﻿Let’s give all of you watching some homework. This is a Rolex Daytona, or more specifically
a Rolex Daytona 116500 Lunette Noir, which I do realize saying out loud makes it sound like a piece
of French agricultural equipment, so most people just call it the Panda. Pretty cute, right?
Anyway, the homework… I want to play a little game, I want you to go to an authorized Rolex dealer in
your respective city and buy this watch. You don’t even need to haggle on price, just try and buy it,
it should be worth the equivalent of $13,000 to $15,000 USD depending on
your local exchange rate and sales taxes. Pretty steep, but for dropping small car money on
a shiny piece of metal that tells time worse than your iPhone, you would at least expect they would
roll out the welcome wagon at the shop, right? Well, chances are they probably won’t.
Now, if you're thinking, "What gives Mr. Economics Man, you want me to drop a quarter of the average
American’s income on a watch from a store where they're just going to snub me? This sounds
like the worst piece of homework ever." But, here is the kicker: if you do buy one from one
of these particular watches from an authorized dealer, you have just made yourself an easy
$15,000 to $20,000 in a few hours. Not bad, right? Now, if you're thinking
all of this sounds too good to be true, let me give away the secret...
It’s almost impossible to buy one of these things. Trust me, I wanted to get one to celebrate the
channel getting over 1 million subscribers and I basically got laughed out of the shop.
So, if by some miracle you do manage to buy one at retail price,
there will be a line of people willing to buy it back off you at a 100% markup or more.
So, what is going on here? This particular watch is just one
example of a new phenomenon of consumer goods that are theoretically for sale
but you can almost never buy. Now, you might say, "Well, that sounds like everything
right now, from PlayStations to toilet paper." And sure, there are some similarities here, but this
particular class of goods is a little bit different. For starters, this isn’t a temporary supply chain
issue caused by an unforeseen global pandemic, this has been going on for years and years.
What’s more, is that these items don’t have to adhere to price controls in the same way
that regular consumer goods do, so there is nothing stopping these companies from
charging the demanded market price for these products and pocketing an extra
$20,000 per watch or $10,000 per handbag or million dollars per car as pure profit.
But they are not, and there is a very good reason why…
So, what are these items that can so easily break market expectations of supply and demand?
Why don’t these companies just charge more for these items and make themselves more money?
And finally, how is this whole practice actually entirely logical within our traditional
understanding of economics?
So, we have already seen one example of these products,
but there is a pretty diverse range of them. It’s everything from certain luxury wristwatches to
designer handbags, invite-only sports cars, and even things like sneakers.
These products all have a few distinct things in common. For starters, they are obviously
all luxury goods. But just being a luxury good itself is not enough to be classed as one of
these market-breaking goods. I could walk into a Gucci store tomorrow and buy this hideous sweater;
it doesn’t mean that I could then turn around and sell it on eBay for double the price,
if anything, I would be lucky to sell it at all.
The next thing that they have in common is that they are limited in supply in some way. Some
companies do this directly like automakers who might only make a set number of a certain car, and
other companies do this indirectly like a fashion brand refusing to produce their bags outside of a
small studio in France to maintain quality. The third ingredient is obviously strong demand,
which should go without saying, but there is a little bit more going on
here than you might expect, so remember this for later because it is really important.
Finally, there is an unwillingness to move on price. Typical market expectations go something
like this: if demand exceeds supply, then prices rises to such a point where demand and
supply are equal and everybody that is willing and able to purchase an item at
the new higher price point has done so. Now, this is especially true for these types of
totally unnecessary items, because they are what is known as Veblen Goods, or goods that actually
attract more demand as prices increase. We have looked at Veblen goods in detail in our
video on the luxury goods market, so I don’t want to repeat too much here. But, basically,
if you are buying something to -- let’s be honest, show off -- its usefulness is directly
proportional to how expensive it is. A $500 coach bag? Eh, that’s cool. But a $20,000
Hermes Birkin? Oh damn, that person’s got the cashola.
A $1,000 Longines might look identical to this $150,000 Patek Philippe, but the people that know,
know that one of these is a great watch and the other identifies you
as the most important person in the room. So, why then are these companies not just playing
into this and jacking up their prices to such a point where they can get the most possible money
out of the most possible people? Well, the official answer they will give
is that they are all about the artistry, and they want to make sure that anybody that is
truly passionate about the brand is able to afford one of their watches, or bags or whatever.
So generous of them to be so concerned about the affordability of their 5-figure
fashion accessories. But anyway...This might almost start to make sense when
you consider companies like Rolex are actually owned by charitable foundations, in their case
the Hans Wilsdorf Foundation. But most aren’t. Most are owned by giant multinational corporations
with shareholders who want to see a return on their investment, artisanship be damned.
Even beyond that, sure, Rolex is technically owned by a charity, but that charity would be
able to do more if they made more money. So, the reason these companies give for not
charging more money for their products doesn’t really hold up to too much scrutiny.
So, the real reason they do this is twofold. You might have noticed one last similarity
between these products, and that is that they are sold by authorized dealers, not
the companies themselves. You are probably most familiar with this in the context of a car.
If you want to buy a new pickup you don’t go to the Ford website or into a Ford store,
you go to an authorized Ford dealership which is technically a middleman between
the manufacturer and the consumer. Why that is, is a whole separate story but,
for now, just remember that for better or worse these dealers handle the retail
sales of the manufacturered product. Now, this relationship works well in a few ways,
it means that manufacturers, especially boutique luxury manufacturers, can focus on what they do
well. It also means that they don’t need to handle operations in dozens of different countries.
But, of course, with that ease of operation come a few points of tension,
some dealers might want to charge more or less for a given product, while others might
aggressively compete with other dealers that just so happen to be selling the same brand.
Dealers may also want to go about selling their products in a certain way that might land them
a commission in the short term but damage the brand in the long term. Just imagine,
if you had a terrible experience at a car dealership, you wouldn’t think, “Oh, Bob’s Chevy
and Pontiac Automotive Group” are terrible, you would think that Chevy and Pontiac are terrible.
Of course, manufacturers can always sever relationships with the dealers
that sell their products, but that’s a bit drastic. What works better is saying,
“Hey, if you sell a lot of our cars or watches or whatever, we will send you some stock of these
ultra-limited and highly in-demand models.” A Ferrari dealership that keeps Ferrari happy
will get an allocation of SF90s. A Rolex boutique that sells lots of models that are less in demand
while maintaining the product image of Rolex, will be given Submariners and GMTs and Daytonas
that will sell instantly. Now, this is really important for
these dealerships because even though they are still not allowed to sell these rare
items for any sort of markup, they can use them for something much more important:
building relationships with crazy rich people with more money than common sense.
If a car dealership says to a regular client of theirs, “Hey, buy 10 of these regular Ferraris,
and when we get an allocation of a really rare model, we will make sure you are first on the list,
then they have a pretty good shot at selling some very expensive automobiles.
They might never say it in as many words, there is normally a lot more wink-wink,
nudge-nudge. But, that’s basically what it boils down to.
So, now that we understand all of the players in this market,
we can see that it is all pretty logical. The manufacturer makes a whole bunch of items
including some very special items in very limited supply. They can be sure that the dealers that
work for them will be more than willing to buy up all of their regular stock,
in the hope that they get a nice healthy allocation of the special in-demand stock.
These dealers can then leverage access to these rare items by encouraging their customers to buy
up more and more of the regular stock in exchange for their name being bumped up the waitlist a bit.
This means more sales for them and more commission than they would have
otherwise got for just selling the rare items at their fair market value.
And don’t think this little dance screws over the end customer either.
So long as they actually do get to buy the rare product that they were informally promised,
they would be in a pretty good spot. If they actually want to keep the product great,
they get the ultimate status symbol, something that is obviously expensive, but also so exclusive
that their rich golfing buddies wouldn't even have the privilege of being invited to buy it.
If they wanted to sell it, well, that’s where things get interesting...
We have already seen that the difference between the retail price and the fair market price of
these items can be huge. Some extreme examples like a Patek Philippe Nautilus can sell for as
much as 5 times what they are worth retail, so if anything the client is probably the
biggest winner in this deal, right? Well, not necessarily, because simply
looking at this transaction in isolation ignores all of the other goods that they
would have had to purchase to be granted the privilege of buying these exclusive items.
If you needed to buy ten Ferraris in order to be invited to buy one limited edition car,
you have probably dropped at least 2 or 3 million dollars in the process. Suddenly,
the one million dollars you might make by flipping this exclusive car doesn’t sound so amazing.
And you might say, “Yeah, well, if they really wanted to they could sell the other ten cars too,
right?” And yeah, they could, but there are actually two major problems with that.
For starters, this is where we actually get to find our market equilibrium. If, for example, you wanted
to turn a profit by buying a fancy watch at retail and then reselling it in the secondary market,
you are going to need to buy up a whole bunch of unpopular watches first.
Each one of these purchases is going to lose money, even though they might be luxury goods,
they aren’t that hard to find, so they don’t demand the secondary market premium.
Let’s say you need to buy ten watches to be offered a special watch and each one of
these watches loses you $2,000 on average in the difference between the retail price and
the secondary market price. Well, that means that when you do turn around and sell all of these,
you have, at best, broken even. Not great when you consider the time and
effort that went into this process. Not to mention the fact that you might not get offered one
of these watches to purchase. You would be tying up hundreds of thousands of dollars in capital,
locking in a significant loss, all in the hope that maybe you would be offered a watch,
in which case you would make a tiny profit if you're lucky. Not a great deal.
The particularly astute amongst you might see what has happened here, though.
This is market equilibrium. Don’t think of Rolex or Hermes or Ferrari as selling
individual watches, handbags, or sports cars. Think of them as selling collections. They
have priced their collections perfectly. Sure, they could sell their special goods for
more, but then people wouldn’t be willing to buy up all of these qualifying pieces.
What they have effectively created is an auction house in disguise.
People don’t bid directly with cash, they bid with how many regular luxury items with insane
markups that they are willing to purchase. What this means is that if someone really does
just genuinely want a nice watch, they are often better off just buying it at the resale price,
because they would end up blowing just as much doing it the other way.
These items don’t break market expectations, they just shift them around a bit.
Now, the other reason that you might find it hard to create a profitable little side hustle
by flipping luxury goods is because the manufacturers are surprisingly tough on this practice.
Ford may not be the first company you think of when it comes to high luxury, but they have
recently released one of these ultra-limited run products with the Ford GT. They invited 400 people
to purchase these cars and almost everybody did because, you would be kind of silly not to,
right? Even if you didn’t like the car you could flip it for a healthy profit.
Well, Ford knew this, so they put stipulations into the contract of sale that the car could
not be resold for the first 24 months of ownership. Sounds pretty weird to be told what
you can do with your own property, right? Well, John Cena of all people thought so too,
as he was one of those lucky 400 people invited to buy the $500,000 car,
and then he almost immediately resold it for $1.54 million. Not a bad little deal.
But, needless to say, Ford was not super happy about this, and actually took him to
court before forcing him to settle the case for an undisclosed amount.
There are numerous other cases just like this where the brand will try
very hard to stop people from openly scalping their ultra-exclusive goods
because it kinda makes them look bad and detracts from the whole brand appeal that made this insane
process possible in the first place. Now there is one last group at play here,
the actual end-users. Remember when I said demand for these products was
something to keep in mind throughout this whole video? Well, I hope you have been because this all
ultimately still relies on people that are willing to put a $30,000 watch on their wrist.
Market demand relies on a variety of factors, but one of the biggest ones is the expectation
of future price growth. We have explored this in a few videos as well as our video last
week on China’s insane real estate market. The reason it’s important here is that throughout
this process certain luxury goods have managed to disguise themselves as investments with a healthy
expectation of future price growth. You might hear of people talking about how
it’s actually cheaper to own a Rolex than it is to buy a Seiko because after you get bored of
your Rolex you can sell it for the same price, if not more than you purchased it for.
Now, there are a few problems with this. I mean, for starters, that money could have been invested
and been making more money, but ultimately they are not entirely wrong until they are.
This whole process is reliant on end-users demanding ridiculously expensive luxury items.
The demand from those end-users is going to be a lot higher if they can convince their husbands,
wives, accountants, or even themselves that this isn’t a terrible investment.
Hiding the fact that these really are just normal products that respond normally to
the forces of supply and demand maintains the illusion that these items are something
so special they deem themselves worthy of being classed as investments.
So, why is this important? Silly rich people doing silly rich people things with other
silly rich people? Interesting, maybe, but far from consequential right?
Well, maybe not, as the pandemic has shocked supply chains, a lot of regular companies are
starting to see the power of these semi-attainable halo products. Luxury goods are the logical place
to start this scheme thanks in equal parts due to their distribution network, their insane margins,
and, let’s be honest, their loose relationship between price and utility value.
But there is no reason that this marketing tactic couldn’t slowly move downmarket,
PlayStation 5s only being made available to gamers with the largest Sony-exclusive content libraries.
Don’t tell me that sounds totally unreasonable.
But, for now, anyway, I am just going to need to sit here and hope that one day I'll
be given the chance, nay, the honor of being able to drop a dumb amount of money
on a shiny wrist trinket that commemorates passing a million subscribers on YouTube.