How Ability to Pay Trumps Willingness to Pay in Southeast Asia The 'market-mandated margin compression' strategy will be a driving force for the future of digitally-native brands across the region

While business schools around the world are teaching students about willingness to pay, they are often taking a more foundational concept for granted, especially in emerging economies: ability to pay. Ability to pay can be defined as the price someone can pay given the amount of money they earn. In developing regions like Southeast Asia, the most successful Western digitally-native brands are gaining market share slowly because they don't understand that ability to pay trumps willingness to pay. In response, local entrepreneurs are building digitally-native brands with the ability to pay at the forefront of their strategy.

Games They Play

There's a good reason digitally-native brands in emerging markets can undercut the competition coming from more developed markets—the margins in these industries are "out-of-whack", as described by David Gowdey, managing partner at Jungle Ventures. "Out-of-whack" means astronomical in the sense markups can be thousands of times over the manufactured price (i.e. a pair of eyeglasses selling for $250 versus a manufactured cost of $3).

As a result, the two most important drivers of success for digitally-native brands in Southeast Asia are:

1. Identifying an industry with "out-of-whack" margins
2. Knowledge of the "ability to pay" by the local market

I like to call this the "market-mandated margin compression" strategy.

Local entrepreneurs can be confident in the "market-mandated margin compression" strategy because Western brands can't go country to country and price at ability to pay. These companies are handicapped because they can't price their product dramatically differently across markets as it will dilute their brand and eradicate consumer trust among their target consumer, the millennials.

What Matters

In size alone, the two billion millennials worldwide comprise a substantial business opportunity for any industry, but millennials around the world have dramatically varying abilities to pay. Malaysian millennials earn an average of $6,674 annually, while the US' rake in $35,592. Understanding this difference and how it varies across countries is vital for entrepreneurs to build successfully digitally-native brands in Southeast Asia.

It might seem that given the drastically smaller incomes of millennials in Southeast Asia, the opportunity is minimal. This is quite the contrary because the younger demographic of Southeast Asian millennials makes up for this. Below is a chart of the median age across the ten ASEAN countries. For perspective, the median age of the population of the US is 37.

Median age across ASEAN Countries

Source: Statista 2015

To see the "market-mandated margin compression" strategy succeeding we will explore the eyewear industry.

USA's Warby Parker and India's Lenskart

According to Crunchbase, Warby Parker disrupted the eyewear industry by creating a lifestyle brand built around social consciousness at a "revolutionary price". The average price point of $95 (interestingly, the exact same price point as Allbirds footwear) is significantly less expensive than other designer quality eyeglasses in the US market. Compare Warby Parker with Versace, for example. At $250, Versace frames are over two and a half times as expensive as this new competition.

In India, the average millennial income is $5,064, which means that $95 a pair is largely out of reach. The founders of Lenskart identified this issue and saw it as an opportunity to build a digitally-native eyewear company offering comparable eyewear at Rs999 ($14.25 USD).

This price is much better aligned with the target audience's income level, which raises another question: is the quality of these products similar?

The answer is yes, and for a notable reason. Ninety percent of the world's eyewear is manufactured in China, with 30 percent of it made in just five factories.

According to marketing professor Dr Lois Bitner Olson, who visited some of these factories, "You'll see several production lines and running down them are sunglasses that are going to end up at Target (an American department store) for $6.99 and sunglasses that are going to end up at Nordstrom or Saks that are designer sunglasses for $250. And they cost pretty much the same amount to make."

Regarding these costs, she says, "Some of the ones you're buying for $6.99 might cost 25 cents to make. They are really, really inexpensive. Total markup, you know, on those versus the ones that are $3 being extrapolated to $150. Those have a higher margin but most of them are still inexpensive [to produce]."

Unique model?

Assuming both Warby Parker and Lenskart buy their high-end glasses at $3 a piece, these are strong margins. This puts the $95 pair from Warby Parker at a margin of 3,100 percent. The $14.25 pair from Lenskart has a margin of 475 percent. Lenskart can thrive on these smaller margins because India has 440 million millennials compared to America's 71 million. The smaller margin is easily compensated for by the larger market.

This industry example is not unique as most consumer categories have "out-of-whack" margins because powerful brand names demand high premiums. Therefore, the "market-mandated margin compression" strategy will be a driving force for the future of digitally-native brands across Southeast Asia and there is certainly a unicorn out there on the horizon.