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Cover Story July 23, 2009, 5:00PM EST

The Leaner Baby Boomer Economy

The downturn is putting a crimp on baby boomers' free-spending ways, and the likes of Mercedes and Starwood Hotels are scrambling to keep up

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Steinberg at Mercedes' U.S. headquarters in Montvale, N.J. Bill Cramer/Wonderful Machine

By David Welch

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Wang feels boomers' pain: "You don't have 30 years to reinvent yourself" Bill Cramer/Wonderful Machine

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McGuinness' team at Starwood is developing two low-cost but hip hotel chains Bill Cramer/Wonderful Machine

Mercedes is the quintessential boomer brand. Drive down an American highway, and odds are good that the person piloting the Benz in the next lane was born between 1946 and 1962. And Mercedes-Benz (DAI) has prospered right along with America's huge postwar generation. Back in 1986, when the first baby boomers turned 40, Mercedes sold 99,000 cars in the U.S. In 2006, when those boomers hit 60, the automaker moved almost 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's North American market research operation, has a nagging fear: that sales won't recover for a long time because boomers, history's wealthiest generation, are tapped out. "I don't know if anyone knows yet if this is a blip," she says, "or a defining moment like the Great Depression."

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

FAITH IN RISING MARKETS

When 79 million people—nearly a third of Americans—start spending less and saving more, you know it won't be pretty. According to consulting firm McKinsey, boomers' conversion to thrift could stifle the economy's hoped-for rebound 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." And that's why everyone from Mercedes to Nordstrom (JWN) to designer Vera Wang are scrambling to remake themselves for the Incredible Shrinking Boomer Economy.

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

Meet Tim Woodhouse, 56. He owns Hood Sailmakers in Middletown, R.I., a business that helped finance a plush life. Woodhouse owns a boat, five Ducati motorcycles, and every few years treated himself to a new Porsche 911. He figured he'd retire when he felt like it. Then the markets crashed, the economy tanked, and suddenly Woodhouse 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 Porsche and bought a Mini Cooper. The boat spends more time tied up these days than out on the water. He and his wife 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 their products and marketing to appeal to the next generation. With boomers, however, many companies became complacent. It wasn't that they ignored younger consumers but that they counted on boomers to keep spending longer. And why not? Until recently boomers typically reached their spending peak at age 54, according to McKinsey. Contrast that with the previous generation—a thriftier bunch whose consumption typically peaked at 47.

Now many companies are scrambling to appeal to Generations X and Y. You can already see this thrust in the stores. Clothing designer Vera Wang is selling a casual line called Lavender aimed at twenty- and thirtysomethings. It's fashion, but not the pricey garments the company typically has sold. Meanwhile, says Wang, her namesake brand needs to get a lot less expensive. In one instance, Wang made a high-end dress using fabric that costs $5 a yard instead of $12 but used the fabric in several layers to give the garment a richer look. 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 focus group it calls Generation Benz. Mercedes researchers are seeking their views on the economy, car ads, model designs, and more. The automaker sent 20 Generation Benzers into dealerships wearing flip-flops and other casual attire to see how much attention they received. Four of the 20 were ignored. The results, says Steve Cannon, vice-president for marketing, served as a wake-up call to Mercedes dealers "that we have to start paying a lot more attention to tomorrow's customers, especially if tomorrow is coming faster than we thought."

VALUE SHOPPING

Can younger consumers pick up the slack? Consider the demographics. Generation X, Americans born between 1964 and 1980, is generally estimated to be about two-thirds the size of the boomer cohort. And with boomers working longer, especially since the crash wiped out many retirement funds, it may take longer for Xers to move into their prime earning (and spending) years. And what about Generation Y, the 81 million-strong group born between 1981 and 1994? Right now, 14% are unemployed and will have their own hole to claw out of when the economy revives, according to Edward F. Stuart, who teaches economics at Northeastern Illinois University. In other 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—but is now on a budget. Timothy Malefyt, an anthropologist who studies consumer trends for the ad agency BBDO New York (OMC), argues that boomers, having ridden a wave of technological change, are highly adaptable and well versed in problem-solving. (Or at least they see themselves as such.) Already, he says, they are making a virtue of value shopping, once viewed by this group as hopelessly déclassé. For many boomers it's no longer about keeping up with the Joneses, it's about outthinking them. "If you make boomers feel they've failed, you'll lose them," Malefyt says. "They want to feel they've outsmarted the system or their circumstances."

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