Tag: benchmark

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Looking at Business Models – Consumer Behaviors and Gross Margins

startup business models, waves, consumer behaviors

While sipping on my morning green tea, I’m inspired by Venture Stories’ recent podcast episode where Erik was interviewing Charles Hudson of Precursor, where they codify Charles’ investment thesis, markets, business models, among many other topics. A brilliant episode, if I say so myself! And it got me thinking.

Some market context

In the past few months, I’ve been chatting with a number of founders who largely seem to gravitate towards the subscription business model. Even pre-COVID, that seemed to be the case. And this notion was and is further perpetuated where a plethora of VCs turned their attention to XaaS (X-as-a-service).

Why? Pre-COVID, the general understanding was that consumers were:

  1. More expensive to acquire,
  2. And, harder to retain,

…which I shared in one of my February posts. I’d even heard some investors say: “Consumer social is dead.” Although I personally didn’t go as far as to illustrate the death of a vertical, I had become relatively more bearish on consumer than I did when I started in venture. Clearly, we were wrong. The question is: how much of this current situation will still hold true post-COVID? And honestly, your guess is as good as mine. But I digress.

Given the presumption that the consumer industry was faltering, many VCs re-positioned their theses to index more on enterprise and SaaS models. Models that had relatively fixed distribution channels and recurring revenue. It became some form of ‘guarantee’ that their investments could make their returns. And as the demand for startups shifted, supply followed.

The Business Models

Though there seemingly has been an overindexing of subscription models in the consumer space, I’m still an optimist for its future. The important part is to follow consumer behavior.

  • What do their consumption patterns look like?
  • What do their purchasing patterns look like?
  • How do customers think about value?

Here is a set of lens in which I think about business model application:

Subscription“One-off”
Continuous consumption patterns
>3-4 times in a month
(Ideally, >3-4 times per week)		Discrete consumption patterns
~1-2 times a year
Extremely episodic in nature
Proactive, expectant behaviorReactive behavior
Examples:
Food
Groceries
Music
Education		Examples:
Moving homes
One-off Conferences
Travel
Car
Note: The examples are generalized. The business models will depend on your target market. For example, travel for the average family may not happen on a recurring basis, but travel for a consultant happen weekly (pre-COVID).

The Extremes of Gross Margins

Of course, I can’t talk about business models without talking about profits. The ultimate goal of any business model is to realize returns – gross margins. Unfortunately, there’s no silver bullet on how you price your product. While you find the optimum price (range) for your product A/B testing with your customers, here’s a little perspective onto the two extremes of the spectrum.

  1. If you have insanely high margins, expect lots of competitors – either now or in the near future. Expect price-based competition, as you may most likely, fight in a race to the bottom. Much like the 1848 California Gold Rush. Competitors are going to rush in to saturate the market and squeeze the margins out of “such a great opportunity”.
  2. If your margins are incredibly low, as Charles said on the podcast, “there better be a pot of gold at the end of the rainbow.” You need extremely high volumes (i.e. GMV, “liquidity” in a marketplace) to compensate for the minimal cut you’re taking each transaction. A fight to monopolize the market. I’m looking for market traits like:
    1. Growing market size.
      • Ideally heavily fragmented market where you can capture convoluted, antiquated, and/or unconcentrated processes in the status quo.
      • Why unconcentrated? Don’t underestimate the power of your incumbents’ brands and product offerings. Like don’t jump in ad tech if you’re just going to fight against the Google and Facebook juggernauts, who own 80% of the ad market.
    2. Insane network effects.
    • For example, payments or food delivery. Food delivery is one where you have to reach critical mass before focusing on cash flow/profitability. I get it. It’s a money-eating business… until network effects kick in. Sarah Tavel wrote a Medium article about this where she explains it more elegantly than I have.

In closing

I’ve seen many founders end up taking their models for granted or sticking to a single generic revenue structure. But the best founders I meet make this a very intentional part of their business. Sometimes, even having different revenue streams for different parts of the business. If that’s the case for you too, Connie’s piece about multimodal models may be worth a read.

Photo by Denys Nevozhai on Unsplash

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An Innovator’s Inspiration

Photo by Skye Studios on Unsplash

Creativity.

I have a love-hate relationship with that word. On one hand, I love and seek to learn from creative souls. It’s a trait that I seriously respect in individuals, regardless of industry, profession, or background. On the other hand, it’s rather amorphous. What’s creative to me may not be creative to you. We are bounded by the parameters of our experiences and what we, as individuals, are exposed to.

So, where do innovators draw inspiration?

Over the years, I’ve seen inspiration stem from three main frameworks:

  • The flow from art;
  • Margins;
  • And, what people dislike.

The Flow from Art

I seem to find that the data largely (with a few outliers) points towards the following:

Art precedes science. Science precedes tech. Tech precedes business. Business precedes law.

Art is bounded only by one’s imagination. Science, which draws inspiration from art, is limited by our physical universe and the fundamental laws. And, tech rides on the coattails of science, restricted by the patterns recognized in our universe by scientists before them. Similarly, business can only optimize existing technology. Following suit, regulations and legal practice can only debate and prevent ramifications that have turned from hypothesis to reality.

On one end of the spectrum, fiction has driven innovation on the fundamental, scientific front. Scientists have tried to make the impossible – fiction, superstition, assumptions, and imagination – possible. On the other end, the legal and regulatory space has empirically lagged behind business innovation. From autonomous driving to the shared economy to video games, a regulatory emphasis came only after incidents occurred. I’m a huge proponent of founders becoming self-regulatory. But that is a discussion for another day.

Margins

As Jeff Bezos famously said:

“Your margin is my opportunity.”

In the lens of a businessperson, profits exist on the margins. In a fully saturated market, as we learned in economics class, perfect competition will squeeze out profits. That margin can be delta between human perfection and imperfection. It can be the difference between a naive and sophisticated individual. It can also be the blind spots between a self-awareness and ignorance.

The good news (and bad news?) is that humans aren’t rational. As much as we try to be, we’re not. We repeat the same mistakes. After all, that’s where our favorite stories come from – the fact that we’re imperfect. If we were rational, our friendly neighborhood kid from Queens wouldn’t have to struggle with identity. Or, Skinner, the head chef at Auguste Gusteau’s restaurant, wouldn’t be out to exterminate my favorite rat chef.

From a nonfictional front, if we were rational, gambling, the lottery, therapy, and more wouldn’t exist. In fact, there’s a whole industry that capitalizes on human imperfection – insurance. We choose to reach for that last cookie when we know a healthier diet with less sugar is better for us (I’m guilty as well). We set New Year’s resolutions to work out more, but regress to our couch norm after the first month. Walter Mischel famously conducted The Marshmallow Experiment. When given the option to wait 15 minutes to double their treats, many children opted for immediate gratification.

There would be way fewer founders if they were rational. I mean, come on, the numbers work against them. 90% of startups fail. So, from a VC’s perspective, we have to ask ourselves:

What’s is the underlying notion that makes this product work?

What is that innate theme in human or societal development that won’t disappear anytime soon? What factors produce such a trend? And what margin is it taking advantage of? Uber was made possible with the evolution of smartphone and faster data. As more data were archived online, Google became a reality because of the internet and browser. Two current examples of underlying notions include:

  • Audio, including, but not limited to, podcasts and audiobooks, is the new form of content consumption. Not only does it free up consumers’ hands and eyes up, audio content is often easier to digest. The spoken word has been around millennia, whereas print is fairly new invention. Emotions and sarcasm is often easier to relay via audio than via print. So, what else is possible?
  • With growing consumer sentiment against traditional social media, like Facebook, Twitter, and Instagram, there is a shift to social experiences surrounding active participation. Sarah Tavel writes a great piece on this. Examples include Discord, Medium, TikTok, and user-generated content (UGC) in video games, like mods and in-game skins. Many of the traditional social media platforms leave users with a more negative passive experience, where they feel a sense of FOMO (fear of missing out). Through active participation, users can be a part of the conversation, rather than watch from the sidelines.

What do you dislike?

Speaking of negative experiences, aversion is a strong motivating emotion humans have. Like prospect theory illustrates, loss invokes a stronger response than gains. It also happens to be one of the reasons why I probe how obsessed a founder is about a certain problem.

In a recent interview with Andrew “Kappy” Kaplan, host of the podcast, Beyond the Plate, Grant Achatz, legendary chef, talks briefly about how he drew inspiration from his daughter’s dislike of cheese, yet she still ate pizza and grilled cheese sandwiches. Similarly, when his guests at Alinea didn’t like sea urchin, he thought about the ‘why’ and if he could circumvent their aversion by playing with various variables, including iodine concentration.

So, what do you dislike (with a passion)? What about the people around you? And can you figure out a way to change or eliminate that frustration? Take some time through the idea maze.

In closing

Ideas come in all shapes and sizes. Some may be more obvious than others. Some may snowball into a best-selling one. Although I’ve shared the three most common frameworks that I’ve personally generated and seen others find inspiration, it is, of course, not the only ways to exercise your creative muscle. In fact, the first step into being more “creative” is being cognizant about everything around you.

Two years ago, one of my former professors recommended I start ‘idea-journaling’ every day. Since I’ve started, I began noticing more and more stimuli from my surroundings, conversations and frustrations.

It may be a start, but it’s by no means an end. Stay curious.

Photo Credit: Ariel Zhang @yuzhu.zhang
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Finding Product-Market Fit and “Idea-Market Fit”

Photo by Loic Leray on Unsplash

I was recently inspired by a fascinating conversation between Mike Maples Jr., co-founder and partner at Floodgate, and Andy Rachleff, co-founder of Benchmark Capital and Wealthfront, but more interestingly, the founder of the term, product-market fit, or PMF – a term that signifies when a product is recognized by a strong demand in the market. Over the years, there have been various ways entrepreneurs, go-to-market strategists, and investors have defined when an idea reaches product-market fit. But before I dive into the PMF, let’s take a look at market definitions first, which admittedly is a step off the beaten path.

The Markets

How I Like to Think about Market Sizes. *Not drawn to scale

Traditionally, the total addressable market (TAM), serviceable addressable market (SAM), and the serviceable obtainable market (SOM) are defined according to the geographic location of your market. It makes sense – your market is as big as where you can offer the service. But now, in an increasingly connected world, technologies are less and less inhibited by the geographical boundaries that plagued the decades before. That said, there are still cultural, social and economic differences when accessing new demographics, which is why I like to characterize the TAM, SAM, and SOM by psychological resistances to new ideas. The TAM is still defined by the total upside potential of a product, where it still excludes laggards, or folks who would most likely never (seek to) use your product. The SAM is construed of people who would use the product after three to five friends in their network recommend and are using the product themselves. And finally, the SOM consists of customers who are desperate, as Andy Rachleff called it, for your product. They have spent sweat, blood, and tears finding or building their own solution. They have already traversed the idea maze themselves and put the dollar (or the euro, peso, krone, pound, yen, RMB, BTC, ETH… you get my point) here their mouth is at. And here, in the SOM, is where you find your product-market fit.

Product-Market Fit

PMF is most noticeable on the hockey stick curve. Before PMF, traction is slow and looks very much like the blade of a hockey stick. And after PMF, traction skyrockets and exemplifies exponential growth.

The Hockey Stick Curve

While there are many heuristics to assess PMF across different verticals, I’m the most fluent in consumer tech where I’ve spent most of my time in. And in consumer tech, I’d like to underscore the notion of ‘exponential organic growth’, and subsequently, a short analysis on each word of that phrase.

Exponential is probably the most straight-forward, where at the early stages of a business, we’re looking for rapidly compounding growth.

Organic growth, as opposed to paid growth, is a measurement for word-of-mouth. Investors tend to measure the effectiveness of a product by its virality from its initial customers to its nth customer – growth that is achieved without directly spending (ad) dollars on acquiring the new customers.

Growth is something I break down into – retention and adoption. Increasing adoption is great as measured by the growth of total users on consumer platform or for a consumer product, but focusing only on adoption leads to a leaky funnel, or in my case, trying to hold too many groceries in my hand without a shopping cart. Every time I grab another item on the shopping list, I drop some other item I was already trying to balance and hold. Of course, focusing only on retention means there’s no growth, which for keeping your best friend circle is fine (unless you want a thousand BFFs), but not for growing a startup.

Below are some growth signs to pay attention to signify that your product is near/at PMF:

RetentionAdoption
> 25% DAU/MAU 100s of organic signups/day
40% are active day after signup> 30% MoM growth
Usage 3 days out of every week

“Idea-Market Fit”

As a founder with an ambitious idea, reaching product-market fit is a great goal to have, but the truth is PMF is a mystical beast – a chimera – in and of itself. Market demands change; what satisfied the definition of PMF a decade ago may not satisfy it now and will most likely not satisfy it ten years from now. Many studies have shown that most startups don’t fail from technological risk, but rather the inability to reach PMF, which ends up leading to lack of investor interest, demotivation, and the founding team falling apart. And quite obviously, before you reach PMF, the hardest part about starting a business is reaching PMF, or what Peter Thiel and many call the Zero to One. I’ll dive into the lessons I learned about the journey to “1” in future posts, but for the purpose of this post, I’m going to focus on the “0” – or what I like to call, “idea-market fit“, or IMF.

What differentiates a good idea from a great money-making idea? I’m going to borrow Andy’s thought calculus exercise. In a 2×2 matrix with right/wrong on one axis and consensus and non-consensus on the other, “you want to be right on the non-consensus.”

Andy Rachleff’s 2×2 Startup Idea Matrix

Why? Discounting the situations where you’re wrong (because you don’t make much, if any money), if you’re right on consensus, it means the market’s already mature, and perfect competition in a capitalistic market squeezes you out of your profit margins. If you do pursue this option as a founder, you’re more or less tackling an execution risk. On the other hand, if you’re right on the non-consensus, the market is still nascent, and you have the potential for monopolistic control of the market. In other words, you’re taking a market risk.

It definitely isn’t intuitive. At the very least, it wasn’t to me when I was on the operating side of the table. I wanted validation. When I was at Localwise helping build a community of local talent, I wanted people to say “I totally agree” or “You’re onto something.” But often times, I just received friction and resistance, with the toughest to receive from some of my friends.

“No one would ever buy that.”

“You’re wasting your time.”

“When are you going to get a real job?”

And at some points in time, I did think, “Maybe they’re right.” Until I started meeting a few people who thought a hiring destination for local mom-and-pop shops wasn’t a bad idea, and especially when small business owners started opening up about their frustrations. Hiring platforms, at that time, focused on the sexier brands and companies to get more demand side traction – the Googles, the Big Four’s, or the Bains, but had seemingly completely underrepresented the population of local businesses. Even if these SMBs were on these other platforms, they were overshadowed by the presence of bigger brands.

When validating startup ideas, you don’t want consensus. If your idea is truly revolutionary, people have yet to be conditioned to accept the idea. Take Uber or Airbnb, for example. If you asked the average person if they would use such a product, most would have thought that you’d be crazy to have a stranger sharing a car ride or home with them. These days, take e-sports or streaming. If someone told me in my pre-teen days that I could make a living off of playing video games, I’d most likely think I was dreaming. After all, I grew up playing Snake on my dad’s Motorola Razr, which admittedly seems to have made a return to the markets.

IMF is about challenging convention and the status quo. That’s what makes an idea revolutionary, or as people in Silicon Valley like to call it, disruptive. A crazy good idea challenges the explicit and implicit biases we have about society and ourselves. In other words, we have to detect the deception we bestow onto ourselves to find the gems in the rough, which Josh Wolfe of Lux Capital explains in his 2019 Lux Annual Dinner Talk – one of the best VC thesis-driven thought pieces I’ve ever seen.

In closing

As a geeky quote collector, I’d like to close this piece not in my own words, but in the words of three brilliant investors who have a few more patches of scar tissue on their back than I do now.

“Some of the best ideas seem crazy at first.”

– Curiosity, in my Thanksgiving blogpost

“Most of the big breakthrough technologies/companies seem crazy at first: PCs, the internet, Bitcoin, Airbnb, Uber, 140 characters…you are investing in things that look like they are just nuts… it has to be something where, when people look at it, at first they say, ‘I don’t get it, I don’t understand it. I think it’s too weird, I think it’s too unusual. “

– Marc Andreessen

“Breakthrough ideas have the traditionally been difficult to manage for two reasons: 1) innovative ideas fail far more than they succeed, and 2) innovative ideas are always controversial before they succeed. If everyone could instantly understand them, they wouldn’t be innovative.”

– Ben Horowitz, in his new book What You Do Is Who You Are
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