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Venture Investment Themes


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Identifies, defines, and analyzes seven common venture investment themes, including:

1) Vertically Integrated E-Commerce
2) Human Instrumentation / Activity Trackers
3) Subscription Commerce
4) Verticalized Online Marketplaces
5) Alternative Education Platforms
6) Crowdfunding
7) Sharing Economy

Published in: Technology, Business
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Venture Investment Themes

  1. 1. Venture Investment Themes Written by Brian Borton / /
  2. 2. Table of Contents (Links) • • • • • • • Vertically Integrated E-Commerce Human Instrumentation / Activity Trackers Subscription Commerce Verticalized Online Marketplaces Alternative Education Platforms Crowdfunding Sharing Economy 2
  3. 3. Vertically Integrated E-Commerce Vertically Integrated E-Commerce companies sell their own branded products directly to customers, exclusively through their own websites. These companies also tend to control a significant portion of their product’s supply chain, such as design, development, production, warehousing, distribution, fulfillment, and customer service. Examples of Vertically Integrated E-Commerce companies include Warby Parker, Harry’s, and Beachmint. The more general E-Commerce business model emerged in the 1990’s as Internet adoption accelerated and trust of online payment methods led to broader acceptance of bringing commerce and the transaction process online. As E-Commerce has matured, it has followed the trend of brick-and-mortar retail sales, with large “warehouse-style” retailers using their purchasing power to largely control the market. These include online-only retailers, like Amazon and eBay, as well as the online counterparts of brick-and-mortar retailers like Target and Walmart. The holy grail for emerging consumer product companies has long been winning the interest of buyers at large retailers, who in turn buy their product in bulk and distribute it through both online or offline channels. This approach is attractive because having their product sold by a popular retailer gives widespread distribution, instant credibility among potential customers, and the advantage of scale. Scale is particularly important, as it enables the consumer product companies to produce more units at a lower cost, positioning the company to more effectively compete against rivals. However, the downside of selling through large retailers involves extended payment terms, charge-backs for unsold merchandise, and onerous vendor agreements. 3
  4. 4. Vertically Integrated E-Commerce Vertically Integrated E-Commerce companies have a number of features that suggest the business model is more appealing than selling through other retailers. These include more attractive cash flow characteristics, as they sell directly to the end customer and receive payment prior to shipping the product. They also have better control over product pricing and discounting, as their website is the only avenue for a transaction to take place. Lastly, and perhaps most importantly, these companies have substantially more control over their brand and customer purchase experience. As a result, these brands are able to engage with their customers on a much deeper level than those who rely on resellers. Due to the reasons discussed above, the attractiveness of Vertically Integrated E-Commerce relative to both offline retail sales and horizontally integrated e-commerce is expected to persist over time. Winners in this industry will have expertise in 1) branding/customer experience, 2) supply chain management, and 3) creative online marketing. As a result, Vertically Integrated ECommerce companies represent an attractive growth area for entrepreneurs to monetize as well as a compelling trend in which venture capitalists should selectively consider investing. 4
  5. 5. Human Instrumentation Human Instrumentation (aka Wearable Computers) represents a very broad category of technological development that has accelerated in the last several years. For our purposes here at FuturistVC, we are going to focus solely on the consumerization and mass adoption trends of a subset of Human Instrumentation known as Activity Trackers. Activity Trackers are effectively a bundle of miniature sensors, a processor, and a battery that are all integrated into various types of wearable devices, including wristbands, watches, and pendants. Importantly, these devices are connected to software applications that automatically record, analyze, and display the data collected from the various sensors. Examples of popular Activity Trackers today are Fitbit, Nike+ FuelBand, Jawbone UP, Misfit Wearables, and Pebble. The growing popularity of Activity Trackers is largely a function of 1) the commoditization and declining costs of the necessary components and 2) advances in device energy optimization. We can attribute the declining costs of Activity Tracker components to the widespread adoption of smartphones. Smartphones entered the market around 2005, and now account for more than 50% of mobile phone sales globally (SOURCE). Smartphones incorporate a number of micro-electromechanical systems (MEMS) such as accelerometers, pressure sensors, gyroscopes, and GPS componentry that are common in today’s Activity Trackers. As a result, the growth of smartphones has increased the production volume of MEMS and attracted numerous competitors, driving down the cost of this componentry. Now that these components are cheaper, they can be combined to produce technologically advanced sensors at a price point that is accessible to consumers. Additionally, improvements have been made in device energy consumption through better architecture, sleep modes, low energy Bluetooth, and better display technologies. These developments are important for Activity Trackers because they need to be always on to function as intended, and battery technology has not kept up with the power demands of these devices. 5
  6. 6. Human Instrumentation We expect prices of these components to continue to decline, encouraging further consumer adoption as well as the entrance of new competitors. This trend is common in hardware and has been seen previously in PCs, digital cameras, and printers. As this occurs, and the differentiation among Activity Tracker hardware blurs, the software layer of Activity Trackers will be increasingly important. It will be imperative for Activity Tracker companies to develop robust, proprietary software as well as an application ecosystem (similar to what Apple has done with the App Store) to layer into the user experience. For instance, the Pebble smartwatch has done a phenomenal job of providing developers with an open platform, a software development kit (SDK), and access to application programming interfaces (APIs). Developers have in turn created thousands of unique apps to enhance the Pebble experience. These applications increase the Pebble’s functionality for users and will help differentiate Pebble from other smartwatches and Activity Trackers. However, it remains to be seen whether this is enough to combat other smartwatch creators such as Sony and Samsung as well as the rumored Apple iWatch. Due to the reasons discussed above, the attractiveness of Activity Tracker companies is mixed. Winners in this category will be companies with 1) purchasing scale, 2) distribution capabilities, 3) robust software, 4) an extensive third-party application ecosystem, and 5) proprietary sensors. Large device manufacturers such as Apple and Samsung are well positioned to compete against startups such as Misfit Wearables due to their purchasing scale of components that are also used in smartphones as well as due to their extensive distribution relationships. However, certain early entrants that have begun to scale, such as Pebble and Fitbit, have combined their modest purchasing power with a robust software platform and third-party application ecosystem to support their devices. These companies will also likely continue to do well. Also, companies with proprietary sensors (i.e. ingestible sensors for digital health tracking) will continue to have a unique edge. Overall, Activity Trackers represent a fairly competitive and difficult market for entrepreneurs to successfully break into today. Venture capitalists should only selectively consider investing in new Activity Tracking businesses - focusing on identifying companies with a unique software edge or proprietary sensor technology. 6
  7. 7. Subscription Commerce Subscription Commerce has gained significant traction in the last several years. These E-Commerce companies follow a variety of models. Some offer subscription plans to conveniently deliver disposable goods to consumers at their home, freeing them from frequent trips to the store. These can either be popular, branded products such as those distributed by BarkBox, or private label products that have been rebranded such as those distributed by Dollar Shave Club or The Honest Company. Other Subscription Commerce companies offer a subscription plan to deliver a professionally curated assortment of durable goods such as clothes (BeachMint), stationery (Nicely Noted), or beauty products (BirchBox). These also can be either branded (Svbscription) or private label (JustFab) products. The competitive landscape outlining the positioning of each of these Subscription Commerce companies can be seen in the diagram below. This diagram is a simplification of the competitive landscape, but it can be broadly used to project the success and sustainability of Subscription Commerce companies. Here at FuturistVC, we believe the most attractive companies with this business model offer disposable, private label goods. And of course, this implies that the least attractive companies with this business model offer durable, branded goods. As noted by Kent Bennett (Bessemer Venture Partners) in a recent post on All Things Digital, the value proposition for subscribers revolves around 1) Entertainment, 2) Enrichment, 3) Curation, 4) Cost, and 5) Convenience. He believes that the sustainability of the Subscription Commerce value proposition over time is largely dependent on the Cost and Convenience components. 7
  8. 8. Subscription Commerce Perhaps the best example to demonstrate this view is by comparing the success of Dollar Shave Club to the demise of 12 Society. Dollar Shave Club purchases bulk, private label men’s grooming products (razors, shaving cream, and wipes), and rebrands them communicating a degree of uniqueness to subscribers. Additionally, Dollar Shave Club’s monthly delivery of disposable men’s products is an obvious convenience to men who are not frequent visitors of Walmart, Target, or other retailers of competing products. The bulk purchasing of private label razors and direct to consumer distribution model enables Dollar Shave Club to undercut the pricing of Gillette and Schick razors, offering subscribers a convenient, cost efficient offering all wrapped up in a compelling, approachable brand. Compare this to 12 Society, a celebrity-endorsed box that regularly delivered durable, branded goods to subscribers. Since these were durable products, they were inherently not products that were previously purchased on a monthly, replacement basis, effectively removing the convenience value proposition. These were also branded products, meaning the exact same products could be purchased directly by the subscribers on an as-needed basis. As a result, 12 Society needed to convince brands to give products to them for free (or heavily discounted) to actually generate a decent margin. This could work on a small scale, but as the subscriber base grew, it became more difficult to source branded products for free, forcing 12 Society to start purchasing them wholesale. The celebrity endorsement and curation was not a compelling enough reason for customers to continue paying, and the high cost of purchasing branded goods kept 12 Society from operating profitably. This led to their eventual demise and “sale” to Quarterly, a similarly poorly positioned competitor. Due to the reasons discussed above, the attractiveness of Subscription Commerce companies is mixed. Winners in this category will be rare, and those that do succeed will be focused on selling private label, disposable goods and offer a clear value proposition in terms of lower costs and greater convenience to consumers. The curation strategy of durable, branded products is not compelling enough to be sustained as the business scales. As a result, Subscription Commerce represents a highly competitive and difficult strategy for entrepreneurs to monetize. Venture capitalists should only selectively consider investing in these businesses. 8
  9. 9. Verticalized Online Marketplaces Marketplaces facilitate the exchange of goods or services between buyers and sellers, users and producers, and renters and owners. Marketplaces operate as intermediaries; therefore, they tend to be capital efficient businesses with no inventory to purchase or manage. Verticalized Online Marketplaces leverage information technology to create large, online platforms serving very specific markets such as music lessons (TakeLessons), flower delivery (BloomNation), artisan-made goods (Etsy), or dog sitting (DogVacay). A simplistic chronological history of marketplaces can be broken down into three stages: offline classifieds (newspapers) → online horizontal marketplaces (eBay/Craigslist) → Verticalized Online Marketplaces. By taking a verticalized approach to building a marketplace, these businesses can 1) achieve meaningful scale and market leadership with fewer overall participants, 2) provide a more focused and unique user experience, and 3) disrupt more complex or regulated industries. Together, these three advantages enable them to compete effectively against offline transactions and horizontal online marketplaces. Craigslist represents one of the most popular horizontal online marketplaces today, but its appeal and relevance in certain areas is declining amidst new competition from specialist competitors. Craigslist is not verticalized - it operates as a one-size-fits-all platform that largely applies the same user experience (i.e. posting, searching, and viewing) regardless of the product or service being offered. Of course, Craigslist is still a fierce competitor of many emerging Verticalized Online Marketplaces due to its largely free listings and simple user interface, which together have resulted in broad adoption rates and enormous network effects. However, these network effects are not impenetrable as Craiglist’s traffic appears to have been steadily declining since traffic peaked at 50 million monthly unique visitors in 2011. As of September 2013, Quantcast reports traffic had declined to 37 million monthly unique visitors (-26%). Andrew Parker, a general partner at Spark Capital, designed an interesting graphic back in 2010 which illustrates Craigslist’s myriad new competitors targeting a number of its individual marketplaces (see next page). 9
  10. 10. Verticalized Online Marketplaces Source: Due to the reasons discussed above, the attractiveness of Verticalized Online Marketplaces relative to offline transactions and horizontal online marketplaces is expected to persist over time. However, not all Verticalized Online Marketplaces are created equal. Those with a focus on more complex, regulated industries such as financial services (i.e. Dealstruck, Funding Circle, and Covestor) will enjoy higher barriers to entry once established and are less likely to face competition from large horizontal marketplaces. Additionally, those with a focus on local services (i.e. DogVacay) may struggle to generate recurring revenue as marketplace participants can more easily transact outside of the marketplace once the introduction has been made. With these differences in mind, certain Verticalized Online Marketplaces represent an attractive growth area for entrepreneurs to monetize as well as a compelling trend in which venture capitalists should consider investing. 10
  11. 11. Alternative Education Platforms Alternative Education Platforms exist to promote the democratization of education through free or low-cost technology-enabled courses. Types of Alternative Education Platforms range from Massive Open Online Courses (“MOOCs”) such as Coursera, Udacity, and Udemy to other unaccredited platforms for skill development such as Codecademy, General Assembly, and Khan Academy. The recent popularity of Alternative Education Platforms is a function of the perceived declining value proposition and relevance of traditional, accredited college and advanced degrees. Myriad data support this perceived decline, though the current value proposition is arguably still compelling in terms of higher employment rates and earnings. However, tuition costs have been rising rapidly while earnings of college graduates have been flat to declining, a persistent trend that will inevitably lead to further deterioration of the value proposition. From 2002 to 2012, the nominal, annual cost of attending a 4-year college rose from $13,639 to $23,066, an increase of 69%. Adjusting for inflation, the annual cost of attending a 4-year college rose from $17,418 to $23,066, an increase of 32%. This trend of rapidly rising college tuition has been persistent since at least 1977, the beginning of the Bureau of Labor Statistics data series. Over the last 36 years, the nominal cost of college tuition and fees has grown at an annual rate of 7.4%, almost double the rate of inflation at 3.8%. 11
  12. 12. Alternative Education Platforms Although the data continues to show that higher levels of education are linked to lower unemployment rates, the value proposition of these college degrees has begun to be called into question due to unsettling trends in post-college earnings. As seen in the chart below, the median, inflation adjusted earnings of college graduates have been in steady decline since 2000. 12
  13. 13. Alternative Education Platforms Additionally, from 2007 to 2011, the unemployment rate of recent college graduates exceeded the unemployment rate of the total population of those who just have high school-level educations. Information technology has also contributed to lowering the cost of distribution of courses and increasing the effectiveness of online delivery of these Alternative Education Platforms. The nearly ubiquitous nature of broadband internet access (mobile+fixed), new collaboration tools, and innovative methods of media delivery have narrowed the quality gap between a brick-and-mortar classroom and an online classroom. The catalysts underlying the growth of Alternative Education Platforms are largely structural in nature and are expected to persist over time. The prohibitive nature of rising college tuition costs, coupled with declining earnings of recent college graduates, suggest that alternative, lower-cost forms of education will continue to be adopted rapidly. As a result of these trends, Alternative Education Platforms represent an attractive growth area for entrepreneurs to monetize as well as a compelling trend in which venture capitalists should consider investing. 13
  14. 14. Crowdfunding The concept of Crowdfunding, effectively the application of Crowdsourcing to fundraising, is rooted in connecting entrepreneurs and other creators with alternative sources of capital, namely individuals, by leveraging information technology and networks. Crowdfunding can effectively disintermediate traditional external funding sources such as banks and venture capital firms by sourcing capital directly from interested individuals. Capital raisers benefit from Crowdfunding by typically paying a lower cost of funds than is required by traditional external funding sources due largely to the irrational or uneconomic motivations of individuals. The lowered cost of funds can present itself in a number of ways, including lowered interest rates on loans, lowered ownership requirements on equity investments, or lowered or eliminated underwriting hurdles such as FICO scores, collateral, and documentation. Two examples of this trend include Funding Circle, an online peer-to-peer lending platform connecting individuals to small business borrowers, and Kickstarter, the largest online platform for funding creative projects. The use of Crowdfunding to capitalize projects or companies has accelerated in recent years due to growth of social networks, the Maker Movement, and changes in government regulation. The growth of social networks has empowered individuals by providing them with access to a low-cost/high-reach communication channel to the masses. In addition to this, the Maker Movement has become popularized due to rapidly declining production costs (i.e. 3D printing) and increased access to large distribution channels (i.e. Etsy, eBay, Amazon). Changing government regulation has also supported Crowdfunding by legitimizing and clarifying Crowdfunding rules through the JOBS Act while placing additional regulation and restrictions on banks (i.e. Dodd-Frank). As a result of this heightened regulation for banks, underwriting standards for small business lending have not yet shown any sign of easing since they were tightened amidst the US recession. 14
  15. 15. Crowdfunding Another important driver of the Crowdfunding trend is the irrational or uneconomic motivations of individuals relative to rational and economic motivations of traditional funding sources. Traditional funding sources (i.e. banks) are structured to operate profitably into perpetuity, rationally providing loans based on their ability to accept risk and their extensive track record of appropriately ascertaining borrower risk (in theory, at least). Individuals tend to be less rational funding sources, providing loans or investments based on their willingness to accept risk which is determined personally through potentially irrelevant and simplistic underwriting considerations (i.e. social influence, personal relationship, etc.). Additionally, individuals contributing to crowdfunded projects are susceptible to mob psychology which is characterized by the loss of responsibility of the individual. This inefficiency creates an opportunity for entrepreneurs and other creators to fund companies and projects based more on their marketing tactics and social influence than on traditional means. The catalysts underlying the acceleration of Crowdfunding are largely structural in nature. As startup costs and production costs decline and access to online distribution channels grows, barriers to entry for entrepreneurs and other creators will also decline. This will lead to continued proliferation of capital raisers who will tap into Crowdfunding to capitalize companies and projects. However, a key potential obstacle in the future will be the persistence of irrationality among the individuals funding these companies and projects. This irrationality will inevitably lead to poor returns as capital raisers take advantage of the inefficient market, effectively making individuals more cautious and less willing to contribute to new ventures or projects. Despite this expected increase in market efficiency, Crowdfunding currently represents an attractive growth area for entrepreneurs to monetize as well as a compelling trend in which venture capitalists should consider investing. 15
  16. 16. Sharing Economy The concept of a Sharing Economy, closely tied to Collaborative Consumption, is rooted in turning underutilized assets and resources into new jobs, income streams, and community networks. The Sharing Economy leverages information technology and social networks to efficiently match potential users with non-commercial providers of goods or services. This process enables owners to monetize their assets (physical goods or time) while simultaneously enabling users to “rent” those assets, effectively avoiding the cost and complexity of ownership and/or transferring time intensive activities to those with excess availability of time. The growth and relevance of the Sharing Economy was accelerated by the US recession and its persistent aftermath, including significant underemployment and declining US median incomes (real): 16
  17. 17. Sharing Economy As a result of these two factors (among others), job seekers and owners of assets have sought alternative forms of income to supplement their smaller or non-existent paychecks. This has typically been accomplished through either renting their available time to others or through renting underutilized assets to others. Two examples of this include TaskRabbit, a network of trusted helpers available to do basic tasks for a price, and Sidecar, a ridesharing service for car owners enabling them to operate as temporary taxi drivers. Additionally, consumers (or users) have sought to use the Sharing Economy to obtain lower cost goods and services. These goods and services can be rented to users at a lower cost than traditional commercial methods for two often intertwined reasons: 1) the goods and services would otherwise be unused and 2) the owners’ main intention for the asset is personal use, therefore the costs associated with owning the asset are mentally tied to the benefit received from having unlimited access to the asset. As a result, renting the asset to others during periods of underutilization does not have to be a profitable in the sense that it fully reflects the cost of ownership, plus profit. Instead, assets offered to users of the Sharing Economy tend to be irrationally priced on a standalone basis, as owners are willing to rent their assets based on marginal cost, plus profit. Though the catalysts underlying the acceleration of the Sharing Economy appear to be cyclical in nature, the existence of underutilized assets by non-commercial owners will continue to be a persistent feature of the economy regardless of employment and income levels. As a result, the rise of the Sharing Economy presents an attractive growth area for entrepreneurs to monetize as well as a compelling trend in which venture capitalists should consider investing. 17