Feeling Pinch, U.S. Trades Down

Brian LaCroix, a 34-year-old computer engineer, developed a taste for expensive coffees. Earlier this year, however, he stopped frequenting a French coffee shop in Dallas and bought an espresso machine, slashing the daily cost for deux lattes from $8 to $1. The newlywed and his wife, who have a combined income of about $200,000, have also cut spending by mowing their own lawn. And Brian asked to work from home two days a week to save on gas for his 2002 Ford Ranger. The LaCroixs have been motivated by a combination of factors: frugality, environmentalism and concern about the job and real-estate markets. (Earlier in the decade Yvette, now an operations manager for Fannie Mae, lost her job in the telecom bust.) "We want to be sure that we can afford our home on just one salary without having to dip into savings," says Brian.

For the past several years, American consumers at every rung of the income ladder have been trading up—splurging on a growing array of luxury products, from $4 lattes to $4,000 handbags. With easy access to credit, especially home-equity loans, middle-class Americans began regularly trading up for items that appealed to them, buying food staples at Kroger but splurging on Kobe beef at Whole Foods. Suddenly, everybody was a luxury consumer—for certain items.

But as the saying goes, what goes up must come down. Now many of those same Americans who traded up are shunning luxuries and returning to basics. The upshot: many of the companies that expanded in the hopes of reaching a mass audience of luxury consumers are suffering. Blame the overall slowdown in economic growth, the growing scarcity and cost of credit, and, above all, the sad-sack housing market. "The top 20 percent of households haven't seen a decline in real income, but the bottom 20 percent is suffering and the middle 60 percent is getting by," says Michael Silverstein, senior partner with Boston Consulting Group and coauthor of "Trading Up."

Across the economy, consumers are now opting for smaller, less expensive items. In the past three years, sales of compact cars—cheaper to buy and operate than SUVs—have risen from 13.6 percent to 17.7 percent of total U.S. auto sales, even as automakers' incentive spending per compact car fell by 55 percent. Leasetrader.com, a 10-year-old company in Miami that helps people get in and out of car leases, says that up to 15 percent of its customers are seeking to trade down to smaller cars. "This is the first time in at least six years that we've noticed people wanting to do that," says Leasetrader.com spokesman John Sternal.

Mark and Erin Reed Adams, wedding photographers who live in Reynoldstown, a neighborhood near downtown Atlanta, have kicked this trend down a notch. This spring, they bought a pink 2005 Stella scooter on eBay for $2,300. By using the scooter for most transportation, the couple has cut its monthly gasoline bill by $250. "It's also nice that we're doing our part to reduce our dependence on oil and help the environment a little bit," says Adams.

Like the Adamses, many consumers who are trading down are influenced by the trend toward environmentalism. But for others, simple economics is the main motivator. In October, Alex Yakulis, a 47-year-old marketing executive, and his fiancée, Meg Stewart, put their million-dollar mega-manse in the affluent Dallas suburb of Frisco on the market, posting on a real-estate blog. While he loves the home, and the gated community in which it sits, it was more than they needed, especially with a variable-rate mortgage about to reset. "I find myself going into rooms I haven't been into in a couple months, in a home that's too big with a mortgage payment ready to double," he says. Yakulis still wants his granite countertops and travertine tile—but in a house half the size and half the cost.

He should have no trouble finding one. The median size of newly completed single-family homes, which had been rising steadily, fell from a record 2,302 square feet in the first quarter of this year to 2,241 in the second quarter, according to the Census Bureau. Bernard Markstein, a senior economist at the National Association of Home Builders, says builders are "putting in fewer amenities, [and] a lower grade of cabinet and counter." Meanwhile, many owners of existing homes have stopped remodeling. In the pricy Santa Fe, N.M., area, smaller-scale renovation jobs have dried up. "The $20,000 to $30,000 kitchen job and the $12,000 to $15,000 bathroom are harder to come by than last year," says Douglas Maahs, president of Honey Do Home Repair and chair of the Santa Fe Remodelers Association.

The phenomenon is even having an impact on what people eat. Waiting outside a Beverly Hills Ruth's Chris Steak House, Tom Brant, a retired CPA?who lives in Covina, Calif., said the bill for dinner to celebrate his daughter's 35th birthday hurt: $400 for four people. His real-estate and stock-market investments "aren't doing so well lately," says Brant, 69. "I like to eat out and I like steak. But do I come a couple of times a month. Not lately, or any time soon." McCormick & Schmick's Seafood Restaurants, Inc., a high-end chain that has expanded rapidly from business districts in major cities to places like Dayton, Ohio, hit a wall this summer after 16 straight quarters of comparable-restaurant sales growth. In late September, it reported that traffic at its 72 U.S. restaurants was weak, "which we attribute primarily to less demand from our aspirational guest," as Doug Schmick, chairman and chief executive officer, put it in a news release. Meanwhile, McDonald's and Burger King are reporting supersized sales growth.

Apparel shoppers are similarly sheathing their debit cards. An online survey conducted this spring by WSL Strategic Retail found that 70 percent of respondents were cutting back on spending for accessories like watches, jewelry and bags. And when big retailers posted same-store sales for September, many reported disappointing results: down 4.6 percent at JCPenney, up only 1.2 percent at Target. Consumers are still willing to trade up. "But if someone wants the designer jeans, they'll cut back on something else," says Mary Brett Whitfield, an analyst at TNS Retail Forward in Columbus, Ohio.

The impulse to spend less and save more has always been cyclical. In the aftermath of a debt binge, Americans always rediscover the joys and benefits of frugality—only to whip out the credit cards once interest rates fall. Michael Silverstein points to powerful, long-term trends that suggest customers will continue to reach for luxury. Real income is still growing, and "trading up has been driven over the long term by women going to work and earning wages that are closer to parity with men."

Of course, luxuries and necessities are in the eyes of the beholder. Janie Pryor, a Los Angeles-based jewelry designer, has had to pare back on discretionary spending. Her company's sales have been off for the last year. But thus far she's been resisting cutting back on one luxury: skin treatments, including her beloved Botox. (Pryor, a 48-year-old former sun worshiper, says the injections take "at least 12 years off" her face.) "I'm not there yet," she says of going Botox-less. "But I'm?starting to accept the fact that?that's what I might have to do if this keeps going on." Oh, the perils of a sagging economy.