How Marketing Feeds the Boom-and-Bust Cycle

It wasn’t so hard to sell people a newspaper every day a generation ago when the price was between 10 and 25 cents. Now that the price is more like a dollar, it’s a tougher sell. Large numbers of people still buy the newspaper, but not as often — perhaps just once a month instead of every day.

And therein lies the failing of one of the most trite ideas in marketing, an idea so pervasive in current management thinking that it often goes without saying. It is, after all, a very simple idea. If business revenue depends on the number of customers, the frequency with which customers buy, and the price they pay, then the way to make a fortune in business ought to be to sell a big-ticket item to a large number of repeat customers.

It makes sense, right? Do everything you can to increase the number of customers, the price they pay, and the number of times they buy, and watch your revenue go up and up. But while this approach may work in the short run, it does not work in the long run. And when you look at what has happened to newspapers, you can see why.

The more your customers pay, the greater the incentive they have to find alternatives. Then, if your competitors don’t take your customers away, some customers will find a way to bypass your industry entirely.

With this dynamic, the most successful marketing strategies will tend to lead to a boom, as more customers buy more often at higher and higher prices, followed by a bust, as customers notice how much they’ve been spending and seek out alternatives.

Worse, the bust tends not to happen until customers get squeezed financially and are forced to cut back. We saw newspaper revenue hang on remarkably well, in spite of the industry’s obvious problems, until about two years ago. Then it declined rapidly, and the decline in newspapers is adding momentum to the recession.

The same thing is happening, of course, in automobiles. That industry did remarkably well over the past half century at increasing its customer base, frequency of purchases, and prices. Most impressive was the way it kept a large number of its customers on a three-year replacement cycle even as the improved reliability of the product made that unnecessary. When that pattern started to fall apart around 2005, the industry was in trouble. If customers move from a three-year cycle to a five-year cycle, that is a 40 percent decline in sales, which of course, is about what has happened so far. Auto dealers say a five-year cycle will be the new norm, with people replacing their five-year-old cars, but it could just as well be a 12-year cycle. It depends on what the customers decide. It is not up to the dealers, who cannot influence this pattern until the potential customers find time to visit the showroom.

Whenever you see an industry that is doing remarkably well at expanding its customer base, frequency, and price, it is fair to ask when the collapse will come. We have been asking this question about the cellular phone business for three years, and indeed, two former industry leaders, Motorola and Nokia, are being forced to cut back. But looking more broadly at the economy, what about:

• Health care. Prices keep going up, and the industry is lobbying hard for universal coverage to expand its market reach, but are people actually getting healthier?
• Banking. The latest refinance boom is just another reminder that this industry relies too heavily on loans to repeat customers, many of whom would really prefer not to be in debt at all.
• Entertainment. Look at cable TV, movies, or concerts, and you can’t help but ask, “How can they keep raising their prices like that?”
• Government and education. A sector can use its monopoly powers to postpone modernization only so long. The cracks are already starting to show.

It might seem strange to list the banks as potentially heading for a fall when many of them are in serious trouble already, but it would be foolish to dismiss the many consumers who swear they will never borrow money again as merely blowing off steam. And when the top financial experts talk about the collapse of the financial system, they are not talking about something that has already happened, but something that could happen in the next couple of years if things go badly.

Last weekend we heard this from renegade financier George Soros, who in an interview with The Times saw the G20 summit as the last chance to avoid a financial system meltdown.

The odds would favour that it fails because there are such differences of opinion. It’s difficult enough to get it right in your own country let alone with 20 governments coming together, but if it’s a failure I think then the global financial and trading system falls apart.

Soros’s prediction of a depression is probably a fair description of what will happen across the financial sector, and also in automobiles, home construction, and other areas of the economy that have perhaps been a little too successful in squeezing money out of their customers in recent years. As the recession leads people to examine and adjust their spending priorities, it will create permanent realignments in economic activity.

Putting the “Plan” Back in Planning

Maybe it’s a sign of what Washington has become. People promise plans, then deliver documents that don’t have any kind of plan in them, and think they can get away with it.

Last week, it was the House Republicans, putting out a 19-page pamphlet that barely mentioned the budget and calling it a “budget plan.” When they were quite properly taken to task for that deception, you would think General Motors and Chrysler would know what was coming to them. Both companies had promised turnaround plans as a condition of their emergency loans, but when it came time to deliver, had nothing to offer. General Motors apparently did not start on theirs until the weekend before the deadline, and offered, an hour late, a vague document with no “turnaround” and precious little “plan” in it. Chrysler’s “plan” was even more superficial. At the time, I assumed that General Motors and Chrysler would be rushing to get their real plans to Washington over the next couple of weeks, but from what I am hearing, they never did anything of the kind. They turned in “F” papers and sat back and waited, hoping the professor would return them marked with the “B+” they needed.

Backed into a corner, Obama did the only thing he could do: offered an extension (60 days for General Motors, 30 for Chrysler) in the hope that the two companies would try harder knowing that this was really their last chance. But it should not have been necessary. The executives of these companies had two months to come up with business plans and effectively another month to remedy any defects in the plans. The skeleton of a business plan, the back-of-the-envelope version, takes only about a day to do, but they did not even do that. And I am sure it is not that they did not know how, but that they did not believe it was really necessary.

I am not quite sure how Washington turned into a place where you can promise a plan, deliver a token document with no plan in it, and expect to be taken seriously, but I hope that these stories are an indication that that is now changing.

Ford Gets Its Bailout From Car Buyers

It is one of the great economic ironies. Ford has spent the last two years shrinking as fast as it could. The result? It is rapidly gaining market share. Meanwhile, customers are deserting the competitors that tried the hardest to expand in 2007 and 2008.

A Los Angeles Times story today suggests that the shifting market is because of the ongoing public relations disaster related to the federal bailout at General Motors and Chrysler:

A survey released this month by polling firm Rasmussen Reports found that 88% of Americans would prefer not to buy a car from an automaker receiving government aid. That’s worse than the 63% who said they would eschew buying from a bankrupt car company.

The bailout boycott is surely a part of what’s going on, but I believe it’s only a small part. There is also a positive reason for the shift to Ford. People believe that by buying a vehicle from Ford, they are contributing to the company’s survival. Ford encouraged this kind of thinking when it turned down bailout money and said that the sales revenue from the vehicles it sold would be enough for it to survive. In essence, Ford said that its bailout would come from car buyers. This positioning lets Ford customers buy into a survival story.

It’s the American way to root for underdogs, winners, and people who work hard. Right now, the way the public sees it, Ford is all of these. When people are choosing a new car, why wouldn’t they choose one that comes with a story like that?

The Republican Road to Minor-Party Status

The House Republican leadership is being mocked from all quarters for their new “budget proposal,” and rightly so. “The Republican Road to Recovery” is not a budget plan at all, but a 19-page political pamphlet that consists of little more than a rant against the various proposals for economic recovery and health care reform. The 29 short paragraphs that come under the heading “Republicans’ Solution” don’t offer any solutions at all for the budget. The few legitimate proposals they do offer — expanded oil drilling off the coast of Alaska and the Carolinas, windmills in the middle of the ocean, more coal plants, winding down Fannie Mae and Freddie Mac, and national licenses for health insurers — don’t really belong in the budget process, and offer the sort of minor tinkering that people undertake when they are trying to avoid the real issues. The many bubble charts included are the kind of empty filler you put in your high school term paper in the vain hope that your teacher won’t notice that you didn’t really write anything. The pamphlet as a whole does nothing but reinforce the popular perception that the Republicans don’t care about solutions because they don’t expect to be in a position of any real responsibility. In short, it’s the kind of document you expect from a political party trying to make the jump from 0.1 percent support to 1 percent support so they can be sure they’ll be included in the third-party debates. And that is the kind of position the Republicans in Washington could find themselves in if they don’t eventually decide to go back to work.

Fun facts about “The Republican Road to Recovery”:

• Total length: 19 pages. Net length, excluding front and back cover, 2-page cover letter, and three nearly empty chapter pages: 12 pages.
• Number of graphs that estimate the financial effects of an early version of the Democratic budget proposal: 3. Number of graphs that explain the Republican proposal: 0.
• Number of signatures: 10. Number of House members attempting to explain it to the press at the press conference on Thursday: 1.
• Quotes from Barack Obama: 2. Quotes from Republicans: 0. Quotes from other U.S. citizens: 1. Quotes from U.K. citizens: 2.
• The only budgetary number included in the “Republicans’ Solution”: $3,128, an estimate of the annual cost per household of a proposed energy tax.

This Week in Bank Failures

Wall Street is getting mad. An AIG senior manager resigned very publicly on the editorial page of the New York Times this week, pointing fingers at both AIG executives and Washington politicians. Bank CEOs have started to issue veiled threats directed at Washington in their public statements. A parade of large banks have said they no longer want the bailout money they got last fall, and plan to return it. Yet the threats are empty and the anger is more an expression of frustration than a preparation to go to battle. Wall Street has scarcely any ammunition left. Some of the Treasury money that banks say they are giving back cannot be returned until the banks earn their way out of the hole they are in, and that might not happen. Banks want to return the money because they are not using it to make loans, yet making so few loans, it is hard for them to make the profit they need to make so they can pay the money back.

The strategy of the largest banks seems to be to wait out the recession and then go back to business as usual. It is not exactly a business plan. The recession is not likely to end until the economy has shrunk another 5 percent or so, and the banking sector could be absorbing most of that decline, coming out, by some estimates, 30 percent smaller than it was at the peak of the bubble three years ago. If that is true, the rest of the economy may start to turn around 6 months from now, but the banks and closely related businesses may continue to decline for another 5 years.

The banks that are hurting the most now are those that competed most aggressively for real estate and consumer loans in 2005 and 2006. Perhaps the biggest temptation for banks in 2009 is to view the current turmoil as an opportunity to grab market share. Banks that think they can expand their footprint now and get their operations under control later may find themselves repeating the mistakes of MCI and AOL, the champions of customer acquisition when you look at the last 20 years, but companies that saw their hard-fought market positions evaporate when they couldn’t deliver.

You don’t have to look very far to find examples of bank operations that are out of control. In a bizarre story that came out this morning, Wachovia, a failed bank now owned by Wells Fargo, apparently was trying to use a preemptive foreclosure to force a borrower to accept changes in the terms of a loan. That is the way the court saw it, at any rate. The court not only issued an injunction preventing Wachovia from proceeding with the foreclosure, but will be holding a hearing to determine whether Wachovia is entitled to any of the cancellation fee it claims it is owed on the loan.

There is a legal basis for the idea of a preemptive foreclosure. If a lender can prove that a borrower will not be able to repay a loan, it might be able to initiate foreclosure proceedings even though all loan payments so far have been made on time. It is nevertheless a terrible idea, and it must have taken several layers of management failures at Wachovia to let a story like this reach the point where people can say to each other, “They made all the payments on time, and the bank still tried to foreclose!”

This kind of story is bad for business. The perception that it is no longer safe to borrow from banks already has consumers paying off their loans. The Federal Reserve calculates the household debt service ratio (DSR) as the percent of income taken up by required debt payments. DSR peaked at 14.29 percent in 2006 and 2007, then fell to 13.90 percent by the end of 2008. It may be falling faster this year, as the savings rate has jumped up from near zero in recent years to 4 percent this year. That’s a savings rate large enough to cut total household debt by about 10 percent a year. DSR could easily fall back to the 11 percent level of the 1980s, or below, and if banks try to replace the lost income by raising consumer interest rates further, it could fall even more.

When banks get a smaller share of income, it means the banks have to be smaller. This is the kind of shift that has people projecting a banking industry shrinking by 30 percent.

You might think bank failures could provide a way for the banks to shrink, but so far, most failed banks have been taken over by other banks, providing no immediate change in the size or capacity of the industry as a whole. Tonight’s failure, though, is an exception.

Omni National Bank, a billion-dollar bank based in Atlanta with 6 offices in 4 states, was closed tonight, and when its offices reopen on Monday, it is only to let people take their money out in an orderly fashion. In Houston and Dallas, Texas, Omni National Bank used the name OFSI National Bank. SunTrust Bank, a large regional bank also based in Atlanta, is taking custody of Omni National Bank’s offices and deposits.

Unlike other recent bank closings, SunTrust is not assuming the failed bank’s deposits, but instead is acting as an agent of the FDIC to operate the failed bank for one month to give depositors time to withdraw their deposits. Customers can access their accounts, make deposits, and receive direct deposits starting probably on Monday and continuing until April 27, but they should make arrangements next week to open accounts at other banks.

Omni National Bank specialized in loans for urban redevelopment, and that can become a tough business in a time when no town is a boomtown. At the end of last year, a third of the bank’s $600 million in loans were considered nonperforming. Its holding company was placed under financial oversight by the Fed last week because of concerns about its capital levels. The Office of the Comptroller of the Currency (OCC) ordered the bank closed today after finding that its capital and earnings were rapidly disappearing.

The FDIC is projecting a cost of $290 million from the Omni National Bank failure. Omni National Bank is the largest of three banks to fail in Georgia this month and is the most expensive bank failure for the FDIC so far this year.