Memo: Gen Z Arbitrage

For those with Android-based smartphones in 2010, you may recall a fear of missing out. For iPhone owners who had access to a fledgling startup called Instagram, they made sure to remind you that your phone was incapable of using the software. Nothing matched the aesthetic or network effects of the photo-sharing platform for the rich kids. The fear of missing out moved many to leave Android for iOS. For those who couldn’t, Apple’s products lived – rent free – in their minds until they too had the opportunity to own their very own iPhone. This was Apple’s strategy and there’s a chance that it wouldn’t have been executed without John Doerr’s vision for Steve Jobs and his app store.

In 2008, Kleiner Perkins Chairman and partner John Doerr recognized the transformative influence that the iPhone’s launch would provide for the mobile software industry. As the story would go, Steve Jobs privately discussed the prospects of the iPhone’s fledgling app store with Doerr. Jobs originally viewed the marketplace as a private entity, one that would remain under the complete control of Apple’s management. Doerr had different plans. He believed that by outsourcing the development and marketing of apps to third party teams of software engineers, Apple would build an effective moat around their mobile operating system.

Eventually, Jobs obliged. He agreed with the ecosystem lock-in potential of tens of thousands of software engineers building products for Apple’s new mobile operating system. Managed by Kleiner’s Matt Murphy (now with Menlo ventures), the $100 million iFund launched in 2008 and was later doubled to $200 million. Kleiner’s commitment to the burgeoning mobile software industry directly and indirectly impacted consumerism forever. Numerous venture firms identified the massive opportunities that mobile applications would provide and billions in venture capital followed suit.

Just as Kleiner’s pioneering iFund once inspired an arbitrage that even Steve Jobs couldn’t have anticipated, the iPhone is once again at the center of an equally critical opportunity. As of March of 2019, the iPhone had an installed base of around 193 million in America. An astounding number given that the United States population is estimated to be around 372 million. By 2021, 45.4% all Americans are projected iPhone users.

China already is outpacing the U.S. and much of the developed world in mobile payments, and a new digital currency that authorities say would be like cash and accepted everywhere would put China miles ahead in the currency space. [1]

Apple’s app store helped to solidify the iPhone as perhaps the most pivotal consumer product of the early 21st century. One that powered transportation, communication, advertising, and global commerce. But nearly 12 years later, America’s commerce adoption still lags behind other global powers. Consider China, a country that achieved 73.6% digital shopper penetration in 2018. Mobile payments continue to drive the vast majority of online retail activity in the Asian country.

As a result, over 35% of all retail sales in China are done through online retail channels. In the United States, online retail adoption hovers at 12%. Mobile payments are commonplace throughout China across age, geography, and economic status. The ability to buy and sell goods online is so commonplace that Generation Z is the leading market for online luxury shopping in China. This has been bolstered by explosive growth in mobile payments over the past five years, a transaction volume that reached $45.1 trillion in 2018. According to the People’s Bank of China, this figure grew 28x in five years. It was largely driven by a cultural shift that saw China’s youth (Generation Z) empowered to transact for goods and services across China’s online retail and media ecosystem. According to Chinese media, proximity payment platforms Alipay and WeChat account for nearly 90% of the transactions. In America, there are 61.9 million proximity payment users, transacting just 113.79 billion in retail sales according to Statista’s 2019 data.

The Retail Arbitrage Ahead

Generation Z is the largest, youngest, most ethnically-diverse generation in American history. With over 82 million members, this cohort comprises over 27% of the US population.

While China’s Generation Z is more active in the purchase of consumer goods than their American counterparts, a snapshot of Gen Z’s current buying power would likely surprise you. TransUnion studied the credit market for buyers between the ages of 18 and 23 between Q2 2018 – Q2 2019. In that year, this consumer cohort accounted for 319,000 mortgages, 746,000 personal loans, 7.75 million credit cards, and 4.37 million auto loans.

Nearly 27% of Americans (and growing) fall within the birth years of Generation Z, a demographic that is of critical importance to legacy retailers and DTC brands, alike. In China, a country often measured as a leading indicator for American commerce trends, Generation Z leads in luxury retail adoption. In America, Generation Z is awaiting the opportunity to buy with the frequency of Millennials and Generation X. The data suggests that their consumer activity will trump that of previous generations. While Millennials prefer DTC brands by a margin of just 4% over traditional retailers, Generation Z prefers these online-born brands to their legacy counterparts by over 40-45%.

Gen Z, the group born between the mid-1990s and 2010, is already known for its financial literacy. More mature and pragmatic than its older millennial forbearers, the cohort is savvy with both finances and technology, survival skills that members gained after watching siblings and parents suffer through the 2008 recession. [2]

These are the brands that they’ve grown up with on social channels used over their iPhones: Snapchat, TikTok, WhatsApp, Instagram and others. The DTC arbitrage in 2020 and beyond will be closely tied to mobile payments. The growing adoption of CashApp, Venmo, and teenage banking programs like Current may begin to help Americans close the gap between the US v. China mobile payment adoption rates. At the center of this activity is Apple Pay, the tool with the most potential to influence Gen Z’s retail habits.

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Online retail / DTC arbitrage:2008: Shopify over custom builds2012: Warby’s PR playbook2014: Facebook advertising2016: Key affiliate partnerships 2018: Selling the first $3-5M w/o ads

Generation Z is as technologically dependent as Generation X is physically independent. Whereas all day bicycle excursions and unannounced sleepovers were a fixture in the 70’s and 80’s, that is much less so today. The meeting places and opportunities are increasingly presented in the form of digital layers. In that way, millennial parents have had to come to terms with moderating a new era of independence. Fewer drivers licenses and cars, more subscriptions and teen banking accounts.

Alexis is a middle school-aged girl in the American Midwest. An A student, athlete, and all-around great kid, she tends to earn extra privileges from time to time. Equipped with her Apple Pay-enabled iPhone, her love of TikTok and Instagram, her fascination with Glossier and Athleta, and a bit of granted independence – she’s transacted $113.41 with Glossier and Athleta’s cart in the first three quarters of 2019. The limiting factor has been her access to funds, a constraint that Apple will likely account for by offering a peer-to-peer subscription product. Apple Pay provides an independence that Americans are still dueling with. But that’s evolving. Parents are trusting of their children maintaining cash balances on their mobile phones, especially if they can easily monitor spend and availability.

If you ask the founders of Warby Parker how the team scaled so quickly, they may mention the low costs of Facebook and Instagram ads at the time. They may cite the savvy public relations work that led to that magnanimous GQ article. This moment was responsible for the  initial sell-through of their first run of prescription glasses.

70% of Gen Z has made in-app mobile payments in the last year. More than any other generation. [3]

From time to time, there are technological and economic advantages that lift the brands that are prepared for the moment. For direct to consumer brands, a category of brands that Gen Z prefers over traditional retail, there is an opportunity to shorten the marketing funnel by appealing to a generation of consumers that have been written off by the incumbents in retail. Traditional brands are marketing to the parents of America’s youth rather than directly communicating to a demographic that could benefit them. The data suggests that as Apple Pay’s adoption rates continue to improve, Gen Z will become the primary consumers of the goods that have, so far, been marketed to Millennials and Gen X members.

Year 2020

We underestimate the significance of the Apple card being used as a function of the Family Share, a program that allows Apple users to share access to digital products and assets with their families. The moment that ‘Gen Z’ is capable of spending (while accountable to their parents) is the moment that 27% of American consumers, with a preference for DTC brands, floods the market. This is the potential arbitrage that awaits for this era of retail.

And in this way, this small shift in corporate strategy resembles the magnitude of moment that John Doerr was responsible for. Either Apple will build a native function that allows guardians to ‘subscribe’ and account for potential monthly allotments to their dependents. Or a third-party solution will be engineered by an outside developer. Of all the mobile payment solutions available to consumers, it is Apple that sits at the trusted intersection of family and finance.

The Apple card is a platform that few have recognized. It’s also another lock-in opportunity, perhaps the first of the Tim Cook era. With few exits, low multiples, and increasing customer acquisition costs – the weakening viability of the DTC ecosystem has been difficult for operators and investors alike. By accelerating Gen Z’s path to becoming independent consumers, Apple stands to benefit during a time where the Cupertino-designed hardware is as commoditized as ever.

And like Silicon Valley benefited from Apple’s democratization of the app store in 2008, this era of consumer brands will stand to benefit from democratization of consumerism within the home. Our Gen Z daughters want Balm Dotcom.

Read the No. 330 curation here.

Research and Report by Web Smith | Edited by Tracey Wallace | About 2PM