(Sorry this is a long post – just kept writing)
The experience described here, mirrored in other threads, is increasingly common and, in my view, due the following dynamics:
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The risk to success continues to rise especially in industries which are high cost (require a lot of labor, non-trivial inputs, a physical presence) and are sensitive to consumer tastes. Essentially, anything with non-trivial capital investment and lives or dies not necessarily on quality but on finding consumer uptake is increasingly at risk.
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Given the above happening in an investment environment of seemingly unrelenting equity growth, investors continue to look for clear wins. No need to lose money on an unsure bet if you can just put it in a blue-chip index with huge passive flows and get a solid return.
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This scenario begs the question: what are clear bets? Increasingly, the answer is polarized: low end or high end. The middle is going extinct because it represents too much risk relative to potential reward.
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And what about the consumer? They are just on the other side of this doing the exact same math with their dollars. As prices go up so does risk of a bad experience and, as the value of signaling goes up, the benefits and the risks take on greater importance.
The missing middle
While not everything can or should be reduced to a sports analogy, I think this visual summarizes the point quite succinctly
Whether it be sports, fashion, dining, wine, etc. – the direction of travel is clear: reward vs risk is the metric to optimize. That optimization leads to two places: make the lay-ups (in basketball, this means a high percentage chance shot at making two points) or make the three. What actually falls out of this analysis is that the mid-range shot is not a good risk-reward shot and, likely, not much riskier than taking a three-pointer or working the ball down low.
Broadening out to a more generalized framework, “Low End” most often translates to low cost or low risk. This might be achieved by low quality, but not necessarily – the real thing being optimized for is risk vs reward. What is often gained through low cost is the ability to pivot product direction quickly and without sacrificing much (often thought of us speed). “High End” most often translates to high value which, I would say, is most often associated with high quality. In practice, the quality might not actually be high, but the perception is the quality is high –often signaled through marketing the quality of the inputs or the process. Achieving high quality is a higher risk maneuver, not just in execution but also in term of market penetration, but, if you can penetrate the market, this is essentially the corporate version of a three pointer.
Many companies / brands are dying in no man’s land
Fashion brands which occupied the space between fast fashion and high-end (think Michael Kors, Kate Spade, etc.) are struggling. This article explores some of the important questions well (the role and economics of SM/perception? Are people now living in extremes? Is the middle losing ground because it doesn’t know how to appeal to consumers?) – regardless of the attribution, the fashion world, and generally many consumer brands, is adapting to a new normal.
Universities are facing an enrollment cliff, there is a lot of risk to middle quality schools with smaller endowments and impending loss of students to name brand schools. Given high costs (buildings, professors) and the need to attract students (think dorms, food, student amenities) – the risk of running a school without a real brand is now very high. Universities are one of the highest fixed cost businesses out there and, facing declining demographics, there will be winners and losers. It is a race to attract the full freight paying students (short term international enrollment declines are immediately problematic and are forward-looking risky given most of these students pay full tuition) and that involves investing (which leads to increase in tuition) and leads to alumni donation attraction.
Dining, the impetus of this thread, is caught in the same cycle. Everything feeling expensive is felt nationwide. No one is ever safe in the restaurant business, but it seems the fine dining is having a bit of a better go vs those a bit below. But it makes sense – if ingredients are expensive, labor is expensive and rent is expensive, what are you going to do? You need to generate a lot of covers to pay overhead. And, when you look at the minimum menu prices to break even, owners likely feel forced to offer a better experience which increases costs for them and for consumers. This process leaves everyone offering premium components without necessarily a premium product.
Housing used to have the starter home, but, as you probably guessed it, no one is building starter homes anymore. Why? Zoning is often cited as the culprit, but, regardless of whether zoning is the smoking gun or not, the reality is the cost of building a new home is quite high. If homes are expensive to build, why build a modest home when, for a little more investment, you can build a more expensive home which likely appeals to more consumers? The person who can afford the base home you could build probably doesn’t want that – they want, and can likely afford, more. Take the three-pointer here vs the mid-range shot. Better reward to risk ratio, especially when you are taking home 15% - 15% of 600K vs 15% of $1.5M, at equal likelihood of sale, is obviously more economically sensible at $1.5M.
Wine as an industry is well trodden here (especially in the Fixing the problems of the wine industry thread) and there are lots of thoughts of what to do with the various problems. My take is Wine consumption rose because: the baby boomers aged into wine’s sweet spot with rising disposable incomes and low relative prices, wine signaled cultural prestige, getting into wine was easy because restaurants operated as a positive gateway with low prices and there weren’t strong alcoholic substitutes to wine that provided the same drinking quality and prestige, and wine quality improved greatly during this period, allowing the boomer cohort to having better experiences year-on-year. Wine consumption is now falling because: boomers are aging out and Millennials/Gen Z do not have the same level of disposable income as their predecessors, when people do choose to spend money on alcohol there are now good substitutes like seltzers and spirits to take away wine’s mind and market share, a generational rise in wine demand lead to wine prices rising at all level causing entry-level wine prices to rise a lot leading to bad value, there are cultural shifts both within alcohol drinkers as well as people viewing alcohol differently leading to wine relevance generally declining, and given the high cost of wine and general formal culture around wine the younger generations do not have the good gateway experiences of previous generations. While you can take or leave my analysis, what is hard to escape is the sense that high-end wines seem to keep going up (with some wiggles here and there, but demand doesn’t flag) but the $70-120 napa cab is in trouble. Why is that? It’s the same reason as all of the above: the price level matters. If you are going to spend the money, it better be worth it and, for many today, the risk reducing move is to spend up for the marquee brand. Type “Clos Vougeot” in wine searcher and you will see mor than 20 different Domaines offering Clos Vougeot for $200-$2000. Which one should people buy? Is the $200 Clos Vougeot going to give you as good experience as spending $200 on something else? I don’t know, but I bet the people thinking of spending that much money want something to reduce their risk of a bad experience. Maybe they will pay more or maybe they will go with the Domaine they already know and love. Will they just open this at home or do it in front of others? How much does that factor into the decision?
A predictable decline?
A word which describes optimizing for reward vs risk is efficiency. Maybe people are being more efficient, using the large amounts of information to their advantage to maximize things many people really care about like social value or economic return. The cost of experimentation or losing is just so high economically and socially that it’s not worth it. That doesn’t mean society has solved for this, it just means the risky products are pretending to be either low risk or high reward (and generally, the hiding is in the latter).
