The Market for Luxury Watches & Price Elasticity of Demand

Digital technology continues to transform so many areas of life and one of these is time itself. In the past, to know the time, we consulted wrist or pocket watches, with hand mechanisms driven by mechanical moving parts. For most of us, mechanical spring-powered timepieces have for some time been replaced by quartz-battery powered watches, but now these are giving way to mobile phones and digital smart-watches for telling us the time. The market for traditional watches is contracting — and as it contracts, it’s character changes. Classic watch makers like the Swiss firms of Hermes and Rolex are seeking to exploit this changing character, to maintain their profitability.

In order to maintain profitability, they need to change the price elasticity of demand for their products. Price Elasticity of Demand (PED) measures the responsiveness of quantity demanded of a good to a change in the price of that good.

It is measured as follows:

Percentage Change in Quantity Demanded

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Percentage Change in Price

Goods where the percentage change in quantity demanded exceeds the percentage change in price have what we call ELASTIC demand. By contrast, those where a change in price initiates a relatively smaller percentage change in demand have INLEASTIC demand. Price Elasticity of Demand can have important implications for a firm’s revenue. If demand for its product is ELASTIC then if it raises its price demand will fall by a larger percentage and its revenue will FALL. By contrast if it lowers its price, demand will increase by more and its revenue will increase. So where demand is Price Elastic, there will be a tendency for firms to lower prices and increase its income. Firms facing an Inelastic demand line will tend to raise prices and so revenue and profits.

The effect of technology in the time-piece industry has been to shift the demand curves firms face, making them more INELASTIC. As a result, watch firms are raising prices and making more high-end luxury products. The following diagram helps us to understand this process.

We can think of the market for watches as segmented into two main components:

Ø First there are regular watch users. They just use a watch to tell the time. They are not so wedded to traditional time pieces as such and are happy to use a phone or smart watch if it does the same thing. This group of people therefore have ELASTIC demand and their demand curve is represented by the green ‘more elastic’ line. Here the watch companies can’t afford to raise prices very much and so they will tend to market lower-priced more basic watches to this cohort.

Ø Second there are people who want watches as they want the luxury of a high-status time piece. They value the classic style of leading Swiss brands. These people place a premium on quality, craftmanship and design and they will pay a lot to get them. Their demand curve is INLEASTIC and is shown by the steeper ‘less elastic’ blue line.

Quite simply, in recent years the more elastic, basic, demand is falling as these people are shifting to smart watches or using their phones. In the last ten years total demand for Swiss-made watches has fallen by 50%. It is harder and harder for firms to make money producing for this market and they can’t easily raise prices. Hence watch companies are abandoning this lower-priced elastic demand section of the market. Instead they are targeting high-end buyers of luxury watches. This set of people are prepared to pay high prices, and by adding special unique design and marketing features, they can be persuaded to pay even higher prices — their demand curve is becoming even more INELASTIC and prices are being pushed up even higher. Breitling watches, for example, start at a price of $3,300. According to the Federation of the Swiss Watch Industry, the strategy is working: “Mid-year reports coming in from luxury groups such as Richemont and LVMH relay revenue growth across the board…..We’re seeing the strongest performance in the market within the ultra-rare and collectible space, and consumer interest, as measured by demand, has rapidly grown”

We can therefore see how Price Elasticity of Demand is shaping the developing market for watches as firms target consumers with INELASTIC demand. So next time you are in the market for a watch, don’t be surprised that the cheaper end racks are bare and it’s the specialist luxury Rolex and Breitling which dominate — since these are the brands where the profits lie.