Tricky art of pricing the most expensive luxury

If, like the French fashion house Balmain, you can sell a ripped cotton T-shirt for more than €1,000 (Dh4,514), you might wonder if there is any price your well-heeled customers won't pay.

It is a question the luxury industry has been posing for years as it skipped through the global financial crisis in diamond slingbacks - offered by House of Borgezie at €120,000.

"There is a tendency among the most high-end buyers to forget about cost. They want the best. They want what they want," says Michel Chevalier, the author of Luxury Brand Management.

It is the most expensive brands, dubbed "absolute" luxury, among them Hermès, Van Cleef & Arpels and Bottega Veneta, that are growing the fastest of all, thanks to emerging market demand, particularly from China.

According to Bain research, the "absolute" segment has grown 6 per cent a year, outperforming the general luxury market, since 2000. It now accounts for €40 billion of the €191bn luxury market and is expected to grow faster than other segments through 2014.

"There is limited supply of these products," says Thomas Chauvet, a luxury analyst of prestige and vintage cognacs and champagnes for Citigroup. "This is a fantastic opportunity to increase prices."

Analysts say prices in the luxury industry have surged from 2001 to last year and will keep rising faster than broader prices.

Thomas Mesmin, an analyst at Cheuvreux, estimates that prices for fashion and leather goods rose 62 per cent in that period, while watches and jewellery have risen 78 per cent. Euro-zone inflation, meanwhile, totalled just 26 per cent over the 11-year period.

Much of the rise in luxury prices occurred before the 2008 global financial crisis, but prices have been rising again since the second half of 2010. Cheuvreux estimates that luxury prices rose 7 per cent across the board last year.

Prices for champagne, leather goods, jewellery and the like have been particularly buoyant for the past two years.

A Hermès Cape Cod watch that sold for €1,300 in 2009 now sells for €2,200. A bottle of Moët & Chandon Rosé Impérial that sold for US$60 (Dh220) in 2010 in the United States now fetches $75.99.

LVMH, the world's largest luxury brand, has been especially assertive, raising prices in its Louis Vuitton and high-prestige champagne lines by up to 15 per cent last year. Mr Chauvet says systematic price increases at LVMH account for a third of its revenue growth.

One analyst noted that LVMH frets over the entry price for Louis Vuitton bags every year, knowing that too high would alienate some customers, but too low would cheapen the brand. "The entry price point at Louis Vuitton is agonised over," said the analyst. "I am told it is the single most important decision they make all year."

This pricing strategy contrasts sharply with more inexpensive fashion, where brands such as Gap are offering big discounts to attract bargain hunters and keep revenues up.

"Top luxury will cost more, while mid-priced fashion will cost less," says Brunello Cucinelli, a cashmere specialist who floated his eponymous company in June.

These prices could go up even more if leather and crocodile prices rise this year because of the drought now affecting the American Midwest, as they did last year when harsh weather in Australia helped to push up skin prices.

But the rise in commodity prices is likely to be only a small contributor to price increases. The best brands, including Louis Vuitton, many champagne houses, Hermès and Chanel fragrances, have operating margins of 40 to 50 per cent and gross margins well over 60 per cent, so they could comfortably absorb cost rises if they were so minded.

Margins will instead get wider as more luxury houses pull their products from department stores and set up their own flagship outlets, taking with them retail margins that can be 2.5 times the wholesale price. They can also then shield their brands from the dirty business of regular discount sales.

"No one wants to buy something rare and expensive and find out three months later it's selling for half off," says Fflur Roberts, the head of luxury at Euromonitor. "This doesn't engender respect for a brand. And luxury is about perception."

The question that many luxury retailers now face is how quickly to increase prices, especially in emerging markets such as China, where prices are already 50 per cent higher than in Europe because of taxes and import duties.

That gap is not sustainable and could inhibit luxury market growth in China if Chinese customers, who also account for about a third of sales in French stores, begin to feel they are being taken for a ride in their own markets.

The answer, it seems, is not to cap prices overseas but to let rip at home. Thus LVMH is likely to raise prices in Europe 10 per cent this autumn, says Mr Chauvet, to rebalance the China premium.