Trading Down: How Will Frugality Affect Retail Spending?

It's hip to be cheap! I know, I have a vice-like grip on the obvious. But the trading down trend that is being reported in the media may be more than just a knee-jerk reaction to the economic slowdown. This time "cheap chic" may not be fad but a long-term shift in attitude. So let's explore the "new frugality" and its implications for the economy, markets and even New York's Real Estate market.

In case any of our readers recently woke up from a coma, let's review some recent news from the world over. First and foremost, according to CNN, the Federal Reserve's flow of funds report released yesterday showed consumer debt fell at an annualized $30 billion rate in the third quarter. This is the first time this data series has shown a decline since data started being reported in 1952. The CNN article notes that according to the report, U.S. households have lost $2.8 trillion in wealth during the quarter, an 18% rate of decline, which has only been eclipsed once in the past 56 years. So how's that for a cold shower? It's no surprise people snapped their pocketbooks shut. The question is: Does the trading down behavior we are seeing along with the spending pullback just represent a reaction to the market crash or a long-term change in behavior? Let's check out how people have reacted globally.

According to CBS Marketwatch, David Dillon, CEO of the U.S. grocery store chain Kroger (KR), told investors "We're seeing particularly strong growth in our private selections and value tiers" on the company's recent conference call. Apparently it is doing brisk sales in beer and other items it sells under private label brands. In fact, the firm found that 14% of its customers traded down to its corporate brand items for the quarter ended Nov 8, according to data collected from its shopper cards.

The grocery is also targeting restaurant sales by enticing consumers with more ready-to-eat meals. In addition, it is using its private label brands like a cudgel to beat down prices proposed by its branded product suppliers. This is not solely a U.S. phenomenon, as reported by Talking Retail a UK-based grocery industry report, which has recently had articles on Tesco's (TESO) new Discounter Range of products and the fall-off in holiday food spending plans. Of course, if solid food is too expensive there is always soup, sales of which are apparently benefiting from the belt-tightening trend.

With sales of even necessities being crimped and showing consumers trading down, it should not be surprising that non-durable goods purchases would likewise be impacted. In Australia "Trading down on handbags" was discussed by high-end retailer Oroton, with regard to its recent results.

Is it surprising to anyone, then, that of the Dow 30 stocks only Wal-Mart (WMT) and McDonald's (MCD) are up year-to-year? These purveyors of life's necessities in cheap bulk form are flourishing as consumers cut back. But is this just a diet fad the consumer is on, or does the trend have legs?

My personal feeling is that a lot of the froth in consumption over the last few years was driven by newly rich folks overseas, financial intermediaries/traders/bankers/brokers whose businesses boomed with globalization and the commodity boom and perhaps, most importantly in the U.S., aspirational consumers. The intercontinental super consumers were generally from resource-rich countries like Russia, Brazil, and the Mid-East, or low cost labor rich countries like China.

Another source of added consumption in the U.S. was definitely from the aspirational consumer. Many in the U.S. were not really wealthy, but tried to live like they were or thought they were going to be rich from their real estate investments. The other big contingent of aspirational consumers were the newly upper-middle-class folks in emerging countries who for the first time in history actually had a wide variety of internationally made branded/luxury goods available to them - and lots of savings to spend on them.

Take a recent Investor's Business Daily (IBD) article entitled After Buying Like Truly Wealthy, Aspirational Rich Curb Spending. In the article Howard Davidowitz, chairman of an eponymous retail consulting firm, says "A lot of it relates to a depression in financial services. Additionally, that aspirational customer who shops at Coach (COH), making $100,000, who wants to live like he makes half a million, is completely underwater because of debts."

Interestingly, the aspirational consumer appears to be getting hit hardest. Maritz Research did a recent poll which showed that those in the $75,000 to $100,000 a year income brackets planned to spend 41% less this holiday season than last. In contrast, last year they had planned to spend more on average than those with household incomes of $100,000 or more. The over $100,000 annual income set plan to cut back by only 26%, while the less-than- $75,000 crowd planned to trim just 14%.

According to Hana Ben-Shabat a retail analyst with A.T. Kearney, who was quoted in the IBD article, "Over the last decade global sales among luxury-goods retailers have grown more than 10% a year, vs. 2% for chains generally. Much of this growth came from middle market consumers trading up to luxury."

Now if, as I suspect, the aspirational consumer doesn't just have to cut back this Christmas, but has to semi permanently downshift his/her aspirations to adjust to an economy that just isn't going to offer the same upward mobility for several years, it could have a significant lasting impact.

According to the US Census, the cohort of those earning $75,000 to $99,999 constitutes an estimated 12.1% of the population. The next higher bracket of those earning $100,000 to $149,000 constitutes another 11.4% of the population, for a total of 23.5% of all households captured in these two groups. My guess is that a lot of the aspirational consumers, investors, and real estate owners are ensconced in these two groups. That's a substantial part of the population that has been hit by imploding markets and collapsing availability of debt.

This chart from Business Week just confirms what many of us have suspected for a while. Now completely tapped out, the American consumer has had to start saving. My bet is that the latest uptick is the start of a new uptrend that will continue for quite a while. Why? There's no one left to float our current bills and future obligations any longer.

I know this is a lot of speculation on my part, but "cheap chic" may be here to stay for a while. In the future I'll be reporting once in a while about how durable the trading down, de-leveraging and otherwise lowering of expectations trends appear to be.

Now I would aver that to be in New York City, you might make $200,000 per year and still be an aspirational consumer, if you live in a free market apartment or are/plan to be a real estate owner. Couple that with the decimation on Wall Street and loss of aspirational foreign new rich we could be looking at a serious reduction in buyers for "luxury" apartments. Those multi-media rooms, health spas and private roof decks may seem a whole lot less necessary in the current environment.

Comments

[malach hamo...:]

More and more consumers are now adopting the shop-up strategy, under which when you need something you start shopping for it at the cheapest place around and only shop up if you can't find it at a bargain price. Thus, the first place to look becomes Walmart or the generic aisle of the supermarket; only if WMT's quality doesn't satisfy does one trade up.

The best sign of this strategy taking hold is the number of BMW SUVs one finds in the parking lots of Walmart; it is a massive reversal of psychology as the BMW SUV was the ultimate in aspirational buyer vehicle.

2008 Dec 16 04:39 AM