Premium means more than just good quality.
I remember going out with this girl a couple of years ago. She was really into fashion and always wore a stylish outfit. In a conversation, she was very excited to tell me that she was carrying her rare Louis Vuitton purse that day and the story behind that purchase. I know absolutely nothing about fashion, but I know these are not cheap. Sure, her purse looked good. But why was she so excited about it? Was it because of a unique design? Or extremely high-quality materials? What justifies the four-figure price tag?
Just like low-cost pricing, premium pricing is a widely used pricing strategy, and there are many reasons why some businesses can charge such high prices. It isn’t for everyone, but it can be very profitable. As an example, the market for personal luxury goods keeps getting bigger, from $307B pre-covid to $309 in 2021. The luxury car market was worth $449B pre-covid and is expected to reach $665B in 2027.
What makes a product premium?
Let’s look at these luxury products first. Consider luxury cars, for example; why can brands such as BMW or Mercedes charge a lot more than Honda or Hyundai?
Of course, there is the cost of the materials and parts used – the nice leather, powerful engine, the wood on the dashboard – but that can’t be the only reason. Fewer premium brands are using high-quality materials in their higher-end trims. These days, you can get a really nice Ford that won’t look quite like a Bentley but still looks nice and is comfortable. The main reason is the lower production runs. Development costs for any car, luxury or not, can reach hundreds of millions, even billions of dollars. With high fixed costs and less cars manufactured, luxury brands have to charge the customer more for the car development and design.
The exclusivity of luxury cars drives the prices higher; not only do these high-performance cars use premium materials, but there are less of them on the road. Customers are willing to pay more for the exclusivity. And the prices keep going up: the average price of luxury clothing and shoes went from $648 and $486 respectively in 2020 to $653 and $521 by 2021.
The good old “supply and demand”
Premium pricing is often a consequence of supply and demand. Scarcity and limited offers are the main reasons why companies can charge more for their products.
The scarcity of offers can be due to materials being in short supply. Diamonds, especially higher-quality ones, are expensive because of the high demand (due to their unique properties and the sentimental and symbolic value people see in them). Or it can be because of other barriers to entry. Tough regulations, patents, and development costs explain why some medications can cost thousands of dollars for a few pills. A combination of :
- No competition due to these barriers to entry
- High demand for the product
- No good substitute is a recipe for premium prices.
Is that ethical? Not always. Can businesses do it? Yes, unless governments take measures. Companies often limit the production of some items to create artificial scarcity by releasing “limited edition products”. That is why some pairs of sneakers can be worth thousands of dollars, while the regular editions cost less than $200. Research has shown that quality tends not to be a driver of sales. These purchases are often more emotional than rational. A way to know if a company can use a premium pricing strategy is to understand how their offer makes the customer feel.
Why do customer pay a premium?
Going back to my story about my date’s expensive purse, we can wonder why she chose to spend so much money on this luxury product rather than buying a good quality, similar but cheaper item. For many customers, purchasing luxury items are a way to show their social status and improve their self-esteem. I’m not saying I go after low self-esteem women, but everyone likes to feel good about themselves. You don’t feel the same showing up to a meeting wearing a Rolex or wearing a $5 watch you bought on Wish. When you don’t know someone very well, you make assumptions and judgments based on what you see and their behavior. A luxury item is an efficient way to look successful or stylish. That is often the case for people wearing Louis Vuitton, driving Bentleys, or those who put $5000 chrome wheels on a $2000 car. It is also the reason why luxury products are so easy to identify, by using a unique style, identity, or a visible logo.
It is interesting to notice that premium products are not only about appearance. While it is true that some people buy counterfeit products at a fraction of the price to appear successful (and some of these fakes can look very authentic), others will buy the real product. For most, there is a feeling of accomplishment when they buy a high-end item. You can’t treat yourself to a fake pair of Gucci shoes. Authenticity is paramount, and makes a big difference in customer behavior. Basically, if your product can make the customer feel important, stylish, and successful and gives them a sense of accomplishment, you can charge a higher price.
The bottom line is that businesses can use a premiun pricing strategy and charge whatever they want, but customers won’t buy unless they:
1- Get a feeling of accomplishment and improved self-esteem (e.g: designer handbags)
2- Want to enjoy the exclusivity and want a high-quality product that is in limited supply (e.g: luxury cars, limited edition sneakers)
3- Need the product and don’t have any other alternative (e.g: medication only manufactured by one company).
Quality is the main factor in high-end utilitarian products, but it does not drive sales in many other industries. Despite record-high inflation and the economic conditions, the market for luxury goods is continuing to grow, and we can expect to see new businesses succeeding in this highly competitive space.