For generations, Procter & Gamble Co.'s growth strategy was focused on developing household staples for the vast American middle class.
Now, P&G executives say many of its former middle-market shoppers are trading down to lower-priced goods—widening the pools of have and have-not consumers at the expense of the middle.
That's forced P&G, which estimates it has at least one product in 98% of American households, to fundamentally change the way it develops and sells its goods. For the first time in 38 years, for example, the company launched a new dish soap in the U.S. at a bargain price.
P&G's roll out of Gain dish soap says a lot about the health of the American middle class: The world's largest maker of consumer products is now betting that the squeeze on middle America will be long lasting.
Melanie Healey, group president of P&G's North America business says.
"It's required us to think differently about our product portfolio and how to please the high-end and lower-end markets. That's frankly where a lot of the growth is happening."
In the wake of the worst recession in 50 years, there's little doubt that the American middle class—the 40% of households with annual incomes between $50,000 and $140,000 a year—is in distress. Even before the recession, incomes of American middle-class families weren't keeping up with inflation, especially with the rising costs of what are considered the essential ingredients of middle-class life—college education, health care and housing. In 2009, the income of the median family, the one smack in the middle of the middle, was lower, adjusted for inflation, than in 1998, the Census Bureau says.
COLLAPSE OF THE MIDDLE CLASS
The slumping stock market and collapse in housing prices have also hit middle-class Americans. At the end of March, Americans had $6.1 trillion in equity in their houses—the value of the house minus mortgages—half the 2006 level, according to the Federal Reserve. Economist Edward Wolff of New York University estimates that the net worth—household assets minus debts—of the middle fifth of American households grew by 2.4% a year between 2001 and 2007 and plunged by 26.2% in the following two years.
HOW P&G AND OTHER COMPANIES ARE MAKING THE ADJUSTMENT
P&G isn't the only company adjusting its business. A wide swath of American companies is convinced that the consumer market is bifurcating into high and low ends and eroding in the middle. They have begun to alter the way they research, develop and market their products.
- H.J. Heinz Co., the food giant for example, is developing more products at lower price ranges.
- Saks Inc. the luxury retailer is bolstering its high-end apparel and accessories because its wealthiest customers—not those drawn to entry-level items—are driving the chain's growth.
THE CONSUMER HOURGLASS THEORY
Citigroup calls the phenomenon the "Consumer Hourglass Theory" and since 2009 has urged investors to focus on companies best positioned to cater to the highest-income and lowest-income consumers.
It created an index of 25 companies, including Estée Lauder Cos. and Saks at the top of the hourglass and Family Dollar Stores Inc. and Kellogg Co. at the bottom. The index posted a 56.5% return for investors from its inception on Dec. 10, 2009, through Sept. 1, 2011. Over the same period, the Dow Jones Industrial Average returned 11%.
Citigroup analyst Deborah Weinswig explains.
"Companies have thought that if you're in the middle, you're safe. But that's not where the consumer is any more—the consumer hourglass is more pronounced now than ever."
Companies like Tiffany & Co., Coach Inc. and Neiman Marcus Group Inc., which cater to the wealthy, racked up outsize sales last Christmas and continue to post strong sales.
Tiffany says its lower-priced silver baubles, once a favorite of middle-class shoppers craving a small token from the storied jeweler, are now its weakest sellers in the U.S. Tiffany Chief Operating Officer James Fernandez said in June.
"I think that there's probably more separation of affluence in the U.S."
Firms catering to low-income consumers, such as Dollar General Corp., also are posting gains, boosted by formerly middle-class families facing shrunken budgets. Dollar stores garnered steady sales increases in recent years, easily outpacing mainstream counterparts like Target Corp. and Wal-Mart Stores Inc., which typically are more expensive.
P&G's profits boomed with the increasing affluence of middle-class households in the post-World War II economy. As masses of housewives set up their new suburban homes, P&G marketers pledged that Tide detergent delivered cleaner clothes, Mr. Clean made floors shinier and Crest toothpaste fought off more cavities. In the decades since, new features like fragrances or ingredient and packaging enhancements kept P&G's growth robust.
CHANGES IN CONSUMER BUYING HABITS
Despite its aggressive expansion around the world, P&G still needs to win over a healthy percentage of the American population, because the U.S. market remains its biggest and most profitable. In the fiscal year ended June 30, the U.S. delivered about 37% of P&G's $82.6 billion in annual sales and an estimated 60% of its $11.8 billion in profit. P&G says that Americans per capita spend about $96 a year on its products, compared with around $4 in China.
During the early stages of the recession, P&G executives defended its long-time approach of making best-in-class products and charging a premium, expecting middle-class Americans to pay up.
But cash-strapped shoppers, P&G learned, aren't as willing to splurge on household staples with extra features. Droves of consumers started switching to cheaper brands, slowing P&G's sales and profit gains and denting its dominant market share positions.
In late 2008, unit sales gains of P&G's cheaper brands began outpacing its more expensive lines despite receiving far less advertising. As the recession wore on, U.S. market-share gains for P&G's cheaper Luvs diapers and Gain detergent increased faster than its premium-priced Pampers and Tide brands.
At the same time, lower-priced competitors nabbed market share from some of P&G's biggest brands.
- Bounce - P&G's dominant fabric-softener sheets business, including its Bounce brand, fell five percentage points to 60.2% of the market as lower-priced options from Sun Products Corp. and private-label brands picked up sales from the second quarter of 2008 through May 2011, according to a Deutsche Bank analysis of data from market-research firm SymphonyIRI.
- Tide - P&G's grasp of the liquid laundry detergent category, led by its iconic Tide brand, also posted a rare slip over the same period as bargain-priced options from Sun and Church & Dwight Co. gained momentum.
- Gillette - Even the company's huge Gillette refill razor market suffered, declining to 80.1% by May from 82.3% in the second-quarter of 2008, as Energizer Holdings Inc.'s less-expensive Schick brand gained nearly three points.
P&G CHANGES COURSE
P&G began changing course in May 2009. After issuing a sharply lower-than-expected earnings forecast for the company's 2010 fiscal year, then-CEO A.G. Lafley said the company would take a "surgical" approach to cutting prices on some products and develop more lower-priced goods. Mr. Lafley said.
"You have to see reality as it is."
When the company's 2009 fiscal year ended a month later, P&G's sales had posted a rare drop, falling 3% to $76.7 billion.
In August that year, P&G's newly appointed CEO, company veteran Robert McDonald, accelerated the new approach of developing products for high- and low-income consumers.
Mr. McDonald said in September 2009.
"We're going to do this both by tiering our portfolio up in terms of value as well as tiering our portfolio down."
THE GINI INDEX SAYS IT ALL
To monitor the evolving American consumer market, P&G executives study the Gini Index, a widely accepted measure of income inequality that ranges from zero, when everyone earns the same amount, to one, when all income goes to only one person. In 2009, the most recent calculation available, the Gini coefficient totaled 0.468, a 20% rise in income disparity over the past 40 years, according to the U.S. Census Bureau.
Phyllis Jackson, P&G's vice president of consumer market knowledge for North America says.
"We now have a Gini index similar to the Philippines and Mexico—you'd never have imagined that. I don't think we've typically thought about America as a country with big income gaps to this extent."
HOW P&G'S TARGETS THE NEWLY DIVIDED AMERICAN MARKET
Over the past two years, P&G has accelerated its research, product-development and marketing approach to target the newly divided American market.
Globally, P&G divides consumers into three income groups.
- "Ones" - The highest-earning "ones" historically have been the primary bracket P&G chased in the U.S. as they are the least price sensitive and most swayed by claims of superior product performance.
- "Twos" - The "twos," or lower-income American consumers, have grew in size during the Great Recession. Consequently, P&G decided to target them aggressively, too.
- "Threes" - P&G doesn't specifically target the "threes", the lowest wage earners in the U.S., since they comprise a small percentage of the population and such consumers are typically heavily subsidized by government aid.
At the high end, it launched its most-expensive skin-care regimen, Olay Pro-X in 2009, which includes a starter kit costing around $60. Previously, the Olay line had topped out around $25. Last year, the company launched Gillette Fusion ProGlide razors at a price of $10 to $12, a premium to Gillette Fusion razors, which sell for $8 to $10, and Gillette Mach3, priced at $8 to $9.
At the lower end, its new Gain dish soap, launched last year, can sell for about half per ounce of the company's premium Dawn Hand Renewal dish soap, which hit stores in late 2008.
Developing products that squarely target the high and low is proving difficult for a company long accustomed to aiming for a giant, mainstream group.
Conquering the high end is difficult because it usually involves a smaller quantity of products.
Bruce Brown, P&G's chief technology officer said.
"We do big volumes of things really well. Things that are smaller quantities, with high appeal, we're learning how to do that."
Likewise, the cost challenges at the bottom of the pyramid are also proving difficult, Mr. Brown said. Over the past two years, P&G has increased its research of the growing ranks of low-income American households.
Ms. Jackson says.
"This has been the most humbling aspect of our jobs. The numbers of Middle America have been shrinking because people have been getting hurt so badly economically that they've been falling into lower income."
COMMENTARY: A growing cadre of economists have chronicled the steady decline of the middle class, and a corresponding loss of its massive buying power. Charles Hugh Smith, in an article for Business Insider, provides the following disturbing forensic evidence for the disappearance of the middle class, at least in terms of wealth.
- The top 20% of the American populace holds roughly 93% of the country's financial wealth.
- The top 1% of the country holds approximately 43% of the money in the U.S.
- The middle 20% of the population -- what would, officially, be called the middle class -- holds only 6% of the country's total assets.
- The bottom 40% of the country controls less than 1% of America's wealth.
What Constitutes Middle Class
According to Smith, what income defines "middle class" is a function of locale and prevailing wages/costs ($100,000 in Manhattan or San Francisco isn't much because costs are so high), but in terms of purchasing power it can be generally agreed that middle class includes:
- Ownership of one or more reliable vehicles.
- Homeownership with meaningful equity.
- Healthcare insurance coverage.
- A 401(k) retirement fund of some sort.
- A college education/higher education or training.
By these measures, the middle class comprises at best 20% of the populace.
America's Widening Income Disparity
Barry Ritholtz of the Big Picture blog recently published a chart which depicts the actual distribution of wealth in America and the perceived distribution of wealth--what people estimate based on their knowledge.
G. William Domhoff of "Of Two Minds" created this chart that correlates almost exactly with Barry Ritholtz chart above.
The first chart depicts total wealth, which includes depreciating assets that are illiquid (SUVs, boats, furniture, etc.) and typically overvalued. In terms of financial wealth, the top 20% own fully 93% of all assets.
If we characterize the top 20% as "wealthy," then the next 20% would be the "upper middle class" (60% -80%) and the third quintile (60% - 40%) would be "middle class."
"In terms of financial wealth, the Great Middle Class owns a mere 6% of total assets."
The "Ones" have always been the "sweet spot" of P&G's target market. The collapse of the middle class has changed the whole equation. P&G has been forced to introduce products to fill the needs of the ever growing "Twos" and "Threes", the two markets it has largely ignored through its long history.
The Collapse of Household Income
Clearly, middle class Americans are holding a fantasy-view of their piece of the American Dream. A number of people I know consider themselves middle-class based on their substantial income--but they own very few financial/liquid assets, and if they lose their jobs then their health coverage vanishes.
When the average "middle class" American looks at the below chart, they probably reckon this enormous rise in net wealth includes them. But as we have seen above, it doesn't; their "ownership" of this vastly increased wealth is a meager 6%. In other words, the vast majority of this increase flowed to the top 20%.
The Causes Of The Middle Class Collapse
So how did the middle class become second class citizens -- or, as Smith puts it, "Debt Serfs"?
Not surprisingly, the answer is complicated, involving factors like the rising cost of education, the loss of pension funds and affordable health care, falling middle class wages, and the skyrocketing price of housing.
Yet one clear and daunting answer lies in manufacturing.
"When looking at the declining American middle class, a good number to start with is 42,400. That's the total number of factories that the U.S. lost between 2001 and the end of 2009. Put another way, this translates into the outsourcing of 32% of all manufacturing jobs in America."
The loss of manufacturing jobs has left a massive job drain.
At the end of 2009, 15.7 million people were unemployed, while 12.6 million-- 20% fewer -- worked in manufacturing. This represented only 9% of the American working populace; at manufacturing's height in 1960, 29% of Americans were employed in the sector. By the way, as of August 2011, the unemployment rate stood at 9.2% and there were still 15 million unemployed Americans.
This bleeding of American manufacturing represents a massive drop in the products that are made in America.
According to one economist, the country currently doesn't produce any television sets. Computer manufacturing in the U.S. employs about 166,000 people; in1975, it employed almost 300,000. Meanwhile, Asia's computer manufacturing sector has about 1.5 million workers and a single tech manufacturer, Foxconn, employs more than 800,000 people. NOTE: In a blog post dated October 23, 2010, I profiled Foxconn, the Chinese company that manufactures all of Apple's products: iPod, iPhone and iPad. Foxconn is quite literally a gulag or slave labor camp, with corrupt management, lack of workers rights, and appalling work conditions that has led to a dozen worker suicides at one of its plants. Take this into account when you buy one of Job's magical devices.
If the middle class is to rise to anything approaching its former power, American manufacturing must rebound. While the U.S. is still in the upper ranks of the world's largest consumers, its economy is rapidly slipping down on the global list. According to some economists, China's economy is on track to overtake the U.S. by 2040; ten years later, India will also outstrip America. Economic strength requires a strong manufacturing base, but while Asian countries are building theirs, America has slowly allowed its own base to starve.
In one of my most comprehensive blog posts dated July 10, 2011 titled, "The Root Causes of Today's High Unemployment Situation, And Why This May Not Change Anytime Soon", I identify three key job destruction forces:
- Computerization - Faster computers, the internet, software productivity tools and applications).
- Globalization - Outsourcing jobs to countries where labor is cheaper, especially NAFTA)
- Industry consolidation - Mergers and acquisitions due to relaxation of deregulation, elimination of unionization and competititive forces) .
I also identify the destruction of America's manufacturing base as one of the key reasons why America's unemployment rate continues to remain high.
Target - $65.81 billion, +3.8%
Walgreen - $61.24 billion, +6.3%
The Home Depot - $60.19 billion, +2.2%
Costco - $58.98 billion, +5.5%
CVS Caremark - $57.46 billion, +3.5%
Lowe’s - $48.17 billion, +2.8%
Best Buy - $37.11 billion, -0.4%
Sears Holdings - $35.62 billion, -2.2%