Shoppers, Enjoy Those Discounts While They Last
(Bloomberg Opinion) -- How will we know that inflation is finally bubbling up? This year a truck driver shortage raised freight rates, and consumer goods companies began passing on those higher costs to consumers. Last Friday’s jobs report, with wage growth now at its fastest rate since 2009, is another sign. Still another, which may become more apparent as companies begin to report third-quarter earnings over the next month, is a reduction in discounting on big-ticket items, as General Motors and a couple of home-goods companies just reported.
Economists like to think about inflation in terms of mathematical models and curves on a graph, where faster economic growth and lower unemployment should lead to higher inflation. But that doesn’t say much about how actual businesses responsible for setting prices operate. For that, we have to watch what companies are doing and saying. For low-priced goods that consumers buy all the time, like diapers, the strategy might be just passing on price increases as costs rise. But for higher-priced goods that consumers buy infrequently, and where discounting and incentives come into play more often, reducing incentives is functionally the same thing as raising prices, and that seems to be the strategy for now.
Last week when automobile companies released their sales figures for August, one notable outlier for weakness was General Motors, where, even though the company no longer posts monthly sales figures, reports suggested sales fell 13 percent. In terms of economic activity this was a disappointment, but for profit-focused GM shareholders the news was not as bleak as reported. The reason for sales weakness was that GM cut back on incentives, with incentives falling $800 per vehicle compared to August 2017. According to J.D. Power, GM incentives averaged $4,146 per vehicle compared to $5,097 per vehicle for Ford.
Over time, a strategy of selling fewer vehicles at higher effective prices may be at least as profitable as Ford’s strategy of more sales at lower effective prices. It’s also a more sensible strategy in today’s environment of increasing costs, in part driven by global trade tensions. If your costs are rising faster than the prices your customers are paying, that’s a recipe for a profit squeeze.
It was a similar story for home furnishings company RH, which reported earnings last week. The company attributed its performance to “strong full price selling,” leading to faster profit growth even as revenue disappointed analysts. In the earnings release, the company contrasted its performance with “the failures of high growth, no profit online pure plays.”
Williams-Sonoma said similar things when it reported earnings a couple weeks earlier. On its earnings call, the company said: “We are favoring the regular-priced sales, the higher margin sales versus just competing on price.”
There are a few reasons we might be seeing companies take this new approach. One is the higher costs companies are feeling. Those costs have to be accounted for some way, and it might be easier psychologically on consumers to see fewer discounts than to see sticker prices go up. Another is that steady economic growth has allowed companies to reduce their inventories, making them less pressured to sell merchandise at any price. And the third is that a strong economy with rising consumer confidence might have consumers feeling flush and more willing to pay full price on more expensive merchandise, which companies are happy to accommodate.
But as I wrote about a month ago, an environment where a growing number of companies decide to raise prices — either via price increases or less discounting — creates new risks for the economy. On the one hand, it might just lead to higher broad-based inflation, which the Fed will feel compelled to lean against. On the other, consumers with fixed budgets may not be able to pay higher prices on everything, with higher prices in some areas leading to spending cutbacks in others, with companies exposed to the latter area suffering the consequences.
As price increases increasingly become the norm in corporate America, that “higher inflation versus a household budget crunch” scenario should become more of the market’s focus.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Conor Sen is a Bloomberg Opinion columnist. He is a portfolio manager for New River Investments in Atlanta and has been a contributor to the Atlantic and Business Insider.
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