Inflation: the rules have changed - Business & Finance

USA Today (Society for the Advancement of Education), May, 1997 by Michael Marn

Business reality will continue to keep prices in check, regardless of where the Fed chooses to take interest rates.

The U.S. economy continues to thrive, and inflation is not raging out of control. Producer prices are rising at an annual rate of less than two percent; consumer prices less than three percent. Federal Reserve actions have been credited widely with keeping inflation in check. However, forces much more powerful than Fed interest rate manipulation have come into play in recent years and deserve the real credit for keeping the lid on price increases.

Sharp price jumps have accompanied prior economic recoveries. Suppliers historically used recovery-driven inflation as cover for "passing through" cost increases (plus a little additional) to customers in the form of higher prices. These excessive raises widened profit margins for the suppliers while, of course, further exacerbating inflation.

The days of price inflation being the natural bedfellow of economic growth and recovery may be over, though. A fundamental revolution in how we buy and sell has occurred since the recovery of the early 1980s--both in consumer and industrial markets--that will hold down prices, independent of where the Fed takes short-term interest rates. The roots of this revolution are deep and powerful and include:

Graying boomers. The "middle-aging" of the baby boomers is a potent driver of change in consumer demand. Since 1985, some 33,000,000 baby boomers have entered their 40s and have begun to rein in their expensive spending habits from the 1980s. This is a result of their having been hit squarely between the eyes with the economic realities of needing to pay for the education of their children, help longer-lived parents in their retirement years, and save for their own retirement. With another 25,000,000 boomers poised to reach their 40th birthdays before the end of the decade and with gains in average household incomes expected to be modest at best, this trend toward more conservative spending is likely to expand and restrain consumer price increases.

Frugal "Generation Xers." The generations behind the baby boomers are showing little of the conspicuous consumption behavior that boomers displayed--and that fueled consumer price inflation--in the "go-go '80s." Having grown up with plenty of exposure to discount retailing and being less confident about job security and future earnings potential, this group unabashedly seeks out bargains and values. To reach these parsimonious consumers, apparel suppliers who once sold exclusively through department stores are being forced to sell increasingly through discounters and mass merchandisers. "Cheap is cool" may be the de facto consumer purchasing slogan for Generation X.

The ascent of private labels. The emergence of quality private label products is pressuring consumer packaged goods suppliers to hold or even lower prices on leading national branded products. Replacing the substandard generic offerings of the 1970s and early 1980s are premium private label products that are quite acceptable substitutes for the higher-priced national brands.

Private label goods have grown to 20% of items sold in grocery stores today, up from 15% in 1990. This continuing growth has pressured national brand leaders, such as Procter & Gamble, to cut prices 15% and more on laundry detergent, dish soap, disposable diapers, and other items.

The rise of discounters. A growing portion of retail sales in a wide variety of product categories are through deep-discount retailers operating on a national scale. Discount department stores (War-Mart), warehouse clubs (Price-Costco), and specialized "category killers" (Toys "R" Us, Staples) use their buying clout to negotiate deep volume discounts from their suppliers. These retail formats have become far too dominant for most suppliers to avoid, and any attempts by them to pass through even modest price increases usually are met with stout resistance.

For instance, when Rubbermaid tried to pass along burgeoning raw material costs in the form of higher prices to retailers, Wal-Mart countered by refusing to stock a number of Rubbermaid products and featuring a competitor's wares in stores and promotional materials.

Furthermore, these discount retailers are working ever more closely with major suppliers to minimize distribution costs--e.g., ordering, shipping, handling, warehousing--and much of these savings are passed or to consumers in even lower paces. With discount store sales approaching 45% of general merchandise store volume (up from 37% in 1990), this downward pressure on consumer goods prices has no end in sight.

Tougher corporate buyers. Few management functions have advanced more over the past decade than purchasing and procurement. Buyers of commercial and industrial goods are tougher and more sophisticated than ever. With the advent of "open book costing" (whereby suppliers are required to provide detailed cost and profit information on goods they intend to sell), buyers understand their suppliers' operations and economics better than ever. This knowledge allows them to be more informed negotiators and work with suppliers to drive down costs and become more efficient. In today's more aggressive purchasing environment, any attempts to "pass through" unwarranted price increases are rejected out of hand.