Fast Company

The Price is Right

Sure, everybody loves a bargain. But smart companies know we'll also happily pay a premium for products we really love. These "new luxuries" aren't always what you'd expect, either.

Danielle Servedio, a student at New York's School of Visual Arts, is a frugal shopper. She found an apartment in Hoboken, New Jersey, to avoid paying Manhattan rents. She has a keen eye for a bargain at the grocery store, buying mostly items that are on sale. She filches cleaning supplies from her parents' house when she goes home to visit. But when it comes to shoes, she gives Carrie Bradshaw, Sex and the City's footwear-obsessed columnist, a run for her Manolos.

"I'm partial to stilettos," the 21-year-old Servedio says, stretching out her foot to reveal a sexy $350 pair of open-toed Via Spiga pumps, with pink and yellow polka dots and three-inch heels.

Patrick Hayes, 43, an account manager with Selway Machine Tool Co. in Union City, California, is an unrepentant skinflint when it comes to buying computer equipment and cameras, vigilantly searching online for rock-bottom prices. But when it comes to the premium Belvedere vodka in his martinis, he's utterly indifferent to cost. "I don't even think about the price because I know I'll enjoy it," he says. "The taste is so dramatically different, I never order anything else."

Joan and Robert Weiner, empty nesters in Sudbury, Massachusetts, recently completed an extensive remodeling of their colonial home, including a top-of-the-line kitchen renovation. Joan figures she spent $4,000 for her cherished Sub-Zero refrigerator, $900 for a warming drawer, and $1,200 for a state-of-the-art Fisher & Paykel dishwasher that Robert, a gadget fanatic, thought was "the coolest thing ever." But when it's time to stock up on paper goods, you're likely to find her hauling home a giant 12-pack of Bounty from her neighborhood warehouse discounter. "I'm a cheapskate," she says unapologetically. "When it came to this house, I didn't give in on anything. But when it comes to food shopping, or cleaning products, if it's not on sale, I won't buy it."

These consumers, with their schizophrenic buying habits--spendthrifts on some products, tightwads on others--are part of a growing trend, says Michael Silverstein, a senior vice president and director for the Boston Consulting Group. "They're willing to pay a premium price for products and services that possess higher levels of quality, taste, and aspiration--but are not so expensive as to be out of reach," he says. Silverstein uses the term "new luxury" to describe these products. Think Starbucks coffee, Aveda shampoo, Victoria's Secret lingerie, BMW cars, and Viking ranges--all of which command a pretty penny and engender fanatical customer loyalty.

Silverstein and his former BCG partner, Neil Fiske, have been studying this phenomenon, which they term "trading up," for the past 10 years, during which they have analyzed more than 30 categories of consumer goods and services and surveyed 2,300 consumers about their buying habits. Their new book, Trading Up: The New American Luxury (Portfolio, 2003), documents their investigation into the forces driving this trend and profiles companies that have cracked the code to success in this market.

We're not just talking Tiffany's here. New-luxury products range from such homely items as dog food and beer to such pricey but unromantic necessities as household appliances. But these products all share one im-portant characteristic: They evoke a stronger emotional response from con-sumers than comparable goods. And although they are priced as much as 20% to 200% more than their competi-tors', they also sell in much greater volumes than traditional up-market products, turning the usual price-volume demand curve on its ear.

That's good news for companies fretting that pricing pressure brought on by everything from the Internet to Wal-Mart to globalization has locked them into a corner with low margins and no flexibility. "The idea that it's impossible to raise prices anymore is totally false," says Silverstein. "New-luxury competitors have proved the opposite."

It's a huge opportunity for companies that understand consumers' lust for quality goods that forge an emotional connection. It also represents a huge risk for companies that offer neither low prices nor premium products. "When a new-luxury competitor enters the category, polarization can happen so fast that it becomes difficult to escape death in the middle," Silverstein says. But more about that later.

Trading Up . . . and Trading Down

Ron Shaich, CEO of Panera Bread, does not worry when Burger King starts touting "three meals under $3." Lunch at his bakery cafés generally costs twice as much. But with sales soaring 30% in the first half of 2003, it's clear that customers don't mind paying more if it means getting smoked tur-key breast with chipotle mayonnaise on Asiago-cheese focaccia and a chai latte instead of a cheeseburger and a Coke. "Give people something of value, and they'll pay for it," he says, happily sampling Kalamata olive bread in one of his St. Louis cafés. "In our shops, the food's essential. We want you to start salivating when you come in the door."

Shaich can charge more and get away with it because his cafés deliver on all three rungs of the ladder of benefits that Silverstein says are common to successful new-luxury goods: technical benefits (how a product is engineered), functional benefits (the experience it provides the customer), and emotional benefits (how it makes the customer feel). In other words, it's not enough to slap a new coat of paint on a product and roll out a big advertising campaign. "This is absolutely not a marketing phenomenon," Silverstein says. "It's about real quality, delivered."

Companies that are really willing to think through the shortcomings of products in a category and come up with something genuinely better will find the potential market to be huge. Silverstein says that the trading-up universe generally begins with households earning at least $50,000. In the United States, more than 47 million households have that kind of spending power. Assuming an average household size of 2.6 people, that translates into about 122 million Americans with the means and desire to trade up. What's more, Silverstein figures new-luxury products already account for 19% of the total (or about $350 billion) of the combined $1.8 trillion in annual sales of 23 consumer-goods categories. And the luxury-product segment is growing 10% to 15% annually.

Indeed, in the first half of 2003--a year distinguished by high unemployment, low consumer confidence, and a backdrop of terrorism and war-- the 15 companies that BCG studied as a sort of new-luxury index grew, on average, by about 18% over the first half of 2002. (That index includes the likes of Coach, Callaway Golf, JetBlue Airways, and Restoration Hardware.) By contrast, overall spending on personal goods grew by a tepid 2.6% during the same period, according to government statistics.

New-luxury items are by no means spur-of-the-moment indulgences. "The conversations that consumers have in their heads about their purchases are fantastic," says Silverstein. "It's a very intelligent, very careful decision to buy a new-luxury good. People collect information, they can tell you about different brands and models, and they can describe features and benefits. They ask themselves, 'What's the value here? Is it important, and should I be scrimping and saving in another area to fund it?' "

Most often, this interior dialogue happens in the heads of the world's most powerful consumers: American women. Some 85% of new-luxury purchases are driven by women, who now control much of any household's discretionary income. Between 1970 and 2001, real median income for women rose 41%, and with that earning power comes a sense of entitlement about spending. At the same time, changes in women's lifestyles have made them an enviable target for purveyors of new-luxury goods. Single working women, for example, are a prime market for fashion, pet food, and travel. Time-strapped working mothers will spend for restaurant meals and labor-saving appliances. Divorced women spend freely on clothes and cars.

What's more, women don't feel guilty about spending on things that make them feel good. "I call it the Oprah Effect," says Silverstein. "Oprah says it's okay to take care of yourself. Oprah says if you want it, buy it. Americans have gotten comfortable with the idea of taking care of their emotional needs."

But even consumers with a lot of discretionary income do not trade up in all categories. Income, age, and family structure determine the areas in which a person is likely to splurge. At $50,000 of household income, people tend to trade up in three categories; at $100,000, they trade up in six; and at $200,000, it's eight. The top 10 categories for trading up overall include houses, food away from home, kitchen appliances, furniture, bedding, cars, home-entertainment systems, shoes, travel, and cookware.

However, the same folks who are willing to spend extra for Coach bags, Callaway golf clubs, or organic raspberries from Whole Foods Market can be as tightfisted as Scrooge McDuck when it comes to car insurance, bottled water, or fast food. Indeed, Silverstein says, although the book's title is Trading Up, the phenomenon works both ways. People also trade down in various areas to fund purchases at the higher end. Mass retailers such as Costco and Wal-Mart have facilitated this process, reducing costs on household goods so much that they actually freed up nearly $100 billion in consumers' budgets in 2002 alone, he says. Those savings are often funneled into new-luxury purchases.

That's true even for people who can afford to pay more, a phenomenon that Bobos in Paradise author David Brooks has noted. "There's no class consciousness about how you shop anymore," he says. "People don't think you're white trash if you shop at a discount store."

Death in the Middle

For every Panera bakery café, or Kendall-Jackson wine, or Williams-Sonoma store, there's a company that has missed or ignored the new marketplace dynamic and is losing market share as a result. Sales in department stores, for example, have been declining over the past eight years, with no turnaround in sight. General Motors got stuck in the middle, between highly engineered German imports in the luxury market and high-value Japanese and Korean models in the economy class, and has seen its market share erode for 20 years. Grocery stores, squeezed between Costco and Wal-Mart supercenters at the low end and Trader Joe's and Whole Foods at the high end, are desperately trying to figure out a way to compete.

In Silverstein's view, companies mired in the middle have two choices. On the one hand, they could decide to get down and dirty, strip out all costs, and offer the cheapest possible alternative in the marketplace (as Dell has done with computers). On the other, they could decide to play the game, commit a team toward the initiative, do the research, and develop a product with a full set of technical, functional, and emotional benefits (as Apple has done with the iPod). The hazard is in doing nothing. Says Silverstein: "If you stay the same, you're going to lose sales and lose momentum, and the profitability will be sucked out of your business. You'll be Kmart."

If, instead, you're Ron Shaich, you will take your successful new-luxury product and push yourself to keep innovating. "There's a reason we're doing these volumes," he says, surveying the long lines at the bakery counter. "People have to walk past competitors to get here. We better be doing something special."

Sidebar: Living in the Material Whirl

Whirlpool

The little buddy in the laundry room

Is there any household appliance less likely to inspire love and devotion than a washer or dryer? For years, that's what manufacturers thought. They figured that if they built a product that was reliable and cheap, they could make up in volume what they couldn't achieve through premium pricing. Then along came Duet.

In 2001, Whirlpool introduced a front-loading washer-dryer combo tagged at $2,300--a staggering price, considering that most models retailed for about $600 a pair. But the Duet had features never before seen in an American appliance. It could wash big loads, yet used a skimpy 16 gallons of water--28 gallons less per load than a conventional washer. It used less electricity yet cleaned clothes better than competitors' models. It could handle silks and lace, as well as sleeping bags and comforters.

Most unexpectedly, it inspired real affection among its users. "We've been surprised by the passion women have when they talk about it," says Ali Evans, Whirlpool's brand manager for fabric care. "They call it their 'buddy' or their 'baby.' They invite people over to see it and use it. People say it's changing their lives."

What's Duet's secret? Besides delivering a better wash, it's giving women something even more precious. "By doing larger loads, women can do fewer loads, and the chore of doing laundry is minimized tremendously," Evans says. "It's giving them back some freedom and time."

Petco

Meet my children: Sarah, Josh, and Fluffy

According to the American Animal Hospital Association, the number of people who call themselves the "mommy" or "daddy" of their pets climbed 28 percentage points between 1995 and 2001 to a whopping 83%. You know who you are. Small wonder then that sales at Petco, the upscale pet retailer that sells everything from premium cat food to $450 doggie mansions, are booming; second-quarter sales soared 12.4% over the same period in 2002. "People think of pets as family members," says Don Cowan, Petco's director of communications. "They want to pamper them more than ever."

That may explain why 90% of the food sales at Petco are of premium brands such as Nutro and Eukanuba, which cost as much as 58% more than basic beastie chow. "The extra buck you pay per day will deliver tremendous emotional benefits," says Silverstein. "You'll know you're feeding the dog you love the very best food you can."

It will also, Cowan says, deliver significant technical and functional benefits. Compared with, say, Wal-Mart's low-cost, fiber-filled Ol' Roy brand, premium pet food provides better nutrition and absorption (which means less, uh, waste), he says. "People are willing to pay more for the science that goes into this product, and not just because of the poop factor." But for the product that is inevitably left behind, Petco is also happy to sell you a deluxe Oopsie Poopsie scoop set for only $20.99.

BMW

Take the long way home

Folks who drive BMWs tend to be Type A, time-stressed, driven people, says Jim McDowell, vice president of marketing for BMW of North America. So why, then, do they often take the long way home from work? "They just love to drive," he says. "They tell us the happiest hour of their day is the time they spend driving to and from work--especially if they can find a more interesting route than the highway."

That's why BMW owners are passionate about their "ultimate driving machines." More than other upscale vehicles, BMW emphasizes performance. So engineers build in a little engine noise (even though they're perfectly capable of making a quieter engine) to give drivers the thrill of the roar, and design steering wheels to provide more feedback, giving BMWs entertainment value, as well as sensory satisfaction.

As a consequence, the company says its moderately priced 3 Series cars, which start at $27,800, attracts a younger group of buyers than the Mercedes C-class or the Lexus IS series. "They may live in a one-bedroom apartment, but the BMW is a car that they will voluntarily stretch for at an earlier age," McDowell says.

And when BMW researchers asked the hard-traveling buyers of their cars when they knew they were home from a business trip, many of them said it wasn't when their spouses, children, or pets greeted them at the door. It was when they spotted their car in the airport parking lot.

Sidebar: A Work Plan for a New-Luxury Product

  1. Create a Vision
    Target a category, then become a master sleuth to determine its shortcomings. Understand what consumers in that category dream of having, and design a product that captures their imaginations.
  2. Move From Abstract to Tangible
    Develop a prototype and field test it with expert users. It's your job--not the consumers'--to translate their dreams into workable ideas.
  3. Roll Out Flawlessly
    Invent a retail system that allows you to deliver that product consistently and perfectly. Use word of mouth to help spread the buzz.
  4. Repeat
    Engage in continuous research, knowing that if you're successful, imitators are sure to follow. Focus on core customers for signs of a shifting market and ideas for next-generation products and features.

Linda Tischler (ltischler@fastcompany.com) is a Fast Company senior writer. She trades up in coffee and shoes, but never shops at Linens 'n Things without a coupon.

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