A discussion about the pricing of luxury watches

As certain watches gain popularity and resell for multiples of the original retail price, this post aims to discuss some of the pricing dynamics in the watch world, and think through the considerations a brand would need to make before setting the price of a watch. It is simply a discussion and thought experiment, hope you find it interesting.

Economic Theory

The laws of supply and demand broadly dictate the nuances of most macro and micro economic theories. As you will know, usually when prices rise, demand falls… and vice versa.

Thorstein Veblen was an economist and sociologist who is best known for coining the term “conspicuous consumption” in his 1899 book The Theory of the Leisure Class1. Veblen critically analysed the consumption habits of the wealthy and questioned their values. He coined the terms “conspicuous waste” and “pecuniary emulation” (striving to meet or exceed someone else’s financial status)2. Veblen’s work led to the concept of a Veblen good. These are designer, luxury goods with a strong brand identity, the demand for these goods increases as the price increases. This is because consumers consider it to be an exclusive status symbol i.e. a product that is consumed conspicuously.

Now, generally speaking, Veblen goods are sought after by affluent consumers who place a premium on the utility of the good – this is typically beyond the product’s typical/intended purpose, and this utility takes the form of status and symbolism that comes with being seen to have acquired the good. Many items fall into this category from luxury watches and handbags, to certain cars and even yachts. The topic here is of course, watches, and consider for a moment how this market is possibly now disrupted by consumers who are not even affluent at all – but simply participating in this game seeking a profit. While it may be simple enough for many people to pull together somewhere between £8-£30k for a steel Rolex, Vacheron or Patek Philippe … there are significantly fewer people who will be able to find £100-500k – i.e. only the truly affluent consumers will play at this level… so raising prices to exclude more people, might stabilise the extreme demand we see today.

Should watch brands set retail prices at the market equilibrium point? (i.e. close to grey market prices)

A couple of people proposed this as a solution to the current hype in the watch market which sees certain models being resold for many multiples of the original retail price (shout out to @valereds73 for the interesting conversation and thought provoking comments).

So let’s start by imagining a particular watch model as a monopoly. The current production volume is set below market equilibrium at the current price, since supply is not meeting demand. We know the brand will not increase production volume, as they want to keep the product scarce, and protect the value for existing owners. This also feeds into the product maintaining its status as a Veblen good. So instead, can they not raise the retail prices instead? In doing so, they increase margins (directly taking away from the grey dealer margins), and more importantly… reduce demand. I’d imagine that most people would buy a Patek 5711/1A for under £30k retail, even if they needed to borrow the money or remortgage the house – because they can easily double their money (and more) the moment they leave the store. If the retail price was double what it is today, the number of people who would simply buy it for the profit goes right down, does it not?

At present, a brand will engage in the annoying practice of bundling low-demand pieces with hyped pieces, simply to sell the watches which are not really in-demand, at full price – and yet, they continue to make smaller margins on the ‘hot’ watches – a grey dealer then makes even more money on the very same watches later on. I hear you… the market prices are volatile, and the brand leaves themselves exposed to future price drops, where they might find themselves ‘overpriced’ relative to the market… heck, they might end up selling the hyped watches for more money that the complicated watches in more precious metals (portfolio pricing, to be discussed later) – Anyway, lots of reasons come to mind. Let’s take a step back and look at textbook pricing strategies.

Pricing strategies

Generally there are three approaches: cost-based pricing, market-based pricing and value-based pricing. The first, cost-based pricing, is self-explanatory; You have a known production cost, you want a certain margin, and you set the price. The next one takes into account the broader market, and most of the time it is driven by key competitors’ pricing. Here, companies benchmark their price to their key competitors, either market leaders or those similar in terms of size and geography. I would say this best describes the luxury watch industry’s current approach, aside from portfolio pricing which I will discuss in the next section. Some brands do use a cost-based approach, but I think that people who believe that luxury watch prices are solely reflective of the production cost are naïve.

The final strategy, value-based pricing, actually incorporates a customer’s willingness to pay for a good or service. This approach has become very popular over the last few years, but it is also one of the most difficult to execute. Marketing departments favour this approach as it quantifies and charges for the value a product or service delivers. The reason for its notoriety is because this approach squeezes customers for every last buck… assuming they price almost exactly what customers are willing to pay. The thing is, to be able to price based on value, a company must be able to accurately calculate the perceived value (i.e. the customer’s willingness to pay).

The other obvious problem is trying to price based on value, when all the key competitors are not doing so – this is the big gamble which brands are probably too afraid of. Imagine if Patek raised the retail price of a 5711/1A from below £30k to, say, £75k? It is certainly an interesting thought experiment. Yes there would be a backlash, and the arrogance of the brand would be the main topic – but given we have seen the market has enough willing buyers… why should the brands care what the peasants think?

What else is there to consider?

Anyway, let’s consider other industries which have the same situation with hyped products. Sneakers, Hermes bags, high end cars… Veblen goods take us back into the realms of behavioural economics and psychology – I was trying to reconcile whether Veblen goods are hype goods… The answer, for me, is yes. Here, even though the retail price isn’t going up, the market price is what rises as the product gets hyped. As I said in the Vacheron article, hype may not last forever – so what then? Brands will be remembered for fleecing the customers during the hype, and perhaps never regain their trust.

There’s also the small problem of portfolio pricing, mentioned earlier. Each watch in a brand’s catalogue is priced relative to the others; This is across different metals, and even across different models and complications. (Incidentally, this also serves as a useful data point when you’re trying to figure out what watches fit where, in a watch allocation matrix). So if a brand were to raise the price of the ‘hot’ steel sports watch to be equal to the retail price of say, a grand complication, this simply looks idiotic. Arguably, this also ‘devalues’ the grand complication in terms of consumer perception. Alternatively, this might lead to the brand selling more grand complications, who knows

A further consideration is the brand’s ethics – simply fleecing consumers “because they can” is hardly indicative of good values, and perhaps it behooves each brand to remain grounded regardless of how hyped its products become.

Just some final food for thought… A fun approach which was proposed by @doublewristauctions with regard to limited edition pieces. The brand can contact everyone interested in the watch to submit a closed bid. The top bid sets the price of the watch. Perhaps this could even be extended to normal allocations, where each month or quarter, a boutique gets an allocation and contacts everyone on the waitlist to submit a bid. The highest bidders get the watches. Although some people might not EVER get a watch as a matter of principle, since they will never bid above retail – it could be an alternative for the brand to use for ‘high demand’ pieces until such time as the high demand dissipates. Let’s be honest, this will never happen, but I thought it was a fun idea.

Conclusion

I had originally intended to break down pricing with examples, and I quickly realised this is a pointless endeavour without hard data. While I have no idea how these brands set their prices, I have no doubt that competitors’ pricing plays the biggest role. It is basically impossible for brands in the same ‘league’ to deviate drastically from their retail price points, regardless of how the grey market moves.

There might be an innovative solution to introduce a ‘hype’ category which sets a ‘market-linked’ price for certain models – and the brands can make it clear this is an outlier… but this is arguably unmanageable for any brand. What triggers it becoming a ‘hype’ product? Vacheron recently made the overseas boutique-only (not sure if its blue dial only, or all models)… this seems like an example of where ‘hype’ has been triggered – but at what point do they open the overseas up to be sold by authorised resellers again? Will they ever, assuming hype dies down?

It is worth remembering that indexed pricing is not that unusual. We see it in our daily life with petrol prices rising and falling with oil prices. Granted, this is a giffen good, not a Veblen good. However, take Tiffany & Co as another example… they will increase their jewellery prices as the cost of platinum and gold rises – if you suddenly saw gold rise 10x, you wouldn’t expect the jewellery prices to remain flat, right? Similarly then, there is an argument to make for watch prices to be similarly indexed to account for hype – and this can rise and fall to buffer the extra demand that comes with hype. Not saying this is an easy thing to accomplish, just pointing out it’s not completely outrageous as a concept.

People commented on my post yesterday about this subject (interesting comments, worth a look), and one person suggested that the ability to buy a watch which appreciated in value as you buy it, is like a ‘reward’ for customers – the thing is, this situation is fairly new, and historically watches were mostly depreciating assets… so I find it difficult to believe that this ‘reward’ angle was conceived as an outright strategy. Where it is used as a ‘reward’ instead, is the bundling, which is deplorable behaviour. Brands should sell you a watch, or tell you that you don’t spend enough. They should not ask you to buy other pieces you never wanted, in order to ‘unlock’ the piece you want. I think this is bad for the brand but, I digress. We all know this will continue to take place, and we can either participate or walk away – that remains our choice as customers.

Share your thoughts in the comments below; I certainly enjoyed all the thought-experiments which this post brought up!

-F

References

2 Comments Add yours

  1. Conrad says:

    Another way – which I believe companies are trying to go down – is forget about your initial retail price changing…but into the grey market dealers instead.
    If you control the secondary market of your own product then your initial profit margin at retail is less important. Watchbox & DeBethune, Richmont & Watchfinder… you can manipulate and control both demand and pricing structure to a certain degree. I’m surprised it took so long for brands to jump onto the grey market mark ups, as if I was retailing a watch at 20k and seeing it sell grey market at 80, as a business I’d be wanting a slice of that 60k! That way also I can look after my actual “preferred clients” at retail level and the ones who will pay whatever I can look after also via my secondary sellers.
    I think what I just wrote makes some sense but it was definitely a ramble 😂

    Cheers! Conrad (HermesDefender on IG)

    Liked by 1 person

    1. kingflum says:

      Cheers Conrad! You’re right about the examples you’ve shared about controlling the secondary market – what is worrying, however, is how this might lead to outright market manipulation. You may recall from the Watchbox example with F.P. Journe – due to the very limited number of watches in existence, with enough capital they were able to create something close to a monopoly and thus, were able to set prices… and so they did – extortionately high. The market was ripe for this, as people were flush with cash, and so this ‘locked’ in the new higher watermark for the brand. Now, with DeBethune, I feel there is some skullduggery going on. Very recently, I had a call from a friend who offered me a choice of 6 DeBethune watches at a massive discount – and now, suddenly, the market has dried up, and market prices are over retail? Gimme a break – it’s manufactured hype, and people are suckers. Anyway, thanks for the comment, appreciate it.

      Like

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