In the very first episode of Mad Men, the critically acclaimed AMC series about the advertising business in 1960s New York, ad man Don Draper is approached by Rachel Menken, the head of a fictional high-end department store called Menken’s. She wants Don’s help in raising her store’s profile.
After some brainstorming, Don has an idea: coupons. “Ms. Mencken,” he tells Rachel, “coupons work.”
But Rachel isn’t convinced. People don’t visit her store because they think the merchandise is affordable. Instead, she says, they go there precisely because it’s expensive.
This attitude may seem counterintuitive to some, but it has a lot of merit. By positioning her store as out-of-reach for most consumers, Rachel teaches Don a valuable lesson about the economics of luxury goods.
But first, what is a luxury good?
Everyone has their own ideas of what defines “luxury.” For some, it’s high quality and price. For others, it’s rarity and exclusivity. These are the qualities Rachel seems to have in mind.
We like to go a bit further with our definition and add that luxury goods are those for which demand has tended to grow faster than potential buyers’ disposable incomes. This contrasts with “necessities,” for which demand growth has been more in line with income growth over time.
Take a look at the chart below. It shows the year-over-year percent change in luxury good sales, consumer staple sales and disposable income. With one (very big) exception in 2015, luxury sales grew faster on an annual basis than both people’s after-tax income and sales of essential household products. Often the difference was substantial.
The more disposable incomes rise, the more households may be willing to splurge on luxury items such as designer clothes, makeup, accessories, fine wine and liquor, automobiles and more. Like Mad Men’s Rachel Menken, many consumers understand that one of the biggest appeals of luxury items is that they’re expensive and out-of-reach for a lot of people. Because not everyone can afford them, they’re universally seen as status symbols. Being spotted driving your high-performance sports car while wearing a designer jacket and carrying a genuine leather handbag is perhaps the most emphatic way to tell others that you’ve “made it.”