The CQ: The Joy & Pain of Compounding
Inflation is hitting consumers harder than many realize–and founders will need to adapt.
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Compounding Inflation Will Squeeze Consumers
By Jason Bornstein, Principal
On Tuesday, the Bureau of Labor Statistics (BLS) reported inflation for the month of August: the numbers did not instill confidence that we’ve turned the corner on high inflation. While August inflation came down to 8.3% for the trailing 12 months, the improvement of 9.1% in June to 8.5% in July had the markets hoping for August to demonstrate a consistent or accelerating month-over-month drop. As we enter the final stretch of 2022, the impact of compounding inflation has become a reality—the 8.3% percent inflation in August is magnified by the 5.3% percent inflation seen in August 2021. In fact, we have now had 3 consecutive months of over 8% inflation in 2022 compounding on top of over 5% inflation for the same 3 months in 2021, and the trend does not appear to be letting up.
When consumers think about compounding, investments and retirement typically are top of mind—saving more earlier in life affords more years for the value of dollars saved to compound. When you reach retirement, a dollar saved in your 30s will be much more valuable to you than a dollar saved in your 40s, 50s, or 60s. Warren Buffet famously said, "My life has been a product of compound interest. The first rule of compounding: Never interrupt it unnecessarily.” With inflation, the same exponential growth rules of compounding apply, but this time the compounding works against consumers and the urgency to slow compounding is palpable.
In the first 2 years and 8 months of the 2020s, the economy has experienced more inflation than the first 5 years of the 2000s and the first 6 years of the 2010s, excluding food and gas inflation, which have been especially high this year. For every $1 a consumer had in August 2020, they would need $1.12 today to have the same buying power. The alarming nature of inflation is that it’s rarely followed by a decrease in prices, called deflation. Once prices go up, they stay up. Since 1913 when the BLS started tracking inflation, there’s only been 13 years where prices dropped annually and 12 of those years were before 1955.
While inflation may continue to be high for some time, the consensus today is that we are unlikely to experience the enduring inflation of the 1970s and 1980s, decades during which cumulative inflation reached 87% and 79%, respectively, excluding food and gas. In other words, for every $1 a consumer had in January 1970, they would need $1.87 in December 1979. The sooner inflation slows, the sooner the compounding effects will lessen. Yet, for every year we have at the 2022 level of inflation, the economy needs 2-3 additional years of inflation at the relatively low 2010-2019 average inflation to overcome the effects.
So, what does this mean for consumers? And what, in turn, does that mean for founders?
It’s a dynamic and confusing time in the economy for consumers. Consumer spend remains high, yet consumer sentiment is below Great Recession levels. On the one hand, consumers want to live their life coming out of Covid – they want to travel, eat out, shop in stores. On the other hand, dollars are not going as far as they used to. Lower-income consumers are no doubt already feeling squeezed by inflation. Walmart cut its profit outlook last quarter as consumers shifted dollars toward necessities and away from discretionary categories, like apparel. The impact to middle and upper-income consumers has yet to play out to the same degree, but these consumers will likely change behaviors in the coming quarters. With rising interest rates, consumers have slowed down larger purchases that are typically financed, like homes. They are also watching their overall monthly expenses come in higher, and it’s beginning to sink in just how much that breaks down into smaller, everyday purchases.
Going forward, expect to see more consumers switching to cheaper options, but do not expect all of them to switch back to the higher priced goods when the economy settles. A McKinsey study in 2009 found that on average across categories 18% of consumers switched to cheaper alternatives, and of those, 34% said they no longer preferred higher-priced products, and an additional 75% saying that while they preferred the premium brand, it “was not worth the money.”
For founders and brands selling to consumers, the impact of inflation and consumer spend will vary by category, but generally the pressure of higher cost of capital and the higher cost of goods will bring into focus the conversation of whether to raise prices to maintain margins. Brands may consider launching lower-priced lines or packages for consumers they may not otherwise be able to acquire or retain. For example, Target prioritized more designer collaborations starting in 2007. For founders and companies building B2B businesses, keeping a close eye on customer base diversification across categories and price points will help you get ahead of over exposure to challenged categories down the line. Likewise, updating your sales efforts to focus on categories that hold up better in tough times will set you up for success – think beauty, healthcare, groceries, and personal care.
Responding to the market is no doubt prudent, but it’s important to not lose faith in powerful consumer trends that extend beyond the backdrop of today’s economic environment. Some of these trends gained momentum heading into the pandemic and some developed during the pandemic. I think back to the consistent growth of e-commerce throughout the Great Recession. Today resale, digital health, education, working for yourself, climate, and B2B e-commerce stand out. These are topics that matter to the consumer personally and professionally and should endure over the next decade.
This Week’s Top 10 Consumer Insights
Yvon Chouinard, the founder of Patagonia, has given away his company to a non-profit organization and specially developed trust to help combat climate change. The nonprofit will make sure that the company's annual profits, about $100 million per year, will be used to protect nature and biodiversity and fight environmental crisis.
Now Starbucks is getting in on Web3 with the introduction of Odyssey, their new customer loyalty program that uses NFTs that will unlock rewards like events and trips.
Railroad unions and companies reach a tentative deal, avoiding a strike by tens of thousands of freight railroad workers that would intensify supply-chain problems and inflation.
While 62 percent of tech founders and executives agree that the flexible work model led to increased productivity, 37 percent plan to work in the office more over the next year even though a significant number of their top performers left due to the Great Resignation.
Aiming to cater to travelers seeking luxury and privacy, RH, formerly Restoration Hardware, opened RH Guesthouse New York, its first “overnight hospitality concept” that is “not a hotel.”
Retail analysts predict consumers will limit holiday gift giving to close family members and focus on smaller presents that are meaningful or practical.
Gen Z is getting real about how they feel about work on TikTok, where hashtags like #corporatetok are revealing open and honest takes on salary transparency, the Great Resignation, quiet quitting, work-life balance, and more.
Inflation fears are lingering as retailers approach the holiday season, with 79% of consumers saying their finances are a concern and 62% expecting their living costs to increase even further in the next six months, according to EY‘s Future Consumer Index.
More than a dozen tech companies, including DuckDuckGo, Mozilla, and Proton, are backing a bill that will rein in the anti-competitive conduct and privacy failures of tech giants like Amazon, Google, and Facebook.
The state of California filed an antitrust lawsuit against Amazon, alleging that Amazon penalizes sellers and suppliers that offer cheaper prices on other online sites (including Target and Walmart) by displaying their items less prominently or outright blocking their new postings.
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