The Perils of Going Down Market

Investors would be well advised to carefully review any company strategy that proposes to increase demand by moving to capitalize on its brand name by introducing lower priced products.  High priced and universally admired brands tend to benefit from exclusivity.  Rolex watches and Jimmy Choo shoes are far more than time pieces or footwear.

Any effort to develop and market significantly cheaper versions of these products are likely to disappoint the buyers of the lower priced version, thus not achieving the expected increase in demand.  At the same time, the existence of a cheaper product would reduce the exclusivity feature that probably drove much of the demand for the expensive line.

An excellent example of this phenomenon was Packard Motor Car Company.  Prior to World War II, Packard was considered to be one the most highly regarded manufacturers of luxury automobiles.  During the war, Packard converted to 100% war production.  After the war, Packard sought to return to the passenger car business with, increased volumes, by emphasizing middle class models.  The company lost its premium customers and was unable to compete in the middle market.  By 1957, Packard had virtually disappeared

Currently, we are going to be able to observe another effort to broaden demand for an automotive product.  Today, Tesla is marketing its acclaimed Model S, with annual volume on the order of 30,000 units, at a typical retail price approaching $100,000.  In the near future, the company plans to introduce the Model X, a crossover SUV, which is also expected to be low volume, highly innovative and again retail in the vicinity of $100,000.  The next step is the proposed Model 3, which is aimed at the mass market with a planned retail price of approximately $35,000.

Will this work?  Are Model S and X buyers going to continue to pay $100,000 for what has been a very innovative and exclusive plug-in electric, when the guy next door is buying a vehicle with substantially the same functional values for $35,000?

There have been numerous instances of established enterprises (Coach, Jaguar with the X Type and Cadillac with the Cimarron, for example) seeking to move down market, with little success.  Investors should be aware that material departures from an established business plan can increase risks and should act accordingly.

All comments and suggestions are welcome.

Walter J. Kirchberger, CFA®