The middle class is eroding – just ask the business world

New York TimesFebruary 8, 2014 

MIDDLE CLASS CONSUMPTION

At a GE facility in Louisville, Ky., Anthony Adams tests a refrigerator recently in the appliance manufacturer’s Cafe Series, which is directed at the high end of the consumer market.

ANGELA SHOEMAKER — NYT

In Manhattan, upscale clothing retailer Barneys will replace bankrupt discounter Loehmann’s, whose store closes in a few weeks. Across the country, Olive Garden and Red Lobster restaurants are struggling, while fine-dining chains such as Capital Grille are thriving. And at General Electric, the increase in demand for high-end dishwashers and refrigerators dwarfs sales growth in mass-market models.

As politicians and pundits in Washington continue to spar over whether economic inequality is in fact deepening, in corporate America there really is no debate at all. The post-recession reality is that the customer base for businesses that appeal to the middle class is shrinking as the top tier pulls even further away.

If there is any doubt, the speed at which companies are adapting to the new consumer landscape serves as very convincing evidence. Within top consulting firms and among Wall Street analysts, the shift is being described with a frankness more often associated with left-wing academics than business experts.

“Those consumers who have capital like real estate and stocks and are in the top 20 percent are feeling pretty good,” said John G. Maxwell, head of the global retail and consumer practice at PricewaterhouseCoopers.

In response to the upward shift in spending, PricewaterhouseCoopers clients such as big stores and restaurants are chasing richer customers with a wider offering of high-end goods and services, or focusing on rock-bottom prices to attract the expanding ranks of penny-pinching consumers.

“As a retailer or restaurant chain, if you’re not at the really high level or the low level, that’s a tough place to be,” Maxwell said. “You don’t want to be stuck in the middle.”

Although data on consumption is less readily available than figures that show a comparable split in income gains, new research by economists Steven Fazzari of Washington University in St. Louis and Barry Cynamon of the Federal Reserve Bank of St. Louis backs up what is already apparent in the marketplace.

In 2012, the top 5 percent of earners were responsible for 38 percent of domestic consumption, up from 28 percent in 1995, the researchers found.

Even more striking, the current recovery has been driven almost entirely by the upper crust, Fazzari and Cynamon say. Since 2009, the year the recession ended, inflation-adjusted spending by this top echelon has risen 17 percent, compared with just 1 percent among the bottom 95 percent.

More broadly, about 90 percent of the overall increase in inflation-adjusted consumption between 2009 and 2012 was generated by the top 20 percent of households in terms of income, according to the study, which was sponsored by the Institute for New Economic Thinking, a research group in New York.

The effects of this phenomenon are now rippling through one sector after another in the U.S. economy, from retailers and restaurants to hotels, casinos and even appliance makers.

Economy more volatile

While spending among the most affluent consumers has managed to propel the economy forward, the sharpening divide is worrying, Fazzari said.

“It’s going to be hard to maintain strong economic growth with such a large proportion of the population falling behind,” he said. “We might be able to muddle along – but can we really recover?”

Fazzari also said that depending on a relatively small but affluent slice of the population to drive demand makes the economy more volatile, because this group does more discretionary spending that can rise and fall with the stock market, or track seesawing housing prices. The run-up on Wall Street in recent years has only heightened these trends, said Guy Berger, an economist at RBS, who estimates that 50 percent of Americans have no effective participation in the surging stock market, even counting retirement accounts.

Regardless, affluent shoppers such as Mitchell Goldberg, an independent investment manager in Dix Hills, N.Y., say the rising stock market has encouraged people to open their wallets and purses more.

“Opulence isn’t back, but we’re spending a little more comfortably,” Goldberg said. He recently replaced his old Nike golf clubs with Callaway drivers and Adams irons, bought a Samsung tablet for work and traded in his minivan for a sport utility vehicle.

And while the super-rich garner much of the attention, most companies are building their business strategies around a broader slice of affluent consumers.

At GE Appliances, for example, the fastest-growing brand is the Café line, which is aimed at the top quarter of the market, with refrigerators typically retailing for $1,700 to $3,000.

“This is a person who is willing to pay for features, like a double-oven range or a refrigerator with hot water,” said Brian McWaters, a general manager in GE’s Appliance division.

Investors take notice

At street level, the divide is even more stark.

Sears and J.C. Penney, retailers whose wares are aimed squarely at middle-class Americans, are both in dire straits. Last month, Sears said it would shutter its flagship store on State Street in downtown Chicago, and J.C. Penney announced the closings of 33 stores and 2,000 layoffs.

Investors have taken notice of the shrinking middle. Shares of Sears and J.C. Penney have fallen more than 50 percent since the end of 2009, even as upper-end stores such as Nordstrom and bargain-basement chains such as Dollar Tree and Family Dollar have more than doubled in value over the same period.

Competition from online giants such as Amazon has only added to the problems faced by old-line retailers, of course. But changes in the restaurant business show that the effects of rising inequality are widespread.

A shift at Darden, which calls itself the world’s largest full-service restaurant owner, encapsulates the trend. Foot traffic at midtier, casual dining properties such as Red Lobster and Olive Garden has dropped in every quarter but one since 2005, said John Glass, a longtime restaurant industry analyst at Morgan Stanley.

With diners paying an average tab of $16.50 a person at Olive Garden, Glass said, “The customers are middle class. They’re not rich. They’re not poor.” With income growth stagnant and prices for necessities like health care and education on the rise, he said, “They are cutting back.”

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