One of the buzzwords in marketing in the last few years has been “share of wallet”. “We don’t aim for market share in any particular segment”, they say. “What we are aiming for is a larger portion of the customer’s share of wallet”. Basically what marketers try to do is to design their products such that a larger portion of customers’ spending comes to them rather than go to competitors (again – they claim they have no direct competitors and everyone else who competes for the customer’s spending is a competitor).
So far so good. But the problem with looking at things from a “share of wallet” pespective is that it assumes that the wallet is homogeneous. That each part of the wallet is similar to the other, and spending for different items comes uniformly from all parts of the wallet. This isn’t usually very well recognized, but what matters more than “share of wallet” (of course that matters) is the “tranche of wallet” that this particular product sits in.
I don’t think I need to give a rigorous proof for this – but some spending is more equal than others. For example, if you are dirt poor and have only ten rupees left in your pocket, you would rather buy a loaf of bread than buy a tube of lipstick. Some goods are more important than the others. “Necessities” they call them. The rest become “luxuries”. Even the “luxuries” are not homogeneous – there are various tranches in that.
So the aim for the product manager should be to get into the deeper tranches of the customer’s wallet (assuming that the top tranche is the “equity tranche” – the one that takes the first hit when spending has to be cut). Targeting the top tranche may be a good business in good times, but when things go even slightly bad, spending on this product is likely to take a hit and thus the “share of wallet” falls dramatically. Getting into a deeper tranche means more insurance, so to say.
In the world of CDOs (from where I borrow this tranche, equity, etc. terminology), people who take on the equity tranche and other more risky tranches do so only in exchange for a premium – basically that you need to be paid a premium amount (compared to lower tranches) during good times so that it compensates for lack of income in the bad times. So this means that if you are trying to target the most disposable part of the wallet (i.e. the part of wallet that takes the first hit when spending has to be cut), you better be a premium player and make enough money during good times.
So the basic insight is that. The more disposable spending on your product is for your customer, the more the premium that you have to charge. Some products such as high end fashion accessories seem to have got it right. Extremely disposable spending, which leads to volatility of income; balanced by extremely high margins which make good money in good times.
Certain other products, however, don’t seem to have got it right. One example that comes to mind is Indian IT. Some of the offerings of Indian IT companies come near the disposable end of their customers’ wallets. However, to compensate for this, they don’t seem to charge enough of a premium. So they make “normal” profits during good times, and sub-normal profits during bad times – leading to an average of sub-par performance.
So before you enter a business, see which part of your customer’s wallet you are targeting. See if the returns that you will get out of this business in good times will be enough to tide you over during bad times. And only then invest. Of course, before the 2007-present downturn happened, people had no idea what bad times were, and thus entered into risky businesses without enough of a risk premium.