Terry College of Business - Fall 2008 - (Page 14)
advanCes From The Terry College oF Business Consumer spending in tough economic times By Joanna Carabello n today’s troubled U.S. economy, individuals and families face difficult decisions in order to make ends meet. For some, the answer is merely to trim non-essential spending habits, such as eating out at restaurants. For others, it may be necessary to cut back on essential items, like prescription medicine. Predicting how consumer spending will respond to economic pressures is of vital importance to government officials and public policy analysts, and a research article co-authored by Terry marketing professor Rex Du outlines a new model for understanding how consumers pick and choose where to spend their money. “These days, budget constraints are even more rigid because the credit market has tightened and people can’t borrow to cover higher costs,” says Du, whose research article, “Where Did All That Money Go: Understanding How Consumers Allocate Their Consumption Budget,” will appear in the November issue of the Journal of Marketing. “Energy and health care costs have increased so dramatically that the question becomes, ‘Where do people cut?’” Finding that answer should be easier with the help of Du’s model. “Public policy makers need this tool to predict how different tax levies and tax rebates will affect individual households,” says Du. “For researchers and business analysts who are concerned about the trajectory of a whole industry, this is relevant because now they can combine this model with predicted demographic changes.” Du and Duke marketing professor Wagner Kamakura created their computational model by analyzing the spending patterns of 66,000 households across 31 different consumer categories from 19822003. Their research takes components of the economy — income, demographics, and consumer prices — and combines them to create an economic model that can predict future outcomes. The model examines the difficult 14 • Fall 2008 I tradeoffs consumers sometimes have to make in tough economics times, such as forgoing medical care to pay the heating bill. It also shows that marketers need to look beyond their product categories to get the full view of their competition. The article cites a recent study that showed a decline in candy sales among teens was the result of young consumers choosing to spend their money on text messaging rather than sweets. To illustrate how their model works, Du and Kamakura applied it to three hypothetical scenarios — a spike in fuel prices, a $500 tax rebate, and lower prescription drug costs. When they began working on the paper, they didn’t know just how prescient the first two scenarios would prove to be. “When we first proposed a 50 percent increase in fuel prices, one of the (journal) reviewers said that was unrealistic. Obviously that’s not the case anymore,” says Du, who was recently honored by the Marketing Science Institute as a 2009 Young Scholar. Faced with a spike in fuel costs, consumers reduced their spending on motor and home heating fuels as well as their spending on education, health care, charities, personal care, and home furnishings, according to the model. How much they cut back was related to overall wealth. The poorest households cut energy use 43 percent after the price spike; the richest one-fifth of households reduced their energy use by 20 percent. After fuel spending, the next-largest budget cut for the poorest households was for prescription drugs, which dropped 27 percent. The most significant changes in the richest households were 31 percent spending cuts on both education and jewelry-watches. When consumers enjoy even a small windfall, such as a $500 tax rebate, the model suggests they are just as choosy about where to spend it. For all households, the largest portion of the extra money would be spent on food at home, so grocery stores likely received the biggest boost from the federal tax stimulus checks distributed earlier this year. For poor households, one out of every five rebate dollars would be spent on food, followed by extra spending on health insurance, electricity, and recreation. In rich households, spending priorities for the extra money, after groceries, were recreation, eating out, and apparel. This model gives researchers the ability to do counterfactual analysis, such as looking at how consumer spending might have been different from 1982-2003 if prescription drugs had followed the average inflation rate of about 91 percent for that period rather than the 262 percent that the prices actual increased. The model shows that consumers could have saved an average of 37 percent on their prescription drug spending — money that would likely have been spent on such things as extra insurance, household services, dining out, alcohol, and tobacco. “After going through all of the literature, what was missing was a tool to allow consumer spending to be examined at a very granular level,” says Du. “This model gives researchers the flexibility to drill it down.” ■ Terry College oF Business
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