I. Introducing the Behavioral Change Economy
COVID-19 has altered our daily lives in ways that we’re just beginning to comprehend. Our physical work environments have changed dramatically, with companies across industries shifting to partially or fully-remote work. Our previous everyday experiences, ranging from eating in a restaurant, attending a sporting event or concert, staying in a hotel, or going to the gym, either do not exist or look very different than they did less than six months ago. Schools are scrambling to adjust to this new environment via transformed in-person teaching combined with online classes, but many institutions of higher education are shutting down. Almost all forms of transportation are being restructured due to safety precautions.
In the words of Steve Blank, Stanford Professor and creator of the customer development method that launched the Lean Startup movement, “The Pandemic has upended the business models of most startups and existing companies. As the economy reopens companies are finding that customers may have disappeared or that their spending behavior has changed… In sum, whatever business model you had at the beginning of the year may be obsolete.” (1)
But there is a silver lining for entrepreneurs. In our view, the COVID-19 economy presents an entrepreneurial environment unlike any we’ve witnessed in recent history, due to structural changes forcing consumers and enterprises alike to change their behaviors. Accelerated behavioral changes are creating a once-in-a-lifetime opportunity for startups, which thrive in chaos and are best suited to adapt to a new normal.
In this article, we describe the unique characteristics and implications of the Behavioral Change Economy, explain why this economy has changed traditional patterns of technology adoption, and describe why technology founders are now cast in the role of industry saviors vs. disruptors.
II. The Pace of Behavioral Change Has Accelerated, Driven by Enterprise and Consumer Necessity Rather than Choice
The first unique characteristic of the Behavioral Change Economy is the rapid rate at which new technology-driven behaviors are being adopted. Historically, mass adoption of tech-enabled behaviors has been measured in decades. (2) As an example, Amazon was founded in 1994, and it has driven the growth of e-commerce for more than twenty-five years. However, despite Amazon’s exponential growth, e-commerce was only 16% of U.S. total retail sales at the end of 2019. Despite the innovations that e-commerce introduced in terms of selection, convenience, and cost, more than 80% of retail is still transacted offline.
COVID-19 is changing historical patterns by dramatically accelerating the adoption of tech-enabled behaviors. Satya Nadella, CEO of Microsoft, described the pandemic’s impact in April by saying, “We’ve seen two years’ worth of digital transformation in two months.” As an example, consider the growth of business software applications since the pandemic began. According to App Annie, there was a 90% increase in global downloads of business apps during the first few weeks of the pandemic (see diagram below). For the entire 2nd quarter ending in June, there was a 40% increase in the usage of apps, far above the historical growth rate. (3)
The Impact of COVID-19 on Global Downloads of Business Apps (Source: AppAnnie)
The adoption of online video conferencing is a prime example of enterprise behavioral change. Zoom grew from 10 million daily meeting participants in December 2019 to 300 million daily participants in April 2020, growth of 30x in four months.(4) Microsoft Teams grew from 44 million daily active users in March to 75 million DAUs in April, a 70% growth rate in one month.(5)
Similar behavioral changes are occurring in consumer consumption. According to a survey by RBC Capital Markets, the adoption of online grocery shopping increased from 36% of the U.S. population in 2018 to 55% of the population in March of 2020.(6) That is an increase of nearly 20% of the U.S. population in less than two years. Instacart, the market leader in the category, has experienced order growth of almost 500% year-over-year. (7)
Online food delivery has grown even more significantly, as shown in the graph below from the Wall Street Journal. Comparing current spending to spending in January / February of 2020, we see that food delivery spending has grown almost 100% from its average during the previous period.(8) The food delivery industry effectively doubled in size in a six-month period. This growth came at the expense of dine-in restaurants, which experienced unprecedented unemployment as consumers moved their spending online.
Change in U.S. Food Spending (Source: Wall Street Journal)
The overarching commonality across these behavioral changes has been a shift away from in-person behaviors which require close, physical interaction toward digital behaviors that come as close as possible to replicating the benefits of in-person behaviors, without the health risks.
While these digital behaviors may come up short in fully replicating in-person experiences, they introduce new benefits that we may not have previously considered. These include time and expense savings due to not having to travel, as well as increased selection and choice vs. the in-person experience.
As an example, consider changes in consumer spending in apparel and accessories during COVID, shown in the graph below.(9) There was an initial significant reduction in in-store spending, and commensurate growth in online spending, after COVID hit in March. However, even after U.S. states have reopened, online spending remains more than 25% above pre-pandemic levels, while in-store spending remains more than 25% below pre-pandemic levels (see graph below).
Change in Consumer Apparel Spending (Source: Wall Street Journal)
Skeptics would argue that these behavioral changes are temporary, and that we will revert to our old behaviors when they become safe again, perhaps after there is a COVID vaccine. But these skeptics overlook a unique characteristic of these behavioral changes. Where the behavioral change results in a fundamentally better experience for the customer or user, this customer or user will not revert back to the old way of doing things, even when choice returns in the future.
For example, online grocery delivery has historically been perceived as a luxury or non-necessity for much of the U.S. population. However, delivery costs have come down over time, and convenience of online delivery has gone up. The user experience is so good today that a grocery trip that may have taken 1 to 2 hours in the past can be done in 15 minutes online. Many who have adopted online grocery delivery during COVID will not return to in-person grocery shopping, because the online experience is fundamentally better. Switching costs are also low, which also accelerates adoption.
The implications of behavioral changes in the enterprise will play out over a longer period of time. When forced into quarantine, companies of all sizes were forced to use tools such as Zoom or Slack in order to communicate with colleagues, customers, and partners. Usage has become a necessity, rather than a nice-to-have. Companies are now discovering that many interactions which previously required in-person meetings can be accomplished more efficiently using online productivity tools, freeing up valuable time.
These behavioral changes will have a long-term negative impact on business travel, and will also likely reduce commercial real estate spending, due to more employees working from home. However, enterprise behavioral changes may lag consumer changes, because of higher switching costs, as well as the fact that incentives of enterprise decision-makers may not be the same as those of the users. For example, because large enterprises have significant legacy investments in real estate, they cannot eliminate their physical space immediately. In addition, while employees working remotely may prefer this work environment, enterprise decision-makers may not prefer it, due to reduced ability to monitor and supervise their staff.
III. Post COVID-19 Behavioral Changes Alter the Crossing the Chasm Framework
The third unique characteristic of COVID-19 is that groups who were not historically early adopters of technology products are now joining that group. To better understand what’s happening, we need to refer back to the Diffusion of Innovation theory by E.M. Rogers and the landmark text, Crossing the Chasm, by Geoffery Moore.
Under the Diffusion of Innovation theory, adoption of new products follows a lifecycle, with sequential adoption by five groups: innovators, early adopters, early majority, late majority, and laggards. These groups form because individuals have different abilities and incentives to adopt new technologies, and each group’s adoption influences the adoption of the next group. The distribution of these groups takes the form of a normal distribution, with the early and late majority being within one standard deviation from the mean, early adopters being within two standard deviations, and so on.
Moore expanded upon Rogers’ theory in Crossing the Chasm, arguing that there is a chasm between the Early Market (comprising Innovators and Early Adopters) and the Mainstream Market (comprising all other groups). This chasm could be overcome by applying creative strategies, including choosing the target market, positioning the product, and selling the product through specific distribution channels. The traditional Crossing the Chasm framework is shown below.
Over the past decades, we have gotten used to Early Adopters of new consumer technologies being the same group of people. We might describe them as young, technologically-literate, and having sufficient time and disposable income to adopt the newest technology product or service. Consider the first people you knew who purchased an iPhone or IPad, hailed an Uber, or used a Peloton.
In contrast, the Late Majority and Laggard consumer groups are often comprised of people for whom the cost-benefit equation of adopting a new technology only makes sense years later. The Late Majority often consists of age and income groups who don’t see enough utility from the product, or where the price is prohibitive. These individuals look to the Early Majority to adopt the product first, for the kinks to be ironed out and the price to come down, and for technology standards to be established before they adopt.
The irony of COVID-19 is that it is forcing consumer and enterprise groups that typically fall into the Late Majority group to become Early Adopters due to necessity. Consider, for example, the adoption of telehealth. Whereas telehealth previously was adopted by individuals who didn’t have time to go to the doctor, or could pay for an alternative option, it is now it is being adopted by our most vulnerable individuals, who need to be able to access critical care immediately. These include our elderly citizens, as well as individuals with critical illnesses, who can access care via a connected device.
We see the same phenomenon occurring in the enterprise context. In enterprise, innovators and early adopters have often been in technology-forward industries. For example, productivity tools were first largely adopted by startups, but enterprises were slow to adopt. Fortune 1000 companies, historically in the Late Majority, are now rapidly adopting these tools.
The same phenomenon is occurring in vertical industries. Consider the real estate industry, as an example. In the past, real estate developers and managers have often been slow to adopt new technology, due to established business practices and lack of incentive to innovate. COVID-19 is now dramatically impacting how the real estate business works. Property managers can no longer carry out in-person real estate tours, and managers are forced to adopt digital innovation.
We believe that COVID is transforming the traditional Crossing the Chasm Framework. It is driving a larger portion of the population into the Innovator and Early Adopter segments. This comes at the expense of the “Late Majority” and “Laggards” categories, both of which shrink considerably. COVID is also reducing the chasm between the Early Market and the Mainstream Market. The Early Majority no longer needs as much time or encouragement to switch over to the new behavior. See below for our view of the new COVID technology adoption framework.
A real-life illustration of the new framework can be found in the real estate vertical. As we described above, real estate managers and landlords are being forced to quickly adopt technologies in order to serve their customers. As a result, there has been a dramatic increase in demand for virtual home showings, with Redfin reporting almost a 500% increase in agent-led video tours.(10) Overall, Redfin’s video tour requests jumped from .2% of all requests to almost 19% of requests within a month, an increase of over 90x within a month.
This behavioral change mimics our prediction that the Innovator and Early Adopter segments will increase post-COVID, as industries are forced to adapt quickly. Real estate companies have been forced to adopt technology to enable virtual tours. Startups like Matterport, one of the leaders in 3D virtual tour software, are being deluged with demand as a result.
IV. COVID-19 Provides Opportunities for Startup Founders to be Industry Saviors Rather than Disruptors
So where do startup founders come in? This brings us to a final unique characteristic of the COVID era as it applies to entrepreneurs. While startup founders are traditionally tasked with being industry disruptors, COVID-19 is requiring them to be industry saviors, because the survival of traditional industries depends on their entrepreneurial innovation.
Why is this the case? This is because COVID is threatening foundational parts of our lives that we cannot live without, the loss of which is creating tremendous disruption and trauma in our daily lives. For example, children need to be able to eventually attend school, but they need to do it in a safe manner that doesn’t endanger their health. We need to be able to travel again, but we need our modes of transportation to be safe and enable social distancing. We need to be able to congregate together with our families and friends, but not in a way that threatens our health. These needs are fundamentally different than the drivers of much of our technology adoption over the past decade, which largely impacted “nice-to-have” aspects of our lives.
This provides an opportunity for technology entrepreneurs to be industry saviors, by re-imagining traditional industries to ensure safety but also improve their economics. Startup entrepreneurs have always been perceived as disruptors, shifting traditional behaviors and putting established companies out of business (think Netflix vs. Blockbuster). The result of these disruptions is typically job losses and bankruptcies of incumbent companies. But in this case, startups founders are tasked with helping to save Main Street. They can have a huge impact on helping workers return to work, and preventing bankruptcies of small businesses.
As an example, our portfolio company Squire is playing that role in the barber shop and salon category. Squire’s software enables barber shop customers to book appointments ahead of time, allowing shops to manage capacity more effectively and reduce customer wait-times in a socially-distanced environment. Squire also helps barber shops increase profitability and manage cash, by streamlining product sourcing and managing expenses. Businesses like Squire have the potential to help traditional industries navigate the new normal, acting as saviors while these industries adjust to new economic realities.
COVID-19 has ushered in the Behavioral Change Economy, which we believe will lead to the formation of a new generation of billion-dollar technology companies. These startups will capitalize on the unique characteristics of this entrepreneurial environment: the rapid adoption of new technology-driven behaviors; changes being driven by necessity rather than choice; the transformation of the traditional “crossing the chasm” framework; and the power for startups to act as saviors for traditional industries.
These startups will look very different than the ones that came before them. They have the potential to grow more quickly due to faster technology adoption. They are targeting customers who have not historically been early adopters. They may not have to market their products nearly as much to drive adoption.
We believe the Behavioral Change Economy is one of the few silver linings that have resulted from the pandemic. At 645 Ventures, we’re excited to be investing in this unprecedented entrepreneurial environment, and we’re seeking to back founders who are re-imagining the world post-COVID.