There is an old saying that goes “If one person gets cancer on your block, check the person. If ten people get cancer, check the water.”

The economic corollary to this maxim is that individuals and small groups cheat the system all of the time. But when large groups of people cheat it is because there is a problem with the system.

In the case of luxury goods, the problem would seem to be obvious. After having invested millions or even billions of dollars in their brands, luxury goods manufacturers are ‘knocked-off’ by imitators who fake the logo and the appearance of these products but not the quality of the real thing.

This advertising blog has generally held the opinion that imitation is the sincerest form of flattery. While Luis Vuitton, Rolex and the rest need to make a public show of stamping out imitators, they should be secretly pleased. The counterfeit goods market can be seen as a sort of shadow stock market for brand equity, showing which luxury brands command the most respect among ordinary people.

As a branding tool, in fact, counterfeit goods may even give luxury brands a useful advantage: they give ordinary people access to these brands without cheapening the brand. Why? Because anyone who owns a knockoff has tacitly endorsed the brand proposition. These people know they have knockoffs. They may not have the funds or the stomach to spend $10,000 on a Gucci purse, but they know they don’t have the real product in their hands. And at the heart of it, they still would rather have that $10,000 purse. So they are buying in to the brand’s value equation, whether they realize it or not. That actually strengthens the brand. And it is actually a safer way for the brand to let average consumers interact with it than launching a value line (which can degrade the brand image) or selling $100 t-shirts.

But something has changed recently that should make luxury goods manufacturers think seriously about their pricing strategy.

There has been a gradual shift of luxury manufacturers to China to lower production costs. This has been true for some time on certain items like clothing but has become more widely practiced as quality out of China has increased dramatically.

The “China effect” is well known throughout manufactured goods. But in luxury items, this effect has played out very differently than in other categories. The price for high quality home furniture has plummeted because of the China price. Electronics have also continued to both improve in capability and drop in price, partly because of improving Chinese manufacturing capabilities.

But with luxury goods, the “China Effect” has not had an impact on price. In fact, luxury goods manufacturers have learned to segment their markets even more finely, discovering super-premium segments in premium categories. Basically these manufacturers are just taking advantage of lower production costs without providing any new consumer benefit. (NOTE: This advertising blog is sensitive to the fact that there are many segments in the fashion and luxury industries and some of the middle-ground players like Banana Republic are taking advantage of the China price to offer better values to consumers.)

This has created an opportunity for knockoff goods manufacturers to produce virtually the SAME GOODS as luxury manufacturers and still capture good profits by selling them through illicit channels. The Wall Street Journal today reports on this trend, noting that “As more genuine luxury items are produced in China, more counterfeits are being manufactured nearby – often using the same technology.”

We believe the problem here is not in China, but with the brand strategy of the luxury goods manufacturers. The value equation has shifted, and the instinctive response of the luxury goods manufacturers has been to avoid cheapening their image by lowering the prices they charge to consumers. While this advertising blog believes that luxury goods have emotional benefits which have real value and this can create higher margins which are justified for the manufacturer, there is a limit. That limit has been reached.

Luxury manufacturers are in grave danger now of having the entire brand proposition for luxury destroyed. If consumers begin to believe that there is no functional difference between the luxury goods and the knockoffs (they don’t last longer, perform better, feel silkier, etc.), then they will stop believing that premium brands have extra value over products providing the same functional benefits. This will break down the ‘marketing lies’ that Seth Godin argues are part of the contract between consumer and the brand. And then luxury goods will, ironically, become another commodity category where product attributes will be the only relevant points of comparison for the consumer.

There are two choices facing luxury goods manufacturers wishing to avoid this fate. Start differentiating the product (using more expensive materials, more labor intensive processes, etc) or lower the price of the brands. Either action will lower margins. But doing neither may have a worse result in the long-term.

This entry was posted on Friday, December 9th, 2005 at 12:33 pm and is filed under commentary. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.