The curious economics of luxury brands

The curious economics of luxury brands

Mumbai: The late Elizabeth Taylor once famously said: “Big girls need big diamonds."

She never explained why. But what we do know is that most people like to buy expensive goods for both personal satisfaction and to tell the world who they are.

A recent study by behavioural economist Dan Ariely and his colleagues even suggests that luxury brands could improve human performance.

You are what you buy.

The demand for luxury goods has puzzled economists for long. It makes little sense on the face of it.

A rational buyer should ideally be buying cheaper variants of consumer paraphernalia, especially when there is little discernable difference in quality. Various blind tasting experiments show that even the most discerning connoisseurs are sometimes incapable of separating a good wine from a mediocre one. So what’s the fuss all about?

Adam Smith used the example of a linen shirt worn by a labourer in the Europe of his time to explain why people buy stuff that do not really qualify as necessities of life. Modern economists call this signalling.

“A linen shirt…is, strictly speaking, not a necessary of life. The Greeks and Romans lived, I suppose, very comfortably though they had no linen. But in the present times, through the greater part of Europe, a creditable day-labourer would be ashamed to appear in public without a linen shirt, the want of which would be supposed to denote that disgraceful degree of poverty which, it is presumed, nobody can well fall into without extreme bad conduct," Smith wrote in a famous passage of his classic work, An Enquiry Into The Nature And Causes of The Wealth of Nations, published way back in 1776.

The linen shirt was thus a message that the wearer was hard-working and successful— and a sign of social anxiety.

However, the gradual spread of prosperity and the easy availability of moderately priced options makes the very concept of a luxury good hard to pin down. One of the great successes of capitalism is to reduce the number of hours an average man or woman needs to work to afford various consumer goods. Consumption gets democratized.

For example, the British government this month added champagne prices in its consumer price index. “Sparkling wines are also being added due to their increased consumption, showing that despite difficult economic times, people still want to enjoy themselves," its statisticians explained in an official note.

Technology goods fall prey even faster to democratization because their prices keep falling. You have a BlackBerry? Big deal!

The latest edition of the Forbes Cost of Living Extremely Well Index is one indicationthat exclusivity is still alive and well. Its components include: Gucci loafers, one year at Harvard University, a night at a one-bedroom suite at the Four Seasons in New York, 1oz of Joy (a perfume by Jean Patou), Davidoff cigars, a Hermès calfskin bag, a dozen Turnbull & Asser shirts and much more.

The Forbes list shows that what really matters today is not the category, but the brand —not the linen shirt that Smith wrote about, but under what brand name it is sold to us.

New research by Ariely and his colleagues at the Hebrew University of Jerusalem, published in February, shows that brands matter not just as ways of sending social signals, but that they also act as performance boosters.

The researchers conducted an interesting experiment. The subjects of their experiment were given sunglasses, earmuffs and chamomile tea.

In each category, half the group was given an expensive brand while the other half was given a cheaper one. The groups given the more expensive brand performed the given task better than the competing group.

For example, in the case of the sunglasses, the subjects were asked to read a list of 84 unrelated words while looking into bright light. The group with Ray-Bans made fewer mistakes than the group with Mango sunglasses. Participants wearing 3M earmuffs did a better job hearing 62 unrelated words recorded at a noisy construction site compared with what those wearing Etkes earmuffs did. And those drinking a cup of Wissotzky chamomile tea could concentrate better than those who had drunk Hamutag chamomile tea.

Ariely and his colleagues believe that brand names act like marketing placebos—a term originally used in medical science to describe how a patient who is given a sham pill or an injection of distilled water actually starts feeling better. Something positive happens in his brain. Luxury brands could also have the same effect on human beings. “They fool people into believing they are superior, and this belief proves self-fulfilling. And like placebos, expensive ones work better than cheap ones," writes Chris Dillow in a blog post about the Ariely study.

It’s an intriguing thought.