Anchored to luxury

Marketers often wonder at the size of the luxury goods market in China and the extraordinary ardor and passion with which the Chinese consumers have embraced this product category. While many factors contribute to China’s status as the largest luxury consumer in the world, the “anchoring effect” from behavioral economics also provides an important explanation.

It is well established by behavioral economists, that when the consumers are challenged with the task of estimating an unknown quantity or assessing the monetary value of a new product or service, they clutch at any straw they can get their hands on. Daniel Kahneman, in Thinking Fast and Slow, describes experiments where people take their cues from totally unrelated and absurd anchors in order to make some guesses about the quantities they are asked to estimate or prices they are willing to pay. One such experiment shows that the number arrived at after spinning a wheel of fortune, significantly influences people’s estimate about the number of African nations in the United Nations! Dan Ariely, who refers to this phenomenon as arbitrary coherence, proved that the last two digits of the participants’ social security number can influence how much they are willing to bid for a bottle of wine.

China is a unique market, which experienced a long and severe discontinuity of consumption and marketing.  After the cultural revolution once the economy started growing and more and more products started to appear, there were very few anchors for the consumers to compare the prices with. This served to the advantage of premium and luxury products, as there were no similar products in the market, and hence no unfavorable price comparison with existing products could be made. Luxury products, were therefore, free to establish their own price anchor, which was the same as their international price or often even higher. Despite the much lower income levels in China as compared to the developed markets (in 2015 per capita GDP in China was $8,028 as compared to the US figure of $56,155 – Source: World Bank), the high price did not serve as a major deterrent, and in fact served as a credibility enhancer by priming high quality. This factor has definitely been one of the key contributors to the growth of luxury brands in China.

Not only luxury brands, but even premium brands like Starbucks were able to charge the same price in China as did in the US, despite a much poorer target group – simply because there was no established anchor of what a reasonably good cup of coffee consumed in a comfortable and trendy ambience should cost. In fact in its home market Starbucks had a more uphill task of de-anchoring itself from the two dollar coffee lapped up by the American consumers from Dunkin Dounuts and other similar outlets (which they managed very cleverly by establishing a totally new aura and image around the brand and the product – including referring to the sizes of the cups as tall, grande and venti, rather than small, medium and large).

McDonald’s on the other hand maintains a significant difference in the prices between the US and China – a Big Mac costs $5.06 in America and only $2.83 in China (Source : The Economist January 14, 2017). When McDonald’s and KFC entered China, did they have an option to charge the same or comparable dollar price in China as in the US? Perhaps yes, and while it could be argued that it would have restricted their penetration and volume, it would definitely have made them more profitable.  Clearly they did have an opportunity to establish their own anchor, with practically no burgers and Western fast food chains in the market (if you ignore the local roujiabing, which even today remains a much more delectable alternative to the Big Mac).

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