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If familiarity breeds contempt, then the term 'luxury' has become contemptible over the past few years. The luxury goods industry is currently worth about $134bn (£74bn) and is set to grow by 4% this year, according to consultancy Bain & Co, but it is facing something of an identity crisis. When a cat food or breakfast cereal can call itself a luxury product, where does that leave Bond Street and Fifth Avenue?

And if Coronation Street stars can hit the nightclubs dressed in Gucci and Versace, how do luxury brands retain their traditional smart, high-earning core customers?

In broader commercial terms, the luxury industry is facing a particular dilemma: how to grow its markets and expand its businesses while maintaining its most essential asset: exclusivity. As standards of living rise and consumers are exposed to images of luxury goods and wealth with the growth of celebrity culture, a democratisation of the luxury market has left many questioning the very definition of a luxury product.

'Luxury brands need to keep expanding their businesses because their shareholders demand it,' says Bill Bachle, chairman of trade organisation the Luxury Marketing Council, which has more than 500 corporate members.

'Thirty years ago, Bond Street and (New York's) Madison Avenue were selling to a very small club, but now even in the most benighted parts of the UK people can list the names of luxury products,' adds style consultant Peter York. The emergence of the grey market has also driven the issue, with once exclusive brands now available to everyone.

Diffusion lines

'Some of the biggest customers of Calvin Klein are non-fashion, price-restricted customers. Why? Because they are the ones buying three-packs of Calvin Klein underpants in Asda. As a result, no one can take the brand seriously anymore,' says Sanjay Nazerali, managing director of brand consultancy The Depot, whose clients include Kenzo and Ferragamo.

One solution to this devaluation of luxury has been to try to keep ahead of the mass market with the development or 'super-luxury' or 'uber-premium' brands. 'Brands such as Armani Prive or Burberry Prorsum are exploiting a migration to super luxury and creating a new market segment,' says Nick Liddell, director of brand valuation at Interbrand, whose clients include American Express and BMW. But the danger here is that the mainstream brand is devalued - and is a self-styled six-star hotel really any more likely to appeal to a first-class traveller than a five-star hotel?

During the 80s and 90s licensing was seen as the way forward for smart labels, which lent their names and logos to everything from sunglasses to key rings and baseball caps. But as the balance sheet benefited from these brand extensions, the all-important brand image suffered. One of the first companies to realise this was Gucci.

'Under (chief executive) Domenico De Sole and (designer) Tom Ford, Gucci spent years buying back licenses,' says James Ogilvie of industry publication Luxury Briefing. 'It was the start of the recovery of the Gucci brand.'

Yves Saint Laurent, which is also owned by the Gucci Group, has cut the number of licences it grants from 167 to 15. 'Let's face it, the brand was in a mess when we bought it,' admits Robert Polet, the group's chief executive. 'Now it has been cleaned up.'

These days, luxury brands have learned their lesson about licensing. 'If you license something it must follow on from the core brand image and it must have some integrity,' explains Dunhill chief executive Simon Critchell. 'Everything that we license comes from our motoring heritage.'

Other luxury houses, such as family-owned Italian footwear and accessories specialist Ferragamo, have maintained their image by simply avoiding licensing.

'We are in total control of the process of production,' says chief executive Leonardo Ferragamo. 'We control all manufacturing to guarantee consistency. We have one licence, which is for our sunglasses.'

Joshua Rex, senior consultant at Ledbury Research, believes that luxury brands need to return to a focus on customer experience. 'The in-store service, which is just one of a multitude of experience triggers, should be a key point of differentiation for luxury brands.'

Defining luxury

The development of products created for individual customers is another trend in luxury brand differentiation. 'We are witnessing growth at the super-luxury end of the market that is driven in part by demand for bespoke products,' says Rex.

Giles Hedger, planning director at advertising agency Miles Calcraft Briginshaw Duffy, suggests other ways to bring luxury brands back to their core strengths. 'You can re-establish a luxury brand by limiting it through price, distribution and even awareness so that only the right audience knows about it,' he says. 'The second option is excellent customer service or simply offering something more than the competition - Ocado grocery delivery is a luxury, for instance, as are a few extra inches of leg room in an aeroplane.'

If developing a distinct luxury proposition is becoming difficult, targeting appropriate audiences is even trickier. As other sectors are fast realising, advertising alone is not enough, and co-branding events are fast becoming the means to position products with the people most likely to buy them.

Careful positioning

'We are increasingly using events to reach our audience by aligning our brand with luxury partners,' says Sharon McLaughlin, global brands PR manager at The Macallan whisky distillery, which also has tie-ups with the American Express Centurion card. 'We are very specific about those partners,' she adds. 'We had a two-day event with a group of Rolls-Royce owners, for example, at which they visited our private fishing beat and tasted our fine and rare range.'

Differentiating the luxury end of a brand from its respectable, profitable but less glamorous sibling products is becoming more common. Collaboration can be a useful tool, explains Jackie Cooper, founding partner of Jackie Cooper PR, whose clients include Courvoisier cognac. 'Courvoisier cognacs sell at up to £10,000 a bottle, but also at £18.49 in Tesco,' she says. 'You have to look at both ends of the market, which is challenging.' One example of this came in 2003 when, to emphasise the brand's upmarket image, Cooper arranged a collaboration with handbag designer Anya Hindmarch for which Hindmarch created a Courvoisier clutch bag using her signature photographic images on gold nappa leather.

Luxury brands must also take a longer-term view than other brands. 'Luxury has to be more than a fad, desirable today and forgotten tomorrow,' says Cooper. Nazerali agrees. 'You need to divorce luxury from fashion because fashion moves very quickly and real luxury products can't do that. Luxury cares where it is made, whereas for fashion it doesn't matter - Italy or Indonesia, it's all the same,' he says.

Indeed, provenance is now part of the integrity of a true luxury brand.

'We are returning to the idea of craftsmanship and individuality and away from the product's price tag,' adds Nazerali. 'Luxury clothing and accessories have to become works of art to differentiate themselves.'

Interbrand's Liddell argues that consumers knowing where and how an item is made will emphasise its luxury status and improve their emotional relationship with it. 'Exclusivity is also important,' he says. 'There is a trend for quirky limited editions and brands such as Comme des Garcons are opening guerrilla stores in edgy areas.'

But Nazerali has a more challenging view of where luxury needs to go to continue to be something that is much sought after but enjoyed only by the few. 'It might be time for luxury to place itself as free from stress in its positioning,' he says. 'Things that are very difficult to label and position in traditional marketing terms.'

Marketers of luxury brands have their work cut out if they are to truly differentiate their products.

BURBERRY

The image of quintessentially English brand Burberry has suffered because of its association with soap stars and its adoption by young working-class consumers, including chavs. 'I walked past a nightclub in South London that had a sign saying "No jeans, no trainers, no Burberry". That says a lot about a so-called luxury brand,' adds Sanjay Nazerali of brand consultancy The Depot.

On reporting in January that third-quarter figures showed underlying sales growth had slid to just half the rate experienced in the previous quarter, finance director Stacey Cartwright admitted that the chav connection had 'not been helpful'.

Burberry has been fighting back with the launch of the Burberry Prorsum range, which features little of the signature beige check so beloved of the brand's customers who do not fit the luxury consumer profile. 'The chav phenomenon is a storm in a teacup,' says Joshua Rex of Ledbury Research. 'It only features in the UK and that accounts for just 10% of Burberry sales.'

DUNHILL

'Dunhill has done a good job of reviving itself and putting a new spin on the idea of the English gentleman,' says Ledbury Research's Joshua Rex. 'It used to be all about gold cigarette cases and lighters, but Dunhill has managed to become smart without being stuffy or boring.'

Careful licensing has helped Dunhill control its image and limited department store concessions allow the brand to maintain a suitable customer environment.

Sponsorship and co-branding opportunities with English cricket and the Goodwood Festival of Speed have helped emphasise its associations with traditional masculine British sports which are nonetheless smart and subtly sexy.

MERCEDES

Mercedes' tie-up with easyCar damaged its reputation as a luxury marque. 'Suddenly people were saying "Hey, I can drive a Merc for a tenner day", and that is not what top-of-the-market cars are about,' says one luxury car reviewer.

Its reputation for customer service is also in decline. In last year's JD Power motor survey, Mercedes' highest placing was with its E-class model, which came 41st - equal with the Nissan Primera in a field of 120 cars. Every other Mercedes was placed in the bottom half of the table.

Mercedes owner DaimlerChrysler recently resurrected its Maybach marque after 60 years to compete with super premium brands such as Rolls-Royce.

Whether this will emphasise that only Maybach is a real luxury Mercedes remains to be seen.

HERMES

'Hermes has maintained exclusivity and traditional qualities although it has been expanding, especially in Japan, for instance, where it has opened a number of stores,' says James Ogilvie of Luxury Briefing. 'It is often cited by the luxury industry as the one that got it right.'

The group has a wide range of product offerings, from jewellery to homewares, but a distinctive style and a clear creative direction. One reason is that it avoids the temptation to run with fashion themes, according to The Depot's Sanjay Nazerali. 'Hermes just seems to do whatever it wants.'

Nick Liddell of Interbrand adds: 'Hermes seems to be insulated from the problems faced by many other luxury brands - mainly because it has maintained rigorous control over areas such as image and licensing.'

Having no star designer in the mould of Tom Ford (formerly of Gucci and Yves Saint Laurent) might have cost it gossip column inches, but it has enabled Hermes to let its product design and store concept speak for themselves.

THE BASICS

Luxury goods

- The number of 'high net worth individuals' is increasing around the world. In 2003 the number of dollar millionaires rose by 7.7%, according to Richemont Swatch Group, which owns the Cartier and Mont Blanc brands.

- Europe accounts for 34% of the global luxury goods market, the US 30%, Japan 16% and the rest of Asia 16%, according to German consultancy Convensis.

- Ledbury Research estimates that the diamond jewellery market is growing at about 10% a year.

ESSENTIALS

Dos and Don'ts

Do limit licences. Brands need to ensure that licensed products are well made and in keeping with their core business and image.

Do improve customer service. Like all consumers, upmarket product buyers are becoming more demanding. Luxury is now as much about the retail experience as the item itself.

Do maintain brand integrity and authenticity. Luxury leather goods are best made in Italy by traditional craftsmen, not mass made in the Far East.

Do control retail outlets and all customer interface. 'Online selling is exploding in the luxury market,' says Bill Buchle of the Luxury Marketing Council. 'Moneyed customers have access to it and you must control the retail environment.'

Do develop synergies with other luxury brands. Events and sponsorships, rather than advertising, help customers get closer to, and feel an affinity with, products aimed at them.

Don't expect the core luxury brand to benefit from the introduction of super luxury diffusion lines.

Don't allow short-term concerns about increasing profits to outweigh long-term considerations about the direction and image of the brand as a whole.

Don't assume that associating your product with celebrities will improve brand image. Glitzy personalities can put off your more loyal but low-key consumers.

Don't rely solely on advertising, even in glossy magazines.

Don't tailor marketing to the mainstream. Luxury products should appeal to the individual.