives are deciding on an eye-popping price for jeans or putting a $1.8 million sticker on a car, as Volkswagen does with the Bugatti Veyron, they weigh the same factors. Sure, performance and function are on the list, but perceptions of quality are more important. Other factors: the pricing of the nearest luxury competitor, the sense of exclusivity, the emotional message wrapped into an item given as a present, and the reputation that comes with ownership of certain luxury goods.
Selling a $40 bottle of water or an $83,000 burial plot? Anything priced for the top of the market has to weigh the same set of considerations.
One of the worst mistakes a seller can make: marking down. "If a product is priced too low, it will have the reverse affect on the emotions," says Baumgarten.
Volkswagen certainly looked beyond the value of function when it priced the Bugatti Veyron. While the car certainly has outstanding features--it's the only production car with more than 1,000 horsepower--the $1.8 million price reflects the kudos that comes with owning a unique vehicle.
According to John Gourville, a professor of marketing at the Harvard Business School, companies putting a price tag on an item like the Bugatti Veyron find benchmarks in the prices of items they consider to be the next best alternatives. But, he says, "pricing in the luxury market requires a lot of guess work" to gauge the dollar value of the desire to own the product.
"If a consumer is deciding between a Volkswagen Jetta, a Toyota Camry and a Nissan Altima, they are comparing function," he adds. "But anyone willing to pay $1.8 million for a car is taking into account the scarcity of that vehicle as well as the status or image they hope to attain by owning it."
Professor Gourville, who says he drives a Subaru Forester, also notes that what passes as sophisticated in one area might be considered average in another. For instance, he says that a Mercedes in his middle-class suburb of Boston might turn heads, but the same car in Beverly Hills would not.
"The willingness of consumers to buy luxury goods is often a factor of who they are trying to impress," says Gourville.
Applying the adage "what the market will bear" is not always simple when customers have no limits. When thirsty celebrities at the MTV Video Music Awards and the Emmys pop open a $40 bottle of the event's featured beverage, Bling H2O, they are sipping more than just purified water from Tennessee. Bling H2O is the creation of Hollywood writer and producer Kevin G. Boyd, best known for his work on the Jamie Foxx Show in the late 1990s and Girlfriends in 2001. Rather than a similar-sized Poland Spring bottle that retails for about $2, luxury consumers are turning to Bling H2O for what Professor Raju of Wharton believes is a desire to reach a certain status level.
Professor Raju, who says he owns both a Mercedes and a Lexus, notes that many luxury items fall into a category of negative externality; thus the more people who have access to the product, the less value it holds. An element of exclusivity allows the consumer to feel like a part of an elite group. What does he want when he goes car shopping? Raju says he looks for both function and comfort in the vehicle, but also values the quality of service at the dealership.
Even cemeteries have a luxury market. The Santa Barbara Cemetery in Santa Barbara, Calif., offers couples burial plots overlooking the Pacific Ocean. The price for two to rest for all eternity in this prime piece of ground: $83,000.
Like Baumgarten, Professor Raju emphasizes the emotional value in something intended as a gift. "If an item is given as a present, then the price is a demonstration of affection and consumers will often justify a higher price," says Raju.
For consumers who think a $3 bar of Dove soap isn't enough, San Francisco's Spa Radiance offers the Grand Luxe Facial at $750. With a caviar eye treatment and Diamond Peel Microdermabrasion, Spa Radiance swears its top-priced facial heals years of sun damage and irritation.
Professor Raju talks about "credence products"--goods with utility that is difficult or impossible to ascertain. Outside of business schools, people talk about reputation. For instance, it would be nearly impossible to determine whether the Grand Luxe Facial actually improved skin quality, and even more difficult to measure that improvement. However, if luxury consumers spread the word that a given product is worth the splurge, demand for that product will rise regardless of the value of its function. "Price is often a signal of perceived quality," said Raju.
The art of luxury pricing goes beyond costs, competitors or market prices, according to two consultants from Simon Kucher & Partners, Dr. Andreas von der Gathen and Burkhard Gersch., who wrote: "Emotion-based pricing is the key to success."
Even if you never get the chance to do 0 to 60 in 2.48 seconds, just owning the Bugatti Veyron should make you feel like $1.8 million bucks.