Tag: consumer

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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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Brand as a Moat

startup brand, moat, defense, defensibility
Photo by Keith Johnston on Unsplash

What is the underlying notion that makes this product work?

It’s the question that almost every investor, especially early-stage startup investor, tries to answer when they’re entertaining potential investments. Some close cousins include:

  • What social, economic, or political trend is enabling this technology/business to work?
  • Why will people want to continue using this product? Consciously? Subconsciously? How much will they regret not being able to use this product?
  • Why is this idea crazy good, and not just crazy?
  • Is there a predictable road to traction? Product-market fit? $1M ARR? etc.
  • Is this a scalable business?

Needless to say, when I chat with founders, their business’s defensibility often comes up. Every business – small or large – needs to be defensible. Grandma’s cookies are just that good ’cause of that ‘secret’ brown butter element. Or Sally’s lemonade stand sells better than her neighbor’s down the street since she can keep her drinks cool for longer. Just like every good medieval castle has a moat, possibly filled with alligators, every good business has to have that one (or many) unfair advantage, as they call it in B-school. Not that I ever went, but I’ve heard from friends and professors who have. And this is even more true if you want to build a scalable business.

Those who have gone generally claim that their moat is their experience at X Fortune 500 company. Those who have a technical background often claim that their moat is their IP – patents owned and pending. Neither are wrong. And frankly, there are a multitude of factors that come into play when arguing for a business’s defensibility. And most of the times, it’s a permutation of the above and more. But the purpose of this post is to focus on an often discounted notion of brand as a moat. Both the company brand and the personal brand.

Disclaimer:

I should mention that before you even consider your business’s defensibility, and subsequently, brand, first, make a damn good product. I’ve seen too many founders take that leap of faith before they even have a product. They pitch the dream of them making a better world – the company vision – before they even figure out the first steps they need to take to get there.

The only ‘exception’ to this rule, at least from a fundraising and pre-PMF perspective, is if you have an amazingly robust personal brand. Though that may help with early traction, it won’t be enough to sustain a scalable business in the long run.

The startup brand

Your startup’s brand is a collective composed of the:

  • Company mission,
  • Company vision,
  • Internal culture,
  • And, the openness and responsiveness of the team.

The vision is that ultimate dream. The mission is what you’ll do now to get to that dream. Back in college, someone I really respect put it to me like this:

“The vision is the Sun. The mission is that ladder up. You can’t get to the Sun without building a ladder. If you only stare at it, you’ll eventually blind yourself. And if you just build a ladder, or else you might up on Mars instead, poorly equipped to survive there.”

Culture is something that you can set at the beginning, but know it’ll be an evolving beast with every new hire and every new incident. What you let happen defines the new culture. Although I share my thoughts in a post earlier this year, Ben Horowitz puts it into a much better perspective in his book, What You Do is Who You Are: How to Create your Business Culture. Quite a story-filled read, especially when you’re looking for something to do at home now.

And, the above three culminates into how your team acts.

  • Do your current customers/users feel like their concerns are either addressed or at least, valued?
  • Do they feel they are a valued member of your community?
  • What is your customer satisfaction rate? NPS score?
  • How do you prioritize and act on customer feedback?
  • Are your users engaged? How do you reengage them, if they become inactive?
  • For apps, what are they saying on the App Store/Play Store?
  • And, how are new customers hearing about your product? What do they hear? What are their explicit and implicit assumptions when using your product?

Why it Matters

Together the 4 elements answer the fundamental questions:

  1. Why would a potentially great customer want to use your product?
  2. Why would a potentially great hire want to join your company?

In the past few months, many VCs have been shifting their investment focus from consumer and towards enterprise/SaaS. There’s the argument that consumers are (1) more expensive to acquire (increasing CAC; the average number of apps a person downloads a day is zero), and (2) harder to retain. (For a more in-depth explanation, I would recommend you to check out the “Consumer App Conundrum” section here.) Aka, it’s more competitive than ever in the consumer markets. When we get closer to perfect competition over a saturated market seeking attention, having a great product just isn’t enough anymore. When some of the most active and vocal consumers happen to be people on the younger spectrum (millennials and Gen Zs), to fight for their attention, you need a brand that resonates with them on causes they care about – whether it’s diversity or climate change or another social cause.

We see this notion affecting two other verticals: the public sector and enterprise.

  • The privatization of X (let X be education, healthcare, transportation, etc. for all that were empirically public sector functions)
  • The consumerization of enterprise

For the purpose of this piece, let’s look at the consumerization of enterprise. What does that mean? Before enterprise sales worked from a top-down approach. A founder of an enterprise/SaaS startup pitches to a senior executive at a Fortune 500 (or similar) company. And the executive makes the call and the budget allocation towards their team’s usage of said product.

Now, many startups/companies, like Slack, Trello, Lever, and Soapbox, are taking the bottom-up approach, garnering brand loyalty among the people who will be/are using the product itself. And I predict that’ll be so in the near future for Superhuman, the fastest email client, and Woven, my favorite calendar app, as well. After all, progress happens at the most junior level. If you take it in relation to a tech startup of 200 in its growth phase, the founders or executives can make a plan and set deadlines. But if your most junior developer isn’t working on it, the whole business halts to a stop. All this makes me quite bullish on products in the low-code/no-code space, as well as in towards the future of work.

Moreover, this has led enterprise products to be heavily personalized, constantly updating, and has paved the way to multi-modal business models (i.e. subscription and pay-per-use). All this maximizes user satisfaction, which in turn affects their productivity, and transitively, the business flow.

Although the job market looks wildly different now than it did 3 months ago, when I assume the average founder is looking for cash preservation over growth, you still should be cognizant about the latter going forward.

Your Personal Brand

Your personal brand as a founder, or just as a professional, really matters. If you are a founder or thinking about becoming one, start building a public voice. Get people excited about you and what you’re all about.

Why?

Personal brands are extremely scalable and have built-in virality. You put one post out. Some percent of your followers engage with your content by liking or commenting. Then either by social media’s algorithms or by their innate excitement, they’ll share your content with their friends. Subsequently, new folks discover you and your content. And this becomes a virtuous loop, or network effects, as we call it, that helps get you scalable traction. This is why celebrities, like Dr. Dre and Maisie Williams, and their ventures garner quite a bit of traction among consumers and among investors. This is also why influencer marketing has been so bullish over the past few years.

At some point in your company’s lifespan, your personal brand will become the company brand. And that’ll become either shining beacon or the downfall of your company. More than just the followers you have on social media and in public, you are judged by everyone constantly on your aptitude and behaviors. How open, conscientious, agreeable, extroverted, and neurotic are you? (Yes, I took the 5 traits from the Big 5/OCEAN test.) Each and more have an impact on your personal brand. If we look at the culture behind Facebook, we see how large of an imprint Zuckerberg has on it. For Apple, Jobs.

In closing

The best thing about brands as a moat is that it’s effectively free! But both take years of work in building. As someone on the investing side, I love stellar brands. And it’s one of the elements of a business I weigh heavily on for its potentiality in network effects, summarized in the “Why you?” component of my NTY investment thesis (why Now, why This, why You).

Hmmmm, now thinking about it, personal brand may be the biggest reason I’ve been changing my handwashing habits in the past week… after watching Gordon Ramsay, Alton Brown, and Conan O’Brien‘s tutorials on it.

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The Marketplace of Startups

books about startups

Over the past decade, stretching its roots to the dot-com boom, there have been more dialogue and literature around entrepreneurship. In a sense, founding a business is easier than it’s ever been. But like all things in life, there’s a bit more nuance to it. So, what’s the state of startups right now?

Lower Barriers to Entry

A number of factors have promoted such a trend:

  • There are an increasing number of resources online and offline. Online courses and ed-tech platforms. Fellowships and acceleration/incubation programs. Investor office hours and founder talks. YouTube videos, online newsletters, and podcasts.
  • The low-code/no-code movement is also helping bridge that knowledge gap for the average person. Moreover, making it easier for non-experts to be experts.
  • The gig economy have created a fascinating space for solopreneurship to be more accessible to more geographies.

Demand (by consumers and investors) fuels supply of startups, through knowledge and resource sharing. Likewise, the supply of startups, especially in nascent markets, fuels demand in new verticals. So, the ecosystem becomes self-perpetuating on a positive feedback loop. As Jim Barksdale, former Netscape CEO, once said:

“There are only two ways I know of to make money – bundling and unbundling.”

BundlingUnbundling
Market MaturityMarket Nascency
HorizontalizationVerticalization
BreadthDepth
Execution Risk
Bias		Market/Tech Risk
Bias

Right now, we’re at a stage of startup market nascency, unbundling the knowledge gap between the great and the average founder. This might seem counter-intuitive. After all, there’s so much discourse on the subject. There’s a good chance that you know someone who is or have thought about starting a business. But, I don’t believe we’re even close to a global maximum in entrepreneurship. Why?

  1. Valuations are continuing to rise.
  2. Great founders are still scarce.
startup growth
Photo by Isaac Smith on Unsplash

Valuations are shooting up

Valuations are still on the rise. Six years back, $250K was enough runway for our business to last until product-market fit. Now, a typical seed round ranges from $500K-$2M. A decade ago, $500M was enough to IPO with; now it only warrants a late-stage funding round. By capitalistic economic theory, when a market reaches saturation, aka perfect competition, profit margins regress to zero. Not only are there still profits to be made, but more people are jumping into the investing side of the business.

Yes, increasing valuations are also a function of FOMO (fear of missing out), discovery checks (<0.5% of VC fund size), super duper low interest rates (causing massive sums of capital to surge in chase yields), and non-traditional venture investors entering as players in the game (PE, hedge funds, other accredited investors, (equity) crowdfunding platforms). It would be one thing if they came and left as a result of a (near) zero sum game. But they’re here to stay. Here’s a mini case study. Even after the 2018 drop in Bitcoin, venture investors are still bullish on its potential. In fact, there are now more and more specialized funds to invest in cryptocurrency and blockchain technology. Last year, a16z, one of the largest and trendsetting VC players, switched from a VC to an RIA (registered investment advisor), to broaden its scope into crypto/blockchain.

Great founders are scarce

“The only uncrowded market is great. There’s always a fucking market for great.”

– Tim Ferriss, podcaster, author, but also notably, an investor and advisor for companies, like Facebook, Uber, Automattic and more

Even if founders now have the tools to do so, it doesn’t mean they’ll hit their ambitious milestones. For VCs, it only gets harder to discern the signal from the noise. Fundamentally, there’s a significant knowledge delta – a permutation of misinformation and resource misallocation – in the market between founders and investors, and between average founders and great founders.

The Culinary Analogy

Here’s an analogy. 30 years prior, food media was still nascent. Food Network had yet to be founded in 1993. The average cook resorted to grandma’s recipe (and maybe also Cory’s from across the street). There was quite a bit of variability into the quality of most home-cooked dishes. And most professional chefs were characteristically male. Fast forward to now, food media has become more prevalent in society. I can jump on to Food Network or YouTube any time to learn recipes and cooking tips. Recipes are easily searchable online. Pro chefs, like Gordon Ramsay, Thomas Keller, and Alice Waters, teach full courses on Masterclass, covering every range of the culinary arts.

Photo by Brooke Lark on Unsplash

Has it made the average cook more knowledgeable? Yes. I have friends who are talking about how long a meat should sous vide for before searing or the ratio of egg whites to egg yolks in pasta. Not gonna lie; I love it! I’ll probably end up posting a post soon on what I learned from culinary mentors, friends, and myself soon.

Is there still a disparity between the average cook and a world-class chef? Hell ya! Realistically I won’t ever amount to Wolfgang Puck or Grant Achatz, but I do know that I shouldn’t deep fry with extra virgin olive oil (EVOO) ’cause of its low smoke point.

Great businesses are scarcer

The same is true for entrepreneurship. There are definitely more startups out there, but there hasn’t been a significant shift in the number of great startups. And the increase in business tools has arguably increased the difficulty to find business/product defensibility. It’s leveled the playing field and, simultaneously, raised the bar. So yes, it’s easier to start a business; it’s much harder to retain and scale a business.

It’s no longer enough to have an open/closed beta with just an MVP. What startups need now is an MLP (minimum lovable product). Let’s take the consumer app market as an example.

The Consumer App Conundrum

Acquiring consumers has gotten comparatively easier. Paid growth, virality, and SEO tactics are scalable with capital. More and more of the population have been conditioned to notice and try new products and trends, partly as a function of the influencer economy. But retaining them is a different story.

So, consumers have become:

  1. More expensive to acquire than ever before. Not only are customer acquisition costs (CAC) increasing, with smaller lifetime values (LTV), but your biggest competitors are often not directly in your sector. Netflix and YouTube has created a culture of binge-watching that previously never existed. And since every person has a finite 24 hours in a day, your startup growth is directly cutting into another business’s market share on a consumer’s time.
  2. And, harder to retain. It’s great that there’s a wide range of consumer apps out there right now. The App Store and Play Store are more populated than they’ve ever been. But churn has also higher now than I’ve seen before. Although adoption curves have been climbing, reactivation and engagement curves often fall short of expectations, while inactive curves in most startups climb sooner than anticipated. Many early stage ventures I see have decent total account numbers (10-30K, depending on the stage), but a mere 10-15% DAU/MAU (assuming this is a core metric). In fact, many consumers don’t even use the app they downloaded on Day 2.

Luckily, this whole startup battlefield works in favor of consumers. More competition, better features, better prices. 🙂

So… what happens now?

It comes down to two main questions for early-stage founders:

  1. Do you have a predictable/sensible plan to your next milestone? To scalability?
    • Are you optimizing for adoption, as well as retention and engagement?
      • With so many tools for acquisition hacks, growth is relatively easy to capture. Retention and engagement aren’t. And in engagement, outside of purely measuring for frequency (i.e. DAU/MAU), are you also measuring on time spent with each product interaction?
    • How are you going to capture network effects? What’s sticky?
      • Viral loops occur when there’s already a baseline of engagement. So how do you meaningfully optimize for engagement?
    • From a bottom-up approach (rather than top-down by taking percentages of the larger market), how are you going to convert your customers?
    • How do you measure product-market fit?
  2. What meaningful metric are you measuring/optimizing?
    • Why is it important?
    • What do you know (that makes money) that everyone else is either overlooking or severely underestimating?
    • What are you optimizing for that others’ (especially your biggest competitors) cannot?
      • Every business optimizes for certain metrics. That have a set budget used to optimize for those metrics. And because of that, they are unable to prioritize optimizing others. So, can you measure it better in a way that’ll hold off competition until you reach network effects/virality?

Building a scalable business is definitely harder. And to become the 10 startups a year that really matter is even more so. By the numbers, less likely than lightning striking you. In my opinion, that just makes trying to find your secret sauce all the more exciting!

If you think you got it or are close to getting it, I’d love to chat!

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The Different Types of Risk a VC Evaluates

Photo by trail on Unsplash

Founders take on many different types of risk when creating a business. Subsequently, investors constantly put founders and their businesses under scrutiny using risk as a benchmark. In broad terms, in my experience, they largely fall under two categories: execution risk and market risk.

Finding Product-Market Fit and “Idea-Market Fit”
Where I first introduced the dichotomy of market and execution risk in the frame of idea-market fit.

Some Background

Contrary to popular belief, VCs are some of the most risk-averse people that I know. As an investor, the two goals are to:

  1. Take calculated bets, via an investment thesis and diligence;
  2. And de-risk each investment as much as possible.

From private equity to growth equity to venture capital, more and more investors are writing ‘discovery checks.’ Typically, funds write checks that are 2-4% of their fund size. For example, $100M fund usually write $2-4M initial checks. Yet, more and more investors are writing increasingly smaller check sizes (0.1-0.5% fund size). In the $100M fund example, that’s $100-500K checks. This result is a function of FOMO (fear of missing out), as well as a proving grounds for founders before the fund’s partners put in their core dollar. Admittedly, this upstream effect does lead to:

  • Less diligence before checks are written (closing within 48-72 hours on the extreme end, and inevitably, more buyer’s remorse);
  • Less bandwidth allotted per portfolio startup (even less for startups given discovery checks);
  • And, inflated rounds (and therefore, inflated startup valuations).

The Risks

The risks for a startup investor are fairly obvious, and so are the rewards. Effectively, an early-stage investor is betting millions of dollars on a stranger’s claim. But not all risks are the same.

In the eyes of a VC, an execution risk is categorically less risky than a market risk. Furthermore, even within the category of execution, a product risk is usually less risky than a team risk.

Execution Risk

Why are more and more early-stage investors defaulting to enterprise over consumer startups?

Two reasons.

  1. Enterprise startups often run on a SaaS (software-as-service) subscription business model. There will always be recurring revenue, assuming the product makes sense. For an investor, that’s foreseeable ROI.
  2. It’s an execution risk, not a market risk. Often times, an enterprise tech startup is the culmination of existing frustrations prevalent in the respective industry already. And therefore, have reasonably stable distribution channels and go-to-market strategies.

Eric Feng, formerly at Kleiner Perkins, now at Facebook, used Y Combinator’s data set at the end of last year to illustrate the consumer-to-enterprise shift.

Using discovery checks, and playing pre-core business, VCs can evaluate team risk. Between the discovery check and their usual ‘core checks’, VCs can also test their initial hypotheses on their founders.

As a startup grows, especially after realizing product-market fit, market risk becomes more of a product risk. Best illustrated by market share, product risk is when a product fails to meet the expectations of their (target) customers. It can be evaluated via a permutation of key metrics, like unit economics, NPS, retention and churn rate. There is an element of technological risk early on in the startup lifecycle for deep tech ventures, but admittedly, it’s not a vertical I have my finger on the pulse for and can share insight into.

Given that VCs are either ex-operators or have seen a breadth of startup life-cycles, VCs can best use their experience to mitigate a startup’s execution risk.

Market Risk

Market risk requires a prediction of human/market behavior. And unfortunately, the vast majority of investors can predict about the constant evolution of human behavior as well as a founder can. What does that mean? Founders and VCs are walking hand-in-hand to gain market experience. It, quite excitingly, is an innovator’s Rubrik’s cube to solve.

Market risk is frequently attributed to consumer tech products. In an increasing proliferation of consumer startups, consumers have become more expensive to acquire and harder to retain. Distribution channels change frequently and are determined by political, economic, technological, and social trends.

In Closing

Every VC specializes in tackling a certain kind of risk. But founders must quickly adapt, prioritize, and tackle all the above risks at some point in the founding journey. As Reid Hoffman, co-founder of LinkedIn, famously said:

“An entrepreneur is someone who will jump off a cliff and assemble an airplane on the way down.”

Happy hunting!

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