Greater Volatility Affects Spending for Affluent Consumers

The rich always have money to spend. For years, I’ve heard that remark tossed out as the rationale for positioning a business or product line at the high end. It seems much less risky than targeting the middle market, where wallets can close tighter than the seal on a good refrigerator when times get tough.

That may have been true once, but a book about the post-recession affluent, The High-Beta Rich by Robert Frank, punches holes in that theory and offers sobering warnings to businesses that target the high end, such as high-end kitchen and bath dealers and designers. Frank, the author of the pre-recession portrait of the affluent Richistan, has covered the lifestyles of the wealthy for the Wall Street Journal since 2004 and writes The Wealth Report.

In The High-Beta Rich, Frank revisits some of the affluent he wrote about in Richistan to see how they fared during the recession. From repossessed planes and yachts to half-built mansions, it’s not always a pretty picture. And the same is true for the businesses that depended on the ultra wealthy.

Why was this recession different? After all, wasn’t it caused by the mortgage crisis in which middle and lower class homeowners took on way too much debt?

Frank reports that the rich were just as over-extended. What’s more, he explains that because the ways in which people become wealthy today are different than in the past, the affluent are much more vulnerable to economic ups and downs than previously. This means businesses that cater to the wealthy can expect to suffer more radical ups and downs than ever before: Thus the title, High-Beta Rich. (Beta is a financial term referring to the volatility of an investment.)

In the past, wealth tended to be much more stable, leading to our assumptions that the rich would always have money to spend. But starting in the 1980s, that changed, Frank reports.

The “Millionaires Next Door,” the conservative low-key rich, were replaced by more flamboyant wealthy with different values. And they drove the market for mega mansions with 17 bathrooms and multiple kitchens. During this era it became perfectly okay, if not respectable, to flaunt wealth.

Frank notes that “the wealthy are borrowing and spending more than ever before, projecting an image of success in front of a mountain of debt.” He adds that “many of today’s rich are only one crisis away from losing it all.” And because they are making their money differently, they are more dependent on the stock market than ever before.

“The rich today have one thing in common: Their wealth is increasingly linked to financial markets,” Frank reports. And this makes them more susceptible to “booms, bubbles and busts.”

The spending of the rich, he says, is now five times more volatile than their incomes. The top one percent saw their incomes drop 8.4 percent during the recession versus 2.6 percent for the rest of the population.

So if your business depends on the wealthy, you will find your market much more unstable than in the past.

Who would have thought we would have seen so many White Elephant mansions lingering on the market? “The most expensive part of the housing economy, one that used to be among the most stable, has suddenly become the most volatile, “ Frank explains. “The mortgage and housing debts of the richest 1 percent of Americans more than quadrupled between 1989 and 2007, to $500 billion. Their pace of borrowing far exceeded that of the rest of the country, suggesting that it wasn’t just the middle class and poor who lived in homes beyond their means.”

So does this mean the wealthy have become penny pinchers as a result of the recession? Not necessarily. In fact, Frank points out that the spending cycle is picking up again. “The rich are returning to their boom-time ways,” he reports. “While many of the rich who lost money have become far more cautious in their investment and spending (especially aging baby boomers), the younger millionaires and billionaires are spending, and borrowing again. The wealthy are once again the nation’s biggest spendthrifts.”

THE HIGH END

So what could this mean for the kitchen and bath industry? If you are targeting the high-end market, should you change strategies? Not necessarily, because the rich are getting richer, and there are more of them. So the high end is going to remain a strong viable market. “Luxury companies and businesses that serve the affluent will have the fastest growth and strongest profits,” Frank predicts.

But the flip side is, your business will be a lot more unpredictable. “The growing dependence on the wealthy will lead to more instability,” Frank notes.

So how might businesses cope? First, offer as many products and services to the wealthy as you can when times are good. Go beyond cabinets and counters. Sell absolutely everything for high-end kitchens.

Do the same for baths. Be the one-stop shop. Think beyond these two rooms to space planning and storage solutions for bedrooms, closets, master suites, entertainment areas and home theaters.

When times are good, market like crazy to the wealthy, and serve them flawlessly. Be prepared to work in multiple locations, so your wealthy clients can have you do all of their homes, even outside of the country. And speaking of global, be sure you understand how to work with the wealthy from around the world who are buying real estate in the U.S. You must think internationally.

Understand that the high-end business is going to become much more competitive. “As wealth becomes more global and larger in scale, and luxury becomes more pervasive, the arms race of conspicuous consumption is likely to become even more competitive,” Frank warns.

Know, however, that the bubble can burst very quickly. Don’t over expand. Don’t add too much overhead. Larger cushions of capital will be more important than ever. Beef up the rainy day fund when times are good.

Be prepared to react quickly when the next slow down comes. Cut back right away. In other words, play financial defense.

Frank recommends keeping a sharp eye on the stock market and capital gains as an indicator of future business, rather than looking at GDP growth.

“The consumer economy will be mirroring the crazed patterns of stocks rather than GDP,” he believes.

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