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Deflation and Consumers
By Bill Catlin
March 18, 1998
Click for audio RealAudio 2.0 14.4


This story is part of a larger feature about deflation:
The World Turned Upside Down: An End to Inflation?

AT THE BEST BUY STORE in the twin cities suburb of Roseville, Brian Smith is watching movie clips demonstrating the virtues of DVD, digital versatile disk... the latest home entertainment gadget. Smith is kicking the tires and thinking about upgrading, but his current home theater system still has bragging rights.

Smith: It's the whole thing with the big tower speakers, and the 100-watt sub-woofer, and it shakes the living room up real good, you know - makes my cat jump out of its chair, and stuff, you know.

One of the clips Smith is watching shows James Bond and an airplane plunging in an uncontrolled dive. The image captures the trend Smith is finding in DVD prices. He says he's surprised at how quickly prices have dropped, but he's not buying yet.

Smith: I'm waiting for DVD to come down another hundred bucks. When it first came out, you couldn't touch one for under $600. Now you can get them for $400 on sale. I'm waiting till they come down a little more in price.

Lower prices are taken for granted in home electronics, but with the help of consumer vigilantes like Smith, and superstores like Best Buy, the trend is spreading. More and more industries are having trouble raising prices. Prices have come down for home appliances, small cars, home mortgages, and of course, computers. That's great for consumers who can get more for their money. And with the tailwind of a strong economy, businesses may be able to cut prices and make up for it by selling more goods. But it's an unforgiving environment for any business that makes even a minor misstep.

Greg Lund: It's not like an old line, let's say the John Deere tractor company of 50 years ago, when the product was stable, the use was stable, the changes that were made were more glacial instead of instant. Today, the changes are instant. You don't really have much of a chance, I don't think, to make too many mistakes and stay in business.

Greg Lund is a spokesman for the South Dakota-based mail-order computer manufacturer, Gateway 2000. If there is deflation in the US economy, computer makers like Gateway are at the epicenter. The market research firm Computer Intelligence says the average price of a home PC sold in stores dropped 29% in the last year. The trend appears to be accelerating. Government statistics indicate computer prices posted a record one month decline in February. The end of Gateway's production line is stacked with Gateway's signature white boxes, each one spotted to look like a holstein cow. Gateway has stayed out of the booming market for consumer machines priced below $1,000. Spokesman Greg Lund says even so, the company has had to make adjustments at the low end of its products.

Lund: That entry-level price has certainly come down. It's all a response to the sub-$1000 market.

Catlin (reporter): ...Price competition.

Lund: Indeed.

Last year, Gateway offered a dramatic example of how unforgiving deflation can be. The company overestimated how many computers it could sell to businesses. Parts sat around. As technology advanced and prices fell, the excess parts were worth less and less. To cut its losses Gateway settled for much lower profit margins to move hardware. In the fall, the company said it would reassign or lay off up to 300 workers. Third quarter profits were, in the company's words, "marginal." When combined with other unrelated costs, the company reported a third quarter loss exceeding $100 million. In the traditionally strong three months ending the year, Gateway's sales rose enough to overcome declining prices, and profits rebounded. But companies can not count on that.

Earlier this year, the piano in Elizabeth and George Everitt's living room became the sole bread winner in the household. Elizabeth's teaching income brings in enough to cover most of their expenses if they cut way back. George Everitt is a chemist. He holds a PhD and two patents. Everitt began his career as a 3M researcher nearly a quarter century ago. He was one of thousands of 3M-ers who went to Imation, a collection of moderately and marginally profitable businesses 3M spun off in 1996. At the time, Everitt gave the new company a year before the going got tough. The news he feared hit last fall.

George Everitt: The papers all said Imation's going to lay off a thousand people. For some reason, I knew I was one of them, right there.

At the time, Imation was selling more of its products, but the gains were eaten up by falling prices and currency exchange rates.

Catlin: To what extent do you feel your job was a victim of declining prices in the products that you were helping to make?

George Everitt: Uh, probably 90% or more. If there's no money to do... if you have no money, you're not going to do research. I mean, that's just natural. So...

Imation says pricing is only one of several factors that contributed to the layoffs. Everitt says he's not bitter at losing his job. It's just business and you've got to take it. But he's taken it hard.

George Everitt: The worst part is when I talk to people I know real well. You know, I just don't feel like I'm the same person anymore if you don't have a job, and you're not the same person if you don't have a job, in my mind. So, maybe that's over-reacting, but that's the way I see it. People saw me breaking down and all that sort of thing.

Catlin: When you say "breaking down," what do you mean?

George Everitt: Well, I started crying real bad.

Elizabeth Everitt: For him, it's been really, really, really bad. And no matter what I told him, it didn't make a difference. He still felt anxious. It just couldn't sink in, and he couldn't accept it that we were all right. It's been his worst nightmare that would happen to him. Because he thought this might happen. And he talked about it for months before it did.

Declining prices don't always pull jobs down with them, if manufacturing efficiency can keep pace.

The Frigidaire freezer plant in St. Cloud, MN, looks like it's had a fresh coat of paint, giving no hint of its age or history. Roger Juaire is huddling from the snow and rain under an awning across the street. Juaire heads the union representing about 2,000 workers here. He says the plant dates back to early this century, and by the mid 1980s, it's economic survival was in question.

Juaire: Some of the people had some foresight way back then and realized that, you know, we had to get together here to make this facility go.

At the time, employment at the plant was less than half the current level. Layoffs were frequent. The union took a gamble. It agreed to a wage freeze and other cost reductions so the company could invest in new, more productive equipment. Back in his office, Juaire says one of the payoffs showed up in the last contract negotiation. The company felt it could increase wages, even as it has to reduce prices.

Catlin: Would it be going too far to say it's good times now, for this plant, for your people?

Juaire: Well, I guess I'd have to say it's the best I've seen as far as the number of people working there, the business that we have, the amount of hours that people can work without layoffs, and yeah, I'd say times are good, I can't even argue about that.

Juaire says productivity improvements helped the frigidaire plant outlast its competitors, in an era of fierce competition in the home appliance industry - competition that has driven prices down. Just ask Paul Warner, who does the buying for Warners' Stellian, a Twin Cities independent appliance dealer. He's standing next to a wall lined with refrigerators in his St. Paul store.

Warner: Well, we would say that the entire industry has been in a deflationary mode for, oh, I'd say the last seven years. Probably the most visible would be the refrigeration category.

Catlin: Can you give me an example?

Warner: Well, the price on this particular refrigerator, which happens to be a 25-cubic-foot, ice and water dispenser, is $900. A similarly featured box, possibly even less-featured box, two, three years ago, would have sold competitively in the industry for $1099, $1199. So, you're talking anywhere from two, three, $400, even, in some cases, differential, even in the last three to four years.

Catlin: You're getting more for less?

Warner: Oh, the consumers are getting a lot more for less. A lot more.

Catlin: Why is this happening?

Warner: The industry is over-manufactured. In other words, we have more production capabilities than demand. And so it's very competitive at the manufacturing level. The only way to put a 10% or 5% growth on there is to steal it from somebody else. It's extremely aggressive out there.

Jim Thiers, who runs Hoeft Appliance Center in St. Paul, says the job isn't as much fun as it used to be.

Thiers: It's hard work. We have to shop as much or more than the consumer. Because if we don't get the best possible deal, whatever we buy and put on our floor isn't going to sell.

And for all the extra work, Thiers says customers don't really recognize they're getting a better deal on appliances than they have in the past.

Thiers: It's something that for most people they do not enjoy shopping for, and they, no, do not appreciate the value that they're getting.

Catlin: Do people gripe about prices? I mean, you're still looking at stickers of seven, eight, $900 here?

Thiers: Yeah.

Back at Best Buy, customers shopping for personal computers do seem to notice that prices are falling, especially if they already own a computer, like Christina Marble.

Marble: It's like, dramatically dropped than what it used to be five years ago, six years ago, when we bought the first one. So it's really nice. Because we're looking at what they give us here, this one alone has all the extra, extra, extra stuff. And we had a 486 with... it didn't have a modem in it, and it didn't have a cd-rom, and we paid a gazillion dollars for it, and now they give you almost everything for a really nice price. So it really is nice.

A world where prices plunge, with no end in sight. What could be better for anyone shopping for a computer? Well, the secret is, it quietly drives a lot of them nuts.

Shopper One: Well, it's frustrating, considering the fact that my computer is now worth about the price of the plastic on the outside, as opposed to these, which will pretty much take care of my house and do the laundry and the dishes. This is now doing so much more, I mean my computer memory is not even in megabytes. It's sort of like, "yeah, sometimes I'll remember."

Catlin: Are you having more fun now as a computer enthusiast?

Shopper Two: I think about it more. The problem is you see such a good deal today, but you're worried about tomorrow - that the price will drop significantly on that product, and you could have got the next generation for cheaper. The products that are coming out are coming out so much faster, too, that the changes are just hard for me to keep up with. I think a younger person might enjoy that more than me. I'm caught in that, "well, should I buy today, or will it be less expensive tomorrow?"

Call it, "the hesitation blues." If it's a problem, it seems pretty benign. But that mind set could become the leading edge of a deflationary downward spiral; consumers wait for prices to drop further, corporate profits shrink, layoffs rise, consumers hold off buying even more. And so on.