Are Low Prices Here to Stay?Greg T. Spielberg
With shoppers shunning extravagance and merchants eager to sell inventory, prices on many goods and services have plunged. Fancy flat-panel TVs are marked to move, and flights between the coasts have dipped below $120. Forget cell-phone billing; prepaid is in.
For businesses trying to coax consumers to spend, the recession has brutalized profit margins. Still, despite the current profit pressures, an even bigger worry looms: What if the low prices become the norm? A shift in attitudes about consumption and frugality for many Americans could mean businesses' loss of pricing power endures long after the recession ends. "It's a whole lot easier for prices to come down than for them to go up," says Eric Almquist, head of consumer global insights at consulting firm Bain & Co.
No longer, experts say, should retailers expect the same sort of robust profit margins as in the past, and they'll have to work harder to keep brands relevant. With margins cut thin by increased competition—both on the Internet and globally—retailers should expect to woo customers through service and time savings. Even when the economy rebounds, services will almost certainly become increasingly important in a range of industries as big-ticket goods—that once offered healthy margins—become commoditized. "The world of shopping is going to change more in the next two years than it has in the past 100," says Paco Underhill, founder and CEO of Envirosell, a New York-based research and consulting firm.
Baby Boomers Hit Hard
Consumer spending is also affected by the so-called "wealth effect." Rising home values, healthy 401(k) balances, and profitable investment portfolios all increase the sense of net worth. With those financial markers greatly diminished, consumers aren't in the spending mood. Especially dour are the baby boomers, who make up more than a quarter of the American population and have been voracious consumers throughout their lives. After finding their retirement savings wanting, post-recession the boomers aren't likely to resume spending at former levels, says Almquist. "My concern is that those pre-retirement people are going to come out very conservative, and the spending will not come back among that purchasing group," he says.
One significant change is already being realized in the current recession: more pricing control for buyers. Consumers have proven unwilling to spend as much on discretionary items such as vacations, restaurants, and apparel. Where they do spend, they expect great deals and are willing to expend great time and effort to find them. That, of course, is largely due to the shift from the physical marketplace to the Internet, opening up competition and providing comparative information. "It is never going to go back," Underhill says of traditional shopping models.
Communication and IT technology has changed the retail dynamic in obvious ways, especially in the TV and PC industries. The average selling price of PCs fell 14.3% in the fourth quarter of 2008. Down-market competitors like Acer are challenging established companies with lower-cost netbook PCs. Even Apple (AAPL), long a world champion in commanding premium margins, cut the price of its newest iMac desktop earlier this month. Sales of the iMac and iPod both dropped 16% in February, according to NPD Group, a market research firm in Port Washington, N.Y. "That's an industry where, basically, people have been trained to expect prices to come down," Almquist says.
Banking on Intangibles
Like PC gear, electronics manufacturers are especially squeezed on what they can charge in a downturn. Global television shipments dropped 5% in the fourth quarter, to 57 million units, according to market-research firm Display Source. And television sales fell 7%, despite market-share gains for big-screen flat panels, 40 inches and larger, and high-definition 1080p models. Both of those typically command higher prices, demonstrating that even the most technically advanced display has become a commodity item.
Brand differentiation and profit margins will revolve more tightly around intangibles, not just the physical product. Amazon.com's (AMZN) recent strong financial performance stems from bargain prices and stellar customer reviews. Yet innovation can also help to unlock better margins. Dell (DELL) is looking for profit in its new $2,000 Adamo laptop, which hits the market on Mar. 26. The 14.6mm-thick PC is promoted as being thinner than Apple's MacBook Air.
Whenever the recession eases, Dell and other companies are hoping profit margins will be far thicker than an Adamo. Unfortunately, the evidence is scant that prices in many industries can regain their former heft.