Thursday, November 05, 2009

Breakthrough at Tiffany's. (Or, my Tiffany epiphany?) Part 3.

What is something worth?

On its face, it's a pretty straightforward question. In a free-market setting, however, it turns out to be a trick question whose only meaningful answer sounds like a wisecrack: Things are worth what people are willing to pay for them. This isn't just true for pork bellies, unloved household items that turn up on eBay, or rare works of art auctioned at Sotheby's. It applies to most of the basic staples of daily living
and it surely applies to what we call "luxuries." If tomorrow America decided en masse that it would buy no further diamond engagement rings until the per-carat price dropped to $79.93 for an absolutely flawless, colorless stone, the price of diamonds would settle at $79.93 per carat. This adjustment might not be painless; dislocations would ensue elsewhere in society. But if the American consumer's priority was to make diamonds cost $79.93 per carat, that is precisely what they would cost. The ultimate power resides with the consumer.

Things get somewhat more complicated when we're talking about highly manufactured items that are tied tightly to America's economic (and
labor) infrastructure. Gasoline, for example. Though we all bemoan the price of gas, once again, if Americans decided that gas prices should rewind to $.79 a gallon, that could certainly be made to happen. In this case, of course, there would be serious and possibly devastating consequences throughout society. But if reducing the price of gas to $.79 were the top priorityif nothing else mattered as muchthat outcome is within our grasp.

Today we see this phenomenon at work mostly in reverse: Millions of us all but insist on paying a lot of money for things
often useless things that would cost nothing in a world where items were ranked by function. We do this for reasons having to do with a statement we wish to make and/or a certain distance we wish to put between ourselves and mediocrity. (Conspicuous consumption is our preferred, albeit shallow, means of achieving this.) That proclivity either drives the price up or keeps the price up, depending on the item and the retail environment. Perhaps more important, this same phenomenon drives up or props up the retail cost of "lesser" versions of that Something. Like the $374,820 separating the Nissan from the Rolls, the vast monetary gulf between baseline items and their high-line counterparts creates, in any given realm, a silo of marketing opportunity for manufacturers. Within that solo, manufacturers can find price points for their respective products—products intentionally tiered to allow buyers to sort themselves out along the vanity scale. This practice is what adds a vanity tax to almost all goods (and services) in that silo except the ones at the very bottom. And sometimes those, too.

Let's be more specific and take a look at our
vanity tax at work.* Suppose a totally functional car can be manufactured for $12,500. An acceptable profit margin for such a car might be 15%, which means the car would retail for right around $15,000. If, however, the manufacturer knows that consumers want to pay $30,000 for such a car, then $30,000 is what that car will end up costing. (Vanity tax: $15,000.) And why would consumers want to pay $30,000 for a $15,000 car? Because there are Rolls Royces and Jaguars and Cadillacs that condition us to do so. Because those cars, at the top of the aforementioned silo, change our slant on the definition of car. Although upper-tier items like Rolls-Royces sell in minute numbersjust 261 were delivered to U.S. buyers last yearthey serve as artificial ceilings from which other manufacturers (and consumers) can "discount," thereby vastly expanding the dimensions of the ballpark. Ultimately, every item in that category of product or service will cost more than it needs to.

Put another way, if there were no Cadillacs at $50,000, then Buicks ("near-Caddys") wouldn't cost $35,000. I submit that every Cadillac sold adds maybe $1000 to the price of a Chevy, too.

Now let me be clear, lest the economists and other market-savvy types out there jump all over me. At least where cars are concerned, that extra $15,000 isn't just a huge hunk of gratuitous profit tacked onto the price of the vehicle; the consumer isn't literally being charged $30,000 for a car that was assembled for $12,500. Instead, the car maker elevates the base cost of the car far beyond $12,500 by using more costly components (say, titanium drive shafts and valve lifters) and adding other frills to "justify" the added cost. In today's manufacturing and labor climate, one does not have to try very hard to build a car in such a way that it must sell for $30,000 in order to return a profit: You just keep adding things until you get to the price the market expects to pay. But the fact that buyers are "getting what they pay for" when you tote up the cost of the constituent parts isn't the point. The point is that the car didn't need to be fashioned out of $30,000 worth of materials in order to yield a quality product that gets you from Point A to Point B.
The car maker has made a car that is intentionally "too expensive" because it knows that a fair number of buyers will not buy the car if it costs what a car, in its most basic sense, should cost. Buyers are determined to overspend in order to get from Point A to Point B.

That's why I said last time that your neighbor's Mercedes is costing you money. Also costing you money are: your neighbor’s big-screen TV, his closet full of designer-label suits (purchased at the swank men’s store in that stunning new lifestyle mall, thus further inflating the vanity tax for all parties), his multifeatured "shaving system," and on and on. We hear all sorts of complaints about this tax and that tax, but the one tax we're drowning in, as a culture, is the vanity tax.

* * * *

Historically, things acquired value because people wanted them—which is to say, the thing (or at least a desire for the thing, in the raw) preexisted the value. The worth of any given object or item evolved naturally in response to supply and demand. Because people liked the shiny stones with the yellowish hue, gold acquired significant value.

In post-Industrial Revolution America, we began artificially rigging and commodifying the value equation. We began creating things for the specific purpose of being valuable, thereby perverting the entire value equation. Now we confer value by fiat. The entry-level Manolo Blahnik Open-Toe Sandal at $575, having been assigned its cost, becomes desirable and valuable ipso facto. It is valuable because it was created to be thus. It's as if someone held up a lump of clay that no one particularly wanted, announced "This clay costs $50,000!", and suddenly people decided they "had to have it!" for that reason alone.

Having learned to equate (or confuse) status with quality and/or performance, most of us chronically overpay for products and services that provide little or no benefit in anything measurable or perceptible. We go into hock to buy elite, name-brand products that offer few if any real-world advantages for most users. The ultra-high-end camera provides no added benefits that are even likely to be noticed by someone who isn't already shooting film at the Richard Avedon level.
The basic Samsung at $90 would do him just fine. The difference between that and whatever he buys at, say, $490, is pure vanity tax. Same with high-end stereo. I'd be willing to bet that less than 1 in 100 people who buy the "home theater" systems showcased in audiophile stores can appreciate or even hear the subtle, esoteric differences in separation and other technological benefits that elevate these systems to their multi-thousand-dollar cost.

It's interesting to me that in times of recession, we talk about recession-proof occupations: nursing, for one. What makes these occupations recession-proof? We need them. We can't do without them, no matter how tough times get. At this juncture in history, till the field of robotics becomes much, much more advanced (and can make robots that are as robotic as many healthcare professionals), we can't do away with skilled healthcare workers. But it never seems to occur to anyone that America might need to make more recession-proof productswhich is to say, products that people can't do without. Nor does it seem to occur to people that we should focus our consuming appetites on those products: things that "do stuff," important stuff, for want of a more erudite way of saying it.

We don't produce enough of these things anymore.
The economic infrastructure is anchored in products and services (increasingly the latter) that people want, more than that they need. We have built a house of cards from the collective narcissism of a nation, and it is collapsing around us.

We'll wrap this up next time. I appreciate the forbearance of those who think we should've wrapped this up several posts ago.

Read previous post in this series.

* I grant you that this is an oversimplification. That's why I wanted to write the book. But I'm convinced that my argument holds in the overall.

27 comments:

Tyro said...

Reminds me of Cialdini's classic "Influence: The Psychology of Persuasion" where he describes how a gem merchant accidentally increased the prices of his stock when he meant to reduce it and found that sales increased. People use the price as a proxy for worth.

I've heard that when exclusive, high-priced merchandise starts appearing in discount stores then the profit margins vanish but just looking at the stock price of Coach Handbags, the company seems to be doing well even though they're selling in Cost-Co and other discount warehouses. Then again, I know nothing about fashionable handbags so this may be a terrible example :)

Steve Salerno said...

Tyro: This is a bit of a non-sequitur from your comment, but it came to mind as I read what you wrote. I remember reading a fantastic article about Sylvester Stallone, once, and particularly as a writer I will never forget the striking opening line: "Sylvester Stallone remembers the exact moment when he realized he was a self-aggrandizing asshole." The writer then went on to describe how Sly was driving down some boulevard in B. Hills or whatever in his Excalibur (I think that was the car, but it might have been something equally over-the-top), and he looked in a store mirror and happened to catch a reflection of the car, and he was suddenly struck by the thought: What kind of self-aggrandizing asshole would drive a car like that?

I think that question could be asked about many of today's consumer items/services by simply eliminating "drive a car" and substituting whatever applies in the given realm.

Anonymous said...

Steve;

Your analysis is way off base here:
- cars sell for about $27K on average because the marketing mix is skewed towards the low end: More Chevy Cobalts are sold than Cadillacs. If anything, Cadillacs subsidize the low price of the Chevys, not add $1,000 to the price. And the big cost components of a car are not the raw materials; it's the labor costs and overhead (costs of factories, marketing, R&D, engineering...).Automakers sell millions of vehicles, but most are losing money - the customer dictates the sales price, not the producer.
- Your big-screen TV example doesn't fit because their prices have been dropping over 20% per year. I think a better example would be an item in scarce supply with rising prices rather than an item with a supply glut and plummeting prices.

This whole luxury goods idea is just a higher level of the pyramid of Maslow's hierarchy of needs (the self esteem/recognition/status level). You seem to think that the economy should be producing more of the lower level stuff related to safety/security.protection/functionality). But we've got that part covered - nobody is starving. If anything, today's "poor" are vastly overweight.

As you know, the highest layer of Maslow's hierarchy is the SHAM layer - Self actualization. If you can sell your stuff up here, the profit margins are huge! How much did it cost for a seat in James Ray's sweat lodge? The higher up Maslow's pyramid you go, the better the margins for the seller.

Finally, you seem to think that the American consumer can set the prices via demand. But it's a global world, and Americans no longer are the only consumers with discretionary income to blow. Thus, the influence of the American consumer has dwindled.

Steve Salerno said...

Anon: I think you're missing my point (or I didn't make it sufficiently well). If a car can be manufactured for $12,000 (which they still can), then anything above that is not being manufactured and promoted as a car--it is being promoted as a status purchase. The average price of a car is irrelevant in this analysis. Of course more people buy Chevy Cobalts--and they think they're getting a good deal ("a lot for the money") because the car doesn't cost $50,000. In reality, the Cobalt shouldn't even cost what it does.

The big-screen example you give actually illustrates a second phenomenon that I didn't mention here, but had planned to cover in my book: The price of any given "new technology" will remain high until all the status buyers are done buying in at the introductory (high) price. Then the price will moderate to allow people with less money to buy in. But--I submit--the price could've been lower to begin with. The reason it isn't lower is that manufacturers know that they have to allow the well-heeled crowd to get their jollies first by purchasing the big-screen TV (or whatever it is) at an excessively high price. Then when they're done wasting money, the manufacturers let everyone else in, little by little.

Steve Salerno said...

p.s. Americans don't dictate price? Let Americans stop buying gas entirely. Or diamonds. See what happens in the global market.

Steve Salerno said...

p.p.s. Consider also all the goodies that are usually introduced on status autos and then trickle down and become standard equipment in all (or most) cars: power seats/windows/locks, a/c (in the old days), multidisk CD players, sun roofs, nice wheels, etc. Those items exist only because they were made originally to interest and satisfy status buyers. Now they're on all cars. Thus every time a Cobalt buyer plunks down his money, he is probably also buying little pieces of a Cadillac (all that power stuff) that he's been conditioned to expect.

A Cobalt may be a bad example but surely this phenomenon applies in spades on all (so-called) mid-level cars.

Elizabeth said...

Things are worth what people are willing to pay for them.

As a perfect example, see JARay and his harmonic crap. The guy sells spiritual and financial "wisdom" that anyone can get for free from a Polish cleaning lady. But people prefer to waste thousands of dollars on Ray's "brand," rather than stick to common sense.

BTW, Steve, the attractive blonde is Sting's wife, Trudie. They are all in on it.

Love the song, adore Sting; Botti ain't bad either. Thanks for the treat.

Steve Salerno said...

(I'm sorry I'm belaboring this, but it's an important point.)

Or let's use the infomercial example. We all know how it goes:

"Normally you'd expect to pay $99 for this amazing product"--Cadillac imagery--"but if you order right now, you can have it for just $49"--Buick imagery--"and if you order in the next 15 minutes, we'll throw in a second one, free!"--Chevy imagery. Meanwhile, even at the final infomercial price, we all know the item is probably still marked up 100 percent or more.

It doesn't matter that no one ever buys the "Caddy" at $99. That high-line imagery still needs to be there, it needs to exist, to create the proper psychological climate for the final, budget version. The auto industry has conditioned us in the same manner over the years. Even if only a relative handful of Caddys are sold--even if hardly anyone bought a Caddy--they're the tide that lifts all boats (or cars), the product at the top of the pricing silo, at least in GM's case. They need to be there for psychological reasons. They need to be seen driving around to remind non-Caddy buyers of their existence--even if they're an object of envy and loathing--so that people can say "someday I'm going to own one of those" or, conversely, "god, people are so stupid to buy one of those when they could've saved all that money by buying a [fill in the blank]." The people in the latter category are still overpaying but--like the people who order the infomercial product at its final, "special price"--they feel good about themselves.

I am convinced of this.

Steve Salerno said...

Eliz, re Sting etc.: Stupid Steve. Why didn't I know this?

(I have a feeling that's not the only reason people will be calling me "Stupid Steve" after reading today's installment and follow-ups.)

roger o'keefe said...

Again I'm with anon on this one. You are overthinking things to an incredible degree and are also turning the buying dynamic on its end.

Verif word: annis.

Elizabeth said...

A throwaway apropos thought:

Humans are a status-seeking species. We organize our societies according to status and power hierarchies, not much different from those of chimps. Loss (as well as gain) of status (and power) has physiological consequences -- our hormone levels are affected, and so is our emotional well-being. You may have read recently about the testosterone drop in McCain's supporters after he lost the election to Obama. (Perhaps one of the reasons behind the right-wingers' macho-posturing these days, as a way of compensation for their wounded masculinity and egos.)

There is quite a lot of research on biological correlates of status fluctuations in mammals, humans included. The loss of status is particularly detrimental (biologically-speaking) to well-being of males.* Though, of course, human females are concerned about status as well, but not the same way and not in such a degree. (OK, this has nothing to do with feminism, etc., or putting down males, etc., so please do not write offended comments on the subject.) Even when we do not possess real status -- or perhaps particularly in those instances -- we have a need to boost our standing in social hierarchy by status-enhancing possessions (or faux status-enhancing possessions, to only emulate higher status and/or express our aspirations to it). It makes us humans (not all, of course, but as a species, in general) feel better.

*Which makes me think that the bit of conventional wisdom about, um, underendowed men's need to compensate through buying big, loud and/or expensive cars and other displays of conspicuous consumption may have some truth to it, after all. ;)

Anonymous said...

A brand new car for $2000.
http://en.wikipedia.org/wiki/Tata_Nano

I was going to suggest you look at a Trabant, the volkswagon of Eastern Europe, but they have become sought after collectors items and command a shockingly premium price for such a basic and horrible car.

LizaJane said...

Two points:

1. Not all consumption of "non-necessities" is conspicuous consumption. Sometimes you want something beautiful because it's beautiful, not because you care what someone else thinks of you when because you have it. Maybe that's how YOU function, so you apply it to others across-the-board, but it's simply not the case.

For example, what about the beautiful fountain pen that costs FAR more than an equally "useful" Bic, and sits on the writer's desk, beloved, but unseen by anyone but that writer? What about the silk lingerie, seen only by the wearer and her significant other? Clearly this is consumption, and of items that cost far more than they "needed" to, but it's not conspicuous.

Sometimes these luxuries truly are for the user, and the user alone, and because of the pleasure they bring. Haven't you ever bought a hardback book instead of a paperback, because the hardback just feels so much better? If it's a book you really love, and want to keep to read again or refer to down the road, many people would buy the hardback. It's hardly a move to "impress" anyone.

And I don't by thick, thirsty towels to impress guests... I buy them because you I use them every single day, and they feel wonderful.

A rough, thin $2.50 towel from Wal-Mart would dry me off after a shower as well as a $50 Egyptian cotton job (well, more or less -- I'd be dry eventually), but the experience is incomparable. No one else knows. So is it really just for show?

I think that sometimes you just want something yummy, because it's yummy.

2. Saying that something would cost x amount if we refused to pay any more than x amount for it might not be 100% plausible. I think it could only go as low as production cost (which, even if reduced to its minimum, still isn't nothing). A diamond doesn't have to cost as much as it does, but I think it has to cost more than something more easily mined, more abundant, and less beautiful and desired.

Tyro: A Coach handbag lasts forever. It's incredibly well made. Amortized, it's cheaper than a similar bag, cheaply produced of inferior materials. They also stand behind their products, in case there's a flaw of any kind (just like Tiffany's). Seriously, my mom's been carrying the same bag, daily, for more than 20 years, and it looks brand new. It's indestructible. Some things are expensive because they really are better. No, I don't have one. Too expensive!

Steve: Your explanation of how manufacturers start out prices high and they eventually drop is why I'm not an "early adopter." I think they're suckers. Seriously, can't you wait a year for that new gadget? If so, it'll cost less than half as much. So I wait. And a year later, I usually don't "adopt" at all. It's been harder convincing my husband that he doesn't need the new model of gadget-of-the-moment just because there IS a new model.

LIzaJane said...

I'd love to stop buying gas entirely (and get out of the stupid minivan, for that matter). If you can figure out how to do that, let me know.

Can't afford to have hubby quit job so we can pick up and move to one of the very few metro areas with decent and comprehensive public transport.

So what's the alternative? Drive the kids around on a bicycle?

Steve Salerno said...

LJ: A few things. First of all, a thicker towel has a purpose. It feels better (physically), it dries more efficiently, it probably lasts longer than the ones you find in, say, cheaper hotel chains. Off the top of my head, I have no major objection (using the valuation system I propose here) to a thicker towel, any more than I have to a toaster that makes toast faster and more uniformly toasted, and uses less energy. Both items represent improvements in mission-applied technology: They do the basic job the item was designed to do, except they do it better than the previous incarnation.

But I don't think I'm buying your "aesthete" argument--"sometimes we like beautiful things"--or at least I'm not buying it in any kind of blanket way--because there is no reason why those beautiful things necessarily must come with commensurate price tags. I am told by a jeweler acquaintance that today's top-notch cubic zircona/"Diamonique" stones are all but indistinguishable from "the real thing" except under a professional's trained gaze, through a jeweler's loupe. Certainly they are indistinguishable in-passing by laypeople, e.g., when you're on your way out of a restaurant and you wave at an acquaintance.

If that is so...then why buy the diamond? Can't you get your beauty fix from the fake?

Steve Salerno said...

p.s. The "it's an investment" angle doesn't wash, either, and I'll tell you why--from my POV--if you want me to.

Anonymous said...

Well one thing about all this is, it makes you think. I don't agree with a lot of it, at least not in my first reaction. I thank you for posting it, though. It's true most people don't think about these things.

Anonymous said...

I love Anon's point about Maslow and the huge profitability of selling actualisation - a psychological base for SHAM - excellent!

Londoner

Anonymous said...

All this status posturing does have an upside, it at least substitutes for the more primitive domination tactic of clubbing your perceived rival over the head in order to establish your higher place in the pecking order.
Nor sure which is preferable though, in the long run.

Steve Salerno said...

Clubbing.

Cosmic Connie said...

Regarding the "infomercial example" Steve presented a few comments back: Of course, this is used all the time by Internet marketers too. Consider Joe Vitale's latest moneymaking scheme, the Russian wish-dolly, "Hoshun," for example.

On the site promoting the scheme, he wrote:

"I think we should sell Hoshun for $997.

"But considering most people are worried about the economy right now -- I think they should get Hoshun to fix it -- we decided to offer you Hoshun for a very low, fair price.

"You can have a Hoshun of your very own (including unlimited wish worksheets and all four audios)
for only $39.99."

http://cosmicconnie.blogspot.com/2009/10/hello-dolly.html

It's silly schemes like this -- multiplied by hundreds of times -- that enable Joe to purchase products such as his Rolls Royce (which he then charges people five grand to ride in).

However, in the case of the Russian wish-dolly (which is really just a printout of a picture, accompanied by some audio files), he's catching a lot of flak for his scheme, even from friends and followers. Even the woo-inclined have their limits, apparently.

Duff said...

It's notable that most marketing gurus would agree with everything you've written.

Seth Godin in his book All Marketers are Liars talks about how we don't really need much of any of the consumer products that exist, and therefore the job of marketers is to tell a compelling story that makes us want it anyway.

Steve Salerno said...

Duff, the point I'm really trying to drive home, however--and I'll try to tie this up in the (thank God!) last post on this--is what the purchase of all this nonexistence does to the economy, and to us.

When a people is spending the bulk of its money on the emperor's clothes...how long before you realize that you still have nothing to wear (or sell to others, worst-case)...and you're out of money.

info said...

Sorry to be a late-comer to this conversation -- I was busy rearranging my office all day for the first time in 4.5 years. Motivation: I was lusting after new furniture advertised in the Pottery Barn. And then decided that what I really lusted after was a fresh perspective in my office. So I moved around the old, beat-up furniture. At least it will feel freshly new for a few days.

The inflated price justification scheme that Steve describes applies to publishing as well. Ever wonder why so many books seem repetitive -- jet-pufft like a marshmallow? Publishers have to hit a certain word count in order to manufacture a book large enough to create a perception that it is worth the price. The only recent exception to this rule that I can think of is Seth Godin's Tribes. Which is barely larger than a greeting card, and sold full-price at $19.95.

As for me, there was a time when I was flush with cash. So I bought a brand new Volvo convertible. From a broker - the salesman at the dealer's took one look at my Saturn and figured I was just browsing. So he faked a phone call from the office during our test drive, and cut it short, ditching me in the process. The power of perception bit that particular guy right on the ass.

Even though it's over $30,000 more than I needed to spend to get me from A to B, it's safe, reliable, comfortable, and it gives me no end of pleasure as I zip around the desert highways. I can drive from Santa Fe to San Diego confident that I'll actually make it, with a rosy nose in the bargain. And, I know that if I take very very good care of it, I'll still have it 10 years from now -- perhaps longer. So I think it will be cheaper than a row of Focus's.

Plus guys always compliment me on the car at gas stations. Never used to do that re my Saturn.

Steve Salerno said...

Dear "info": Once again I think I may have left people with an erroneous impression. You're not overspending if the added money buys something. For example, long-term reliability.

Unfortunately, in this case, I think you may want to reserve judgment before patting yourself on the back about those 10 years of driving pleasure. Volvo's long-term reliability records (in CR and elsewhere) are sobering--though somewhat better for newer models:
http://tinyurl.com/yk8kjnp

Bottom line, this may not be a very good choice for two-for-the-road, unless the other one is a mechanic. :)

Elizabeth said...

Steve, this from NYT -- Shoes, the Recession's Not-So-Guilty Pleasure -- thought it may interest you:

For months now, consumers have been hunkering down in an economic storm, buying only what they need to survive, like groceries, diapers, medicine — and shoes.

The American public, it would seem, cannot carry on without new shoes. Boots, booties, sneakers, pumps — for the last few months they have all been selling well as the broader economy struggles toward recovery.

Retailing executives and analysts offer varying, occasionally wacky, explanations. The one favored by many of them is that consumers consider shoes more of a necessity than, say, dresses, cuff links or handbags, so people feel less guilt about buying them.

“I would argue you wear out shoes more than you wear out handbags,” said Marie Driscoll, an analyst with Standard & Poor’s Equity Research who is adept at rationalizing her own shoe purchases. Living in New York, she walks everywhere. “I use the argument, ‘If I spend $150 to $300 on shoes, this is my car.’ ”


Further down in the article, there is a mention of open-toe boots. I hear they fit nicely with sleeveless coats.

Steve Salerno said...

Sleeveless coats. I love it.