Startups, Income Inequality, and the Basic Economy

One of the challenges I feel founders face, yet don’t discuss often enough, is how income inequality is changing product development.

One doesn’t have to read through Thomas Piketty’s behemoth Capital in the Twenty-First Century to understand that our society has become far less equal — just take a good, long look around startup hubs like San Francisco and New York. What used to be a continuum of incomes is now turning into a handful of groupings, and products are increasingly targeting a single bucket rather than the broader consumer market.

The best analogy I have to this is the current configuration of domestic airlines. Today, there are roughly four classes of service on Delta and other legacy carriers: Basic Economy, (Standard) Economy, Premium Economy, and Business/First. What used to be the Economy, Business, First three-class distinction has become a two-class distinction, with one of the classes strongly stratified based on a few dollars difference between consumers.

The trend in startups has been to focus on that elite Business/First demographic, but I think that is a mistake given the history of technology exits over the past few years.

Basic Economy

For those who don’t know, Basic Economy takes away such airline “luxuries” as the ability to select a seat or use overhead bin space. What’s happening is that a large number of Americans want to reduce their costs to the bare minimum, regardless of the quality of the product or experience. Thus, we see the massive rise of dollar stores across the country, which in some cases are outcompeting Walmart.

The Basic Economy demographic is hardly tiny – it’s hard to put a figure on it, but I would put it somewhere at 40-60% of the population.

This is in many ways a massively empowered demographic. They need to keep costs under very strict control to make everything work, and so they will seek out discounts and savings wherever they can. They don’t have much of a choice regarding quality — obviously they don’t want to buy junk, but they aren’t going to spend even a single dollar more than they have to.

The lesson here for founders and startups is that targeting this market is all about price, price, price (plus obviously utility). This is not a group that will try new things if they don’t need to, nor will they shell out extra dollars for a better, online experience. It’s all about cost savings. That can be a tremendous advantage if you can use software to save money compared to traditional models. RobinHood is maybe a good example of this – even this demographic has some stocks to trade, and suddenly making those trades free creates a huge competitive advantage.

My guess is that this will end up being Amazon’s core demographic. Since one cannot touch physical products online, it is much harder to tell the quality of an individual good, so people are increasingly driven to the lowest price as opposed to a range of price/quality ratios (a great example of quantification in action).

(Standard) Economy and Premium Economy

To be derisive, (Standard) Economy is really about people pretending that they are still getting decent goods, even though the product quality has decreased for years. This is the cheap Chinese off-shoring of brands that we have known about for years. You pay more, get less, but at least you are not in that Basic Economy group.

This is a legacy classification that I think will be mostly disappearing in the next few years. Products will converge either to Premium Economy or Basic Economy.

Today’s Premium Economy is what used to be (Standard) Economy. This is a group of people who may not have massive wealth or income, but are at least cognizant of quality and are willing to shell out dollars when the price/quality performance is right. In other words, this is the Starbucks crowd.

For founders, I think the Premium Economy population remains heavily overlooked. There is immense value here, not necessarily per customer, but rather because the size of the population is so much larger than the Business/First group. An accessible premium product sounds like an oxymoron, but it really means that you focus on quality while keeping price heavily in account.

Business/First

The popularity of the “Tesla model” (start really high-end and try to drive lower prices over time) has led to many new startups targeting the ultra-rich as their first customer. We can see this in Silicon Valley with startups like the Juicero ($400) or the Peloton bike ($1,995). This demographic represents just about 1-5% of the population.

This model works great if the margins on a unit are sufficiently high that they allow the company to plow those profits back into infrastructure to scale up. When Tesla sold its Roadster, it helped to subsidize research costs as well as manufacturing buildout. That isn’t unique to Tesla, but I think this strategy is much less generally successful than is believed.

The problem with this model is that startup founders have to focus on a very rich customer from their earliest days, and it is very hard to adjust a company to focus on a wider demographic group later. The personalized customer support that comes with these products are absolutely impractical with higher sales at lower prices, and so the business is just never set up properly to be a mass market product.

What Should Founders Do?

Yes, the rich have disposable incomes and can be an easier sale. They have less issues buying beta goods, and while demanding around quality, are also quick to write-off issues for early companies.

But, looking at historical tech outcomes, the reality is that the biggest companies have tended to be the most broadly popular. If you are only focusing on one tiny elite demographic group, you are probably doing it wrong. It’s far more profitable (in terms of gross profits) to get a little income from lots of people rather than a lot of income from a few people. In some ways, this is a margins versus gross profits debate.

I think more founders should engage with income inequality and begin to ask, “How can I serve the broader consumer market? How can I develop the right brand that can engage premium customers but also customers at other rungs of the income ladder?”

It’s not impossible for companies to adapt to all of these demographics. Uber has done a great job with UberBlack (Business/First), UberX (Premium Economy) and UberPool (Basic Economy) of matching a particular quality of service to its customers. The brand, outside of its own scandals, has not suffered from offering all of these different lines.

So if you are looking at consumer startups, don’t be afraid to engage with a large swath of consumers. Learn how to offer accessible support but also elite support for the most valuable customers. Don’t be afraid of feedback from everyone and learn how to integrate that into the product line. Ultimately, income inequality isn’t going to be solved by products, but it can certainly be a lens to a better product strategy.

Photo by Wayne S. Grazio used under Creative Commons