Prices of European luxury goods increase at about two times the broader consumer price index (CPI), which measures changes to the price of a standard basket of consumer goods and services. This is confirmed by both analyses of specific product SKUs over 40 years as well as analyses of broad-based baskets of luxury goods and services, such as the Cost of Living Extremely Well Index produced by Forbes. While the broader CPI grew at around 3 percent CAGR over the past 40 years, the Cost of Living Extremely Well Index increased at 5 percent annually.

Luxury price inflation has been underpinned by growing income and wealth inequality. Over the same 40-year period, the net worth of the Forbes 400 grew by 10 percent annually, far faster than the CPI. And, following this trend, the prices of iconic luxury products — such as Hermès' Birkin and Kelly handbags, Gucci's Horsebit loafers, Louis Vuitton's Speedy bag, Chanel's 2.55 handbag and Rolex's Submariner watch — increased by approximately 5 to 7 percent annually.

This would appear to be good news for luxury brands. But luxury’s pricing power must be taken with a huge pinch of salt. Some brands are better positioned to hike prices than others, and not all luxury price hikes are great news.

To be sure, strong brands can support faster price increases. Our analyses indicate that the brands with the strongest organic growth can increase prices the fastest, driving EBIT margin expansion. Gucci, Louis Vuitton and Moncler are recent examples. But excessive price increases can lead to significant damage. Here, Richemont offers a cautionary case, surfing on gifting one day, cutting prices the next. Its Cartier brand still seems to be atoning for its excesses in the early years of the century and has had one of the weakest price dynamics in recent years, at least in watches.

At an advantage are brands with untapped price increase reservoirs. They have high consumer desirability and strong organic growth momentum and have implemented only restrained price increases in the recent past, meaning they have unrealised pricing upside. On the other side of the spectrum are labels that have increased prices too fast, ahead of brand desirability, and may be forced to face painful downward price corrections that eventually damage brand equity.

How to tell the weak from the strong?

One way is to compare a brand's price increases to the resale value of its products. Hermès, for example, has exercised remarkable restraint and has chosen to increase prices much less than it could have. Rolex, too. The fact that you have long waiting lists to get a Daytona or a Birkin — and a situation where demand far outweighs supply — signals very significant untapped price increase reservoirs.

The China Pricing Gap

The gap in prices between luxury goods sold in Europe and those sold in key markets like China and the US has moderately reduced on average between 2016 and 2020. But foreign exchange fluctuation explains much of the perceived cross-regional price convergence. When we calculate price increases in euros, price inflation in Europe, the US and China looks similar.

Here, soft luxury brands are split into two groups: those that have continued to increase prices in China faster than in Europe (Louis Vuitton, Hermès, Burberry, Saint Laurent) and those that have increased prices in Europe faster than in China to close the gap (Gucci, Tiffany, Dior, Bulgari, Prada).

Interestingly, soft luxury brands with the strongest consumer traction in most recent years — Gucci, Louis Vuitton, Dior — are also the brands that maintain the biggest price gaps between China and Europe. Again, the law of supply and demand seems to be at work here, too.

For years, the Chinese government had pressured luxury goods companies to reduce the price difference between their products sold in China and Europe, so as to encourage repatriation of Chinese luxury spend made abroad to the Mainland.

In 2019, the Chinese bought luxury goods outside of the Mainland worth about €70 billion, or about 70 percent of their total €100 billion spend on luxury products. But Covid-19 has changed the game and, in 2020, Chinese consumers have done virtually 100 percent of their luxury purchasing at home, with their total spend around or above 2019 levels in the third quarter of the year.

Chinese authorities seem keen to try and maintain this situation and have amended duty free regulations accordingly. Thus far, Chinese appetite for luxury has far proven stronger than cross-regional price gaps.

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