A financial downturn is ahead of us – some consumers are already experiencing the first signs of an approaching economic crisis.
This Pricing Nugget is the first of a four-part series.
How do customers behave in recessionary times? And what are the three underlying drivers?
In this first of the four parts, we will find out. In the next three episodes, we look into each of these drivers and what you can do as a business owner or price setter to address these.
We talk about an economic downturn, but what is actually going on? Let us take Germany as an example.
In September, inflation was at an all-time high of 10%. This means prices for the same goods are 10% higher than last year. And this price increase did not match the increase in income levels. It was much higher, leaving people with lower earnings in net terms – so-called “real earnings.” People earned 4.4% less than last year.
Looking into the future, the consumer climate index, it's an instrument to measure consumer sentiment. This metric is also at an all-time low. It measures people's confidence about the financial future and their likelihood to buy something today or postpone it.
All three subcomponents that create this consumer climate index, the economic expectations, the income expectations, and the propensity to buy are all at an all-time low.
Consumers evaluate the current financial situation as constrained and their financial outlook is pretty dark. What happens to customers?
Customers become more price-conscious or price-sensitive.
Studies showed that during recessionary times, customers tend to become more prudent. They spend less, they avoid excessive debt, and they save more of their still available income. In absolute terms, they might say less, but in relative terms, they try to save a bit more.
What does a higher level of price consciousness or price sensitivity do to consumers?
I dug out various studies looking at different populations.
For example, in the US, a Nielsen study found that consumers tend to spend less on non-essential products and services like dining out or out-of-home entertainment, and even groceries. What you could believe are essential products. Even here, people want to spend 17% less on groceries.
Turning to a different population. Looking into an EY study that analyzes a worldwide sample, or into a McKinsey study, they focus on the top five countries in Europe measured by gross domestic product.
Here we find that one out of three consumers switch to a different brand.
So, in recessionary times, consumers tend to switch to a different brand to save money.
In particular, consumers switch to a private brand. These shares are even higher: About 35 to 40% of consumers switch from a branded product to an unbranded product or private brand to save money.
What else? In the McKinsey study for Europe, they found that 14% – or one out of seven customers – who bought previously at brick-and-mortar stores now switch to online channels.
Also, the McKinsey study found that consumers not only switch from offline to online. Looking closer at the offline market, consumers tend to switch from other retail formats to discounters.
One out of four customers switches from any other retail format to discounters.
Consumer switch brands to cheaper national brands or to cheaper private brands. They switch to the presumably cheaper online channel. And within the offline channel, they switch to discounters.
These effects combined with many others explain why in June 22, retail sales fell by 2.8% compared to last year in the European Union. This development leaves a tremendous impact on the financial situation of businesses.
Let us do a quick recap.
We understand that customers become more price-conscious and we see that a higher level of price consciousness changes customer behavior, and we understand that this new customer behavior has a detrimental impact on businesses.
We understand this chain of thought.
The question that we want to answer now is what drives price-consciousness.
Researchers identified three drivers that explain a higher level of price-consciousness during economic downturns.
The first driver is feelings of anxiety about the financial future.
Consumers are very pessimistic about their financial future. They vividly see the consequences and problems of having less money created for them and their loved ones. These anticipated consequences make them feel anxious, and they worry about money. To deal with this situation, they spend less and save more just in case this bad financial future actually turns out to be a new reality.
The second driver is people feel guilty when spending money.
In times of financial downturns, consumers develop a new internal moral compass. And consumers anticipate guilt when they do something that is against their internal moral compass and their new values. For example, when consumers spend money on something luxurious that is not a hundred percent needed. In this case, they believe it is wrong because it increases the financial hardship for themself and for their loved ones. They know it is wrong.
Now assume we have enough money and we are not affected by this financial crisis. Still, if we have a social circle that experiences this financial crisis, we still feel that it is wrong to spend money because not only has our internal moral campus changed, but also the social norms around us changed. The financial norms now are more about financial prudence and frugality. Not only violating your internal moral compass but also violating these social norms causes guilt and pain.
The third driver is the need to feel being a “smart shopper” when spending money.
In particular, in recessionary times, customers feel proud when they make a good deal during a shopping trip.
And this good deal gives them a psychological reward: It makes them feel proud. They feel they have accomplished something and they develop more self-esteem. In this case, feeling oneself as a smart shopper makes customers turn to an internal locus of control.
They feel they can do something about this financial crisis. And also here, even if you're not financially affected by this economic crisis, the social norm of frugality gives you still an intrinsic reward for being a smart shopper.
Strutton, D., & Lewin, J. (2012). Investigating Consumers' Responses to the Great Recession. Journal of Consumer Marketing, 29(5), 378–388.
The Economist (2022): https://www.economist.com/business/2022/10/13/american-consumers-are-becoming-more-price-sensitive-again
NielsenIQ 2022 Consumer Outlook Survey, June 2022 – US – Spending in next 12 months
EY (2022): EY Future Consumer Index, n = 17,904 from 24 countries (Japan, Australia, Brazil, China, Germany, France, India, Indonesia, Mexico, South Africa, Thailand, United Kingdom, USA, Argentina, Canada, Chile, Italy, New Zealand, Saudi Arabia, Spain, Sweden, Denmark, Finland, Norway)
McKinsey (2022): McKinsey & Company Europe Consumer Pulse Survey, n = 5,076 (France, Germany, Italy, Spain, UK), sampled to match European general population 18+ years
Eurostat | Euroindicators – 90/2022 – 3 August 2022: “In June 2022 compared with June 2021, the calendar adjusted retail sales index decreased by 3.7% in the euro area and by 2.8% in the EU.”