The Veblen effect

Stuart Fuller

It’s not been the easiest of times recently for luxury fashion labels as the cost of counterfeiting to their brands continues to grow. In the NetNames report Counting the cost of counterfeiting, published in 2015, we reported that the sale of counterfeit goods online alone increased 15.6% year on year, whilst counterfeiting and piracy are estimated to cost G20 governments and consumers more than $125 billion each year – and have destroyed 2.5 million jobs worldwide.

The cost of counterfeiting has grown at an alarming rate in the past two decades. In the 80s, the cost was estimated at $30 billion; it grew to $200 billion by the 1990s, and it has multiplied nine-fold since then. Luxury brands are among the worst affected sectors for counterfeits, and 70% of luxury brand owners say loss of revenue from fakes is one of the biggest Internet-related challenges they face.

One such brand, Italian luxury fashion group Prada, reported a 25% (€330m) drop in first-half profits in 2016. This is partly due to falling demand in China, but it will have also suffered through counterfeiters. Revenues fell by 15% compared to 2015, which has forced the brand to rethink its strategy.

Traditionally, Prada had focused its activities in the offline environment, but in order to boost revenues it has decided to increase its investment in its e-commerce strategy, targeting today’s Internet-savvy consumers through social media, as well as introducing more ‘affordable’ products.

Although this approach may increase demand for its products, in a similar way that has seen sales increase for luxury handbag and accessory brand Mulberry in the past few years, it does raise a couple of concerns.

First, once again putting my economist’s hat on, there’s the paradox of Veblen goods that could work against Prada if it introduces a low(er)-cost brand. Veblen goods tend to refer to luxury goods – such as jewelry, designer handbags and expensive sports cars – that are aspirational products because of the high prices asked for them; their high price and rarity add to their desirability as status symbols. However, if the price falls, then consequently demand and supply rises, meaning the luxury perception of the brand decreases – which will have a negative effect on demand in the long term. In other words, Veblen goods act in a way completely contrary to normal economic theory whereby a decrease in price also ultimately leads to a decrease in demand for the product.

The second consideration in moving to an online strategy is to ensure that consumers understand what the ‘real deal’ looks like. If all of a sudden consumers see branded goods being sold at significantly lower prices that they’re used to then, unless there’s a customer education program, alarm bells will sound and they may shun the product. Worse still, many less-affluent online consumers use words such as ‘cheap’, ‘discount’ or ‘sale’ when they search for luxury products. Most of the brands don’t use those keywords as part of their online marketing, so allowing your customers to associate those terms with your products could actually see them driven to the rogue-branded websites by mistake.

The change in strategy announced by Prada may have the desired effect of increasing sales through creating a new channel, but it has to be tempered with an understanding of the potential side-effects that such a strategy will expose them to.