Australian Financial Review
PUBLISHED: 28 Jan 2012
Anna Bernasek New York
What’s on Wall Street’s mind right now? It seems to be regulation. Listen to any banker in the US lately and it sounds like regulation is killing them. But take a look at the evidence.
US banks have just reported earnings for 2011 and, at first glance, there is some cause for concern. Acknowledged leader Goldman Sachs’s net income was cut in half in 2011, compared with the previous year. Bank of America, the biggest bank by assets, barely broke even. Without the benefit of a tax provision, BoA would have lost money.
But digging a little deeper into recent numbers tells another story. Those regulations may not be hurting US banks as much as bankers would like you to believe.
Take a look at the strongest big bank, JPMorgan Chase. Its head, Jamie Dimon, has been an outspoken critic of regulations. Since last summer he has openly feuded with global financial regulators about new international capital standards.
Dimon reiterated his criticism of tighter bank rules at JPMorgan’s earnings announcement last week. “Regulatory policy is completely contradictory to government objectives,” he said.
In particular, Dimon singled out two areas of regulation he believes are bad: bank capital rules and restrictions on trading.
But if regulations are hurting so much, why are JPMorgan’s earnings so strong? For the full year, JPMorgan reported a record profit of $US19 billion. That’s up a healthy 9 per cent from the previous year. But it’s also about 25 per cent higher than in 2006 and 2007, when the market was sizzling and today’s regulations weren’t even on the radar.
To be fair, JPMorgan is bigger than it was in 2007 and has to maintain more capital. But other measures of profitability show the bank is not far from boom-time levels. Pre-tax earnings were 28 per cent of revenue, only a shade less than in 2006-07. In this new era, it is turning out results comparable to its best years.
Dimon may have a point on some regulatory details, but in the big picture he’s not getting hurt. For a well capitalised giant such as JPMorgan, it’s clearly possible to thrive under the new rules.
The picture is not the same at the other big banks. Look at Citigroup, for example. According to its latest figures, Citigroup’s profitability is about half what it was during the boom. But the bank’s profitability fell off a cliff in 2007 when its assets and loans problems came to light. That was well before the new regulations kicked in the following year.
For the past two years, Citigroup has turned out steady and growing profits. The fact that they are about half what they were in 2006 probably says more about the bank’s irresponsible practices from the year 2000 on, than about any recent regulatory burdens.
Then there’s BoA, the asset leader. It seems to have some operational and legacy asset problems as opposed to regulatory constraints. The disastrous acquisitions of Countrywide and, to a lesser extent, Merrill Lynch continue to take their toll.
BoA actually showed paper profits in 2008 and 2009, the worst years for its big-bank peers. But throughout 2010 and again in 2011 BoA printed red ink. That doesn’t look like a regulatory problem, especially compared with JPMorgan’s strong results under the very same rules.
So what about the best of the investment banks? How are they faring?
Like Citigroup, Goldman Sachs’s profits have fallen by half. Unlike Citigroup, though, in Goldman’s case the drop is clearly related to regulation. Remember that, to save its skin during the 2008 crisis, Goldman converted from an investment bank to a commercial bank. That brought a whole new set of capital requirements, which more or less directly explain the drop in profitability.
It’s a simple matter of leverage. In the boom era, Goldman’s leverage was about 27 times its equity. Today that leverage is closer to 13 times, essentially cut in half. Investment bankers may make noises about restrictions on proprietary trading and other issues, but it’s no coincidence that profits have dropped in lock-step with leverage.
Morgan Stanley’s numbers tell a similar tale. Profits for 2011 were off 27 per cent versus 2006, while leverage dropped from 32 times to 12 times. Adjusted for leverage, Morgan Stanley seems even healthier than in 2006. There’s just no sign of regulatory strangulation in Morgan Stanley’s numbers.
While everybody misses the profits, the investment banks’ leverage wasn’t healthy for the financial system. At 27 times leverage, it doesn’t take much of a setback to put a company in intensive care. And it is an integral part of the global banking system, then watch out, everyone’s at risk.
On balance, new regulations are not putting banks out of business. What’s more, the financial world is a safer place for it.
Anna Bernasek writes on financial markets, the economy, Wall Street and public policy from New York. Her book The Economics of Integrity was published in 2010.
Saturday, January 28, 2012
Saturday, January 21, 2012
Fed pushes Congress for Housing Policy Action
Financial Review
Published January 21, 2012
Anna Bernasek, New York
US Federal Reserve chairman Ben Bernanke this month sent Congress a report on the housing market urging more policy action. Since then, a rising chorus of Fed officials has reinforced Bernanke’s message in speeches around the country.
Despite “green shoots” in some parts of the American economy, the Fed remains concerned about the effects of continued weakness in the housing sector. Just how big a problem is the housing market?
Housing prices have fallen on average about 33 per cent from the peak in 2006. The last time home prices fell anywhere near that much was during the 1930s. And by some measures at least, the current crash in housing prices is even worse than what happened in the Great Depression. According to the S&P/Case-Shiller home price index, a measure of national housing prices, the average price of a home fell 24 per cent from 1929 to 1933.
As a result of the recent decline in prices, $US7 trillion in household wealth simply vanished, drastically reducing consumer spending. Today the value of all housing assets is about $US14 trillion. It was close to $US21 trillion at the peak.
Falling home prices have a big economic effect due to leverage. A significant fall can wipe out a home owner’s equity and eat away the value of the bank’s mortgage. Analysts estimate that a 10 per cent fall is the typical threshold for those pernicious effects. With home prices falling three times as much, the impact has been unprecedented.
Lots of people are desperate. The Fed estimates that 12 million borrowers owe more on their mortgages than their homes are worth. That represents about one in five mortgages in the US.
In Florida, Nevada and Arizona, where prices have fallen more than the national average, as many as half of all mortgage borrowers owe the banks more than their homes could be sold for.
It all adds up to a whopping $US700 billion in aggregate negative equity, according to the Fed. To put that another way, it would take a 5 per cent increase in prices just to absorb that shortfall, without any gains going to home owners.
About 3.4 million borrowers with negative equity, amounting to $US275 billion, are late or have stopped making mortgage payments. While the remaining 8.6 million or so are still paying, they might stop at any time. That’s a continuing risk for US banks.
Negative equity creates a series of headaches for borrowers. For starters, banks won’t approve refinancing for borrowers with negative equity so they can’t take advantage of record low interest rates when they need it most. Worse still, it ties borrowers to homes and locations that might not offer the best job prospects so it creates a vicious cycle of falling prices, more negative equity and reduced economic prospects. And to top it off, the worst price declines tend to occur where the job market is not terribly strong.
Although the decline in home prices mostly occurred between 2007 and 2009, more recently home prices have begun falling again. As of October, the S&P/Case-Shiller index of property values in 20 cities showed a decline of 3.4 per cent from the previous year.
What worries the Fed is that it has already used its main tool, interest rates, to try to stimulate the housing market, with little visible effect. Mortgage rates are at record lows, with a typical 30-year mortgage priced under 4 per cent. Yet that seems to have had little impact on boosting demand, which would help home prices.
It seems that the banks aren’t eager to lend. The Fed believes there may be a permanent shift under way in the availability of mortgage credit as banks introduce tighter lending restrictions. Americans who would like to refinance their mortgages or buy properties are finding they simply can’t get a loan.
Mortgage applications are at their lowest level in 12 years and the Fed forecasts that home-loan borrowing in 2012 will decline to its lowest level in 15 years.
If the Fed is correct, new lending standards will further burden the housing market as demand is held back while supply continues to flood the market.
The Fed acknowledges that it lacks a silver bullet to end the housing crisis but it has urged Congress to take three steps.
Since rental markets are strengthening, the Fed has asked Congress to reduce barriers to converting foreclosed properties to rental units.
Next, the Fed wants Congress to reduce obstacles blocking people from getting credit.
And finally, the Fed wants Congress to encourage banks to make loan modifications rather than pursuing foreclosures, which are costly and put more pressure on home prices.
The Fed’s recommendations should come as a welcome relief. They rely on rule changes rather than spending money.
So far, though, the response has been lukewarm at best. More than a few Republican members of Congress have told the Fed it has no business trying to affect the housing sector.
For the sake of the economy, let’s hope Bernanke doesn’t give up too easily.
Published January 21, 2012
Anna Bernasek, New York
US Federal Reserve chairman Ben Bernanke this month sent Congress a report on the housing market urging more policy action. Since then, a rising chorus of Fed officials has reinforced Bernanke’s message in speeches around the country.
Despite “green shoots” in some parts of the American economy, the Fed remains concerned about the effects of continued weakness in the housing sector. Just how big a problem is the housing market?
Housing prices have fallen on average about 33 per cent from the peak in 2006. The last time home prices fell anywhere near that much was during the 1930s. And by some measures at least, the current crash in housing prices is even worse than what happened in the Great Depression. According to the S&P/Case-Shiller home price index, a measure of national housing prices, the average price of a home fell 24 per cent from 1929 to 1933.
As a result of the recent decline in prices, $US7 trillion in household wealth simply vanished, drastically reducing consumer spending. Today the value of all housing assets is about $US14 trillion. It was close to $US21 trillion at the peak.
Falling home prices have a big economic effect due to leverage. A significant fall can wipe out a home owner’s equity and eat away the value of the bank’s mortgage. Analysts estimate that a 10 per cent fall is the typical threshold for those pernicious effects. With home prices falling three times as much, the impact has been unprecedented.
Lots of people are desperate. The Fed estimates that 12 million borrowers owe more on their mortgages than their homes are worth. That represents about one in five mortgages in the US.
In Florida, Nevada and Arizona, where prices have fallen more than the national average, as many as half of all mortgage borrowers owe the banks more than their homes could be sold for.
It all adds up to a whopping $US700 billion in aggregate negative equity, according to the Fed. To put that another way, it would take a 5 per cent increase in prices just to absorb that shortfall, without any gains going to home owners.
About 3.4 million borrowers with negative equity, amounting to $US275 billion, are late or have stopped making mortgage payments. While the remaining 8.6 million or so are still paying, they might stop at any time. That’s a continuing risk for US banks.
Negative equity creates a series of headaches for borrowers. For starters, banks won’t approve refinancing for borrowers with negative equity so they can’t take advantage of record low interest rates when they need it most. Worse still, it ties borrowers to homes and locations that might not offer the best job prospects so it creates a vicious cycle of falling prices, more negative equity and reduced economic prospects. And to top it off, the worst price declines tend to occur where the job market is not terribly strong.
Although the decline in home prices mostly occurred between 2007 and 2009, more recently home prices have begun falling again. As of October, the S&P/Case-Shiller index of property values in 20 cities showed a decline of 3.4 per cent from the previous year.
What worries the Fed is that it has already used its main tool, interest rates, to try to stimulate the housing market, with little visible effect. Mortgage rates are at record lows, with a typical 30-year mortgage priced under 4 per cent. Yet that seems to have had little impact on boosting demand, which would help home prices.
It seems that the banks aren’t eager to lend. The Fed believes there may be a permanent shift under way in the availability of mortgage credit as banks introduce tighter lending restrictions. Americans who would like to refinance their mortgages or buy properties are finding they simply can’t get a loan.
Mortgage applications are at their lowest level in 12 years and the Fed forecasts that home-loan borrowing in 2012 will decline to its lowest level in 15 years.
If the Fed is correct, new lending standards will further burden the housing market as demand is held back while supply continues to flood the market.
The Fed acknowledges that it lacks a silver bullet to end the housing crisis but it has urged Congress to take three steps.
Since rental markets are strengthening, the Fed has asked Congress to reduce barriers to converting foreclosed properties to rental units.
Next, the Fed wants Congress to reduce obstacles blocking people from getting credit.
And finally, the Fed wants Congress to encourage banks to make loan modifications rather than pursuing foreclosures, which are costly and put more pressure on home prices.
The Fed’s recommendations should come as a welcome relief. They rely on rule changes rather than spending money.
So far, though, the response has been lukewarm at best. More than a few Republican members of Congress have told the Fed it has no business trying to affect the housing sector.
For the sake of the economy, let’s hope Bernanke doesn’t give up too easily.
Saturday, January 14, 2012
Drug profits are hard to swallow
The Financial Review
PUBLISHED: 14 Jan 2012
Anna Bernasek New York
On New Year’s Eve, John Capano, an off-duty federal agent, went to his local pharmacy in the middle-class suburb of Seaford, on Long Island, New York, to pick up some prescriptions for himself and his cancer-stricken father.
What seemed like a perfectly mundane Saturday afternoon errand ended his life. A gunman entered Charlie’s Family Pharmacy demanding painkillers and cash.
After the robber left, Capano tried to apprehend him and shot him in the leg before the pair became embroiled in a scuffle. A retired police lieutenant and an off-duty New York City police officer were next to arrive. In the confusion, Capano was shot dead and so was the robber.
A pharmacy robbery in broad daylight is not supposed to happen in the quiet suburbs of Long Island. Seaford is the kind of place to which people moved to get away from all that.
And while much of the public’s attention has focused on the tragedy of the mistaken shooting, the incident at Seaford highlights the disturbing country-wide increase in abuse of prescription drugs. That has fuelled a rise in crime – and bumper profits for pharmaceutical companies cashing in on the epidemic.
The number of deaths from prescription painkillers soared from about 4000 in 1999 to 15,000 in 2008, the Centres for Disease Control and Prevention report.
That’s still less than half the number of road fatalities in the United States in a typical year. But while road deaths have been declining, deaths from prescription drugs have been increasing at an alarming rate.
The Drug Abuse Warning Network says 86,000 emergency department visits in 2009 were associated with the non-medical use of hydrocodone, among the most abused of all the prescription painkillers. That compares with 19,000 visits in 2000.
Prescription drugs are second only to cannabis as the most abused class of drug in the US.
Perhaps most disturbing of all, as drug abuse in the US extends from illegal street drugs to prescription painkillers, pharmaceutical companies are only too eager to find new ways to meet this growing demand.
Four companies – Zogenix, Purdue Pharma, Cephalon and Egalet – say they are developing a potentially more potent form of hydrocodone that could be 10 times stronger than existing medicines. Zogenix plans to file an application for its product with the US Food and Drug Administration early this year.
Hydrocodone is used in combination with a non-addictive painkiller called acetaminophen. Hydrocodone is an opiate from the same family as morphine, heroin, oxycodone, codeine and methadone. These drugs are highly addictive and people taking them on a regular basis often need to step up the dose to provide the same effect.
If you don’t count the tragedy, that makes for a very effective business model.
Pharmaceutical companies argue that a pure form of hydrocodone will help control pain for people with liver problems, as acetaminophen can be toxic to the liver.
Some doctors are sceptical. They say there is little medical need for stronger painkillers and argue that the profession already has the tools at hand to manage pain effectively.
The market for prescription opiates is big business, and estimated to be $US10 billion a year in the US. The number of people who have taken hydrocodone for non-medical reasons is thought to be close to 25 million, a 2009 National Survey on Drug Use and Health found. That’s nearly 10 per cent of the population.
So far, the abuse of hydrocodone and oxycodone seems to be an American phenomenon. The International Narcotics Control Board reports that the US consumes 99 per cent of the world’s hydrocodone and 83 per cent of its oxycodone. The discrepancy may be the result of loopholes in US law.
As it now stands, patients get up to five automatic refills of hydrocodone compared with one for oxycodone.
Another factor is the growing supply and widespread availability of hydrocodone. The Drug Enforcement Administration (DEA) wrote in a recent report that every age group had been affected by easy access to hydrocodone and the perceived safety of those products by medical prescribers.
In the US, the DEA sets quotas for the amount of addictive painkillers pharmaceutical companies can make. So government agencies have approved the big increase in supply of recent years.
The increasing trend of prescription drug abuse results from many factors: a medical culture that promotes pills over other solutions, ineffectual laws, a ready supply of dangerous products – and big profits.
Washington puts the cost of drug trafficking and drug abuse at $US215 billion a year. The human costs are even higher.
Anna Bernasek writes on financial markets, the economy, Wall Street and public policy from New York.
PUBLISHED: 14 Jan 2012
Anna Bernasek New York
On New Year’s Eve, John Capano, an off-duty federal agent, went to his local pharmacy in the middle-class suburb of Seaford, on Long Island, New York, to pick up some prescriptions for himself and his cancer-stricken father.
What seemed like a perfectly mundane Saturday afternoon errand ended his life. A gunman entered Charlie’s Family Pharmacy demanding painkillers and cash.
After the robber left, Capano tried to apprehend him and shot him in the leg before the pair became embroiled in a scuffle. A retired police lieutenant and an off-duty New York City police officer were next to arrive. In the confusion, Capano was shot dead and so was the robber.
A pharmacy robbery in broad daylight is not supposed to happen in the quiet suburbs of Long Island. Seaford is the kind of place to which people moved to get away from all that.
And while much of the public’s attention has focused on the tragedy of the mistaken shooting, the incident at Seaford highlights the disturbing country-wide increase in abuse of prescription drugs. That has fuelled a rise in crime – and bumper profits for pharmaceutical companies cashing in on the epidemic.
The number of deaths from prescription painkillers soared from about 4000 in 1999 to 15,000 in 2008, the Centres for Disease Control and Prevention report.
That’s still less than half the number of road fatalities in the United States in a typical year. But while road deaths have been declining, deaths from prescription drugs have been increasing at an alarming rate.
The Drug Abuse Warning Network says 86,000 emergency department visits in 2009 were associated with the non-medical use of hydrocodone, among the most abused of all the prescription painkillers. That compares with 19,000 visits in 2000.
Prescription drugs are second only to cannabis as the most abused class of drug in the US.
Perhaps most disturbing of all, as drug abuse in the US extends from illegal street drugs to prescription painkillers, pharmaceutical companies are only too eager to find new ways to meet this growing demand.
Four companies – Zogenix, Purdue Pharma, Cephalon and Egalet – say they are developing a potentially more potent form of hydrocodone that could be 10 times stronger than existing medicines. Zogenix plans to file an application for its product with the US Food and Drug Administration early this year.
Hydrocodone is used in combination with a non-addictive painkiller called acetaminophen. Hydrocodone is an opiate from the same family as morphine, heroin, oxycodone, codeine and methadone. These drugs are highly addictive and people taking them on a regular basis often need to step up the dose to provide the same effect.
If you don’t count the tragedy, that makes for a very effective business model.
Pharmaceutical companies argue that a pure form of hydrocodone will help control pain for people with liver problems, as acetaminophen can be toxic to the liver.
Some doctors are sceptical. They say there is little medical need for stronger painkillers and argue that the profession already has the tools at hand to manage pain effectively.
The market for prescription opiates is big business, and estimated to be $US10 billion a year in the US. The number of people who have taken hydrocodone for non-medical reasons is thought to be close to 25 million, a 2009 National Survey on Drug Use and Health found. That’s nearly 10 per cent of the population.
So far, the abuse of hydrocodone and oxycodone seems to be an American phenomenon. The International Narcotics Control Board reports that the US consumes 99 per cent of the world’s hydrocodone and 83 per cent of its oxycodone. The discrepancy may be the result of loopholes in US law.
As it now stands, patients get up to five automatic refills of hydrocodone compared with one for oxycodone.
Another factor is the growing supply and widespread availability of hydrocodone. The Drug Enforcement Administration (DEA) wrote in a recent report that every age group had been affected by easy access to hydrocodone and the perceived safety of those products by medical prescribers.
In the US, the DEA sets quotas for the amount of addictive painkillers pharmaceutical companies can make. So government agencies have approved the big increase in supply of recent years.
The increasing trend of prescription drug abuse results from many factors: a medical culture that promotes pills over other solutions, ineffectual laws, a ready supply of dangerous products – and big profits.
Washington puts the cost of drug trafficking and drug abuse at $US215 billion a year. The human costs are even higher.
Anna Bernasek writes on financial markets, the economy, Wall Street and public policy from New York.
Saturday, January 7, 2012
When the world sneezes...
The Financial Review
PUBLISHED: January 7, 2012
Anna Bernasek New York
As street sweepers clean up after the revelry in Times Square, it’s time to think about what’s in store for America. An election campaign is under way, of course. But for the American economy a lot will depend on what happens elsewhere. Three major global trends are affecting the nation.
The carbon rush
Persistent high energy prices are driving the global frenzy to develop new carbon sources. In the US, there is a spectacular boom in oil and gas drilling as new technology – hydraulic fracturing, or “fracking” – opens up new resources.
Touching 38 out of the 50 states, a mining boom on this scale hasn’t occurred in generations. In the past year alone, the number of drilling rigs in the US rose by 313 to 2007, the highest level since the 1980s and four times greater than in the 1990s. Experts believe it is the start of a great new era in American oil and gas production.
James Hackett, chairman and CEO of one of the world’s largest oil and gas companies, Anadarko Petroleum, predicted late last year that North American oil production could double in the next 25 years.
Hackett has reason to be optimistic. In November, Anadarko announced what could turn out to be the single biggest oil and gas field discovered in the US. Based on preliminary findings, the company believes it has found between 500 million and 1.5 billion barrels of oil, natural gas liquids and natural gas in shale beneath the Wattenberg field in north-east Colorado. Only a few billion-barrel fields have ever been found in the US.
Like a good old-fashioned gold rush, the drilling boom is exciting investors and boosting local economies. In North Dakota, for instance, there’s no sign of the great recession. Unemployment is 3.5 per cent, compared with the national average of 8.6 per cent.
But there’s a dark side to the boom. Fracking threatens local water supplies, and growing oil supply undermines efforts to develop alternative energy sources and combat global warming.
And that may be more urgent than ever. According to the Global Carbon Project, emissions of carbon dioxide from fossil-fuel burning jumped almost 6 per cent in 2010. On a tonnage basis, that was the largest increase in carbon emissions ever recorded.
The debt wave
A wave of debt has washed over governments and consumers. With debt markets now global, one region’s problem affects everyone.
After the 2008 US financial crisis, debt problems now engulf Europe. Buoyed by cheap money, runaway property markets in China or elsewhere could be next to collapse.
In the US, consumers are still working off debt as the government struggles with record deficits. So far economic growth has been too slow to make a significant difference and, as the US muddles along, it remains vulnerable to what happens in Europe and China.
It seems Europe is all but certain to enter recession this year and growth in China is expected to slow as the housing boom cools.
In Europe, ill-conceived austerity measures could keep its economies mired in stagnation for years.
It’s much harder to assess the Chinese situation. Property price increases in China have been similar to those seen in Japan in the late 1980s and in the US in the late 1990s and early 2000s. In cities such as Shanghai and Beijing, house prices rose by more than 30 per cent a year.
In response, the Chinese government has introduced measures, including raising interest rates, to take some froth out of the market. Whether the housing bubble turns into a full-blown banking crisis or not, it adds to uncertainty and has the potential to create more volatility in global financial markets.
So while the US is digging itself out of its own debt crisis, the crisis in Europe and a potential crisis in China may only prolong America’s economic problems.
Social unrest
Scenes reminiscent of the Arab Spring are playing out around the world. Public protests have ignited in cities as diverse as Cairo and Oakland, California.
While there are different reasons why people around the world have taken to the streets – the latest Russian protests sparked by election fraud; the Occupy Wall Street protests focused on income inequality and a lack of economic opportunity – much of the unrest has something in common. Weak employment and stagnant wages fuel desire for systemic change.
Little serious effort has been made to address the concerns of protesters. Here and abroad a generation of young people is at risk of losing their chance at a middle-class life, suggesting we’re likely to see more unrest.
According to the International Labour Organisation, the change in the risk of social unrest in the past five years has been greatest in advanced countries, followed by the Middle East and then Africa.
In an open society such as the US, it’s possible for public demonstration to be channelled into constructive change. But social unrest is a dangerous and unpredictable force. And by the time a nation is faced with significant and prolonged social unrest, it’s a sure bet the government hasn’t done its job. Happy New Year!
PUBLISHED: January 7, 2012
Anna Bernasek New York
As street sweepers clean up after the revelry in Times Square, it’s time to think about what’s in store for America. An election campaign is under way, of course. But for the American economy a lot will depend on what happens elsewhere. Three major global trends are affecting the nation.
The carbon rush
Persistent high energy prices are driving the global frenzy to develop new carbon sources. In the US, there is a spectacular boom in oil and gas drilling as new technology – hydraulic fracturing, or “fracking” – opens up new resources.
Touching 38 out of the 50 states, a mining boom on this scale hasn’t occurred in generations. In the past year alone, the number of drilling rigs in the US rose by 313 to 2007, the highest level since the 1980s and four times greater than in the 1990s. Experts believe it is the start of a great new era in American oil and gas production.
James Hackett, chairman and CEO of one of the world’s largest oil and gas companies, Anadarko Petroleum, predicted late last year that North American oil production could double in the next 25 years.
Hackett has reason to be optimistic. In November, Anadarko announced what could turn out to be the single biggest oil and gas field discovered in the US. Based on preliminary findings, the company believes it has found between 500 million and 1.5 billion barrels of oil, natural gas liquids and natural gas in shale beneath the Wattenberg field in north-east Colorado. Only a few billion-barrel fields have ever been found in the US.
Like a good old-fashioned gold rush, the drilling boom is exciting investors and boosting local economies. In North Dakota, for instance, there’s no sign of the great recession. Unemployment is 3.5 per cent, compared with the national average of 8.6 per cent.
But there’s a dark side to the boom. Fracking threatens local water supplies, and growing oil supply undermines efforts to develop alternative energy sources and combat global warming.
And that may be more urgent than ever. According to the Global Carbon Project, emissions of carbon dioxide from fossil-fuel burning jumped almost 6 per cent in 2010. On a tonnage basis, that was the largest increase in carbon emissions ever recorded.
The debt wave
A wave of debt has washed over governments and consumers. With debt markets now global, one region’s problem affects everyone.
After the 2008 US financial crisis, debt problems now engulf Europe. Buoyed by cheap money, runaway property markets in China or elsewhere could be next to collapse.
In the US, consumers are still working off debt as the government struggles with record deficits. So far economic growth has been too slow to make a significant difference and, as the US muddles along, it remains vulnerable to what happens in Europe and China.
It seems Europe is all but certain to enter recession this year and growth in China is expected to slow as the housing boom cools.
In Europe, ill-conceived austerity measures could keep its economies mired in stagnation for years.
It’s much harder to assess the Chinese situation. Property price increases in China have been similar to those seen in Japan in the late 1980s and in the US in the late 1990s and early 2000s. In cities such as Shanghai and Beijing, house prices rose by more than 30 per cent a year.
In response, the Chinese government has introduced measures, including raising interest rates, to take some froth out of the market. Whether the housing bubble turns into a full-blown banking crisis or not, it adds to uncertainty and has the potential to create more volatility in global financial markets.
So while the US is digging itself out of its own debt crisis, the crisis in Europe and a potential crisis in China may only prolong America’s economic problems.
Social unrest
Scenes reminiscent of the Arab Spring are playing out around the world. Public protests have ignited in cities as diverse as Cairo and Oakland, California.
While there are different reasons why people around the world have taken to the streets – the latest Russian protests sparked by election fraud; the Occupy Wall Street protests focused on income inequality and a lack of economic opportunity – much of the unrest has something in common. Weak employment and stagnant wages fuel desire for systemic change.
Little serious effort has been made to address the concerns of protesters. Here and abroad a generation of young people is at risk of losing their chance at a middle-class life, suggesting we’re likely to see more unrest.
According to the International Labour Organisation, the change in the risk of social unrest in the past five years has been greatest in advanced countries, followed by the Middle East and then Africa.
In an open society such as the US, it’s possible for public demonstration to be channelled into constructive change. But social unrest is a dangerous and unpredictable force. And by the time a nation is faced with significant and prolonged social unrest, it’s a sure bet the government hasn’t done its job. Happy New Year!
Saturday, December 24, 2011
Tip: goodwill can lead to profit
Here's my column in this weekend's Financial Review:
Jack Frost nipping at your nose and bells ringing on Fifth Avenue mark the time of year: ’tis the annual tipping season in New York. That’s when all the doormen, supers, nannies, housekeepers, mail carriers, newspaper deliverers, garbage men and the like get a year-end bonus from their clients.The individual amounts can range from a few dollars up into the thousands. In total, seasonal tips will add up to a substantial chunk of a service person’s annual income.
But deciding whether and exactly how much to tip is entirely up to each New Yorker. For some it’s a matter of conscience. For others it’s a more self-interested calculation, a spreadsheet exercise.
The amazing thing about the peculiar American culture of tipping is that it actually works quite smoothly. There’s absolutely no recourse if an anticipated tip never materialises. Nevertheless, the tips arrive like clockwork. And in New York, it’s been perfected to a high degree.
Perhaps that’s only natural in a city that runs on voluntary payments. The waitress at the lowliest hamburger joint depends on tips for survival. And at the other end of the spectrum, a discretionary bonus is likely to make or break the year for New York’s loftiest banker.
The principle of letting the client decide how much an intangible service is worth, in some cases after it is rendered, has lots of interesting implications for business. As the global service economy continues to grow, entrepreneurs have been testing new business models that reflect the usefulness of voluntary payment schemes.
This month, comedian Louis C.K. became the latest entertainer to experiment with a version of pay-what-you-decide business model on the web.
For $5, fans of Louis C.K. could download a video of his comedy show recorded live at the Beacon Theatre in New York. Or they could watch it without paying anything since he didn’t even try to prevent pirating. Louis C.K. says he chose the low $5 price because it was nearly free. And he wanted downloading to be easy, almost like hitting a link and streaming.
In the first week 175,000 people paid the $5 to download his show. The comedian expects that to top out about 200,000. Assuming that pans out, Louis C.K. will have grossed $1 million. After production costs of $250,000, he estimates making $750,000 in profits from his experiment.
Other entertainers who have tried similar pay-what-you-decide business models include Radiohead, hip-hop singer Niggy Tardust, and comedian Steve Hofstetter.
And it’s not just limited to entertainers. The sandwich chain Panera Bread opened a pay-what-you-decide cafe in St Louis, Missouri, about a year ago. The company found it generated valuable goodwill towards its brand. Perhaps just as important, it turned a profit. Since then, Panera has opened a further two pay-what-you-decide cafes.
From its initial experiment, Panera gleaned an important insight into the behaviour of its customers. The sandwich chain found that roughly 60 per cent pay the suggested price and 20 per cent pay more. Only about 20 per cent underpay for their food.
For some time, small software operators on the web have been experimenting with the pay-what-you-decide model.
The potential for this approach is very large. After all,the entire charitable sector is based on a pay-what-you-decide model. Last year Americans paid almost $US300 billion to charitable organisations. That is the biggest sector by far of the pay-what-you-decide economy.
It could be a lesson for other sectors. Some that are in trouble, such as music and publishing, have struggled to adapt old business models to the ubiquitous online world. So far, much of their effort has gone into devising schemes to protect content from unauthorised, meaning unpaid, use.
This month in a lower Manhattan court, Sony Music and Warner Music joined Universal Music Group’s suit against Grooveshark.
Grooveshark isn’t selling the other companies’ content. Instead, they are streaming it without requiring payment to listeners who (presumably) don’t keep a copy.
There’s just one little problem. Given the state of technology, there’s no way to keep a lid on content. And worse, if you actually happen to succeed in your efforts to discourage somebody from listening to a song, or reading a story, you lose a potential supporter. Illicit users could turn out to be an important source of “word of mouth” advertising. And if the product is good, what’s to say they won’t become paying customers one day.
After all, if nobody pays for the waitress, or the musician, or the corporate executive’s bonus, why should anyone expect them to keep doing their thing?
In the end it all boils down to a matter of trust. And the thing is, people actually like it when you trust them. Letting the customer know that you are confident in the value of what you do, and then trusting the customer to pay fairly for that can build a strong relationship. There’s no better way to communicate your worth or to build a business.
The Australian Financial Review
Jack Frost nipping at your nose and bells ringing on Fifth Avenue mark the time of year: ’tis the annual tipping season in New York. That’s when all the doormen, supers, nannies, housekeepers, mail carriers, newspaper deliverers, garbage men and the like get a year-end bonus from their clients.The individual amounts can range from a few dollars up into the thousands. In total, seasonal tips will add up to a substantial chunk of a service person’s annual income.
But deciding whether and exactly how much to tip is entirely up to each New Yorker. For some it’s a matter of conscience. For others it’s a more self-interested calculation, a spreadsheet exercise.
The amazing thing about the peculiar American culture of tipping is that it actually works quite smoothly. There’s absolutely no recourse if an anticipated tip never materialises. Nevertheless, the tips arrive like clockwork. And in New York, it’s been perfected to a high degree.
Perhaps that’s only natural in a city that runs on voluntary payments. The waitress at the lowliest hamburger joint depends on tips for survival. And at the other end of the spectrum, a discretionary bonus is likely to make or break the year for New York’s loftiest banker.
The principle of letting the client decide how much an intangible service is worth, in some cases after it is rendered, has lots of interesting implications for business. As the global service economy continues to grow, entrepreneurs have been testing new business models that reflect the usefulness of voluntary payment schemes.
This month, comedian Louis C.K. became the latest entertainer to experiment with a version of pay-what-you-decide business model on the web.
For $5, fans of Louis C.K. could download a video of his comedy show recorded live at the Beacon Theatre in New York. Or they could watch it without paying anything since he didn’t even try to prevent pirating. Louis C.K. says he chose the low $5 price because it was nearly free. And he wanted downloading to be easy, almost like hitting a link and streaming.
In the first week 175,000 people paid the $5 to download his show. The comedian expects that to top out about 200,000. Assuming that pans out, Louis C.K. will have grossed $1 million. After production costs of $250,000, he estimates making $750,000 in profits from his experiment.
Other entertainers who have tried similar pay-what-you-decide business models include Radiohead, hip-hop singer Niggy Tardust, and comedian Steve Hofstetter.
And it’s not just limited to entertainers. The sandwich chain Panera Bread opened a pay-what-you-decide cafe in St Louis, Missouri, about a year ago. The company found it generated valuable goodwill towards its brand. Perhaps just as important, it turned a profit. Since then, Panera has opened a further two pay-what-you-decide cafes.
From its initial experiment, Panera gleaned an important insight into the behaviour of its customers. The sandwich chain found that roughly 60 per cent pay the suggested price and 20 per cent pay more. Only about 20 per cent underpay for their food.
For some time, small software operators on the web have been experimenting with the pay-what-you-decide model.
The potential for this approach is very large. After all,the entire charitable sector is based on a pay-what-you-decide model. Last year Americans paid almost $US300 billion to charitable organisations. That is the biggest sector by far of the pay-what-you-decide economy.
It could be a lesson for other sectors. Some that are in trouble, such as music and publishing, have struggled to adapt old business models to the ubiquitous online world. So far, much of their effort has gone into devising schemes to protect content from unauthorised, meaning unpaid, use.
This month in a lower Manhattan court, Sony Music and Warner Music joined Universal Music Group’s suit against Grooveshark.
Grooveshark isn’t selling the other companies’ content. Instead, they are streaming it without requiring payment to listeners who (presumably) don’t keep a copy.
There’s just one little problem. Given the state of technology, there’s no way to keep a lid on content. And worse, if you actually happen to succeed in your efforts to discourage somebody from listening to a song, or reading a story, you lose a potential supporter. Illicit users could turn out to be an important source of “word of mouth” advertising. And if the product is good, what’s to say they won’t become paying customers one day.
After all, if nobody pays for the waitress, or the musician, or the corporate executive’s bonus, why should anyone expect them to keep doing their thing?
In the end it all boils down to a matter of trust. And the thing is, people actually like it when you trust them. Letting the customer know that you are confident in the value of what you do, and then trusting the customer to pay fairly for that can build a strong relationship. There’s no better way to communicate your worth or to build a business.
The Australian Financial Review
Saturday, December 17, 2011
Obama, Romney, Same Difference
America Inc: Please read my column in this week's Financial Review
As US businesses close out what looks to be a fairly good fiscal year, there’s plenty of uncertainty about what comes next.
The euro crisis still threatens to slow down the global economy. China’s economy has cooled as dramatically, making it difficult to predict growth coming from Asia. And recent signs of life in the US economy look suspiciously like a mirage that could disappear at any moment. Until there’s real movement in wages and employment it’s hard to believe consumers will be back en masse.
On top of all that, there’s a pretty vigorous competition to challenge for the presidency next year. With so much in play, companies struggle to figure out what they can count on.
On the political front at least, they may have less to worry about. When Americans vote next year, there may not be all that much at stake for business.
Start with the Republican primaries. As the contest unfolds, a parade of potential challengers has captured headlines then faded away. Former Alaska governor and “grizzly mom” Sarah Palin came and went. Self-described business success and reality TV host Donald Trump had his moment in the sun. For a brief time the right was enthralled with former Texas governor Rick Perry, until he couldn’t remember exactly which parts of the government he was desperate to shut down.
Now it’s Newt Gingrich, former House speaker, grabbing the spotlight. Gingrich is an interesting character. A former history professor at a small college who has described himself as a “world historical figure”, he has floated some pretty newsworthy ideas. Recently he made headlines by suggesting poor schoolchildren should be forced to work as janitors in their schools.
Despite the outlandish proposals, though, Gingrich has real leadership experience. He was the prime force behind a Republican takeover of Congress during the Clinton presidency.
But his political success is long gone. He never regained his power or popularity after he shut down the government under Bill Clinton. Since then sordid details of his personal life have come to light. He can count on a segment of the right wing for support, but if he is nominated to challenge Barack Obama it could be a disaster for Republicans.
Gingrich’s momentary popularity has surprised even him. He is only now trying to put together an organisation that could seriously campaign for the presidency, and it’s somewhat late in the game for that.
So that leaves Mitt Romney. Smart, disciplined and well financed, he has the organisation, the résumé and the staying power to earn the nomination. He doesn’t have personal popularity, true, but he can raise money and avoid mistakes.
The smart money is on Romney to get the nomination. If he does, a lot of the political uncertainty facing corporate America goes away. Obama and Romney are more alike than different on most issues affecting business.
Three years into his presidency, Obama is pretty much a known quantity. He’s pragmatic and incremental. And conservative, not in the ideological sense but in his basic character.
The Iraq war was his signature campaign issue and he’s only now winding that down. His biggest policy achievement, health care reform, wasn’t a radical departure from the status quo. And any president who squelches new clean air rules and allows oil drilling over the objections of environmentalists can’t be viewed as rabidly anti-business.
Conservatives label Obama “liberal” but when it comes to corporate America, he’s careful not to rock the boat. Witness the Occupy Wall Street movement. If Obama was really on the side of the “99 per cent”, the movement would not exist; its activists would be out campaigning for him.
While Obama is less of a liberal than he is often labelled, Romney is more of a centrist than he lets on. That’s why the right wing of the Republican party is so loath to elect him. In addition, his record as governor of Massachusetts isn’t exactly pro-business. One of his signature policies was to go after corporate tax loopholes to narrow the state budget deficit.
And then there’s the practical matter of a divided government. Even if Obama or Romney turn out to be more activist than they appear, it’s unlikely they’ll find the legislative support to make big changes. If Romney is elected, the Republicans could also take control of Congress. But experts consider that unlikely at this point, and they give Obama virtually no chance of getting a Democratic Congress. As president, either one would be forced to take a centrist approach.
As the presidential race gets into full swing, the candidates will be forced to promise lots of changes. The reality, though, looks to be more of the same.
Anna Bernasek writes on financial markets, the economy, Wall Street and public policy from New York. Her book The Economics of Integrity was published in 2010. Her column America Inc. appears each week in the Weekend Financial Review.
As US businesses close out what looks to be a fairly good fiscal year, there’s plenty of uncertainty about what comes next.
The euro crisis still threatens to slow down the global economy. China’s economy has cooled as dramatically, making it difficult to predict growth coming from Asia. And recent signs of life in the US economy look suspiciously like a mirage that could disappear at any moment. Until there’s real movement in wages and employment it’s hard to believe consumers will be back en masse.
On top of all that, there’s a pretty vigorous competition to challenge for the presidency next year. With so much in play, companies struggle to figure out what they can count on.
On the political front at least, they may have less to worry about. When Americans vote next year, there may not be all that much at stake for business.
Start with the Republican primaries. As the contest unfolds, a parade of potential challengers has captured headlines then faded away. Former Alaska governor and “grizzly mom” Sarah Palin came and went. Self-described business success and reality TV host Donald Trump had his moment in the sun. For a brief time the right was enthralled with former Texas governor Rick Perry, until he couldn’t remember exactly which parts of the government he was desperate to shut down.
Now it’s Newt Gingrich, former House speaker, grabbing the spotlight. Gingrich is an interesting character. A former history professor at a small college who has described himself as a “world historical figure”, he has floated some pretty newsworthy ideas. Recently he made headlines by suggesting poor schoolchildren should be forced to work as janitors in their schools.
Despite the outlandish proposals, though, Gingrich has real leadership experience. He was the prime force behind a Republican takeover of Congress during the Clinton presidency.
But his political success is long gone. He never regained his power or popularity after he shut down the government under Bill Clinton. Since then sordid details of his personal life have come to light. He can count on a segment of the right wing for support, but if he is nominated to challenge Barack Obama it could be a disaster for Republicans.
Gingrich’s momentary popularity has surprised even him. He is only now trying to put together an organisation that could seriously campaign for the presidency, and it’s somewhat late in the game for that.
So that leaves Mitt Romney. Smart, disciplined and well financed, he has the organisation, the résumé and the staying power to earn the nomination. He doesn’t have personal popularity, true, but he can raise money and avoid mistakes.
The smart money is on Romney to get the nomination. If he does, a lot of the political uncertainty facing corporate America goes away. Obama and Romney are more alike than different on most issues affecting business.
Three years into his presidency, Obama is pretty much a known quantity. He’s pragmatic and incremental. And conservative, not in the ideological sense but in his basic character.
The Iraq war was his signature campaign issue and he’s only now winding that down. His biggest policy achievement, health care reform, wasn’t a radical departure from the status quo. And any president who squelches new clean air rules and allows oil drilling over the objections of environmentalists can’t be viewed as rabidly anti-business.
Conservatives label Obama “liberal” but when it comes to corporate America, he’s careful not to rock the boat. Witness the Occupy Wall Street movement. If Obama was really on the side of the “99 per cent”, the movement would not exist; its activists would be out campaigning for him.
While Obama is less of a liberal than he is often labelled, Romney is more of a centrist than he lets on. That’s why the right wing of the Republican party is so loath to elect him. In addition, his record as governor of Massachusetts isn’t exactly pro-business. One of his signature policies was to go after corporate tax loopholes to narrow the state budget deficit.
And then there’s the practical matter of a divided government. Even if Obama or Romney turn out to be more activist than they appear, it’s unlikely they’ll find the legislative support to make big changes. If Romney is elected, the Republicans could also take control of Congress. But experts consider that unlikely at this point, and they give Obama virtually no chance of getting a Democratic Congress. As president, either one would be forced to take a centrist approach.
As the presidential race gets into full swing, the candidates will be forced to promise lots of changes. The reality, though, looks to be more of the same.
Anna Bernasek writes on financial markets, the economy, Wall Street and public policy from New York. Her book The Economics of Integrity was published in 2010. Her column America Inc. appears each week in the Weekend Financial Review.
Friday, December 9, 2011
America Inc: Heinz meanz big or small beanz
Please read my column in this weekend's Australian Financial Review called America Inc:
Americans are getting a sense that the nation has split into haves and have-nots. Corporate America already knows it.
Since the industrial revolution, American business prospered on the back of a simple strategy: sell to the growing middle class. That formula produced corporate icons such as Ford, Procter & Gamble, Johnson & Johnson and Avon.
As the middle class grew, so did Corporate America’s reach. Products like Campbell’s Soup and Tide laundry detergent could be found in any home across the nation. So universal were certain consumer products that in the 1960s Andy Warhol famously painted Campbell’s soup, Coke and other household names.
“What's great about this country is that America started the tradition where the richest consumers buy essentially the same things as the poorest,” Warhol said. “You can be watching TV and see Coca-Cola, and you know that the President drinks Coca-Cola, Liz Taylor drinks Coca-Cola, and just think, you can drink Coca-Cola, too. A Coke is a Coke and no amount of money can get you a better coke than the one the bum on the corner is drinking. All the cokes are the same and all the cokes are good. Liz Taylor knows it, the President knows it, the bum knows it, and you know it.”
Today perhaps the only household product Warhol could paint is Google. With the growth of premium products, organic goods and fancy foods, there aren’t many brands appealing to all levels of customers.
Welcome to the bifurcated market. Selling to consumers in the U.S. means picking a side: the haves or the have-nots, the high end or the low. And tellingly, companies are preparing for the change to last.
In the past two years, the trend toward segmentation has accelerated. This is due to greater inequality and an economic recovery weighted towards the top. While unemployment remains stubbornly high at close to 9 percent, the stock market has been very strong. The Dow Jones Industrial Average is up 85 percent since its low back in March 2009.
Some companies are scrambling to capture the high end. Ford is one example. Finding itself on the back foot in one of the fastest growing markets in the industry, luxury cars, Ford is investing heavily to revamp Lincoln, its premium brand. In a much anticipated launch this January, Ford has promised to deliver a luxury vehicle unlike any other on the market. And analysts say the launch is critical to the carmaker’s success.
Focusing on the opposite end of the market are companies like H.J. Heinz, maker of ketchup, frozen foods, baked beans and condiments. Heinz recently announced a drop in earnings largely due to flat sales in its North American consumer products division. As a result, it has changed its strategy and will accelerate product launches targeting consumers at the low end of the income scale, essentially households earning less than $50,000 a year.
Heinz found that more consumers at the low end were buying smaller sizes of products because they came with a lower price tag. To get at this market segment, Heinz will launch a 10 Oz package of ketchup in a stand up pouch at a suggested retail price of 99 cents. In addition, Heinz will sell other products like mustard and beans at 99 cents.
Procter & Gamble, traditionally selling to the middle class is also being forced to change course, repositioning its products away from the middle but toward both the high and low end. For the first time in 38 years, Procter & Gamble launched a new dish soap called Gain with a bargain price.
But those companies already positioned at either end of the spectrum aren’t sitting still. The high end is going more up market and the low end more down market.
This is evident in prices where luxury retailers are raising prices while low-end retailers are discounting heavily. For instance, the most expensive pair of shoes at Saks Fifth Avenue cost a bit over $1,000 a year ago. Since then it’s passed $2,000. Increasing prices for premium products and services are evident in everything from business and first class air travel, wine, jewelry, restaurants, and clothing.
Operating in a market where perceived value is often measured by price, high-end retailers want to make sure they are seen as the ultimate for luxury. After all it’s a lucrative market. The top 5% of income earners accounts for about one third of spending.
At the same time, companies like Walmart, catering to the low-end, have to watch their step. Walmart has to be careful not to be undercut by other discounters such as Family Dollar Stores, a growing low price merchant.
What’s good for companies is good for investors. Two years ago, Citigroup created a stock market index of two dozen or so companies that are best positioned to benefit from the segmentation of the consumer market. Included in the list of companies are Saks and Estee Lauder at the high end, with Family Dollar Stores and Kellogg at the low. Since its formation, the index has outperformed the broader market.
It’s hard to foresee any change in a trend that’s fracturing the American market. It would probably take a sharp drop in unemployment and a convincing rise in wages to reverse the momentum. And the chances of that happening anytime soon are pretty slim.
Americans are getting a sense that the nation has split into haves and have-nots. Corporate America already knows it.
Since the industrial revolution, American business prospered on the back of a simple strategy: sell to the growing middle class. That formula produced corporate icons such as Ford, Procter & Gamble, Johnson & Johnson and Avon.
As the middle class grew, so did Corporate America’s reach. Products like Campbell’s Soup and Tide laundry detergent could be found in any home across the nation. So universal were certain consumer products that in the 1960s Andy Warhol famously painted Campbell’s soup, Coke and other household names.
“What's great about this country is that America started the tradition where the richest consumers buy essentially the same things as the poorest,” Warhol said. “You can be watching TV and see Coca-Cola, and you know that the President drinks Coca-Cola, Liz Taylor drinks Coca-Cola, and just think, you can drink Coca-Cola, too. A Coke is a Coke and no amount of money can get you a better coke than the one the bum on the corner is drinking. All the cokes are the same and all the cokes are good. Liz Taylor knows it, the President knows it, the bum knows it, and you know it.”
Today perhaps the only household product Warhol could paint is Google. With the growth of premium products, organic goods and fancy foods, there aren’t many brands appealing to all levels of customers.
Welcome to the bifurcated market. Selling to consumers in the U.S. means picking a side: the haves or the have-nots, the high end or the low. And tellingly, companies are preparing for the change to last.
In the past two years, the trend toward segmentation has accelerated. This is due to greater inequality and an economic recovery weighted towards the top. While unemployment remains stubbornly high at close to 9 percent, the stock market has been very strong. The Dow Jones Industrial Average is up 85 percent since its low back in March 2009.
Some companies are scrambling to capture the high end. Ford is one example. Finding itself on the back foot in one of the fastest growing markets in the industry, luxury cars, Ford is investing heavily to revamp Lincoln, its premium brand. In a much anticipated launch this January, Ford has promised to deliver a luxury vehicle unlike any other on the market. And analysts say the launch is critical to the carmaker’s success.
Focusing on the opposite end of the market are companies like H.J. Heinz, maker of ketchup, frozen foods, baked beans and condiments. Heinz recently announced a drop in earnings largely due to flat sales in its North American consumer products division. As a result, it has changed its strategy and will accelerate product launches targeting consumers at the low end of the income scale, essentially households earning less than $50,000 a year.
Heinz found that more consumers at the low end were buying smaller sizes of products because they came with a lower price tag. To get at this market segment, Heinz will launch a 10 Oz package of ketchup in a stand up pouch at a suggested retail price of 99 cents. In addition, Heinz will sell other products like mustard and beans at 99 cents.
Procter & Gamble, traditionally selling to the middle class is also being forced to change course, repositioning its products away from the middle but toward both the high and low end. For the first time in 38 years, Procter & Gamble launched a new dish soap called Gain with a bargain price.
But those companies already positioned at either end of the spectrum aren’t sitting still. The high end is going more up market and the low end more down market.
This is evident in prices where luxury retailers are raising prices while low-end retailers are discounting heavily. For instance, the most expensive pair of shoes at Saks Fifth Avenue cost a bit over $1,000 a year ago. Since then it’s passed $2,000. Increasing prices for premium products and services are evident in everything from business and first class air travel, wine, jewelry, restaurants, and clothing.
Operating in a market where perceived value is often measured by price, high-end retailers want to make sure they are seen as the ultimate for luxury. After all it’s a lucrative market. The top 5% of income earners accounts for about one third of spending.
At the same time, companies like Walmart, catering to the low-end, have to watch their step. Walmart has to be careful not to be undercut by other discounters such as Family Dollar Stores, a growing low price merchant.
What’s good for companies is good for investors. Two years ago, Citigroup created a stock market index of two dozen or so companies that are best positioned to benefit from the segmentation of the consumer market. Included in the list of companies are Saks and Estee Lauder at the high end, with Family Dollar Stores and Kellogg at the low. Since its formation, the index has outperformed the broader market.
It’s hard to foresee any change in a trend that’s fracturing the American market. It would probably take a sharp drop in unemployment and a convincing rise in wages to reverse the momentum. And the chances of that happening anytime soon are pretty slim.
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