The Big Squeeze

Big events cause big adjustments in all our lives. How consumers react to them will in turn affect commerce. Like a stone dropped into a stream, the economic ripple effects of dramatically rising prices on commodities like gasoline or of an incident such as Hurricane Katrina long influence consumer purchasing. This influence can last for months after the actual incident or price hike. When money becomes tight people flinch at spending on goods and services, become anxious about being able to pay bills and debts, and alter spending patterns to get them through crunch times. When gasoline prices approached $3.50 per gallon this past fall in Seattle, for example, one family there realized that it had to make some long-term adjustments. Fortunately, Jana Claxton and her husband, Tim, regarded the soaring price of gas in their city as motivation to increase their commitment to environmental conservancy. "My husband and I strive to be environmentally conscious citizens," Jana says, "but the gas prices have provided a whole new incentive to cut down on our time spent in the car. My husband now bikes about 30 miles round trip to work two to three times a week. Through rain or shine he gets out on his bike and does the trek. I definitely think he's pretty nuts and so do both of our families, but I also admire and respect his initiative." Claxton herself works part time from home, and says telecommuting is "brilliant" for lowering the cost of her gasoline bill--she estimates a savings of about $50 to $60 per month. She also started walking more to do errands like going to the post office or the bank. As for transportation alternatives Lars Perner, assistant professor of marketing at San Diego State University, says that Americans "are not very favorable to public transportation. It's a very small part of driving that can be cut out. To have even a modest decrease in consumption, you need a very modest increase in prices. You need to increase prices dramatically to really increase supply and demand." High gas prices are likely to have a large impact on consumer spending, but a much smaller impact on the amount of gasoline purchased, according to Perner. Instead, the effect is likely to be felt in other areas of spending, such as vacations, entertainment, or eating out. "Some economists estimate that for every one-cent increase in the price of gas, spending in other areas will decline by one billion dollars," Perner says. "Wal-Mart estimates that higher gasoline prices take away $7 per week from an average family budget." Olwyn Browne works as a defense attorney in San Francisco; she commutes all over the Bay Area for court hearings, so cutting down on gas or driving is not a choice for her. She fills her tank four or five times a month at $45 each time. "Now that excess cash is going to gas, frivolous spending for ease of lifestyle had to be curbed," she says. "It's really expensive to live and it's hard to have a normal lifestyle now that money is going out for things we can't avoid." The GM Effect There seem to be a lot of [strong] head winds," says Michael Gregory, senior economist at BMO Nesbitt Burns. "We have higher energy prices and that's taking out a big chunk of disposable income, and there's less left over for discretionary spending." He explains what he calls the GM effect--a belief that what's good for General Motors Corp. is good for the U.S. economy, and that if GM is struggling it affects consumer confidence. When in November GM announced its plans to slash 30,000 jobs and close 12 North American plants, the news began to shake consumer confidence. The GM effect is one of the reasons consumer confidence did not bounce back after energy prices recovered. Consumers believed that the scaling back of GM's pensions and employee benefits may spread to other areas of the economy, Gregory says--when companies pull back on healthcare benefits, households have to foot more of the bill. "The day of the big companies giving them [a comparable amount of benefits] for the rest of their lives [is gone]." Companies are keeping productivity numbers up to compete globally and changing the way they incentivize employees. GM's gambit was the most well publicized, but other companies are responding the same way. Airlines are walking away from pension liability, and in December Verizon Communications announced cuts to its pension plan for managers. "It's not so much GM, but it could have been one of the proverbial straws that broke consumers' backs," Gregory says. "All of a sudden people have to pay more for energy, debt service, healthcare, and save more for retirement." Business confidence has diminished as a result of the lackluster economy, according to Gregory. "In rough economic times, companies' ability to pass the bill on to the customer in terms of higher cost is very difficult," he says. "Discounting is great for consumers, but it's not the best for corporate profits going forward. It's a vicious cycle. The company has to find some way to bolster profit margins." "For the short term it looks like the worst is over," says Claes Fornell, author of the American Customer Satisfaction Index (ACSI). "Yes prices are higher, but they are going down a bit, so that might be good because [consumers are] used to the high prices and they think they have more money in the pocket than before." Economists talk about the price elasticity of certain products, and posit that a 1 percent increase in the price of a product will result in maybe a 2 percent decrease in consumption, or demanded quantity. Gasoline prices, however, seem to be relatively inelastic, at least in the short term: When prices change there is relatively little change in quantity demanded, according to Perner. Also, elasticity is higher for branded products (e.g., Snickers versus candy bars), but with few immediate substitutions for gasoline, elasticity in that commodity tends to be low. Perner suggests conceptualizing price beyond just a monetary amount, instead defining it as resources given up divided by resources received. This definition suggests there are several ways to change price. The most obvious is to change the sticker price. The next is to change quantity. Perner gives an example: In the 1970s an increase in the wholesale cost of chocolate caused candy manufacturers to make smaller candy bars. The third is to change quality, and the last is to change terms. "In the old days most software manufacturers provided free support for their programs--it used to be possible to call the WordPerfect Corporation on an 800 number to get free help," Perner says. "Nowadays, you have to have a credit card handy to get help." Retailers know that sometimes they can raise a price without inducing sticker shock, and let consumers perceive that there's a sale when an item is marked down. Whether a price change is noticed or not largely depends on the size of the original item, according to Michael Solomon, human sciences professor of consumer behavior at Auburn University. "The car companies made a big mistake with employee discounts [at the end of 2005]. Short term, it moves inventory. In the long term it makes people come to expect it. Now GM is cutting jobs." Big department stores like Macy's want to compete with discounters and run aggressive campaigns to train people to look for sales, starting holiday deals much earlier than on Black Friday. "[Macy's] can't compete with Wal-Mart on price. They need to compete in other areas." Compassion in Critical Times One of the most important dimensions of evaluating companies today is corporate philanthropy, Solomon says. "People want to patronize companies that are seen as having a positive impact on the community," he says, citing Avon's sponsorship of the breast cancer walk. "Long-term loyalty and understanding--and anticipating customers' needs--become doubly important when they are disrupted." If a company could show it is there for consumers, it can use that as a differentiator. Following Hurricane Katrina, Solomon's insurance company sent out notices telling people that if they were affected, they did not need to pay their premiums. "People will remember that just like they'd remember if the companies decided to price gouge," he says. Wal-Mart successfully fine-tunes its inventory tracking when hurricanes are forecast and tells stores to have certain items on hand. The stores can have those items available and easily accessible so customers don't have to look around or go to another store. "It's better just to say, 'We're anticipating your needs and we're here for you, and we're not going to drive up prices,'" Solomon says. "In affected areas you have tremendous disruption, and people lose money and don't have access to shopping," Perner says. Regarding the nation as a whole, it may depress people. After the first Gulf War, pizza parlors were the ones to profit in the short term because people were too depressed to cook, according to Perner. "Some people use shopping as a way to lift moods, but some people may be worried about the economic effect." Those mixed emotions are precisely why companies should err on the side of caution when addressing disasters. Mentioning national tragedies in marketing materials does not always resonate with consumers, and could potentially lower response rates. "Many businesses feel compelled to address national tragedies like 9/11 or Katrina in their marketing campaigns as these events weigh heavy on the minds and hearts of everyone," says Gary Wright, CEO and founder of G.A. Wright Marketing. "However, research indicates that doing so does not influence consumers' business decisions, and may actually harm a company's image if it appears they are trying to capitalize on a tragedy." After 9/11 there were many concerns for Wright's company, which provides advertising and sales consulting to retailers. Wright was concerned that business would drop off and that people would stop going to stores and stop responding to ads, because they were glued to their television sets. But they did come into the stores, Wright says. "When people are distraught and upset and worried about something, they like to talk to other people. Coming into retail stores is, in some way, therapeutic. We expected sales to crater right after 9/11 and it didn't happen." Wright's company started receiving calls from people saying that it had to acknowledge 9/11 in its advertising. "We had to say something about it to acknowledge it was happening and it was affecting them. The objective wasn't to increase business, but to show them we related to the customers," Wright says. "I was concerned about how to do that without seeming like we were trying to do more business based on a huge disaster. It had to be sensitive to the issues." The company tested 43,462 pieces of mail with no acknowledgment of the 9/11 attacks with prospects at the end of November 2001 and sent a separate marketing campaign to 43,578 people that included a letter of the company's perception of the event to prospective customers. Responses to the business offer without the letter were 24 percent higher and resulted in five clients signing contracts to the amount of roughly $79,000. In retrospect, he says, "I wasn't sure if it was a good idea--maybe we should have ignored it." The Future People make a lot of decisions differently during war and unrest that have a long-term impact, Solomon says. More impact is felt on big-ticket items like cars or homes in the short run, and people compensate for that by diverting their money toward small indulgences. "People might go ballistic about paying $3 at the pump, but they won't hesitate to pay $5 at Starbucks," he says. "It's related to splurging at a small level. We'll starve ourselves all day long and then have a super premium ice cream as a reward for dieting all day." As interest rates rise, customer service also suffers. There's a strong negative correlation (see chart below) between increased interest rates and customer satisfaction, according to Fornell. "There is less incentive for companies to improve on customer satisfaction as interest rates go up, because the value of a satisfied customer decreases," he says. "The company can say the future is less valuable and therefore we will allocate our resources for instant results. The CRM industry should fear any increase in interest rates because it reduces the incentive to do CRM." Consumer spending is not going to pick up substantially into the first half of 2006, primarily because of rising interest rates, according to Lynn Franco, director of The Conference Board Consumer Research Center. Home refinancing was fueling a lot of the spending and that has slowed due in part to rising debt and a cooling housing market. Overall, despite a couple of bumps in the road, the economy is stronger today than it was a year ago, Franco says. "But there are unknowns out there, like just how high the heating bill will be, so consumers are in a somewhat cautious crunch." Attorney Browne agrees: "It's not that I have lost confidence in the consumer market, it's just that my ability to purchase has been curbed." Most analysts agree that shoppers are going to strive to be more fiscally conservative in 2006. "As we get toward the end of the winter season and early spring, we'll probably go through another wave of elevated energy prices, and it will bode ill for discretionary consumer spending," Solomon says. "Consumer spending might be rather lackluster for some time, perhaps a year or two. In the end we're going to [see] a consumer that's saving more, is more cautious, and a little more spendthrift." As the chart below shows, there is a strong inverse relationship between ACSI and (lagged) interest rates. The correlation between ACSI and the Prime Rate over the past six years is -0.79. How Do Interest Rates Affect Customer Satisfaction? ACSI and Interest Rates (Lagged One Quarter) 1999 to Q3 2005

Contact Senior Editor Alexandra DeFelice at adefelice@destinationcrm.com