Ellison Chair in International Floriculture
Ellison Chair in International FloricultureTeaching, Research, Extension and Service

Freshness trumps organic

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A recent market research report by the Hartman Group entitled The Many Faces of Organic 2008 (available for a mere $15,000) explores and explains the consumer lifestyle and cultural shifts occurring in organic shopping and usage. While this newest organic study finds that the sky hasn’t fallen, the organic surge may at least be cresting.

To consumers the idea of organic is increasingly less about objective distinctions and is becoming more symbolic in nature. A halo equating quality notions like “non-processed,” “real,” “pure,” “authentic,” “handcrafted,” “tasty,” hovers over organics as much as notions of such products being “free of” negative ingredients. Beneath the halo of healthiness, “fresh” outshines the variety of attributes associated with organic.

Pricing in a downturn

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From the latest McKinsey Quarterly…

Getting pricing right is always a challenge in an economic downturn, as decreasing demand, excess capacity, and greater price sensitivity all conspire to drive down prices. In most downturns, the cost of raw materials, feedstocks, and other upstream supplies—as well as the cost to serve customers (for delivering goods, for example)—tends to stabilize and even decrease as business activity slows. As a result, decreases in downstream prices are at least partially offset by lower upstream costs. But in the current environment, not only is weaker demand from the end user making it harder to maintain prices, but significantly higher and more volatile input costs mean that companies caught in the middle are getting hit from both sides.

What’s a business to do? In this unusual downturn, companies need to manage the profitability of individual customers and transactions with greater precision, develop richer insights into their customers’ changing needs and price sensitivities, and understand more clearly the microeconomics that shape their own industries and those of their suppliers. We’ve assembled six tactics aimed at maintaining the best balance possible between sales volume and profit margins in the current challenging environment.

Watch for sudden shifts in price structure

Companies should be vigilant in monitoring pricing policies that reduce revenue—such as volume discounts, rebates, and cash discounts—as well as cost-to-serve, including freight and sales support. In the current downturn, rising costs and declining demand can cause these elements to change more dramatically and quickly than they have in the past. Rapidly increasing fuel prices, for example, are putting intense pressure on delivery costs. Declining demand means that some customers may be collecting volume discounts they no longer deserve. Best-practice companies are reviewing much more frequently their pocket margin waterfalls, which show how much revenue companies really keep from each of their transactions, and adjusting their pricing policies accordingly—for example, by adding delivery fuel surcharges to every order. Without the extra attention and quick action, erosion at all points of a transaction can quickly destroy profits in times like these.

Monitor customer-level profitability

Companies should use transaction-level data to measure precisely the profitability of each customer. By doing so, companies can detect if the cost to serve particular customers or declining order volumes are nudging those customers below target profitability levels. In this downturn, for example, many customer groups are becoming simultaneously smaller and more costly to serve. One industrial company found that more than 20 percent of its customers had fallen below breakeven profitability, forcing it to raise prices selectively and, where possible, lower cost-to-serve by decreasing delivery frequency, reducing sales support, or fulfilling orders through alternate channels.

Adjust to changing customer needs

Downturns always prompt changes in customer needs and in the benefits they value when choosing a supplier. The dynamics of the current downturn mean that such swings can occur even more rapidly. In this environment, the best companies are constantly assessing—through market research and direct contact—how economics are changing for their customers. Even more important, they are reacting quickly by retooling their price and benefit offerings accordingly. For example, one plastic resins supplier that had developed a fast-curing resin (to enhance capacity of injection molders when the economy was strong) has now developed a less costly resin that doesn’t cure as quickly. The new resin helps the supplier’s customers decrease costs, because molders are not running at full capacity during the downturn. With other supplies raising their prices, many molders see the slow-curing resin as an attractive alternative. As a result, the supplier can maintain its profit margins even while selling the alternative resin at a lower price. The combination of lower demand and higher input costs in the current downturn makes it critical to get these kinds of adjustments to the cost/benefit balance correct.

Update price sensitivity research

Dramatic increases in energy and food prices have made consumers much more sensitive to prices across a wide range of product categories. Each price increase for necessities such as food and fuel has cut a little more from discretionary budgets, sharply increasing price sensitivity. Market price tests become obsolete after just a few months. To get price points right, pricing sensitivity research and market price tests should be rerun immediately to track these changes.

Monitor your industry’s microeconomics

Radical shifts in costs and demand have thrown previously predictable market pricing mechanisms into chaos. Responding correctly requires a keen understanding of the microeconomic forces at play at the industry level. In one example, a building materials company found itself in a precarious position as the downturn deepened: a precipitous decline in US housing starts meant diminishing demand, while the costs for raw materials, energy, and transportation were increasing rapidly. In response, the company reassessed the industry’s microeconomics, looking in particular at the latest supply, demand, and cost dynamics. With this new information, managers cut capacity at a plant in an area where the decreased supply would not cause a local shortage. The capacity reduction, which would have had little if any effect on market prices a year earlier, brought about a better balance between supply and demand and kept market prices an estimated 10 percent higher than they would have been without the change.

Study your suppliers

The extreme volatility in this downturn demands that companies reexamine not only the microeconomics of their own industries but also the microeconomics of their suppliers’ industries. Recently, a specialty chemicals company invested in modeling the current industry supply, demand, and cost dynamics for one of its primary raw materials. By doing so, the company predicted an industry-wide, 15 percent price increase for that raw material three months before it happened—a feat of some significance because there hadn’t been an annual price increase of more than 5 percent for that material within the past six years. Suspecting an imminent and unusually large price increase, the chemicals company began adding clauses covering raw-material price increases to its customer contracts, a move that would have met extreme resistance if made after the price increases were announced. Instead, the move established an industry precedent for passing cost increases through to customers.

About the Authors

Cheri Eyink is a consultant and Mike Marn is a principal in McKinsey’s Cleveland office; Stephen Moss is an associate principal in the Stamford office.

“If you’re not confused, you’re not paying attention.”

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From the NYT…

News on the economy was mixed on Friday morning, with the release of a mildly relieving Producer Price Index report(measuring the average change over time in selling prices received by domestic producers of goods and services) and a discouraging retail sales report for August. Stock markets initially fell on the reports, but stabilized by noon on Friday.

The price index for finished goods, a measure of the change in prices businesses pay, fell 0.9 percent in August after a 1.2 percent increase in July, according to the Bureau of Labor Statistics. The August decline was the biggest since October 2006.

Consumers’ spending on retail and food decreased 0.3 percent in August after a 0.5 monthly drop in July, according to the Commerce Department. Economists had been expecting an increase of 0.2 percent.

Retail sales probably fell for several reasons, economists said. For one, the fiscal stimulus checks that had bolstered consumer spending over the last few months ended in July. Consumers, squeezed by high energy prices and an ailing job market, are expected to reduce their spending for the rest of the year.

One concern is the jobless rate, which jumped to 6.1 percent in August, its highest level in five years, from 5.7 percent in July. The steady rise in unemployment is one that many economists associate with recession.

Dropping gas prices seem to have benefited consumers psychologically, at least, even if these declines are not being reflected in retail sales. The preliminary September consumer sentiment index, released by Reuters and the University of Michigan Friday morning, showed the biggest monthly improvement in American consumers’ views of the economy since January 2004.

My opinion: This is not the ideal situation going into the fall season. The fall retail outlook has been speculative for the past several months and the August numbers play out according to projections. August is usually a very good month for general retailers because of back-to-school-related sales.

Bottom line: This is NOT the time for head-in-the-sand tactics. Review some of my earlier posts regarding retail strategies in the face of a down economy (click here) and be very proactive with fall promotions. Give Ms. Consumer something to be excited about this fall. Sales of plants and other items for themed Fall displays in the home and landscape have been growing the past several years. Let’s keep the streak going.


The Link Between Foreclosures and House Prices

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Rising foreclosures will not cause U.S. home values to plunge, despite widespread concerns to the contrary. That’s the conclusion of a new and first-of-its-kind study, The Foreclosure-House Price Nexus: Lessons from the 2007-2008 Housing Turmoil (NBER Working Paper No. 14294) by Charles Calomiris, Stanley Longhofer, and William Miles. Although the authors recognize that other factors not captured by their analysis could weigh on home prices, the effects of foreclosure shocks – which promise to grow over the next several months, and which have been a source of worry to homeowners and economists – seem to be smaller than many have feared. Even under their most extreme scenario, in which foreclosure rates would substantially exceed current forecasts, the resulting average drop in home prices between the national peak in the second quarter of 2007 and the fourth quarter of 2009 would be less than 6 percent.

The authors emphasize that house-price declines vary across states and argue that headlines pointing to extreme circumstances in a few states can be misleading about the United States as a whole. Despite increased foreclosure rates throughout the country, only 12 states are projected to see foreclosure-induced price declines of 6 percent or more through 2009, led by Nevada, Florida, California, and Arizona. “This suggests that home prices are quite sticky, and that fears of a major fall in house prices, with all of its attendant negative macroeconomic consequences, typically are not warranted even in extreme foreclosure circumstances,” they write.

Part of the reason that foreclosure shocks have small effects on house prices is that these shocks tend to occur late in the housing cycle, after housing starts have declined and the supply of existing homes on the market has fallen sharply. These effects largely offset the price consequences of a supply surge caused by foreclosures.

Another contributing factor to the observed stability of house prices is the measure of price change chosen by the authors. The authors argue that it is appropriate to focus on a house price measure related to the prime conforming segment of the mortgage market (which accounts for more than three quarters of American homes). The authors seek to measure foreclosure effects on the values of homes sold by typical sellers, not the declines in prices of homes undergoing foreclosure-induced distress sales. They argue, therefore, that the house price index from the Office of Federal Housing Enterprise Oversight (OFHEO) — which does not include subprime home sales — is the most reliable and useful dataset for their purposes.

Using quarterly data for each state going back to 1981, the authors model the dynamic linkages among five variables: foreclosures, home prices, employment, permits issued for single-family homes, and existing home sales. Using state-level data makes it possible to measure linkages using the frequent and significant ups and downs that occur in state and regional housing markets. In contrast to the aggregate national market, individual states have seen larger and more volatile swings in foreclosures and house prices since the 1980s. By concentrating on the states, the authors also can take into account the effects of widely varying employment growth during that period — an effect that continues to define important regional differences, in particular between housing trends in the Rust Belt and the West.

One limitation of the authors’ model is that it assumes that rising foreclosure rates have the same incremental effect on house prices regardless of whether the foreclosure rate is high or low. In fact, the incremental effect of increases in foreclosures on prices is much larger when foreclosure rates are high than when they are low. The authors adjust their model to account for this by increasing their assumed foreclosure forecasts for 2008-9 by 53 percent. To test the sensitivity of their results to even greater foreclosure risks, they also build an “extreme-shock” scenario and boost the foreclosure projections by 75 percent. These two scenarios create modest downdrafts in home prices that average 4.7 and 5.5 percent, respectively, through 2009.

“We do not have a crystal ball,” the authors conclude. “Our estimates are based on relationships among house prices, foreclosures, and other variables observed in the past. It is conceivable that unusually tight consumer credit conditions, or other factors, could weigh on the housing market and produce more price decline than we estimate.” But “based on the past experience of the housing cycle, even when one proverbially bends over backwards to inflate estimated foreclosures and take account of…” their effects on house prices, there is no reasonable basis “…for believing (as many commentators do)that the housing wealth of consumers has fallen or will fall by much more than 5 percent,” they write.

Sustainability as a differentiation tool

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With the current emphasis on sustainability, much attention has been placed (and some very good articles have been written) in the trade press on what growers can do to become more “sustainable.” From a marketing standpoint, I tend to focus on whether or not sustainability can be a tool for differentiating products/firms in the marketplace. Click here for an introductory discussion and here for an example of a grower already attempting to use sustainability as a marketing platform. A current research project being conducted by colleagues at Purdue will answer part of the question regarding whether or not consumers are willing to pay more for plants that are produced in a more sustainable manner. More to follow on this topic later. In the meantime, you can check out previous posts on sustainability here.

Latest labor stats good or bad?

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Is there anything good to say about yesterday’s report from the Bureau of Labor Statistics that the U.S. unemployment rate jumped up to 6.1% while seasonally adjusted nonfarm payrolls declined by another 84,000 jobs?

That’s the subject of Jim Hamilton’s post over on Econbrowser in which he says the economy is now in recession. I’m hesitant to do the same just yet, given my recent concerns with the way we tend to interpret the BLS data and the rising unemployment of unskilled workers due to the recent minimum wage increase. But nonetheless, it is another indicator that conditions are not rosy.

Another unsettling report came just last week, when the Census Bureau released its annual study of household incomes, poverty and health insurance — often called the nation’s “economic report card.” Its hard numbers seemed to confirm how many Americans feel. Sure, we’re prosperous, but prosperity is fraying. Except for the rich, living standards are stagnant. Poverty is up; health insurance coverage is down. Naturally, both Barack Obama and John McCain seized upon the report to claim that their policies would restore progress.

Superficially, the conventional wisdom seems convincing. The Census Bureau found that median household income in 2007 was $50,233. Though up 1.3 percent from 2006, that was still less than the peak of $50,641 in 1999 (all figures are in inflation-adjusted 2007 dollars). Meanwhile, the share of people below the government’s poverty line — about $21,000 for a family of four — was 12.5 percent, up from 11.3 percent in 2000. Finally, the ranks of the uninsured have increased in six of the past eight years. They’re now about 15 percent of the population. Case closed right? Not exactly.

A previous Mark Perry post pointed out one of the problems with historical median household income from the Census Bureau income data is that it doesn’t adjust the declining household size over time. After adjusting for household size, real median income is at an all-time high.

Robert Samuelson points out three more problems with poverty and income data from the Census Bureau: (1) comparing real household income or poverty rates in 2007 to the year 2000 is unfair because 2000 was an artificially high benchmark because of the “tech bubble,” (2) immigration distorts commonly cited statistics for both poverty and income, and (3) Census figures understate income gains by not counting fringe benefits.

Greg Mankiw cites yet another problem with Census income data, citing the NY Times, which reported that “The current poverty measure only counts cash as income, and doesn’t include government assistance like food stamps, housing subsidies and tax credits. Such aid has been devised to help support the poor, but its impact is not calculated by the current measure.”

There you have it — a mixed bag of apples and oranges. “Lies, darn lies, and statistics” as the old saying goes. What’s the bottom line? Whether you call it a recession or not, times are tough; not all over and not to the same extent, but we have more work ahead of us to weather this storm. We have serious problems and its going to take some serious people to lead us through them.

But regardless of who is in national leadership positions, Green Industry businesses must be proactive about conserving cash and emphasizing perceived value in the minds of customers. We must make our products and services more inelastic among our consumers or we will fall the way of other luxury goods in tight times.

Fuel costs continue to influence driving behavior

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The Federal Highway Administration reported that travel during June 2008 on all roads and streets in the nation fell by -4.7% compared to June last year. June marks the eighth consecutive month of traffic volume decline compared to the same month in the previous year. Travel YTD through June in 2008 fell by -2.8% compared to 2007.

Now that gas prices started falling in July and August, will consumers continue to reduce driving, or will they revert back to their old driving patterns? We’ll know in about a month, when the July traffic volume report is released.

Seven Ways to Fail Big

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This article in the September issue of the Harvard Business Review answers the question “What causes companies to fail spectacularly?” A recent study of 750 of the biggest U.S. business disasters of the past 25 years reveals that seven popular but risky strategies are often to blame. Drawing on that extensive research, Paul Carroll, a journalist, and Chucka Mui, a fellow at Diamond Management & Technology Consultants, describe seven sirens that lure companies onto the rocks. Click here to download an audio slideshow about how to avoid failure.

Starbucks vs The Little Guy

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As anti-corporate crusaders are now discovering, instead of advocating for legal prohibitions on chain stores or attempting to zone the offending businesses off of Main Street USA, mom-and-pop shops can successfully combat the coffee behemoth by using old-fashioned market competition.

Click here to view the ReasonTV video called “Starbucks vs the Little Guy“