Volume 154: My Deepest Apologies & Getting Wonky.

1. First, An Apology. Sorry Mr. Bierut.

tl;dr: Turns out I’ve been spelling Michael’s name wrong all this time.

When I was a kid, I wasn’t a particularly great student. I always believed myself to be pretty smart, but those smarts rarely translated into good grades because being smart also requires organization, hard work, and dedication. All things that seemed to escape me at a young age. Possibly due to undiagnosed ADHD, but since that remains undiagnosed, I suppose I’ll never know.

Anyway, the one subject at which I was a gold star student was spelling. I suspect the reason was a fearsome memory. It’s also a bit ironic, for I’ve always been as bad at basic grammar as I’ve ever been good at spelling. (Thank you, Grammarly!).

So, for someone with “great speller” etched into the very core of his own self-identity, imagine my horror when a Pentagram partner reached out last week to oh-so-very-politely inform me that I’ve been spelling Michael Bierut’s name wrong. Apparently, he’s used to it and, as a result, doesn’t really mind, but it’s also very clear that she minded on his behalf. Fair enough

Anyway, I’m sorry, Michael. I shan’t spell your name like the city again. Please accept my deepest apologies for the error.

2. Soft Landing or Recession. For many, a distinction without difference.

tl;dr: Getting ever so slightly wonky.

While I majored in Marketing as an undergraduate, I also studied economics. It’s a subject I’ve always had a soft spot for that’s come in pretty handy over the years. And, while constructs such as perfect competition and homo economicus clearly exist only as the most theoretical of theories, they’ve been a consistently helpful baseline and language for comparing and describe things.

What’s also interesting about having studied economics to a small degree is that once you begin to understand the basic macroeconomic constructs like Keynesianism, Friedmanism, Marxism, Modern Monetarism, and the rest, you begin to realize with a sinking feeling that economics is essentially clueless.

Not in the sense that economists themselves don’t have a clue because they have many clues and theories, but because, for any economic occurrence, you can argue the point from multiple wildly diverging perspectives.

I guess that’s why there’s the old joke that if you ask 15 economists to give you a yes/no answer, you’ll get 15 different responses. (In truth, this is probably why I enjoy it so much.)

Unfortunately, the net effect of the same thing being described via multiple wildly opposing theories is that we may as well have no clue whatsoever as to what’s actually going on.

Now, why, you may be asking, is this long lead-in necessary? Well, very simply because economics is the social science that is A. Probably the most important to all of us, as economic policy decisions impact all of us, and B. The most politically malleable. In fact, economic theories, such as monetarism or Marxism, are arguably more powerful as political constructs than economic ones, as the rise and fall of the Soviet Union and 40-odd years of failed “trickle-down” capitalism might tell us.

Currently, the economic issue of the moment is inflation, which the Federal Reserve is attempting to tame by raising interest rates. The basic idea is that higher rates will reduce spending and increase saving, which should, in theory, bring down demand. This, in turn, should reduce the % at which prices increase because lower demand places a cap on what people are willing to pay a good or service. So far, so good, in theory.

However, imagine my surprise at learning that a political decision was made in the 1980s to exclude rises in interest rates from inflation calculations, a decision nobody since has chosen to un-make.

The practical implications are significant, for while the economic news remains one of surprising economic solidity combined with steadily decreasing inflation, none of the inflation figures we see reflect huge rises in interest payments that impact big-ticket items such as mortgages, car loans, and credit cards.

So, while the news that inflation is coming down in line with a “soft landing” for the economy is good, most people, when asked, don’t see it. Instead, in addition to paying more for basic goods, like food, they’re struggling to stay ahead of rapidly rising credit card payments, car payments, and, to a slightly lesser extent, housing costs (primarily because the dominant mortgage type in the US is a 30-year fixed, and the vast majority of homeowners refinanced when rates were low. This creates it’s own issues for the housing market, but for the moment, affordability for existing homeowners doesn’t appear to be one of them).

Anyway, from a consumer economy standpoint, debt is worth paying attention to because economic softening often manifests first in people’s ability to pay debt down. And, while we continue to benefit from record employment, the credit card and auto-loan canaries in the coalmine are looking increasingly…disturbing.

First, auto-loan delinquencies have reacheed their highest since 1994, and are growing fast. A double-whammy of rising car prices and rising interest rates have caused serious issues for many car owners, as 6.5% of all sub-prime auto-loans are now more than 60 days delinquent. Equally concerning, 20% of auto-loan borrowers have payments in excess of $1,000/month for the first time in history, and many have been forced into purchasing cars on 72 month, or longer, loan terms. Because a car is a depreciating asset, this means there are now a lot of people with auto-loans that exceed the value of their car. Meaning there’s no option to sell it in order to payoff the loan. Practical implications? People literally handing the keys to the finance company and saying “here, you have it,” which creates the potential for a glut of used cars hitting the market, not to mention the ongoing costs to people with utterly destroyed credit.

On the credit card front, things are also fairly grim looking. During the pandemic, various forces led to an increase in savings. Post-pandemic, people have spent that excess money, and with inflation raising prices across the board, they’re now increasingly using credit cards to maintain their lifestyles. Lifestyle in this case not meant pejoratively, as for many, it’s about basic survival. Again, the practical effects are significant. US credit card debt now exceeds $1trn for the first time, and 1 in 10 credit card accounts now has “persistent debt,” which means the payment made every month isn’t enough to pay down any of the principal, creating a situation of permanent indebtedness. If you’re a sub-prime borrower, this persistent debt number rises to 1 in 3. Credit card delinquencies and late fees are also rising. The CFPB reporting last week that for the first time ever, late fees exceeded $4bn during the 4th quarter of 2022, while overall credit card interest and fee income exceeded $130bn.

So what happens next? Well, the glass half full version of the future says we have a soft economic landing that steadily brings the Fed target of 2% inflation into sight over the next 12-18 months, without sliding the economy outright into recession, before growth steadily picks back up again. The glass half empty version says a combination of high interest rates, geopolitical instability, and war is going to hurtle us into a deeper recession than anyone wishes to see. One with the potential for a double whammy of long term stagflation - a deeply painful circumstance where the economy recedes, yet prices continue to rise.

Where we’ll land on a spectrum between these two points I have no clue. However, it’s clear that irrespective of whether we benefit from a soft landing or slide into a deeper recession, that there are already millions of indebted - and often very poor - people badly hurting from the combined pain of inflation increasing the cost of goods and high interest rates increasing the cost of borrowing to buy those goods.

3. Is Luxury A Red Ocean Trap?

tl;dr: Idle speculation on brands raising prices too hard, too fast.

Blue Ocean Strategy is a very popular book. And while popularity doesn’t necessarily equate to quality, what it can do is introduce new language into the vocabulary. In this case, the language of “Blue Oceans” and “Red Oceans.”

Summarizing the book into a paragraph, the basic gist is as follows: Red Oceans = bad. These are markets with lots of competition and little differentiation making it very difficult to compete and win. Blue Oceans = good. These are markets with little competition, which means you get to stand out, and ideally dominate the market for years to come.

Like many business books, it’s a super simple concept that’s extremely difficult in practice. My biggest issue being that people who’ve read it tend to cheat. Commonly labeling a “Red Ocean” market “Blue” in order to justify whatever it is they’re planning to do.

Anyhoo, switching gears for a second, if we take a wide angle view of the history of the US and other developed economies, we see what’s known as the “barbell effect,” as the middle classes were hollowed out. This started in the late 1970s/early ‘80s, where historical data shows the beginning of economic divergence. Prior to that, increases in productivity tended to benefit both workers and capital equally. After that, productivity gains went almost exclusively to capital, while worker pay leveled out and often declined in real terms after inflation is taken into account. (For example, a worker on minimum wage today has almost 30% less buying power than a worker on minimum wage in 2009, the last time the minimum wage was increased).

Fast-forward to today, and the practical effect of this phenomenon is that people are now clustered at each end of the economic spectrum. Millions fall into the bottom percentiles, while a much smaller, yet surprisingly large number occupy the uppermost percentiles. With an ever decreasing number in the middle.

From a business perspective, this shift has impacted those brands that have traditionally targeted the middle classes, forcing them to make big price-point decisions that (overly-simplified) boil down to dropping down to a lower price-point and positioning as a value brand, or raising prices and re-positioning as more of a luxury purchase (I’m deliberately over-generalizing the term luxury to capture all things expensive, premium, high-performing etc,. Sorry, otherwise, we’d be here all day).

And this doesn’t just impact old brands. Jet Blue is currently struggling under a “neither fish nor fowl” strategy. It’s neither a true low cost carrier, nor a business/first class airline. As a result, it’s struggling right now with a historically weak stock price, and it’s unclear what will happen should its planned merger with Spirit be blocked. (Which it should, because it’s blatantly anti-competitive. No company should be allowed to use the anti-competitive acquisition of a competitor as a get-out-of-jail-free card to mask a failing business strategy).

Now, here’s what’s really interesting. During the pandemic, governments across the world injected circa $9-trillion dollars into their economies in a largely successful effort to avoid global economic catastrophe. And, because the beneficiaries of much of this capital were average Joe and Jane individuals, they did what most people do when they feel flush…they spent it.

This is why pandemic stimulus led to booming economies, while the 2008/9 financial crisis bailout monies did not, or at least not to the same extent. In 2008/9, the bailout funds went to corporations rather than to individuals, so it was never spent. It just inflated the value of assets.

Anyway, back to the present day. With booming economies and supply outstripping demand across many categories, corporations did what any value-maximizer would do, they raised prices. Often quite considerably, with some rising into whole new pricing tiers.

However, when everyone responds in the same way, we get a classic Red Ocean competitive situation. Everyone raising prices at the same time in categories where there’s little differentiation, and where there’s little or no evidence the brands these higher prices are now attached to can support the demand necessary to make them viable.

Like Ford. Cough, cough, with it’s $100k trucks and $95k SUVs.

You see, it’s one thing to experience a spike in stimulus fueled demand. It’s quite another to re-frame your strategy around it as if it’s going to last forever.

For, as I pointed out above, the booming economic environment looks to be behind us, and brands like Ford now have the very real challenge of trying to flog six figure cars and trucks that people simply aren’t going to buy, because there simply isn’t enough demand to justify it.

Ford, and I’m just using it as an example as there are many others, is very much a mainstream brand, where value has been a watchword since its inception. Arbitrarily shifting from there to borderline luxury-level pricing without doing anything to increase the perceived quality or aspirational value of the brand...is risky to say the least. Downright daft also comes to mind, as competition is going to be hard, very hard indeed.

So this, in a very roundabout, kind of a way brings me to my point. As we appear to be entering a slowdown, if not an outright recession, strategic decisions to raise prices during the pandemic boom-times are very possibly going to backfire as we quickly slingshot toward the opposite economic circumstances. It’s one thing to price like a luxury brand, it’s quite another to have the perceived quality and aspirational qualities of a luxury brand, and the robust demand to warrant it.

If everyone is racing toward a luxury Red Ocean, what will be most interesting of all is to see what happens at the value end of the spectrum. As an example, during the financial crisis of 2008/9, Hyundai very smartly rode the downturn to triple its global marketshare.

Now, as so many brands shift their pricing (but not their brand image) to borderline luxury levels, the real question is going to be which value-driven Blue Ocean opportunities are left behind by those about to be battling it out in a Red Ocean of high-prices disconnected from brand image.