Will the Great Recession have an lasting effect on consumer attitudes?

Okay, this post is a bit nerdy and not the typical brand blogging kind of stuff.  It looks at some of the deeper economic and psychological issues involved in the on-going Great Recession.

Since the beginning of 2010 I have been asked by clients and friends, Is this downturn really going to make a permanent, generational shift in consumer attitudes?  Or will people just return to their old habits once the economy picks up more?

Are we in a state of a “new normal” where the changes are fundamental and profound?  Or is this just another swing in the on-going see-saw in response to the business cycle?

The answer to this question has serious implications for businesses.   To make a broad generalization, if a company believes the changes are temporary, then they will not make dramatic changes in their product lines going forward.  If another company believes there is a fundamental change in attitudes and behaviors — a lasting change — then they will move quickly to capitalized on that new trend.  They will align their offerings and their brand with the shift in consumer values.

The question comes up whenever there is a downturn.  Usually the answer is that people will resume their previous patterns.  Here are two examples:

Following the oil shocks and inflation of the 1970s, many people predicted that Americans would make a generational shift to smaller cars.  The price of a gallon of gas rose to $1.35 by 1981 — which is equivalent to $3.24 in today’s dollars, adjusted for inflation.  Source: Inflationdata.com, based on BLS statistics.  Fuel economy was the catch-word of the day.  Gas rationing was fresh in everyone’s minds.  [A short detour into history of the times.  During the 1970s OPEC companies put an embargo on oil to the US.  One result was that people could buy gas only every other day, depending on the last digit of their license plate being an odd or even number.]  Within a couple of years the cost of gas dropped back down.  The American love affair of minivans and then SUVs soon knocked out any serious discussion of changes in consumer attitudes and behaviors.

Inflation_adjusted_gasoline_price

On a Monday in October of 1987 I was standing at a window on the 21st floor of 1515 Broadway, watching the news ticker on the Times Square Tower.  The news was astounding — a drop of over 22% in stock prices during just one day.  My client at the time, The Prudential and Prudential-Bache was concerned that this signaled the end of people buying mutual funds and other investments closely tied to the stock market.  Was this going to be a generational shock like the crash of 1929?  We conducted market research among mutual fund and stock owners.  Rather than rushing to sell their mutual funds, most said they were going to hold and see what happened.  That was when the stock market high was 2,700.  We all know what happened next — that more and more people put more and more money into the stock market in the years that followed.

Based on past experience it is reasonable to assume that attitudes and behaviors will return to “normal”, that the disruption in purchasing behavior is just temporary.

However, this time really does appear to be different.  This time there is considerable evidence that the severity of the Great Recession is deeper and longer lasting than previous downturns in the US and Western Europe.  Go beyond the typical measures of employment and GDP and look at price inflation.  Or, rather, deflation.  In this downturn prices have actually dropped across the board for almost everything.  Down for home prices, down for commodities, down for goods and services.

In my opinion, it is price deflation, or negative inflation, that makes this downturn different from all others.  And that is why we can expect a longer lasting shift in attitudes.  A generational shift.

What is price deflation?  It is the phenomena of falling prices.  What is expensive today is cheaper tomorrow.  Sounds like a great idea, since everyone wants to pay less for what they are buying.  In practice it is far from a great idea.  It is the exact opposite of a great idea.  Price deflation is dangerous for businesses.

Here is a simple hypothetical example of how deflation works:

The price of a toaster oven is $100 this week.  In a stable price environment it will be $100 next week and so on.  You can but it today or tomorrow and it will make no real difference.

In a slightly inflationary environment it may rise to $102 within a year.  That gives you an incentive to purchase the toaster oven today so that the price doesn’t rise tomorrow.

But in a deflationary cycle the cost will drop from $100 down to $90 (hypothetically speaking).  Therefore you will not buy today or tomorrow.  You will wait for prices to fall further before you buy.  Your demand for the product has now declined.  Why buy a toaster oven today when it will be cheaper in a few months?

This sets a trap for marketing.  Advertising price drops should, in a normal economy, stimulate demand.  So many companies will continue with the price promotions from the recent past.  In a deflationary period it simply reinforces the belief that prices will decline, so consumers will continue to wait before purchasing.

Pushing hard on pricing also de-values a brand.  So now you have a price deflator attached to your brand.

In a deflationary time, marketing has to work harder than ever to stimulate and support consumer demand.  It needs to stimulate desires that counter the consumer psychology of deflation.  Easier said than done, however.

So how real is the threat of deflation?  Very real.  Below is a chart on inflation rates.  Real price deflation has already happened.  And we are on the verge of a long term slide into more deflation or, at best, virtually no inflation.  This is not just an academic exercise or something for politicians and Paul Krugman to argue about.  It has a real effect on stock prices, on the ability of people to buy goods, on income levels on the overall demand for goods and services.

inflation rates

So, yes, this time there is good reason to believe that changes in consumer attitudes are real and lasting.