On the very first day of Economics 101, you will see the below
chart. This simple illustration identifies, in theory, the optimal
price of a product (P), where the supply curve of a good (S),
intersects the curve representing the range of consumer demand (D).
Basic, yet essential.
Over my past few posts I've highlighted a few trends to put on your
radar screen through the remainder of 2013 - margin debt,
) success, where's the beef?, as well as
housing's coming split
. I've really struggled with this last theme on consumer demand due
to the strength of its underlying trends, for what its unwinding
may signal for the overall economy, and also due to the fanaticism
many individual stocks who fit this theme possess.
Recently, and in an increasing frequency, it appears many companies
have hijacked the above referenced supply-demand curve and
levitated the (P) by charging an artificial premium in exchange for
the consumer receiving an "enhanced experience," a "good feeling,"
or a "look of approval" while sporting a new outfit or handbag. If
your grandparents wonder why you dropped $60 for a new sweatshirt
when a $20 one performs the same function, you're well aware of
This upward price shift isn't a result of companies restricting
supply in an effort to drive higher prices. To the contrary, they
are flat-out selling as much as they can to as many as they can,
creating a walking advertisement of consumer demand "premium."
Their strategy intentionally involves creating an aura that they
are indeed the hipster pants, restaurant, beverage, handbag
company, et al and if you are not on board, you are just not with
it. Yes, this has always been the case, but the number of companies
relying on it as corporate strategy, has likely never been higher.
It's difficult to quantify when (and why) the consumer will start
balking at paying these premiums to so many companies. Recently,
retail companies (and thus many stocks) have started to see signs
of a slowdown -
) have all reported frustrating results which appears to signal
that at its core, consumption is waning. Trendy, hipster, cultish
brands won't likely see immediate pressures as consumers will put
off tougher decisions where intense loyalties lie until they are at
last forced to.
Why has this business strategy exploded in popularity? I'm no
sociologist, but it seems the seeds of this new "industry" were
planted over a decade ago when the tech bubble imploded, an event
followed by 9/11. Perhaps companies started to tap into a consumer
need of having to be reassured that they are OK, and that their
financial lives have not been compromised.
If you factor in a few years of quantitative easing to help finance
this new retail and lifestyle phenomenon, and then add in a dash of
social media playing the role of steroid-induced public relations
and marketing (e.g., checking in at xyz on Foursquare to get
instant validation via
)), and you have a recipe for elevated consumer demand "premium."
And this has only helped to compound this new
Questioning companies who are successfully employing these
strategies prompts ire from their fanatical cheerleaders, so I'm
intentionally refraining from highlighting specific companies. Many
of these companies are extremely well known, and if they're looking
beyond next quarter's earnings, aspire to join a very short list of
those who've executed the strategy long-term. Companies like
(TIF) come to mind, but the key is that their product quality has
also passed the test of time. This new breed of company is
attempting to accomplish premium pricing with an increasing number
of basic consumer products, and some of them are actually
succeeding while distributing products of questionable quality.
When the economy experiences a turn of any sort, many of these
companies will be hosed… with a capital "H." Memories get shorter
in bull markets, but it wasn't just a few years back that
Procter & Gamble
(PG) struggled because consumers turned to embrace store brands.
P&G has recently embarked on a strategy to take its productive,
workhorse brands and go after this premium-paying bunch. Getting
you to pay more for laundry detergent because "you deserve it!" is
the bell ringing in my head that this artificial elevation in
pricing has reached a climax. And eventually, when consumer demand
takes a hit, strategies like this falter… and premium prices will
not hold for many companies.
Not all companies that are employing this strategy will be
affected, though - obviously, a handful will thrive, but their
numbers will likely be minimal. What are some signs of
vulnerability? How long has the (P) been elevated? The longer its
elevation, the more exposed the company will be to the "experience"
waning. It's a very short list of companies that have successfully
turned duration into an asset ala
(SBUX), whose success looks rather moat-like, to use Warren
Buffett's famous term.
Other risks? Higher prices come to mind. At the extreme high-end,
companies may be immune from crosscurrents, but for typical
consumers, higher prices will only increase a company's
susceptibility to changing trends. Additionally, be on the lookout
for how easily the product can be substituted by eager competitors.
Perhaps the greatest risk of all to these companies is how deeply
connected a company's future fortunes are to middle-class,
middle-American consumers. Over the past decade, companies that
have successfully implemented these business strategies have
increasingly relied on the middle class' infatuation with these
aspirational products. How much of a company's gross margins are
tied to this geographic and economic class? Analyst channel-checks
in Paris or New York City won't tell you the story that Sioux Falls
and Topeka will until the horse has left the barn.
When this trend subsides, I'm guessing it won't show up immediately
in share prices. It'll likely start to evolve in companies blaming
suppliers, weather factors, an earlier Easter - you get the
picture. Over time, the momentum of previously unbreakable trends
will subside and income statements will start disclosing stalling
revenue growth. When these "turns" take place is always
questionable, but if history is any guide, they always seem to come
well after bears expect them.
Perhaps I am wrong about this trend and am underestimating economic
strength and the risks to the ever-expanding list of
"experience"-touting companies. Maybe our intensely connected
future is to be dominated by brands where "coolness" will be the
overriding factor. Maybe a person like me who still wears his 1996
NFC Championship sweatshirt is the wrong person to evaluate
coolness. But make no mistake - the "right" logo on those
sweatshirts will most definitely change, because innovation
dictates they must.
This article by Ross Heart was originally published on