While the downturn has certainly changed the economic landscape, it may also have fundamentally altered the behaviour of consumers, who are now learning to live without expensive products. Many companies with strong premium brands are anticipating a rapid rebound in consumer behaviour - a return to normality, as after previous recessions. They are likely to be disappointed.
New McKinsey research in the US found that, in any given category, an average of 18 per cent of consumers of consumer-packaged-goods bought lower-priced brands in the past two years. Of the consumers who switched to cheaper products, 46 per cent said those products performed better than expected, and the large majority of those consumers said the performance of such products was much better than expected. As a result, 34 per cent of the switchers said they no longer preferred higher-priced products, and an additional 41 per cent said that while they preferred a premium brand, it "was not worth the money".
As a result, a growing number of consumers are now in play. The percentage up for grabs varies by category of goods and depends on how many consumers switch from higher-priced brands, their experience with cheaper ones, and the way they revise their buying intentions. We found, for instance, that only 12 per cent of beer buyers switched to cheaper brands. Of those, 31 per cent said their experience was more positive than they had expected.
This means that only about 4 per cent of beer customers are in play. Among buyers of cold and allergy medicines, however, we found that more than 20 per cent tried a lower-priced option, and 48 per cent of those consumers said the experience was better than expected. That means 10 per cent of the people who buy cold and allergy medicines are now in play. In industries where consumer shifts as small as 1 per cent can severely dent the profitability of brands, these changes are sufficiently significant to alter market dynamics and force brand leaders to respond. Last year, Procter & Gamble, for example, released Tide Basic, a cheaper version of its category-leading Tide laundry detergent, after Tide's sales began to decline as consumers switched to less expensive brands.
For companies attempting to address the change in consumer behaviour, understanding the economic theory that explains why it is now shifting can help to inform decision-making. Textbook theory posits that changes in the relationship between how much consumers are willing to pay, on the one hand, and their perception of the value they are receiving, on the other, underpins behavioural changes. As the exhibit shows, if consumers perceive enough value in a premium-brand product (Product A), they will favour it over the product of a more basic brand (Product B), despite the premium product's higher price. In a recession, though, consumers become less willing to pay more - the slope of the demand line flattens and the preferences of some consumers begin to shift from Product A to Product B.
Normally, the premium-brand product would return to favour as the economy bounced back. But the central implication of our research is that even if the willingness of consumers to pay rebounds as the economy does, changes to their perceptions of the value of lower and higher-priced products may fundamentally alter what they choose to buy. That is troubling for companies whose brands command premiums. If consumers see no legitimate reason to stick with such products, the premiums will slowly erode and profit margins will shrink until category competition is determined mainly by price.
A prime example is processed meats and sliced cheese, where the difficulty of demonstrating a product's superiority means that there is little scope for brands to differentiate by price. As a result, gross margins in these categories trail those of other branded foods. Our experience in the consumer-packaged-goods sector suggests two priorities for companies addressing this fundamental shift in consumer behaviour.
The first is undertaking a situation assessment to understand a category's dynamics at a greater level of detail than can be achieved anecdotally or through survey research. Such an assessment involves analysing purchasing behaviour and motivations to determine how consumer requirements are changing and the effect of these changes on lower and higher-priced products. In our survey, for example, while most consumers said that the quality of a lower-priced brand was higher than expected, their precise reasons varied. More than 33 per cent of users of bottled water discovered that they no longer needed some of the benefits the higher-priced brand provided. Nearly 32 per cent of users of facial moisturiser felt better about using a lower-priced brand than they had thought they would.
What companies need is a fact-based understanding of the principles of typical consumer behaviour to gauge how the willingness to pay for additional benefits has changed, the experience consumers have with products and how perceptions of their value have changed. The second step is developing action plans based on consumer dynamics and how well positioned products are for recovery. That means deciding where to position them in a way that will optimise the trade-off between prices and benefits on the one hand and margins and volumes on the other. In the case of bottled water, the best response may be a lower-priced product that addresses the needs of consumers who no longer see the value in additional brand benefits.
Yet decisions must also take into account the broader category strategy. We believe there is an opportunity to identify and increase participation in categories that have the potential to recover more rapidly and fully while minimising exposure to those that have a lower chance of recovery or can recover only at the cost of brand or category economics. This means that brand portfolios should be aligned around categories with smaller changes in slope and where consumers have less positive experiences with lower-priced products.
These steps are applicable beyond consumer packaged goods. There is evidence that the shift of consumers away from more expensive products is a widespread trend. In the consumer electronics industry, for example, McKinsey research found that 60 per cent of consumers were more interested in a core set of product features at a reasonable price than in the bells and whistles of the latest and greatest technology at a higher price.
Similarly, in the building-products industry, there is a trend away from premium-price design features and toward simpler, more basic designs. Understanding this challenging shift in consumer behaviour is necessary for companies to compete successfully. It represents an opportunity for those that respond quickly and effectively to differentiate themselves from their peers. Betsy Bohlen is a consultant in McKinsey's Chicago office, where Steve Carlotti is a director and Liz Mihas is a principal.