The Middle Class's Urge to Splurge

By paying less for mundane items, buyers can spend more on the new luxury goods they value, says the co-author of Trading Up

America's concept of luxury has changed. No longer is it about minks and Mercedes for millionaires. Now, entire new categories of premium, yet affordable products -- in such disparate categories as coffee, golf clubs, dolls, and beer -- are aimed straight at the middle class. Premium brands are thriving because customers are willing to pay extra for what they see as important quality improvements over the comparable, but much cheaper mainstream item (see table below).

Millions of people are able to afford these luxury products because they're simultaneously trading down in categories where they don't see important differences in quality. That's the thesis of Trading Up: The New American Luxury, by Michael Silverstein and Neil Fiske (see BW Online, 11/3/03, "Shopping for Gratification").

BusinessWeek Online Senior Writer Amey Stone spoke recently with Silverstein, who's a senior vice-president and head of the consumer and retail practice at consulting firm Boston Consulting Group (BCG ) in Chicago, about the new luxury trend and how long it can last. The following are edited excerpts from their conversation:

Q: What's trading up?

A:

It's a phenomenon that started in the U.S. in the last five years, where middle-class consumers are deciding to buy better-quality goods in a few categories that are important in their lives. Consumers are learning all the details about these products and becoming real aficionados of the brands they care about.

Q: What are some examples?

A:

Think about Starbucks (SBX ) coffee or Sam Adams beer. Or if you consider cars, these are people who are deciding between the BMW 3 series, which starts at $28,600, and a Pontiac for $20,000. They make an informed decision to go with the BMW based on factors like how much the car will be worth at the end of three years and how much it costs to drive.

Q: Middle-class people are engaging in this behavior?

A:

The core market for the trading-up phenomenon is households that make $50,000 to $150,000. There are 40 million such households in the U.S. -- a population of over 120 million.

Q: So you're not just talking about the spending habits of the very wealthy?

A:

This is not the top 0.5% to 1% of the population that makes over $1 million. These aren't aristocrats, blue bloods, and Ivy Leaguers. These are middle-class people who went to college, earn a good living, and are very careful with how they spend their dollars. The ability for so many people to purchase luxury goods is a great equalizer, but we're not talking about people who earn $150,000 consuming at the same rate as billionaires.

Q: How can middle-class families afford to buy so many expensive items?

A:

They trade up and trade down. They trade up in a few categories that are important to them, but in the vast majority of categories they trade down. They're saying: "For this item I can buy private label and feel just as good as if I bought the name brand." It's a budget-balancing exercise. It's not about profligate spending. It's about getting emotional satisfaction from the purchase of better-quality goods.

Q: You say this behavior is only five years old. What brought it about?

A:

There are six things contributing to the growth of new luxury. The first is powerful growth in real income. For the top 40% of households, real income doubled in the last 30 years. Secondly, there has been a tremendous gain in home values, increasing families' net worth. Thirdly, growth in discount shopping at department stores like Wal-Mart (WMT ) and Target (TGT ) has put a windfall into consumers' pockets, freeing up cash for consumption in other categories.

The fourth and most important trend is that all the real income growth at the household level is associated with women going to work and women earning higher wages. Women are smart consumers who now have the authority and responsibility to say: "This is what we're buying." Another contributing factor is that the people who are making more money are highly educated. If you didn't finish college, your real income declined. That means we have more educated consumers making the purchasing decisions.

Finally, there's what we call the "Oprah effect." There are lots of people like her -- who have great influence over the public -- who say it's O.K. to spend to take care of yourself. It's O.K. to consume.

Q: When did you first notice this trend?

A:

I've spent the last decade at BCG working with clients on premium segmentation. But in the last three years, we realized we should develop a deeper understanding of this phenomenon. So we took a good portion of our research budget to study the trend, and this book lays out our findings.

Q: What was the first new-luxury item?

A:

The first big one I noticed is in the frozen-pizza category. The frozen pizza your mother may have fed to you as a kid tasted like cardboard. Then Kraft came along with a new, more expensive frozen pizza that used higher-quality ingredients and tasted much better. Starbucks was also one of the first ones, as was Callaway [with its Big Bertha golf club,] and Kendall-Jackson with their chardonnays.

Q: What's an example of a more recent entrant?

A:

Panera Bread (PNRA ), with their premium sandwiches, has really just taken off in the last few years.

Q: How are these products developed?

A:

They take a tremendous amount of innovation. They have to represent a real technical improvement over the mainstream product in terms of what the product does and what the customer experiences. For it to work, the customer has to make a real emotional connection with the product. Often what's required is a fresh perspective and a new way of bringing the product to market.

Q: For example?

A:

American Girl dolls are a brilliant example of a new-luxury competitor entering the market. The founder, Pleasant Rowland, saw potential for a high-quality traditional doll. She went out, sourced a product with top-quality materials, and developed the dolls as characters that young girls could form an emotional bond with. The dolls are sold directly to customers, first through a catalog and now through their own phenomenally successful American Girl stores (see BW Online, 11/24/03, "American Girl's All-American Success").

Q: Do you expect the new-luxury trend to last a long time?

A:

One interesting point to note is that in the last two years, the economy hasn't been robust, but the market for new-luxury goods has been growing in the 15% to 20% range. We estimate it's now a $400 billion market in the U.S. We expect it to grow undisturbed at least until 2010 in the U.S. and become a $1 trillion market.

Q: Do you think there's anything troubling about consumers gaining so much emotional satisfaction from the purchase of material goods?

A:

That's more of a media issue than a consumer issue. If you ask consumers, they will tell you that new luxury is core to their sense of identity, sense of well-being, and sense of adventure. They care about products that make them more attractive, give them a sense of adventure and learning, and that enable them to enjoy quality time at home with their families.

Is there anything bad in what they're doing? There's a Puritan ethic in America that tells people not to consume, but I don't think it's right to attach a value judgment to this behavior.

Q: But isn't there a problem with rising levels of consumer debt in the U.S.?

A:

My reaction is that debt levels aren't a problem. All the stories about people not saving enough are largely based on bad analysis. Our research found that for 24 out of 25 families, the budget is balanced. People know what they can afford and are very careful with how they spend their money.

For example, during the holidays, they know that they can buy a few fine gifts, then shop at Target, Wal-Mart, and Costco (COST ), and at the end of the day, the budget will balance. One in 25 consumers will have a problem with overspending. They're sad stories, but they're mostly people who didn't quite grow up.

The New Look of Luxury

Dolls: American Girl for $84, vs. Barbie for about $11*.

New-luxury difference: Higher-quality materials for eyes and hair that make the doll appear more lifelike

Sandwiches: Panera Frontega Chicken Panini for $6.50, vs. a Burger King Chicken Sandwich for $3.50.

New-luxury difference: The focaccia bread, baked fresh that day in the store

Coffee: Starbucks Vente Latte for $3.45, vs. Dunkin' Donuts Coffee for 99 cents.

New-luxury difference: A higher percentage of Arabica bean, with all the flavor and taste

Cars: The BMW 3 Series starting at $28,600, vs. a Pontiac for about $20,000.

New-luxury difference: Better engine and faster acceleration

Frozen pizza: DiGiorno Pizza for $7, vs. supermarket brand frozen pizza for $3.

New-luxury difference: Better crust, sauce, and cheese

Golf clubs: Callaway Big Bertha driver for $499, vs. a Golden Bear golf club for $89.

New-luxury difference: The size of the head and titanium face

Washer-dryers: Duet Fabric Care System by Whirlpool for $1,400, vs. an entry level washer-dryer for $800.

New-luxury difference: Large capacity, cleaner clothes

Data: Trading Up: The New American Luxury

*All prices given are approximate and are for entry-level goods

Patricia O'Connell

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