The dirty little secret among luxury goods companies is that they have been persistently overcharging their best customers in China

April 25, 2013, 1:13 p.m. ET

Luxury-Goods Firms’ Little China Secret

By WEI GU

Makers of luxury goods have found a way to add to their profits: Charge Chinese consumers more than their counterparts in the U.S. and Europe. The WSJ’s Wei Gu tells Deborah Kan why luxury cars and fashion brands are more expensive in China. The dirty little secret among luxury-goods companies is that they have been persistently overcharging their best customers in China. With Chinese appetite for everything from expensive cars to handbags is starting to moderate, companies that count on the country as a big growth driver may have to do the unthinkable and lower their prices.

A comparison of three models from Mercedes-Benz, Audi NSU.XE +0.16% and BMWBMW.XE +1.55% shows that, on average, listed prices of luxury sedans in China are 64% more expensive than similar vehicles sold in the U.S. This looks counterintuitive, considering goods made in China are supposed to be cheaper.The listed price of a Mercedes C-Class in China starts at $57,120, or 62% higher than in the U.S. Similarly, locally made Audi A4 and BMW 3-Series are 54% and 76% more expensive in China, according to Bernstein Research. The gap is even bigger when it comes to imported vehicles.

Prices in China already include consumption taxes and value-added taxes, while the ones sold in the U.S. don’t. But even stripping out all the taxes, those three vehicles are still an average of 37% pricier in China.

The makers of the three cars argue vehicles in China include more features. But that alone may not explain the price difference.

The high base factor—cars sold in China used to be even more expensive before the country joined the World Trade Organization and started to make cars at home—has bought foreign auto makers time. They had little incentive to lower prices, since demand was so overwhelming. Customers used to have to pay extra if they wanted to get their car early.

But that is changing now. There are more models available, and demand has softened. This year may be the turning point. Total sales of Audi, BMW and Mercedes in China rose just 6% in the first quarter, compared with 25% in the fourth quarter. BMW said at the Shanghai auto show it expects China sales growth in the upper single digits, after a 40% jump in 2012.

“The risks of a price war in China are building,” said Max Warburton, Bernstein’s auto analyst. “Too many companies are dependent on China right now. Price competition would intensify if sales continue to grow at the current pace.”

Fashion companies face the same pressure. LVMH MC.FR +1.29% shares dropped recently after the company said China sales were “flattish” in the last year or so. The way to win back price-sensitive Chinese consumers, who are serious bargain hunters even when they shop for a $2,000 bag, may just be lower prices.

Luxury-goods makers have always been reluctant to be forthcoming about pricing. But the surge in Chinese overseas travelers has made it harder to keep a secret. The same Gucci Joy Boston handbag was 54% more expensive in China than in France in 2009. The premium widened to 62% in 2012, according to European broker Exane BNP Paribas, even though an appreciating yuan should have made imported goods cheaper.

Traditionally, leather and fashion prices are 50% higher in Asia than in Europe. Gucci said the price difference is mainly due to taxes, duties, transportation and currency fluctuations, but those differences explain just 70% of the price differential, according to Luca Solca, Exane’s luxury-goods sector head. Mr. Solca said he wouldn’t be surprised if the premium narrows more in response to slowing demand growth.

Buying abroad allows Chinese consumers to get around the “China premium.” That is a problem for luxury-goods makers, which could see their stores in China reduced to window displays while they get punished by investors for soft China sales.

Some companies have started to narrow the price gap to entice consumers to shop at home more. The differential between Beijing and Paris for Louis Vuitton products fell to about 30% this year from 50% in 2012, the company said.

Luxury goods sold in Japan used to sport a premium, too, but that has shrunk as demand slowed, said Aaron Fischer, head of consumer research at CLSA. The “Japan premium” on the Louis Vuitton Speedy 30 handbag was cut in half in the past three years to 24% in 2012, according to Exane BNP Paribas.

Lower prices in luxury-goods makers’ most lucrative market will bring pain. A 10% price cut for Mercedes, Audi and BMW means profit per car sold in China will be a third lower, assuming production costs in China are the same as elsewhere in the world.

But over the long term, for the companies’ brands, investors and customers, it makes sense to bow to reality.