Vicious Cycle

Spring is finally here, the war is over and the economy is starting to show signs of life (albeit mixed ones) for the first time in almost three years. The Consumer Confidence Index, which had been on a four-month decline, rebounded in April to 81.0, the third largest increase in the history of the index, according to Lynn Franco, director of consumer research at the Conference Board, which publishes the Index.

Even better news is the indication that the change in mood may not just be a short spike due to relief over the war’s end. “[The increase] wasn’t based solely on post-war expectations,” Franco says. “There seems to be a better feeling about employment and the economy, which means it should be a more sustained increase than in 1991 when the surge after the Gulf War was based on expectations that never panned out. One month does not a trend make but it’s a good sign that consumer spending could surge over the next few months.”

However, with year-to-year net change in private payrolls negative for 22 straight months, the longest labor market slump since World War II, it’s clear that consumers aren’t ready to resume their freewheeling ways. Even with a gain in consumer confidence, most observers don’t believe consumers will start spending heavily again without the major incentives that manufacturers and retailers have been forced to offer to get consumers to open their wallets in the first place. “That’s been the case for some time,” Franco says. “Low interest rates are the primary reason why housing has done so well and zero percent financing is one of the main reasons automotive sales have stayed steady, although the appeal seems to have worn off.”

High-end discretionary purchases have taken a back seat to requirements and small creature comforts. Despite the boost in confidence, the number of consumers who plan to buy an automobile over the next six months has dropped to 5.9% as of April 2003, down from 7.8% in April 2002, according to the Conference Board.

A January consumer survey from Worthington, OH-based Bigresearch found that price far outstrips other shopping considerations, with 90.2% of respondents saying that’s the motivation for them to shop at a department or discount store.

Bargain hunting is so ingrained today that mass discounters such as Wal-Mart are starting to take over categories traditionally dominated by mass traditional retailers, such as grocery and clothes shopping. According to the Bigresearch Executive Briefing for April, discount stores accounted for the largest share of women’s clothing purchases, led by Wal-Mart and Target. Discount stores accounted for 30.1% of purchases, department stores for 24.2% and specialty apparel for 11.7%.

While discounting is a boon for discount retailers, where does that leave everybody else? Everyone from department stores to airlines is feeling the pinch. Discounting is starting to take a toll on categories that superficially appeared to do well. “Look at the holidays,” says Scott Krugman, spokesperson at the National Retail Federation, Washington, DC. “Consumers were spending, but since they got more for their dollar, overall sales weren’t as high as we liked. All retailers, in a way, have become discount retailers. Everyone is offering some kind of bargain. The problem is that we’re conditioning consumers to be bargain shoppers exclusively. What happens when the economy turns around?”

Automobile sales owe their resilience almost exclusively to aggressive incentives such as 0% financing. Manufacturers like General Motors think they’ll be able to follow the old model of recession recovery: the economy improves; demand and supply even out; and consumers can be gradually weaned off incentives that get customers into the store or dealership but don’t add much to the bottom line.

“Consumers live and die by discounts, that’s become a permanent part of our culture,” says George Whalin, president and CEO of Retail Management Consultants. “With something like the auto industry, they’re addicted to this stuff. They’ve got cars to move and the margins of that business are so thin that I think manufacturers have actually started building [0% financing] into the process.”

In other words, they can’t afford to stop, and in the long run, it’s going to catch up with them. “The only thing getting people out the door is heavy discounting and that in no way is sustainable over the long-term,” says J. Walker Smith, president of Chapel Hill, NC-based research firm Yankelovich. “It’s the 0% financing problem. We’re teaching consumers a new way to shop their category. Let’s face it, marketing is tactical and the focus right now is just getting people to buy.”

When it comes to auto sales, “You’ve seen consumers responding to much more generous incentives than usual,” agrees Paul Taylor, chief economist at National Automobile Dealers Association. And while the auto industry seems fairly stable on the surface, “…a lot of what you see now is catch-up,” Taylor says. “The unusually bad winter took a big chunk out of sales, particularly the snowed out President’s Day weekend.”

Ford has been among the most aggressive discounters, including offers of $5-a-day leases on the entry-level Mustang sports car and Ford Ranger midsize pickup trucks However, Ford’s U.S. sales dropped 6.9% in April to 279,933 vehicles.

Taylor doesn’t see aggressive discounting disappearing any time soon. “Popular cars and light trucks that are in short supply are likely candidates for incentives to be removed,” Taylor says. “For other vehicles, I think incentives will stay in place.

Price wars

For more traditional retailers, price wars can kill the business. The consumer packaged goods business went through the same process and their only way out was constant product innovation. “People have learned how to shop differently and that puts a lot of pressure on manufacturers and retailers to reevaluate their value proposition,” Smith says. “In a cycle like this, you have to compete by price. The long-term answer is to introduce value and innovation, or sell.”

But according to Paul Higham, the principal of Taos, NM-based consultancy The h Factor and formerly the CMO at Wal-Mart, the problem isn’t discount shopping, the problem is the idea of short-term incentives. “It’s not wonderful to have sales related only to the current offers,” Higham says. “It’s a shame to make your customers’ purchase behavior predicated just on the lowest price. Instead of trying to get the most for it, why not offer that product at the best price every day. If you offer 0% financing, customers will just wait until that offer. But if you offer best price every day, they’ve got a reason to shop every day.”

And isn’t that the whole point?

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