Consider for any product category there is a quality scale from 1 to 10.
A luxury product is a product at the upper range of this scale.
There is a luxury version of every product category. People care more about quality for some products more than others. For example, the luxury handbag market is larger than the luxury toothpaste market.
Price grows super linearly with quality. A 9.5 bottle of wine can be 500% more expensive than a 9.0 bottle, rather than just 5% more expensive.
What accounts for the higher prices of luxury items?
- There is a smaller market of individuals willing to pay for marginal increases in quality. This smaller market necessitates higher prices to offset fixed costs.
- Income effect: as individuals willing to pay for higher quality tend to have higher incomes and exhibit more inelastic demand.
- Higher marginal costs. Consider the high labor costs of tailoring a suit, or serving Omakase. The higher you go to squeeze out more points of quality, the crazier the costs. Price must be set equal to or greater than the marginal cost.
Certain companies, such as Chipotle and Tesla, offer high value per dollar by increasing quality without significantly increasing prices. These companies have captured gigantic market share.
Many groundbreaking consumer products come about create a new luxury version of an existing product category. Nike for shoes, Apple for phones, Starbucks for coffee. They push the boundaries of quality past what was previously thought possible.