Wednesday, February 28, 2018

Chasing the Gilded Tail - the Hechinger Effect Strikes Again!

Hechingers went out of business when the children of the founder decided the profit margin on small appliances was better than on 2 x 4's.   But you can't build a home out of toasters!

I mentioned before The Hechinger Effect.  Hechinger's went out of business when the children of the founder decided the profit margin on small appliances was better than on 2 x 4's.   The problem to this business approach was twofold.  First, as I noted above, you can't build a home out of toasters.  I went to the store near my house in the 1990's for sheetrock and 2x4's and they had neither.  But they had a huge selection of countertop appliances!  Was I interested in a new coffee maker?  I was not.  I left and never went back.   The next year, they were bankrupt and new stores called "Lowes" and "Home Depot" opened up.

The second problem is that high-profit margin items don't stay high margin for long.  Other retailers realize there is money to be made on those items and jump into the fray - selling for a penny or a dollar less.  A price war ensues and the margins drop back down to...  reasonable.   Countertop appliances are incredibly cheap these days as a result.  Yea, this free-market thing actually works, sometimes.   So even assuming Hechinger's could "convert" its lumber clients to small appliance clients, eventually they would be undercut by a competitor, and the vaunted "high margins" would evaporate.

So when a company says, "Let's just stop selling low-margin items and just sell the profitable ones!" you know trouble is ahead.  Because people come to your business for a panoply of products, and that means you make more money on some items, and less on others - and maybe lose money on some.  This is how grocery stores operate all the time.  Can you imagine going to a grocery store and finding the shelves stocked like it was Venezuala?  "Oh, sorry, we only stock the really profitable items anymore!  You want lettuce?  We ain't got it!  How about some bottled water, organic produce, and greeting cards!  We make lots of money on those!

You'd stop shopping and never go back.    But a third problem is, of course, that stores that only cater to high-end clients, selling products at high prices, are going to run out of customers eventually - particularly if everybody decides that only the very wealthy are worthwhile clients to maintain.   There is only so much upper crust to go around - which is why we call them "1%'ers" - they are minority of the population!

Selling only items which are wildly profitable is not a rational business plan.   Eventually, you run out of customers, as they find those items for less elsewhere and are chagrined at your lack of selection.  In this "new economy" they call this the "long tail" - going after tiny market segments.  In this case, however, it is chasing the gilded tail - going after a tiny market segment that has a lot of money to spend.

Two stories in the news illustrate the Hechinger Effect in today's economy.  First, pending home sales are off once again, and real estate agents are blaming "lack of inventory".   It seems than no one wants to sell because prices are so high and people believe they are sitting on a gold mine (hmmmm... I heard that before, but can't put my finger on when or where!).   It also seems that builders are chasing the "luxury" end of the housing market because they make more money on luxury homes than on middle-class homes.   The problem is, of course, there are only so many luxury buyers.   I suspect the "lack of inventory" story is only half of it.   Real Estate Agents report lots of traffic - lots of potential buyers - but not many sellers.  But I suspect a lot of those buyers are just not willing to pay the high prices of today's housing market, and because of that, they aren't buying and few are selling.

Second, GM is reporting "double-digit profits" with its new line of full-sized SUVs and Pickup Trucks, particularly in the GMC line.  A new truck today can cost $70,000 or more, a comparable SUV over $100,000.   GM and Ford and Chrysler are concentrating on this high-margin, high-end of the market, as it makes them a lot of money.  And so far, the plan has worked.   Declining sales are not a concern, as the profit margins are so high that it makes up for lack of market share.  Again, I've heard this all sometime before, but I can't put my finger on where or when.

Oh, right, the market meltdown of exactly ten years ago.   GM went bankrupt, voiding all my GM stock.   The company was geared up to make high-margin SUVs, and when they stopped selling - all at once - they couldn't keep the lights on.   Similarly, home prices were skyrocketing, builders were putting up luxury condos and "mini-mansions" and it reached a point where no one could afford to buy these monstrosities.   And it all happened very suddenly - or so it appeared.  But the signs were all there for anyone to see, months, if not years, in advance.

Who can afford a $70,000 pickup truck?   I know I can't.   I paid $25,000 for my Nissan, and I thought that was pretty outrageous.   The most expensive car I ever owned was the M Roadster, and I paid the princely sum of $29,000 for that, used.   I have never paid over $30,000 for a car, and certainly not $70,000 or $100,000.   Yet a lot of people have these cars - I see them on the road.  The payments must be outrageous!

Of course, with low interest rates, the payments might be somewhat reasonable.  What's that you say?  Interest rates are going up?   Gee, I wonder how that will affect sales of these expensive trucks and houses?   I mean, no one can predict that, right?   After all, we've never been through a similar situation in the past, other than, of course, the exact same situation back in 2007.

Rates go up, monthly costs go up - making these things less affordable.  People are tapped out.  Car loans are already defaulting in record numbers.  People are heavily in debt.  Who is going to buy the $100,000 SUV?   Sure, the rich guy will.   There ain't a lot of them left.    There are, of course, a lot of people who think they can afford these things, but get them on seven-year loans and are "upside-down" through most of the loan period.  They can't afford to trade-in for a new one.

We can't have an economy that makes nothing but luxury goods, high-end houses, and overpriced food, and expensive cars.   There has to be an economy for the rest of us, in order for that expensive economy to work.   Because at the car factory, the country club, the gated community, and fancy restaurant, there are hundreds, thousands, millions of us plebes who put the bolts on the cars, bus the dishes, and mow the lawns.   And we can't afford these high-margin items, no matter how nice it would be for these companies to reap record profits.

Sorry, GM!  Sorry, Homebuilders!   I'd really like to help you out with your dreams of avarice.  I mean, it is a sweet dream - for you.  But it involves me handing over an inordinate amount of money for something I really don't need or want - a "look-at-me" house and a "look-at-me" car, which really aren't worth even the status value when so many people have them.

An affordable house, or an affordable car - they will sell.  And sell they did, back in 2011 or so, when the carmakers and homebuilders realized that you can't run a business catering to a small minority of wealthy shoppers.  That's not a rational business plan.

Hechinger's slogan was "The World's Most Unusual Lumber Yards!" which we used to parody as "The World's Most Cruel and Unusual Lumber Yards!" particularly after they stopped selling lumber.

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