COVER STORY July 23, 2009, 5:00PM EST

The Leaner Baby Boomer EconomyThe downturn is putting a crimp on baby boomers' free-spending ways, and the likes ofMercedes and Starwood Hotels are scrambling to keep up

By David Welch

Mercedes is the quintessential boomer brand. Drive down an American highway, and odds are good that theperson piloting the Benz in the next lane was born between 1946 and 1962. And Mercedes-Benz (DAI) hasprospered right along with America's huge postwar generation. Back in 1986, when the first baby boomersturned 40, Mercedes sold 99,000 cars in the U.S. In 2006, when those boomers hit 60, the automaker movedalmost 250,000 vehicles, a fifth of its global total.

This year, Mercedes will sell a third fewer cars in America. In Montvale, N.J., Kristi Steinberg, who runs Benz'sNorth American market research operation, has a nagging fear: that sales won't recover for a long time becauseboomers, history's wealthiest generation, are tapped out. "I don't know if anyone knows yet if this is a blip," shesays, "or a defining moment like the Great Depression."

Executives such as Steinberg always knew boomers would curb their free-spending ways as they approachedretirement. But not in their most nightmarish imaginings could they have predicted that an economic maelstromwould cripple the customers they have courted and counted on for 30 years.

FAITH IN RISING MARKETSWhen 79 million people—nearly a third of Americans—start spending less and saving more, you know it won't bepretty. According to consulting firm McKinsey, boomers' conversion to thrift could stifle the economy's hoped-forrebound and knock U.S. growth down from the 3.2% it has averaged since 1965 to 2.4% over the next 30 years."We would have gotten here in 5 or 10 years as boomers retire, but we pushed it up," says Michael Sinoway,managing director of consulting firm AlixPartners. "Now [companies] are scared things won't come back." Andthat's why everyone from Mercedes to Nordstrom (JWN) to designer Vera Wang are scrambling to remakethemselves for the Incredible Shrinking Boomer Economy.

Not so long ago, boomers were never going to die. Filled with a self-confidence born of unprecedentedprosperity, many thought rising markets would assure their future. If the economy faltered, well, it would reboundmore strongly than ever, as it had so many times before. And so boomers spent—and borrowed—as if therewere no tomorrow.

Meet Tim Woodhouse, 56. He owns Hood Sailmakers in Middletown, R.I., a business that helped finance a plushlife. Woodhouse owns a boat, five Ducati motorcycles, and every few years treated himself to a new Porsche911. He figured he'd retire when he felt like it. Then the markets crashed, the economy tanked, and suddenlyWoodhouse felt a lot poorer. In April, with business slowing and his real estate holdings leaking value,Woodhouse hit the brakes. "I was scared," he says. "My net worth took a real hit." Woodhouse sold the Porscheand bought a Mini Cooper. The boat spends more time tied up these days than out on the water. He and his wife

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dine out less often, and they don't entertain at home much either.

Woodhouse and millions of boomers like him are doing what people normally do when they near retirement:They're living more frugally. Companies have long factored in this actuarial reality, gradually tweaking theirproducts and marketing to appeal to the next generation. With boomers, however, many companies becamecomplacent. It wasn't that they ignored younger consumers but that they counted on boomers to keep spendinglonger. And why not? Until recently boomers typically reached their spending peak at age 54, according toMcKinsey. Contrast that with the previous generation—a thriftier bunch whose consumption typically peaked at47.

Now many companies are scrambling to appeal to Generations X and Y. You can already see this thrust in thestores. Clothing designer Vera Wang is selling a casual line called Lavender aimed at twenty- andthirtysomethings. It's fashion, but not the pricey garments the company typically has sold. Meanwhile, saysWang, her namesake brand needs to get a lot less expensive. In one instance, Wang made a high-end dressusing fabric that costs $5 a yard instead of $12 but used the fabric in several layers to give the garment a richerlook. As a boomer herself, Wang, 60, feels her generation's pain. You don't have 30 years to reinvent yourself,"she says.

Even as Mercedes continues to target boomers, it has quietly recruited 500 people aged 20 to 32 for a focusgroup it calls Generation Benz. Mercedes researchers are seeking their views on the economy, car ads, modeldesigns, and more. The automaker sent 20 Generation Benzers into dealerships wearing flip-flops and othercasual attire to see how much attention they received. Four of the 20 were ignored. The results, says SteveCannon, vice-president for marketing, served as a wake-up call to Mercedes dealers "that we have to startpaying a lot more attention to tomorrow's customers, especially if tomorrow is coming faster than we thought."

VALUE SHOPPINGCan younger consumers pick up the slack? Consider the demographics. Generation X, Americans born between1964 and 1980, is generally estimated to be about two-thirds the size of the boomer cohort. And with boomersworking longer, especially since the crash wiped out many retirement funds, it may take longer for Xers to moveinto their prime earning (and spending) years. And what about Generation Y, the 81 million-strong group bornbetween 1981 and 1994? Right now, 14% are unemployed and will have their own hole to claw out of when theeconomy revives, according to Edward F. Stuart, who teaches economics at Northeastern Illinois University. Inother words, companies will need boomers for years to come.

The trick will be finding a way to fulfill the needs and wants of a generation that is used to being catered to—butis now on a budget. Timothy Malefyt, an anthropologist who studies consumer trends for the ad agency BBDONew York (OMC), argues that boomers, having ridden a wave of technological change, are highly adaptable andwell versed in problem-solving. (Or at least they see themselves as such.) Already, he says, they are making avirtue of value shopping, once viewed by this group as hopelessly déclassé. For many boomers it's no longerabout keeping up with the Joneses, it's about outthinking them. "If you make boomers feel they've failed, you'lllose them," Malefyt says. "They want to feel they've outsmarted the system or their circumstances."

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COVER STORY July 23, 2009, 5:00PM EST

The Leaner Baby Boomer Economy(page 2 of 2)

That's why some companies are coalescing around "cheap chic," a marketing conceit that has becomesynonymous with Target (TGT) but also has been tried by the likes of JetBlue, Ikea, and Mini. The latter is ownedby BMW, another classic boomer brand. BMW didn't plan it this way, but the Mini is one solution for a companywhose cars are becoming too pricey for many boomers. A fully loaded BMW 3 Series costs $40,000 pluschange; a comparably equipped Mini: $25,000. The Mini, while a feat of engineering and retro style, can'tcompete with a BMW, which the company bills as "the ultimate driving machine." But the Mini possesses cheapchic in spades. In recent months, says BMW, fiftysomethings have been trading in their Bimmers and otherluxury brands for Minis.

PAMPERING ON A BUDGETStarwood Hotels & Resorts Worldwide (HOT) has embarked on a crash course in cheap chic—or what it prefersto call "style at a steal." The chain has long appealed to the boomer yen for luxury and pampering. Its high-endW, Sheraton, and Westin hotels offer spacious rooms, well-staffed front desks, valets, and extensive roomservice menus. So the polyester sheets and small-bar soap that typify the value hotel experience wouldn't do.Starwood's 40-year-old chief of specialty brands, Brian McGuinness, also knew boomers grew up challengingconvention and still like to feel that they're on the cutting edge. But they also demand creature comforts. "Theyonce drove Beetles and ended up in Bimmers," McGuinness says. "We wanted to strike that balance." Plus,don't tell them but boomers are getting older and presumably creakier. So edgy can't equal bare-bonesminimalism.

After six months of research and brainstorming, Starwood came up with two cheap chic hotel chains: Aloft,named to echo the "urban cool" of loft apartments, and Element, a low-cost option aimed at people who prefersuites with every "element" of their daily lives—including spa-like bathrooms. Early last year the team mocked upan Aloft prototype and invited some boomer-age guests to stay. The mock hotel had an aggressive neon colorpalette, piped-in scents reminiscent of an Indian spice market, and garage band tunes on the sound system. Tohelp bring the room rate down to the $150-to-$170 range, they cut out full-service restaurants, room service, andvalets. The test subjects were fine with parking their own cars, and most said they'd rather explore and find theirown restaurants than eat in their rooms. The garage music? Not so much. Starwood replaced it withcontemporary rock and international music. The neon palette gave way to muted tones, and a mild citrusreplaced the spice.

Starwood has opened 25 Aloft hotels so far, and McGuinness says occupancy rates meet or exceed the averagein most metro markets. Starwood won't say if the downturn prompted it to accelerate the rollout of its new hotelbrands. But the company is opening two Aloft hotels each month, the fastest rate the industry has seen. DavidLoeb, a Robert W. Baird analyst who has been covering the hotel industry for years, says Aloft's ambience maybe too hip and jarring for fiftysomethings. But he says if the chain finds the right balance, it might appeal toboomers and Generations X and Y. Starwood is advertising the new chains heavily online. "Boomers and Gen Y

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congregate in the same places on the Web," McGuinness says.

Starwood started changing its approach to boomers before the economy went south. Other companies areadjusting on the fly. OSI Restaurant Partners has watched its eateries lose boomer customers, whethermiddle-class types who frequented the company's Outback Steakhouse and Bonefish Grill restaurants orwealthier people who once dined on filet mignon at the more upscale Fleming's Prime Steakhouse & Wine Bar.OSI's chief operating officer, Paul E. Avery, reduced menu prices and offered smaller cuts of beef at Outback tomaintain margins before retiring in early July. The company has gone on an ad blitz pushing the more modestportions for $9.99. This is obviously a tricky balancing act at Outback, where a big slab of meat was the chain'smain attraction.

The good news, says Chief Branding Officer Jody Bilney, is that people who order the less expensive entréestypically end up buying dessert or more alcohol, so the average ticket is still about $19 per person. At Fleming's,OSI is offering more wines under $10 a glass and a fixed-price menu that caps everything but drinks as low as$36 a person. Before the downturn diners typically spent $60 apiece. OSI is responding to a recession but isprepared to run its business this way if boomers remain frugal over the long run. "If anyone tells you they knowthat the impact of the last 12 months is permanent or temporary, they're blowing smoke," Bilney says.

Nordstrom isn't waiting to find out. The purveyor of affordable fashion believes that its customers—many of themboomers—will be under pressure for years to come. So even as it starts building fewer full-price departmentstores, Nordstrom has tripled the pace for opening lower-priced Nordstrom Rack stores. It will open 13 in 2009and nine next year. Rack stores offer Nordstrom's usual name brands but for 30% to 70% less than they fetch inthe main stores. Nordstrom figures boomers still want fashion, but at a discount.

What many companies are attempting to do now has worked in the past. After the crash of 1929 few peoplecould afford a Cadillac, so General Motors (GM) created a budget model to keep its luxury sales going. The 1934LaSalle had art deco touches, including chrome portholes along the hood. To cut costs, GM stuck the car on anOldsmobile chassis and gave it a smaller engine. The LaSalle's cheap chic was a hit with Depression-eradrivers, and when the economy recovered, Cadillac again became a totem of material success. Of course,America was about to experience the greatest boom in history. That's unlikely to happen this time.

With David Kiley

Welch is BusinessWeek's Detroit bureau chief.

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