Growth Is at the Edges
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Apr 17, 2015

Growth Is at the Edges

By Kellogg Insight | Based on the insights of Sergio Rebelo

The recent global recession had a lasting effect on consumer behavior. As middle-class workers felt the squeeze, they “traded down” on everything from food to clothes to pharmaceuticals, setting in motion a vicious cycle that polarized the economy. High-skilled jobs paid more and more, while middle-class jobs were widely cut, outsourced, or automated. In the U.S. and around the world, income inequality grew.

For Sergio Rebelo, a professor of finance at the Kellogg School, this is a deep structural change that companies cannot afford to ignore. (“Trading Down and the Business Cycle,” a working paper he wrote together with Nir Jaimovich and Arlene Wong, takes a closer look at this development and its implications.)

“Growth is now at the edges,” Rebelo says. “It’s in luxury and value.” Walmart or Whole Foods, Days Inn or The Four Seasons, the fourteen-dollar haircut or the thousand-dollar spa treatment—in every sector, consumers are either hunting for bargains or spending big. Mid-level brands like Safeway and Sears are struggling to stay afloat; classic brands such as Heinz and Kraft have been forced to consolidate. “This is just the beginning,” Rebelo says. “There’s going to be a lot of consolidation in the middle, because there is not as much room as there once was. The middle is a tough place to be.”

Consumer polarization has huge implications for U.S. companies. It used to be that the middle offered the most growth opportunity; classic American brands depended heavily on the middle class. Today’s consumers are much less equal—both domestically and globally. In the developed and developing worlds alike, demand for luxury brands is strong, even as those in the middle struggle to afford the price points of mid-level brands. Given this new consumer landscape, how should companies respond?

“The most important thing is positioning—firms need to ask whether they should shift towards value or luxury,” Rebelo says. “Maybe something that worked for decades is not going to work going forward.” Companies can no longer rely on the organic growth that resulted from the post-war middle-class surge in wealth and baby boomers coming of age—“all of that is history.” Instead, they need to pay attention to major shifts in demographics and new consumer habits. “The growing immigrant population might have different tastes,” he says, another reason for companies to think more seriously about positioning. “A lot of it is just understanding the market.”

For companies entering overseas markets, this is especially key. Sometimes, Rebelo says, companies are emboldened by their initial success in a new emerging market, only to see demand taper off. “There is a ‘top of the pyramid’ in those markets that aspire to Western standards of living, but once you’ve exhausted this elite, there’s no more growth. In fact, to some extent, what makes you successful at the top of the pyramid will make you unsuccessful in the middle and at the bottom—you need a completely different approach.” Rebelo says the most common strategy for U.S. companies is to take what works domestically and try to apply it overseas. “That usually doesn’t work.”

When advising CEOs on how to navigate the new economy, Rebelo points to the Roman Empire, which adopted a strategy that included embracing local culture and hiring the best local talent. “Sometimes you see multinational companies go to emerging markets and bring their entire team over from the United States,” Rebelo says. “That's usually a recipe for failure, because they don't understand the cultural nuances. They don't understand the local tastes.” Embracing local culture gives companies insight into demand.

Staying competitive also requires a shift in attitude. Before they can properly reposition, companies need to admit to themselves that change is necessary. “They need to have the humility to learn from the consumer, instead of trying to educate the consumer,” Rebelo says. This means preparing for demographic shifts, understanding local habits, and offering value propositions that align with the broader economy. Whether positioning in the developed world or adapting to emerging markets, companies need to make sure they are always ahead of the game.

“There’s a lot of inertia,” Rebelo says. Companies are reluctant to change brands that have worked well for decades. But given the ongoing structural changes in consumer behavior, the status quo might not be good enough. “If you don’t position to take advantage of the segments of consumer demand that are growing,” he says, “this space might be occupied by competitors—and then it will be too late.”

Sergio Rebelo teaches in Kellogg Executive Education programs: The Advanced Management Program: The Global Experience; Corporate Finance: Strategies for Creating Shareholder Value; and Merger Week.

Photo credit belongs to GadgetDan. Published under a Creative Commons license.