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  • Writer's pictureThe San Juan Daily Star

Is the entire economy gentrifying?

By Jason Karaian

Big companies are prodding their customers toward fancier, and often pricier, versions of everything from Krispy Kreme doughnuts to cans of WD-40.

It’s evidence of the corporate world’s new favorite buzzword: “premiumization.”

Businesses are hoping to keep the good times rolling after several years in which they seized on strong spending by consumers and rapid inflation to raise prices and pump up profit margins. Many firms are embracing offerings that cater to higher-income customers — people who are willing and able to pay more for products and services.

One sign of the trend: the notion of premiumization was raised in nearly 60 earnings calls and investor meetings over the past three weeks.

It is an indication of a changing economic backdrop. Inflation and consumer spending are expected to moderate this year, which could make it more difficult for firms to sustain large price increases without some justification.

The premiumization trend also reflects a divide in the U.S. economy. The top 40% of earners are sitting on more than $1 trillion in extra savings amassed during the early part of the pandemic. Lower-income households, on the other hand, have been burning through their savings, partly as they contend with the higher costs of the food, rent and other necessities that make up a bigger chunk of their spending.

“The pool of people willing to spend on small to large premium offers remains strong,” said David Mayer, a senior partner in the brand strategy practice of Lippincott, a consultancy.

As products grow more expensive and exclusive, big swaths of the economy are at risk of becoming gentrified, raising the possibility that poorer consumers will be increasingly underserved.

Businesses have long segmented customers, trying to push richer ones into pricier and more profitable purchases: Think of the spacious premium seats on a plane versus the cramped economy-class alternatives. But the trend picked up during the pandemic, and the lurch toward luxury is now spanning a wider array of products and services.

Executives at some companies are focusing heavily on the rich. At American Express, which reported record spending by cardholders last quarter, “we’re constantly tightening up the cardmembers that we’re acquiring,” CEO Stephen Squeri told analysts on a recent call, describing how the firm has been steadily limiting its focus to higher-earning applicants. “That premium customer base, while not immune to economic downturns, certainly right now is spending on through.”

Other companies are emphasizing premium offerings as an alternative to discounts. Krispy Kreme spent last year attracting customers using deals — including a “Beat the Pump” discount that matched the price of a dozen glazed doughnuts to the national average price of a gallon of gas. But it is planning to do less discounting this year, an executive said on a call, aiming instead to generate “excitement around our premium specialty doughnuts,” which include fancier, higher-priced offerings around holidays.

Pushing premium products has come up in some unexpected corners of the corporate world. WD-40, the firm that makes the lubricant of the same name, has found that customers will pay more for products with enhancements, such as a can with a “smart straw” to spray the lubricant in two different ways — in either a precision stream or more of a mist. “Premiumization creates opportunities for revenue growth, grows margin expansion, and most importantly, it delights our end users,” CEO Steve Brass said on a call.

The question now is what the shift toward more premium products means for the broader economy. It could be a sign that companies are making last-ditch efforts to justify higher prices and cling to fat profits as the economic outlook darkens.

To fight inflation, the Federal Reserve has been rapidly raising interest rates, which is meant to slow economic growth and cool consumer demand. That could make it harder for businesses to continue charging more, cooling inflation and potentially cutting into profits in the process.

“Most everybody had pricing power last year,” said Scott Chronert, a strategist at Citigroup, explaining that his forecasts suggest “that is going to shift.”

And attempts to maintain profit margins by giving products a premium sheen are not guaranteed to pay off.

Six Flags, a theme park operator, recently shifted to a more premium model by raising prices and limiting discounts, which CEO Selim Bassoul described as “bold changes to our business model in order to elevate the guest experience.” It has had mixed results so far. In the nine months through September, attendance at its parks fell by 25% from the year before; spending per guest rose 22%; and in the end, profits fell by nearly 10%.

In January, The Walt Disney Co. acknowledged that it might have pushed too hard on prices at its theme parks, angering loyal customers. It revised its policies on ticketing, hotel parking, ride photos and annual passes.

But the shift toward premium products could signal the start of a more lasting change as businesses settle into a routine of selling lower volumes for higher prices in a divided economy — a strategy that could leave poorer consumers worse off.

Take the U.S. car market. At the end of 2017, 36 models were priced below $25,000, and the share of cars that cost that much or less accounted for nearly 13% of all sales of new cars, according to an analysis by Cox Automotive. At the end of last year, only 10 models had starting prices that low, and their share of sales plunged to less than 4%. Subprime buyers are increasingly falling out of the market, in a sign that poorer people, who tend to have lower credit scores, are struggling for a foothold.

Carmakers may be cutting cheap models in part because it is hard to justify the cost of making them in an era of expensive parts and persistent labor shortages, said Jonathan Smoke, chief economist at Cox. But the expectation is that they will continue to focus on bigger-ticket models while resisting pushing overall vehicle production higher to levels that could lead to discounting even as supply bottlenecks ease.

“They’re better off selling fewer and maintaining pricing power,” Smoke said. That could spur competitors to jump into the market to provide cheaper cars, but such an adjustment is unlikely to happen quickly.

For now, car ownership could increasingly become the purview of the rich. Fewer new cars eventually translates into fewer used cars. That raises prices and, together with higher interest rates, threatens to shut poorer people out of the market.

It’s a window on what a widespread emphasis on premiumization could mean for the economy: lower production, potentially higher inflation in the short run and permanently higher prices in the long run.

But it is too early to tell whether what is happening now is widespread and persistent enough to have a meaningful economic impact, said Isabella Weber, an economist at the University of Massachusetts Amherst who has been studying profits and prices during the pandemic.

“It’s a very confusing moment,” she said.

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