The Price is Right

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."