Trading Up: Drive BMW; Shop Costco

by Michael J. Silverstein and Neil Fiske

America's middle-market consumers are trading up to higher levels of quality and taste. The members of 47 million households that constitute the middle market (those earning $50,000 and above in annual income) are broadly educated and well-traveled as never before, and they have around $3.4 trillion of disposable income. 1 As a result, they are willing to pay premiums of 20 percent to 200 percent for the kinds of well-designed, well-engineered, and well-crafted goods—often possessing the artisanal touches of traditional luxury market goods—not before found in the mass middle market. Most important, even when they address basic necessities, such goods evoke and engage consumers' emotions while feeding their aspirations for a better life. We call these new-luxury goods. Unlike old-luxury goods, they can generate high volumes despite their relatively high prices.

Businesses offer a wide variety of new-luxury products and services—including automobiles; home furnishings; appliances; consumer electronics; shoes and other apparel; food; health, personal, and pet care; sports equipment; toys; and beer, wine, and spirits. Companies at the new-luxury forefront are achieving levels of profitability and growth beyond the reach of their conventional competitors.

Consider, for example, Panera Bread, a bakery café chain that offers freshly made sandwiches with seasonal ingredients. Panera customers line up to spend $6 for a chicken panini and share a meal with friends and colleagues in pleasant, comfortable surroundings. For the first three quarters of 2002, Panera's sales were 41 percent higher than they were for the same period of 2001. By contrast, sales at Burger King—where consumers pay about $3 for a chicken sandwich and sit on hard plastic chairs, were flat. At $750 million, Panera's projected U.S. sales for 2002 are only a fraction of Burger King's $8.5 billion in U.S. sales that year, yet its market capitalization is now about two-thirds of the $1.5 billion that Burger King was sold for that year.

Companies have enjoyed similar results in three major types of new-luxury goods:

Accessible Superpremium. These products are priced at or near the top of their category, but middle-market consumers can still afford them, primarily because they are relatively low-ticket items. For example, Belvedere Vodka, which undergoes four rounds of distillations for a smoother taste, is able to command about $28 a bottle, a 75 percent premium over Absolut at $16. Nutro pet food, which contains nutritious ingredients, sells at 71 cents a pound, a 58 percent premium over Alpo, which costs about 45 cents a pound. Starbucks, an iconic new-luxury brand, charges around $1.50 for a tall coffee, about a 40 percent premium over a similar-sized Dunkin' Donuts cup, which costs about $1.10.

Old-Luxury Brand Extensions. These are lower-priced versions of goods that have traditionally been affordable only by the rich—households earning at least $200,000 annually. In 2002, unit sales of BMW 325 sedans—which consumers buy for their advanced technology, their work-hard, play-hard image, and the excitement of driving them—were up 12 percent over 2001 levels. The Chevy Malibu, by contrast, fails to offer any technological features its rivals lack, or to give drivers any special pleasure in driving or owning it—what might be called technical, functional, and emotional benefits, the three rungs of a product's ladder of benefits. Despite the Malibu's $19,000 list price, $10,000 less than the 325's, its sales were down 4 percent in 2002. In 2001, BMW—with total sales of 172,505 vehicles in the United States—achieved a greater profit worldwide, $2 billion, than any other carmaker. General Motors earned just $600 million on U.S. sales of more than 4 million vehicles; both Ford and DaimlerChrysler suffered losses.

Also on the list of old-luxury companies extending their brands are Mercedes-Benz, Ermenegildo Zegna, Tiffany, and Burberry, offering affordable products alongside their traditional ones.

Mass Prestige or "Masstige!' These goods occupy a sweet spot between mass and class. While commanding a premium over conventional products, they are priced well below superpremium or old-luxury goods. An eight-ounce bottle of Bath & Body Works body lotion, for example, sells for $9, or $1.13 per ounce. That's a premium of 276 percent over an 11-ounce bottle of Vaseline Intensive Care, which sells for $3.29, or 30 cents an ounce. But it is far from being the highest-priced product in the category. An eight-ounce bottle of Kiehl's Creme de Corps, one of many superpremium skin creams, retails for $24, a 167 percent premium over the Bath & Body Works product—and many brands cost considerably more. Coach similarly positions its leather goods at prices below Gucci's, but well above those of Mossimo at Target.

When a new-luxury brand takes hold, it can quickly change the rules of its category, achieve market leadership—as Starbucks coffee, Kendall-Jackson wines, and Victoria's Secret lingerie have—and force the price-volume demand curve to be redrawn. In laundry appliances, for example, conventional industry wisdom held that washers and dryers could not appeal to consumers' emotions. People would therefore never pay more than $800 for the two. Then Whirlpool created the Duet, a front-loading washer/dryer set that costs around $2,100. Due in large part to their European styling and speedier, gentler cycles, these machines have become immensely popular. Now Whirlpool cannot keep up with demand.

As consumers shop more selectively, the categories new-luxury goods occupy tend to polarize. Consumers tend to trade up to the premium product in categories that are important to them but trade down—buying a low-cost brand or private label, or even going without in categories that are less meaningful to them. Consequently, people's buying habits do not invariably correspond to their income level. They may shop at Costco but drive a Mercedes, or they may buy private-label dishwashing liquid but drink Sam Adams beer. Left in the cold are midpriced items that fail to distinguish themselves on any of the three rungs of a product's ladder of benefits. Companies unable to match the prices of low-cost products or promise the emotional engagement of new-luxury goods face what we call death in the middle. It may be a retailer like Sears, which the mass merchandisers and specialists in particular categories of goods are beating on price, or it may be a cosmetics and personal-care line like Max Factor, which does not deliver on the ladder of benefits or offer a cost advantage.

The trading-up phenomenon already affects almost every category of goods—including consumables and durables—and services. Still, new-luxury goods are most often developed by entrepreneurs who are outsiders to the category (as were Ely Callaway of Callaway Golf and Jess Jackson of Kendall Jackson) or imaginative corporate leaders who are able to think like outsiders (such as Leslie Wexner, who built Victoria's Secret). Instead of relying solely on polling and focus groups, they cast a critical eye at categories in which products and services have become expensive and stale, or cheap and undifferentiated. They then spend time interacting with their target customers, often one-on-one.

Even in these difficult economic times, the trading-up phenomenon is powerful. We estimate that new-luxury goods already represent about $350 billion—or 19 percent—of the combined $1.8 trillion in annual sales of 23 consumer goods categories and that the new-luxury segment is growing 10 percent to 15 percent annually. What's more, companies can quickly realize the profit potential of such goods. New-luxury entrepreneurs can move rapidly from idea to prototype, sometimes in as little as a year. They can create initial product runs in low volumes with minimal capital investment. They can often build out their businesses within five years. And when they're ready to sell, they find eager buyers.

Take Pleasant Rowland. In 1985, she had a vision for a new kind of doll—a series of girl characters, each based in a historical period, with expressive faces and high-quality, historically accurate accessories. Each doll would cost $84, about six times the price of a Barbie. Rowland developed her initial product concepts in the course of a single weekend, and, on a $1 million investment, went to market in the fall of 1986. In the first three months of operation, the Pleasant Company achieved $1.7 million in sales. In 2000, Rowland sold the company to Mattel for $700 million.

Trading up is a trend born of a restless and mobile society. In the post-World War II era, the homogenizing effects of the draft and a whole society's mobilization behind a single overriding purpose produced an appetite for middle-market, mass-produced goods. After a decade's psychic and material hardships, Americans wanted cars, refrigerators, and household goods in unprecedented quantities. Thanks to capabilities developed and sharpened in the hurry-up production of wartime matériel—including jeeps, uniforms, and K rations—U.S. industry was ready and eager to meet the demand.

Although many new-luxury brands are global, and the demographic, economic, and cultural forces shaping Americans' buying habits in the United States are at work abroad, nowhere else have the shifts been so pronounced, or are the ensuing opportunities so large. Americans today are much more sophisticated, demanding, and self-absorbed than the World War II generation, and their tastes are accordingly more fragmented. Yet U.S. businesses have the right set of skills and capabilities to satisfy Americans' emergent desires.

Excerpted with permission from "Luxury for the Masses," Harvard Business Review, Vol. 81, No. 4, April 2003.

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Michael J. Silverstein is a senior vice president at the Boston Consulting Group in Chicago, and its global consumer and retail practice leader. Neil Fiske is the CEO of Bath & Body Works in Columbus, Ohio. This article is adapted from their forthcoming book, Trading Up: The Transforming Power of New Luxury (Penguin Putnam).