We live in times characterized by change and volatility, yet as businesses we need to make investment decisions that will equip us to serve markets and consumers as they will be in 10 years time and beyond. This report is ambitious. By drawing together insights into economic and demographic trends, considerations of finite resources and sustainability, and the ever more dramatic impact of technology on our daily lives, it sets out to make some predictions about how our attitudes and patterns of consumption will change over the next decade.
Of one thing we can be certain, consumer values, needs and behaviors will continue to evolve. The effects of the global recession of 2008-09 that rattled consumer confidence around the world will continue to be felt in years to come. Significant as it is, however, the recession is but one of several developments that will have long-lasting impact on consumers. A new middle class is being born in emerging economies with huge implications for demands on a range of essential and finite resources.
The resulting shift in food consumption, to cite but one consequence of this, will fuel a growing sense of crisis around the security of our global food supply. Climate change and sustainability, once the concern of only a few, will increasingly become issues for consumers everywhere, made very real for people by increasingly obvious changes in our physical environment. And developments in media and technology will accelerate the proliferation of information and further empower consumers – redefining how they interact with one another as well as the companies from which they buy products and services.
Each of these forces on its own would have a large impact on consumers. It is their convergence, however, that will make the next 10 years turbulent, uncertain and complex, dramatically changing what consumers talk about, how they communicate with one another and with businesses, and, of course, how businesses talk to them.
This report examines how these trends will most likely shape consumer spending patterns and the world of consumers more broadly. What will consumers in different geographic and demographic segments value? What will they need and want? Given what they have faced in recent years, how will their attitudes and behaviors continue to change in the coming decade? To set the stage for this discussion, the report begins with a broad look at how changes in the global economy are likely to affect consumer spending as we slowly emerge from recession. In so far as one can ever predict the future, it then looks at longer-term economic, demographic, and technological trends and some of the resulting changes in consumer attitudes and behaviors that are likely to take place over the next 10 years.
A number of people provided their time and expertise into developing this report and I would like to extend my thanks to them, in particular, authors Ira Kalish of Deloitte Research in the United States (Deloitte Services LP) and Bryna Lee (Deloitte Touche Tohmatsu Limited); as well as senior retail advisors from the U.S. member firm, Stacy Janiak and Alison Paul (both Deloitte LLP).
I hope you find this report useful and that it sheds some light on the path ahead.
Global Industry Lead, Consumer Business
Deloitte Touche Tohmatsu Limited
THE GLOBAL ECONOMY RECOVERS
Setting the stage
How will the evolution of the global economy influence consumer spending patterns in the next decade? The answer can be gleaned from looking at what happened in the past decade, and how that pattern is no longer sustainable.
In the decade prior to the recent economic crisis, there was very strong consumer spending growth in the United States as well as in smaller equally leveraged economies such as the United Kingdom, Spain, and Ireland. Such consumer spending growth was funded, in part, by borrowing against the increasing value of homes, itself the result of a flood of liquidity from surplus countries such as China. This excessive consumer spending growth was not only the principal source of economic growth in these countries, it also fuelled export driven growth in surplus countries such as China, Japan, and Germany. In fact, the symbiosis between these "consuming" and "producing" groups of countries was the hallmark of the global economy in the first decade of the twenty-first century.
All that has now changed. The global economic crisis of 2008-09 exposed the fault lines of the imbalanced global economy. When the inflated values of property-based assets peaked and then collapsed, global financial institutions suffered huge losses. The resulting loss of confidence caused a near shut-down in global credit markets as investors fled to the safety of short term government securities. Moreover, indebted consumers were forced to dramatically shift gears. They increased savings, paid off debts, and ceased to spend with abandon.
In the coming decade, the countries that borrowed heavily to finance excessive consumer spending will necessarily experience slower consumer spending growth as households struggle to de-leverage, repair tattered balance sheets, and focus on accumulating wealth for future retirement and other needs. More of the economic growth of these countries will likely be driven by exports to countries like China and Brazil, local business investment, and government spending.
Conversely, those countries whose growth was fuelled by exporting to borrowing countries will no longer be able to depend on such markets. The U.S. consumer will not be able to sustain China's export sector as it did in the past. Consequently, countries such as China will shift away from export- oriented growth toward growth driven by domestic consumer spending. The degree to which this adjustment takes place, and takes place smoothly, will depend on the policies put in place by various governments. Nevertheless, an adjustment of some sort will definitely take place. It should be kept in mind, of course, that if China fails to make this adjustment, it will not be able to sustain the rapid growth to which it has become accustomed.
The economist Herbert Stein once wrote that "if something cannot go on forever, it will stop." In some ways, that describes the imbalance in the global economy. It may not stop, but at least for the near future, it won't get bigger and likely will get smaller. What is uncertain, however, is the manner in which the imbalance will be corrected. There are a number of things that could happen.
Reducing the imbalance means that the United States and other debtor countries like the United Kingdom must save more, import less, and export more than would otherwise be the case. The path to this usually includes currency depreciation (already under way) which would change the relative prices of traded goods, thereby stimulating exports and suppressing imports. For countries like China, India, and Brazil, adjustment means undertaking measures to stimulate consumer spending. This could include liberalizing consumer finance, improving the social safety net so as to discourage saving, and allowing the currency to appreciate in value.
If we look at China there are some indications that it intends to move in this direction, but there are obstacles as well. First, China's government appears to be of two minds on the currency. On the one hand, it wants to encourage domestic demand so that it need not accumulate more foreign currency reserves. On the other hand, it complains about the potential capital loss on its existing reserves should the dollar fall further. During the economic crisis, China stopped allowing the currency to appreciate lest it harm its export competitiveness. However, once global recovery is fully extant, China is likely to allow further revaluation. The question is how much.
Second, China's response to the crisis was to massively stimulate investment in infrastructure and state-owned companies. The result is an economy distorted by excessive investment and insufficient consumer demand. If the consumer is to play a bigger role in the economy going forward, China will have to adjust its policy accordingly. The degree to which this will take place remains uncertain.
How will U.S. adjustment take place?
It is not sufficient to predict that American consumers will simply decide to spend less in the future. Something will compel them to do this, and there are several factors that will likely contribute to a significant shift in U.S. consumer behavior. First, the destruction of wealth that has transpired over the past two years will not be reversed quickly unless both the equity and property markets experience unusually rapid price increases. Thus, consumers will feel the necessity to rebuild wealth by saving, a process that has already begun.
Second, given the destruction of housing wealth, most consumers will no longer be in a position to borrow against increased property values. Thus, consumer spending will be constrained by income.
Third, while financial markets are showing signs of recovery, history suggests that banks will remain cautious in their lending behavior for some time to come. Thus, consumer credit will not be as readily available as in the recent past. Changes to the regulatory environment are also likely to exacerbate this. As banks are forced to hold more capital, and as the market for securitization remains a shadow of its former self, there will likely be less credit available for consumers.
Fourth, other areas of government policy may play a role in restricting consumer spending. Increased taxes on upper income households will have a negative impact on spending. Healthcare mandates could affect wage and employment growth. In addition, efforts to restrict emissions of carbon gases are likely to increase the price of energy, thus shifting consumer spending away from other goods and services.
Finally, there is the elusive psychological factor. That is, the length and depth of the recent recession, the worst of the post-war era, may have a lasting impact on the willingness of consumers to engage in risky behavior. This may compel a permanent shift toward more frugal spending – fewer big ticket purchases, more discount and comparative shopping, investments in quality products, and a resurgence of "built to last" values.
What will the consumer world look like?
In the next few years, a fundamental change in the structure of the global economy will likely shift the manner in which retailers and brands obtain growth. The U.S. and Western European consumer will be financially constrained. As such, gross consumption and spending in these countries will increase more slowly than in the past. Consumers will be more value conscious, seeking low prices and avoiding some discretionary spending. Thus, brands will obtain growth through market share gains rather than by simply latching onto a growing market. Achieving this will require good brand management, improved customer experience, and differentiation from competitors aimed at avoiding ruinous price competition.
During the economic crisis, there were several changes in consumer behavior, many of which will persist even when the economy recovers. These include a shift toward discount retail venues, a shift toward discounted private label products, a shift away from eating out and toward eating at home, a decline in the share of income spent on large discretionary items for the home; and greater price sensitivity in general. If these trends endure even partly, they will change the requirements for success on the part of retailers and brands.
The role of China
Meanwhile in China, retail sales have weathered the economic crisis well. The shock to the Chinese economy from the global crisis was concentrated on China's export sector. The drop in exports led to the loss of roughly 20 million jobs at coastal factories. Yet despite this significant rise in joblessness, Chinese consumer spending continued to grow rapidly. Indeed, inflation adjusted retail spending grew at a double digit rate throughout 2009 and well into 2010.
There are several reasons. First, the newly jobless factory workers were low paid and did not contribute significantly to overall retail spending. Rather, middle class service workers in rich cities like Shanghai play a far larger role in generating retail sales. Moreover, these people did not lose their jobs. Second, China's government provided a massive stimulus to the economy, providing a positive impact on consumer income.
This, combined with easier credit conditions, fuelled consumer purchases of homes and cars. Indeed Chinese light vehicle sales in 2009, at 13.6 million, actually exceeded those of the United States which were 10.4 million. On the other hand, as of this writing the Chinese government is attempting to rein in a property price bubble and reduce speculative activity in the housing market.
When the global economy is fully recovered, it is likely that Chinese consumer spending will remain on a high growth path. As this happens, the number of middle class consumers will continue to rise rapidly, especially in the big coastal cities. That means rising discretionary spending, increased spending on home-related products, expanded awareness of global brands (yet pride in high quality local brands), and increased willingness to eat outside of the home. The latter will be especially important as there will be a sizable increase in the number of two-income, middle class households who are highly time constrained. Also, the recent labor unrest among factory workers in China and the consequent substantial increases in wages, suggests an even faster growth of the middle class.
Still, China will remain a relatively poor country – as will the other big, fast growing emerging markets such as India, Mexico, Russia, Brazil, Indonesia, Turkey, and Vietnam. That means serving these "middle class" shoppers requires an understanding of their perception of value. It will most likely translate into relatively small shopping baskets, a high degree of price sensitivity, and a big market for discount shopping.
What about other emerging markets?
The major emerging markets are expected to continue growing rapidly in the next decade, thereby creating a much larger market of middle class consumers. To put it another way, a disproportionate share of global growth of consumer spending will take place in emerging markets, not only China. Naturally, this will have important implications for global consumer oriented companies.
Consider eight important emerging markets: the four BRICs (Brazil, Russia, India, and China), plus Indonesia, Mexico, Turkey, and Vietnam. These eight are important for their economic size and growth as well as their considerable potential. Together they have 3.2 billion people (roughly half the world's population), and a combined GDP in excess of the U.S. when measured using a purchasing power parity (PPP) exchange rate. Per capita GDP, however, is still only about one tenth that of the U.S.
Yet the middle class in these countries is large and growing. The top 20 percent of the population is over 600 million people, many of whom have purchasing power similar to the average citizen of developed countries. In Brazil, for example, the top 20 percent is roughly 40 million people who account for over 60 percent of total income and have an average purchasing power not far below that of Western Europe. As Brazil grows in the next decade, the number of people with such purchasing power will rise very rapidly.
Even the next 20 percent are relatively affluent by the standards of emerging markets, although they are relatively poor by the standards of developed markets. Yet what distinguishes these people from the poor is that they generally have some discretionary income. That is, they are not living hand to mouth. Moreover, as these economies grow, the number of people that shift from poverty into the discretionary-spending middle class tends to grow faster than the overall economy. This market will be of critical importance to global consumer oriented companies in the next decade.
Already, the rise of this early middle class is having a significant impact on global consumer markets. For example, the proliferation of mobile technology to relatively low income consumers in emerging countries has made these markets of greater importance to mobile phone manufacturers than the developed markets. Other factors are also making these markets critical. Consider the following:
- As countries become more developed, the opportunity for women to become educated increases, thus leading to increased female labor participation. This is taking place now in India, for example. The rise in the number of two-income households then leads to increased demand for the convenience of modern retailing. This also leads to increased demand for products and services that save time, many of which can be sold easily in modern retail stores. Demand increases for processed foods, prepared foods, and meals outside of the home.
- As the middle class rises, there is often an increase in the availability of consumer credit. In some emerging markets, such as Mexico, banks and retailers have already recognized the profitability of lending small amounts to large numbers of low income consumers. As this takes place, it leads to increased purchases of big ticket items such as electronics, furniture, and automobiles.
- As the number of automobiles increases rapidly in major emerging markets, lifestyles can change dramatically. Automobile ownership allows greater freedom in choosing where to shop or be entertained. It enables spending larger amounts on each shopping trip, and thus allows for less frequent shopping farther from home. Finally, it allows for a greater emphasis on entertainment and leisure. As such, it can significantly increase the demand for travel and leisure services.
- Middle-class consumers, with discretionary spending power, have the ability to set aside some of their income for future needs such as retirement, healthcare, or children's education. An increased ability to save leads to increased demand for financial services.
What about Europe and Japan?
Much of the discussion so far has involved the U.S. on the one hand and China and other key emerging markets on the other. Yet what about Europe and Japan? After all, these are two of the world's biggest consumer markets. The answer is that, although Europe and Japan are hugely important markets, they did not play a significant role in the huge imbalance in the global economy over the past decade. The big story of the next decade is the reversal of that huge imbalance, one that principally involved the United States and China.
Still, as economic recovery takes hold in Europe and Japan, the consumer markets of these countries will remain critically important to the world's leading retailers and their suppliers. What can we expect?
Although Europe has begun to recover from the global crisis, it continues to face a crisis of its own. The troubles that began with questions about Greek sovereign debt in 2010 ultimately resulted in a massive financial backstop for the high deficit countries of southern Europe. While this successfully prevented default, it did not address the remaining imbalance in Europe. Specifically, over the past decade the southern European countries experienced rising unit labor costs and increased borrowing from abroad. Germany, on the other hand, experienced declining unit labor costs as productivity increased. Moreover, German consumers saved prodigiously. Unless this imbalance is reversed, Europe will slide from one crisis to another. If there were no Eurozone, the solution would partly rest with currency depreciation in southern Europe. This cannot happen now that there is a common currency. What must happen instead is for Germany to consume more and the southern European countries to consume less.
Like the United States, Europe's borrowers will now face a protracted period of slower consumer spending growth. Europe's exporting giants, such as Germany, will either have to find new export markets (such as China and India) or will have to shift gears and stimulate domestic demand. That means consumer spending.
Undertaking such a transition will, at the least, take time. Thus, consumer spending in Europe can reasonably be expected to experience modest growth in the coming decade – especially at a time of slow to no population growth. The source of this growth could shift away from southern Europe and the United Kingdom toward Germany and other northern European countries. Yet that depends heavily on the kind of policy regime that exists in each country.
As for Japan, it faces some of the same challenges as Germany. For years, the Japanese economy was heavily export focused. In the recent deep recession, Japan was seriously harmed by the U.S. recession, especially as Japan has lost some of its market share to other Asian economies such as China. In the process, Japan has moved up-market toward higher value-added products. The result is that the demand for Japan's exports is more sensitive to economic vicissitudes than was the case in the past.
Going forward, the solution for Japan is to shift to selling goods to China (a process already under way) as well as shifting toward consumer demand. There is a general consensus that the latter is the best way to ensure adequate economic growth, yet is not necessarily likely to happen. Stronger consumer spending growth within Japan will require less saving, which, in turn, will require the Japanese to obtain better returns on their assets. Yet due to excessively tight monetary policy, equity returns have been poor. Low inflation has meant that interest rates have been very low. Stronger consumer spending will also require liberalization of Japan's inefficient consumer distribution system. It is not clear as to whether there is sufficient political support for this to take place.
Hence, a reasonable expectation is that Japan's consumer market will grow slowly, especially as the population is not growing larger and is growing older.
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