Why Do Consumers Buy 3.5 Million Won Hermes Sandals? [Seungseop Song's Financial Light]

Luxury Brands Raising Prices Since Early Year
Reasons for Price Hikes Despite Sluggish Performance
"Higher Price Means Purchase" Targeting Veblen Effect
Wealthy Consumers Motivated by 'Prestige' Not 'Utility'

[Image source=Yonhap News]

Major luxury brand companies have implemented price increases for the new year. Luxury prices, which were already expensive, have risen one after another. It’s almost hard to believe they could raise prices this much at once. While it might seem like the luxury industry is engaging in bold profiteering, that is not the case at all. Rather, luxury companies have chosen a very effective method to maximize profits according to economic theory.

Luxury prices keep rising even when performance falters

French luxury brand Herm?s raised the prices of shoes sold domestically by up to about 40% earlier this year. The price of the Oran sandals made from lizard leather increased from 2.45 million won to 3.52 million won, a 43.7% hike. Swiss luxury watchmaker Rolex raised domestic prices by about 8%. The popular Rolex Datejust 36mm model went from 11.42 million won to 12.39 million won.

Did luxury companies raise prices only this year? No. Another French luxury brand, Chanel, raised jewelry and watch prices by about 4-5% earlier this year. Last year, they announced price increases in February and May. They have become known as a representative of multiple rounds of price hikes rather than just once a year. Other luxury companies have done the same, so price increases at the beginning of the year have practically become an annual event.

It is a big misconception to think that luxury brands raise prices because their products are still selling well. Luxury companies, which made huge profits from revenge spending during the COVID-19 period, are now faltering due to prolonged high interest rates and inflation. The world’s number one company, Louis Vuitton Mo?t Hennessy (LVMH), reported a 9% increase in third-quarter sales compared to the same period last year. This is a significant drop from the previous quarter’s 17%. LVMH’s Chief Financial Officer (CFO), Jean-Jacques Guiony, even said, “The three-year dazzling boom has ended.”

But isn’t it strange? Even though sales have declined due to poor product sales, instead of maintaining or lowering prices, they are actually raising them. If the quality of the products hasn’t changed at all, rational consumers would not spend more money. This contradicts the supply-demand curve. Price and demand quantity are inversely proportional. It’s common knowledge that “if the price is low, demand increases; if the price is high, demand decreases.” So why did luxury companies raise prices amid a performance crisis?

'The rich consume to show off'... The birth of the Veblen effect

It may sound absurd, but some goods or services sell more as their prices increase. This phenomenon is called the “Veblen effect.”

The Veblen effect was first introduced by American economist Thorstein Veblen in his 1899 book The Theory of the Leisure Class. Veblen lived from 1857 to 1929. At that time, the world was increasing production efficiency through industrialization. Naturally, some people made astronomical amounts of money. Veblen called these newly rich people the “leisure class.” His book examined how these newly wealthy people spent their money and where they spent it.

Thorstein Veblen, an American economist who published the book "The Theory of the Leisure Class" in 1899.

When Veblen looked into the consumption patterns of the wealthy, he found behaviors completely different from traditional economic theory. This was “conspicuous consumption.” It means consuming to show off to others. Even if there was no significant difference in quality, they would buy expensive products. The motivation for consumption was neither efficiency nor rationality. The main goals were to satisfy envy, jealousy, and social self-consciousness from others. They sought even more expensive goods to flaunt their wealth.

Of course, there is nothing wrong with buying things to show off. Everyone does that to some extent. However, Veblen was concerned about “imitative consumption.” People who are not rich also want to buy the same products as the rich. Over time, expensive consumption and leisure activities become popular throughout society, according to Veblen. Ultimately, conspicuous consumption spreads to general consumption, causing problems of excessive consumption behavior.

Veblen’s analysis may sound unpleasant. Few people recognize themselves as engaging in conspicuous or imitative consumption. They may think they are rationally consuming excellent luxury goods made with fine materials and craftsmanship. But if you have ever felt good posting a certification shot of your luxury purchase on social media, bought luxury items after seeing a famous celebrity wear them, or felt proud when friends complimented your luxury goods, you are not free from Veblen’s analysis.

Should we follow luxury, omakase, and hotel vacations to be happy?

In May 2020, as luxury brand Chanel announced a price increase, customers lined up in front of the luxury goods hall at the Lotte Department Store main branch in Jung-gu, Seoul. [Image source=Yonhap News]

Based on the Veblen effect, luxury companies must raise prices to make money. What if a luxury company lowered prices? Many people would buy their products. Sales might increase temporarily, but wealthy customers would stop coming. Products that everyone owns lose their bragging value. If the rich stop buying, ordinary consumers will eventually close their wallets too. They bought luxury goods to look rich, but now the brand is shunned by the wealthy.

So, there is no need to blindly criticize luxury companies for raising prices. Companies aim to make money, and they have chosen the most rational method to do so. In fact, telling luxury companies to “lower prices” is like telling them to “go bankrupt.” Moreover, there is nothing wrong with wealthy people buying expensive items like luxury goods. If their consumption is legally and ethically justified, we should not blindly condemn wealthy consumers for spending according to their means, even if it is out of vanity.

However, Veblen’s theory in The Theory of the Leisure Class offers a point for reflection. Veblen criticized that “the conspicuous consumption of the upper class is carried out unconsciously to display social status.” It is undesirable for people who are not rich to consume like the rich. There is no need to follow others to high-end omakase restaurants. Staying at a hotel and eating expensive food does not necessarily make life happier. Luxury goods do not prove a person’s worth. What matters is the rationality of consuming products that truly bring happiness and value to one’s life.

Editor's NoteEconomics and finance are difficult subjects, mainly due to complex terminology and background stories. Financial Light delivers easy-to-understand economic and financial stories every week. Even without any prior knowledge, you can read smoothly and ignite your interest in economics and finance.