Conspicuous consumption from Ferraris to Birkin bags

In the CAIE A Level Economics course there is a section on ‘Other objectives of firms’. This refers to other outputs and prices other than producing at profit maximisation – MC=MR. This includes: sales volume maximisation; total revenue maximisation; satisficing; limit pricing; predatory pricing etc.

One area that I have blogged on is conspicuous consumption which influences the firms pricing decisions. The concept was introduced by economist and sociologist Thorstein Veblen in his 1899 book ’The Theory of the Leisure Class’. It is a term used to describe the lavish spending on goods and services acquired mainly for the purpose of displaying income or wealth. In the mind of a conspicuous consumer, such display serves as a means of attaining or maintaining social status. So-called Veblen goods reverse the normal logic of economics in that the higher the price the more demand for the product.

Over the last three decades conspicuous consumption has accelerated at a phenomenal level in the industrial world. Self-gratification could no longer be delayed and an ever-increasing variety of branded products became firmly ingrained within our individuality. The myth that the more we have the happier we become is self-perpetuating: the more we consume, the less able we are to tackle the myth.

Michael Cameron’s blog ‘Sex, Drugs and Economics’ had a very good post on this subject entitled ‘Pricing like Ferrari’. He mentioned the Wall Street Journal story on the Ferrari’s new “hypercar” which had a price of US$3.7m. All 799 units of the low-slung, high-haunched F80 model—the most expensive production vehicle in Ferrari’s history weren’t available for sale but promised to those long-term customers like Montreal real estates entrepreneur Luc Poirier who already owns 42 Ferraris.

Money isn’t enough to buy a top-of-the-range Ferrari. You need to be in a long-term relationship with the company.By leveraging the rabid fandom of its customers through a business model based on uber-scarcity, the storied Italian company is enjoying a new golden age.

The graph shows the AR and MR curves for elastic and inelastic goods. In both situations the company produces at MC=MR where profits are maximised. If the good is more inelastic profits are higher. By making premium Ferrari cars only available to consumers who have already bought a lot of common Ferrari’s, this makes the common Ferrari more inelastic. The price goes up to P1 and the profit area is much greater than that of the more elastic demand curve. Furthermore, other luxury cars become less close substitutes for a regular Ferrari. Since they sell a lot more common Ferraris than hypercars, this is likely to be much more profitable for Ferrari overall.

Anyone with a few hundred thousand dollars to spare can buy a regular Ferrari as long as they are willing to wait a couple of years. While the standard models aren’t subject to strictly limited runs, the company still lives by Enzo Ferrari’s scarcity dictum: “Ferrari will always deliver one car less than the market demands.”

Birkin bags

The Birkin handbag (named after Jane Birkin, an Anglo-French actress who spilled the contents of a overfull straw bag in front of Jean-Louis Dumas, Hermès’s chief executive) has become one of the world’s most expensive – prices start at $7,000; in June Christie’s Hong Kong sold a matte Himalayan crocodile-skin Birkin with a ten-carat diamond-studded white-gold clasp and lock for $300,168. The rationale for its expense is that it is hand crafted and can take up to 18 hours to complete although the production cost is estimated to be around $800. Normally producers of Veblen goods should raise the price till the point where the demand curve starts to follow it normal shape – downward sloping from left to right. However with Birkin they maintain its exclusivity not by raising the price but by limiting the supply. Unlike other Veblen goods you just can’t walk into a shop and buy a Birkin bag – you have to place an order and wait for it to arrive. But you would wonder why they don’t sell more and make more money? It is a supply constraint – limited availability of high-quality skins and craftspeople to make them – it takes two years training. Hermès suggests, Birkins are mined, not simply made. Commercial Reasons to limit supply Rationing by supply rather than price does make good commercial sense for the following reasons:

1. It gives Hermès a buffer as if demand drops, sales will not.

2. It creates excess demand for the bags, which overflows into demand for other Hermès products – wallets, belts, beach towels etc.

3. Profitability in the short run would reduce its exclusiveness as the main buyers of the bags would eventually be those concerned with social climbing. Therefore the rich may lose interest in the bags and so will those that aspire to be like them.

For more on Market Structures view the key notes (accompanied by fully coloured diagrams/models) on elearneconomics that will assist students to understand concepts and terms for external examinations, assignments or topic tests.