With record inflation, rising interest rates, and economic jitters weighing on consumers, pricing strategies could become more critical to getting customers to buy during the coming weeks and beyond.
Do you have that one friend who seems to snag the coolest, most fashionable shoes, jewelry, or clothes?
Now new research shows that when luxury goods companies cater to these trendy consumers by controlling how rare certain items are—seeking to make them exclusive and sought after, but not too obscure—they may sell hard-to-get products at higher prices.
“There’s a balance between social influencers who want to be rare and unique, and the equally important goal of fitting in with the rest of society,” says Chiara Farronato, assistant professor at Harvard Business School. “Too much of a thing and it becomes a commodity, too little of a thing and it becomes something that’s not even recognized when you walk down the street.”
Many companies, however, struggle to find the optimal balance. While Farronato’s research shows that producing fewer items allows retailers to charge more for them, if companies produce too few, they also risk losing out on additional sales.
Farronato’s findings hit as American retailers prepare for a murky holiday shopping season. With record inflation, rising interest rates, and economic jitters weighing on consumers, pricing strategies could become more critical to getting customers to buy during the coming weeks and beyond.
The rare red shoes
How much more is a rare product worth to trendsetting fashionistas? And if companies focus more on these consumers, how is the broader consumer pool impacted?
Farronato studies these questions in a working paper recently published by the National Bureau of Economic Research. Written along with El Hadi Caoui of the University of Toronto, John J. Horton of the Massachusetts Institute of Technology, and Robert Schultz of the University of Michigan, the paper uses the quirks of an online auction to quantify just how much social influence matters when it comes to what people will pay.
The online marketplace StockX features “initial public offerings” (IPOs) of in-demand consumer products, such as shoes, handbags, and watches, in which consumers bid on items to “win” them. In early 2019, celebrity jewelry designer Ben Baller—a popular figure in the hip-hop community—staged an IPO for a new pair of outdoor slippers, or slides. The slides came in two different colors, black and red. However, the two colors were not equally available; there were far fewer red shoes than black.
Farronato and her colleagues were able to use this information to compare how much more people were willing to bid on the rarer red shoes. Importantly, the shoes were also sold in a variety of sizes, with a different proportion of red to black shoes for each. By also comparing consumer bids across different sizes, they could dismiss the possibility that the red shoes were just more desirable based on their color, and focus on the premium paid for their rarity.
“The way we explain this finding is through social influences,” Farronato says. “I can now go around and show off an item that is recognizable to my friends, but also hard to get.”Also read: Is it time to raise your prices?
Paying a premium to be trendy
The researchers ran simulations to determine just how much more consumers would be willing to pay for the privilege of owning the hard-to-get red item—or how much less for the more plentiful black. They found that doubling inventory of an item reduces the willingness to pay by as much as 7 to 15 percent.
The impact on profits could be considerable if retailers made fewer items. When they completely ignored rarity as a factor in their model, the researchers found that companies substantially overproduced—with quantities 82 percent higher than they should be to maximize profits. In other words, Farronato says, by considering consumers’ appetite for trendy items, companies could make a lot more money by making fewer products.
“That’s one of the fundamental values that a company like StockX can create for manufacturers—because all of a sudden you have a platform that collects these data on willingness to pay,” Farronato says. “That can help inform strategic decisions on how much to produce and what price to set.”
Farronato and Horton also wrote an HBS case study on the StockX’s platform. “The goal of the case is to bring our research insights into the classroom,” Farronato says. “We want managers to know firsthand the many ways in which this kind of data can help luxury brands improve inventory and pricing decisions.”
Also read: Consumer streaks are motivating, the key is keeping them alive
Balancing the impact on consumers
While the platforms can help companies, consumers don’t necessarily benefit, the researchers say. After all, restricting the amounts of an item to the optimal levels for company profits also constrained the number of people who were able to enjoy it. And, the researchers caution, limiting production could get the attention of anti-trust regulators, who may frown on companies deliberately curtailing supply to drive up profits at the expense of consumers.
Plus, retail companies may question: At what point does the profit they make from more exclusive goods run up against the customer loyalty they gain from making those goods more widely available?
“There are groups of people who can’t afford to pay more for a good and will be obviously annoyed if they are left out,” Farronato says. “When a good is more widespread, there are way more people who can enjoy it.”
[This article was provided with permission from Harvard Business School Working Knowledge.]