A big part of managing two-sided marketplaces involves managing tensions between the two, often opposing “sides”. Typically these are consumers on one side and micro-entrepreneurs or small businesses on the other. Depending on the type of marketplace it is, this tension could be between buyers and sellers (Amazon, eBay, etc.); diners and reviewers and restaurants and establishments (OpenTable, Yelp); guests and hosts (Airbnb); riders & drivers (Lyft, Uber); and so on.

So what should you do when you believe introducing a new product or feature will benefit the marketplace as a whole — but one or both of the sides have trouble seeing that big picture? Here are some tactics that I have deployed while managing different marketplaces… MORE

YouTube does a fantastic job of generating zillions of video views for its community. Yet it does a relatively poor job of helping their users earn money. There hasn’t been any serious competition that can deliver viewers at such scale… Until now. MORE

Until now, crowdfunding has mostly been an occasional, desktop sort of experience. We might back a new gadget launch or a charity a few times a year, but it’s not an everyday thing. With a smartphone in our pocket, however, we not only have access to crowdfunding platforms whenever we want, but to the crowd that comprises the various social circles of our lives. MORE

When new media technologies start out, their programming tends to be aimed at the mass market. It’s only when these technologies mature and their audiences grow that it becomes feasible to go beyond general interests and target segments of the audience with specialized content or commerce.

This evolution happened in the magazine industry, which exploded in the 1920s with new general-interest magazines like Reader’s Digest and Time but later targeted more specific interests with magazines like Jet, Sports Illustrated, and WIRED. This evolution also happened in television: As new technologies like UHF, cable, and then satellite emerged, programmers responded by developing channels like BET, Nickelodeon, and Zee TV targeted at specific segments of the population. Similarly, on the Internet, the early winners were “portals” that carried a broad range of programming. Next came e-commerce companies like Amazon and eBay that could address a long tail of interests—and now we’re seeing ever-more-targeted e-commerce companies such as Zulily, Warby Parker, and Julep.

What’s happening throughout all of these examples is a shift from broadcasting to “narrowcasting”, a term first coined by computing pioneer J.C.R. Licklider in 1967 about the “multiplicity of television networks aimed at serving the needs of smaller, specialized audiences”. Today, the Internet (and social media) enables us to target these segments more precisely. There’s an important nuance here, however: This targeting is not about narrowing per se, but about reaching and including segments that weren’t addressed before.

That’s why our newest investment is e-commerce company Walker & Company, which was founded by Tristan Walker to build a modern personal care brand for people of color. Globally, this is not a narrow audience given that a giant percentage of the world’s populations are people of color. But we believe Tristan is on to a big idea, because in the U.S., this segment appears woefully underserved—even though it is growing.

Brands catering to this segment are badly dated, and customer needs aren’t being met

clyde1
I’m a huge basketball fan, and one of my favorite players when I was a kid was Walter “Clyde” Frazier in spite of the fact that he played for the hated Knicks (I grew up in Philadelphia and Washington, D.C.). Clyde epitomized cool, and he helped lead the Knicks to NBA championships in 1970 and 1973.

No offense to Clyde, but I think it’s a symbol of how neglected these markets are that one of the leading selling brands in the category hasn’t updated its spokesperson or its packaging in multiple decades…

People of color also have specialized personal care needs that are often not served by the global CPG (consumer packaged goods) brands.

For example, 80% of black and Afro-Latino men—and 30% of other races—suffer from Pseudofolliculitis Barbae (PFB) or “barber’s itch” due to curly hair follicles. The resulting razor bumps are not only annoying, but also can be unsightly and painful. Current leading selling shaving products tend to exacerbate this condition.

The market is large and growing

The population of people of color is growing in the U.S. and “over-indexes” significantly on beauty and personal care CPG products. For example, black consumers spend 2x the general population on cosmetics and 1.8x on skincare (Essence Communications, Inc.). And black women represent approximately 7% of the population but 30% of hair care spend.

We believe Walker & Company is extremely well positioned to build a big business catering to this market:

• Their first product, the Bevel shaving system for men (which they designed and manufactured), is impressively designed and executed — but more importantly it works. Clinical tests show that shaving with Bevel reduces razor bumps among men of color. More importantly, customers perceive that difference too: “Last razor I used had my face looking like nestle crunch. Been using @Bevel for some days now and my face still feels like a baby’s bottom”. “You guys did it! The first shaving system I’ve used that actually works as advertised. I will be a life long customer… Thank you…”

• The Internet enables efficient marketing to previously difficult-to-reach segments, and Tristan is quite adept at social marketing. He was the first business development person at Foursquare, and personally has 280,000 Twitter followers. Walker & Company takes customer satisfaction and feedback so seriously that he and his employees personally reply to and engage with every customer on Twitter.

• Results are early, but Bevel is off to a great start. They have gone to market with a five-part shaving system sold through a subscription format—and sales as well as customer retention have been strong out of the gate.

• There are numerous other huge segments in this market with under-served needs, and Tristan already has an extensive product roadmap for adjacent markets.

Yet it’s important to note that Tristan’s mission goes beyond profits. For the consumer, it’s hard to feel like a first-class citizen when you’re only able to buy second-class products. That’s why Walker & Company focuses on developing brands that solve acute physical problems (beginning with PFB) in the community—they won’t be making shampoo just to make shampoo.

Tristan feels he has found his life’s work at Walker & Company, and he is hell-bent on building the modern health and beauty brand for people of color. We’ve known Tristan for years, and consider him to be a charismatic, talented, and passionate leader. We look forward to joining him on this journey.

Photo: Getjustin

 

E-commerce has disrupted a number of large categories, including media, electronics, apparel, and home furnishings. If you’re shopping in these categories, there’s a strong and rapidly growing chance that you’re going to buy them online. But that’s not the case for the largest retail category: grocery. For the vast majority of people, filling the fridge still means rolling a cart down the aisles at the local grocery store.

As I outlined in a previous post, groceries are among the last huge e-commerce opportunities. Online penetration of groceries is extremely low. It’s not that innovators haven’t tried—it’s that they haven’t enjoyed significant success. To date, virtually all of the digital efforts to attack the grocery vertical—i.e., the brick and mortar franchises—have followed a very similar model: by building out e-commerce grocery businesses end-to-end, including warehouses, inventory, and trucks. They’ve essentially replicated the grocery store supply chain at great cost and complexity. During the first wave of Internet startups, we saw this centralized approach most famously with Webvan, but also at Peapod, FreshDirect, and more recently Amazon Fresh.

But now a new wave of digital companies is going after the grocery business with a very different approach. That’s why we’re thrilled to announce we’re backing Instacart.

The proliferation of mobile devices is enabling what I call “People Marketplaces”: two-sided marketplaces that connect consumers with people providing specific services.From finding a ride with Lyft, to getting your house cleaned with HomeJoy, home-delivered restaurant meals from DoorDash and Caviar, and instant pet-sitting from DogVacay, the variety and usage of People Marketplaces are exploding. It’s really becoming a thing!

People Marketplaces couldn’t really exist before the smartphone; the efforts of all these people couldn’t be efficiently managed or optimized without that supercomputer-with-GPS that’s now in everyone’s pocket. Today these devices can run sophisticated software that orchestrates tasks like order placement, driver location and logistics, delivery timing, and payment.

Instacart offers same-day delivery from your favorite grocery store via an army of local contractors, often within the hour. The service is expanding rapidly and is already available in the San Francisco Bay Area, New York City, Chicago, Boston, Washington D.C., Philadelphia, Los Angeles, Seattle, and Austin. Instacart is doing this by taking what I’d term a “virtual” approach that requires negligible infrastructure investment relative to other more centralized models; they leverage the existing grocery store infrastructure with a workforce enabled by digital tools.

I know what you’re thinking; I’ve written extensively on how brick-and-mortar retailers will be disrupted by e-commerce companies, and how they’re at risk of becoming dinosaurs in many retail categories. Yet Instacart is partnering with these same brick-and-mortar grocery stores in the delivery of their service. Have we cast our lot with the dinosaurs?

Not. Traditional brick-and-mortar retailers have a large advantage relative to e-commerce companies (if they can figure out how to harness it): Each of their stores is essentially a mini-warehouse with inventory widely distributed throughout the country. So we’re making a bet that Instacart’s partnerships with brick-and-mortar grocery stores will be the winning play in grocery delivery to the home, with the ability to fend off competition from e-commerce companies that build out their own infrastructure.

Here’s why we think the virtual model wins in this case:

  • It’s capital efficient – Instacart’s virtual approach to delivering groceries is extremely capital efficient relative to the approach of e-commerce grocery players like Amazon Fresh, Fresh Direct, and Pea Pod. Instacart’s leveraging of existing infrastructure obviates the need for physical capital investment. To put a point on it, Webvan raised $1.2 BILLION  largely for cap ex in their unsuccessful attempt to build a centralized grocery e-commerce business back in the day.
  • Faster to market – Instacart’s virtual model lets them expand to new cities quickly; their market entry strategy requires them to digitize local grocers’ inventory, hire drivers, and acquire consumers. Contrast this with the centralized e-commerce players and their need to build warehouses, buy trucks, buy and receive inventory, hire both warehouse workers and drivers… For these same reasons, Instacart should also be able to service smaller cities more efficiently.
  • Offers potentially superior operations – Instacart’s model is much more simple operationally; an order on Instacart results in a shopper going to the grocery store you selected, picking the items on your list, and delivering them immediately to your door. This should enable them to provide service that’s both high quality and FAST (remember that Instacart is often able to deliver groceries within an hour). By contrast, centralized e-commerce approaches have significant operational complexity. They need to buy, store, and pick inventory that’s often fragile and/or perishable (e.g., fruits, vegetables, meat, dairy) and keep it fresh and undamaged inside their trucks that run around the city all day making multiple deliveries.
  • Capitalizes on well-known brands – Instacart leverages the brands of the physical grocery chains, which typically are well known to the neighborhoods they serve. These chains know and carry the SKUs that people in their community want to buy. In the Bay Area, this already includes national chains like Whole Foods and Safeway as well as iconic local brands like Rainbow Foods and Berkeley Bowl. Centralized e-commerce businesses, on the other hand, need to build a brand from scratch and optimize for the tastes of an entire city.

We’re not alone in thinking that grocery will develop differently than other e-commerce verticals.  Fred Smith ,the founder of FedEx — which re-invented the delivery business — had this to say about the delivery of groceries (as part of a 1999 InternetWeek interview):

 “A lot of retailers are coming to the conclusion that well, maybe the best thing is not a total inventory-less environment but maybe what we do is use the Internet in concert with our bricks and mortars. And that’s what I think will happen, because you have a lot of things that have very low value, and they don’t lend themselves to e-commerce and fast-cycle distribution.

Groceries are the best example of that. Now, maybe there’s an example where you have an e-commerce interface and home delivery of groceries, but those groceries are not going to be delivered from across the country, and they’re not going to be built on demand for your order.”

FedEx was the pioneer of the centralized approach to delivery,jet planes and all. And even back in 1999, he thought the virtual approach in partnership with brick-and-mortar grocery stores was the future of online grocery distribution. Fast-forward 15 years and throw in the smartphone — and we think he just might be right.

I see lots of analogies between Instacart and OpenTable, the business I ran for four years before joining a16z. They are both local, requiring city-by-city rollouts. They both provide convenience to consumers. They both drive incremental business for their retail partners, providing those retail partners with an incentive to promote the service. They both have the potential for network effects. And FWIW, they both involve food!

In addition to these strategic advantages, we as always are making a bet on the founder. In this case, it’s Apoorva Mehta, a former Amazon programmer who is the founder and CEO of Instacart. Apoorva and the team have made extremely impressive progress, leading Instacart to strong early results on very modest resources. This round will give them a deeper war chest to rapidly bring the convenience of Instacart to cities across the country. We look forward to supporting their efforts to revolutionize grocery shopping. Your fridge awaits!

Many folks make the observation that it’s challenging to run a fast-growing technology start-up.  I personally think that’s a dramatic understatement.  It’s the hardest thing I’ve ever done…as well as the most rewarding.

I’d had very modest experience actually running a business when I got to eBay in 1999.  Most of my management experience had been in running functional groups within organizations, such as being the CFO of The Disney Stores.  I had a very brief stint running a business as CEO of Reel.com, the now defunct movie superstore that Amazon steamrolled once it expanded beyond books.  But that doesn’t really count as it wasn’t really a business—for example, no viable business spends something like $40 million in marketing to sell something like $40 million in DVDs at a gross margin loss.  Reel.com went from filing to go public in December 1999 to being closed down in June 2000, ostensibly a casualty of the end of the “Bubble”.  I saw the writing on the wall and left as they were preparing to file.

But Meg Whitman was willing to take a chance on me in spite of this lack of operating experience.  Meg had been my hiring manager at The Walt Disney Company in 1990 when I joined their Strategic Planning unit.  Nine years later, after we both had departed Disney, she reached out about my joining eBay.  Frankly, my impressions of eBay going into those conversations was that it was a quaint website that sold lots of collectibles like Beanie Babies, and it was already public so that most of the potential upside had already been realized.  But Meg is quite compelling, and she successfully disabused me of those notions and convinced me to join—no small feat given the Bubble was still alive and well at that point and I had lots of other offers (companies in the Valley in the late ‘90’s were hiring anyone with a pulse!).

My first role at eBay was managing a fledging “Services” unit whose charter was to develop partnerships with companies to facilitate trade on eBay, such as bulk auction management tools or electronic postage.  And she gave me a whopping two employees to manage, one of whom it turns out was plotting to start a Baja Fresh franchise and soon left.

But I had joined eBay as part of a management “bench”, in the hope that a bigger job would materialize down the road.  And one quickly did when Meg decided to split eBay into two divisions with the launch of the International unit, and in early 2000 she appointed me as head of the legacy eBay North America business.  Fast forward, I ended up running that unit for about five years during its period of hyper-growth.  During that time I championed eBay’s acquisition of PayPal, and in 2005 I moved over to head PayPal during its hyper-growth period.  Having started my eBay career managing effectively one person when I joined, seven years later I was managing something like 5,000 people.  What a ride!

Over the course of my seven years at eBay, I discovered the experience and requirements of successfully running a hyper-growth business changes dramatically over time.  The best analogy I have for it is a sports analogy:

Employees = 1-10.  Player:

When I first started managing eBay North America, I recall I was managing about a half dozen people.  At this scale, I found myself involved in pretty much every decision.  Heck, I found myself making pretty much every decision.  It felt like I was on the field of play during a high stakes game, my adrenaline pumping as the action crashed all around me.  It was unbelievably exhilarating, and it seemed to be working—the business was growing like crazy!

Employees = 10-100.  Coach:

…Until it wasn’t working any more.  It turns out the number of decisions to be made scaled tremendously, seemingly even faster than the business.  The line of people outside my cube waiting for decisions kept growing longer, and it quickly became obvious that the old M.O. wasn’t going to scale.  I found I needed to hire talented people to supplement my efforts and delegate more and more decisions to them.  And I needed to manage these daily decision makers as a team, giving them high-level direction and coordination but watching from the sidelines as they executed the plays.  I had to become a coach.  I found it a bit less exhilarating, but it scaled a whole lot better and at least I was able to make it home at night.

Employees = 100-1,000.  General Manager:

And then almost just as quickly coaching wasn’t working any more.  The business continued to explode, and the folks I was delegating the daily decisions to soon found out they couldn’t make all of the decisions themselves either.  They now also needed to become coaches, building out their teams and delegating their decisions to their players.  And I found I now needed to coach these new coaches differently.  I still needed to give high-level direction, but other tasks soon became required such as setting high-level organizational goals, coordinating their efforts, and tuning the organizational relationships of these rapidly growing groups.  I had to become the general manager of this rapidly growing team.

Employees 1,000-10,000.  Commissioner:

By the time I moved over to manage PayPal, the size of the team had grown into the thousands.  And I quickly discovered that I needed to supplement my just discovered and nascent general manager skills substantially.  The organization was so big that the players on the field were now two or three levels below my direct reports.  I continued to set high-level direction, but I quickly found that the organization performed best when I executed a set of administrative tasks that I came to refer to as the “-tions” (pronounced “shuns”) such as vision, motivation, communication, organization, simplification, and coordination.  If I performed these “shuns” well, then the team was freed to devote most of their energies to the game.  With my sports analogy, I’m not sure now whether I was the team owner or the commissioner of the league, but I do know that I felt like I was in a Sky Box near the top of the stadium, squinting down trying to see what was happening on that distant field of play.

The most important discovery I made in this process was the recognition that I needed to quickly and continually develop entirely new sets of skills to manage the business effectively as it very rapidly scaled.  And given the rate of scaling, that required massive learning and adaptation at a ridiculously fast pace.  And given eBay/PayPal was a high profile business and I had a high profile role, any failures on my part to deliver would be widely known.  This was really, really hard work that needed to be done at a break-neck pace amidst very high levels of stress, much of it self-imposed.

I heard G.E. chief Jeff Immelt speak to a small group of executives during this time.  He said something that stuck with me, that leadership requires high levels of self-awareness and requires an intensive journey into knowing oneself.  Becoming a great leader requires you to know yourself, your strengths, weaknesses, and idiosyncrasies.  And it requires you to understand how others experience you, perceive you, and respond to you.

In looking back, I think he was precisely right.  Here are some of the tools I used on that journey to self-awareness that enabled me to scale from managing one to thousands of employees:

– Periodic 360 feedback from the organization.  It’s really quite straight forward: If you ask people for feedback and typically respond to it in a constructive way, then they will typically give it to you.  I usually awaited this periodic feedback with a sensation somewhere between dread and abject terror each time it was coming.  But done right this feedback was almost always constructive, and it invariably gave me a roadmap for what was working as well as what wasn’t, which led directly to the new skills I needed to develop.

– Working with a talented coach that I trusted.  My buddy John Donahoe, the current CEO of eBay, turned me on to the concept of using a coach in a session during my eBay tenure when I was pulling my hair out in frustration.  He observed that if world-class athletes like Tiger Woods (recall this happened last decade) utilized swing and strength coaches, why shouldn’t executives who aspired to improve use a management and leadership coach?  I ended up using a number of coaches over the years and one that helped me tremendously was a wonderful woman named Jane Creech.  Jane’s efforts in helping me develop my management and leadership skills made me better…and probably had an indirect impact on improving the lives of thousands of people at eBay and PayPal!

– Find a mentor or mentor(s).  I eventually made the realization that I wasn’t the first person who had gone through this situation.  One of the things that makes Silicon Valley unique is that it’s one of the few places in the world where hyper-growth companies are spawned with fairly high regularity.  So over time I developed a few close relationships with people who had “been there, done that” that proved very helpful to me.  John Donahoe was one of these people, as were a few members of my Young Presidents’ Organization who were in my forum.

The keys to success to using these methods are a hunger to learn and improve, a willingness to be vulnerable and share weaknesses as well as strengths, and often owning up with your organization to shortcomings that you’re working hard on improving.  And for me, these were the heavy-lifting parts of the process.

That said, it was an incredibly gratifying journey to be able to scale effectively from running a small start-up to leading a huge organization.  Personally, I found the early days to be a whole lot more fun.  I recall a conversation late in my eBay tenure with Scott McNealy about how I was becoming more effective but having less fun over the years as the business scaled.  He said something to me along the lines of “You idiot, don’t you realize that your job is to do the shit stuff so that everyone else in the company can be productive and happy?”  I didn’t then, but I do now.

The news around shopping during the holiday season was dominated by two separate stories. One talked about how traffic to brick-and-mortar stores was well below expectations, and that these retailers were forced to discount tremendously to drive sales. The other talked about how an enormous late surge in packages coming from e-commerce companies overwhelmed the capacity of UPS and, to a lesser extent, FedEx, and caused many of these packages to arrive after Christmas.

But, to me, these two stories are not at all separate, they simply reflect different sides of the same narrative: We’re in the midst of a profound structural shift from physical to digital retail.

The drivers of this shift are simple:

  • Online retail has strong cost advantages over its offline counterparts and is rapidly taking share in many retail categories through better pricing, selection and, increasingly, service.
  • These offline players have high operational leverage and many cannot withstand declining top-line revenue growth for long.
  • The resulting bankruptcies of physical retailers remove competition for online players, further boosting their share gains.

So, how has this shift been playing out? Recent data suggests that it’s happening faster than I could have imagined.

The U.S. Census Bureau publishes what I consider to be the most accurate figure on e-commerce penetration in the U.S. It reports that e-commerce penetration of total retail sales in the U.S. was around eight percent in 2012. But, as I’ve blogged previously, this aggregate figure seriously underestimates the impact of e-commerce in large sectors of the retail landscape. Let’s unpeel the onion and look at the next level of reporting from the Census Bureau, where it segments the retail landscape into six large categories of goods. It’s at this level that things start getting more interesting:

The data suggests that there are two very different patterns going on with respect to e-commerce penetration. The two largest categories — “Food and Beverage” and “Health and Personal Care” — show e-commerce penetration well below the overall average. These categories essentially are the domains of grocery stores and drug stores, and e-commerce (at least to date) has achieved only modest penetration of these massive categories (but Amazon Fresh has designs on changing that).

The other four categories are what I would consider to be the domains of traditional specialty retail categories, the ones that are transacted in the malls of America. All of these demonstrate e-commerce penetration well above the overall average, ranging from a low of 12 percent for “Clothing and Accessories,” up to 24 percent for “Media, Sporting and Hobby Goods.” It’s in these specialty retail categories where e-commerce to date has had its strongest impact.

One additional observation is that the pace of online share gain in the specialty retail categories shows absolutely no signs of slowing down. All of these charts are “up and to the right.”

So it’s clear that a growing share of the retail pie in the specialty retail categories is being captured by e-commerce. Now let’s throw in one more massive complication for brick-and-mortar retailers in these categories: The total retail sales in these markets have been extremely sluggish, and have barely recovered back to pre-recession levels. This is a toxic combination — physical retailers in these categories are losing share of a total retail pie that isn’t growing. The inevitable result is that the portion of the pie left available for physical retailers is shrinking rapidly:

And that’s just what’s happening. The Census Bureau reports that the four specialty retail categories representing total sales of just over $600 billion grew by only $5 billion between 2007 and 2011 (the last date that this level of detail was reported). That’s less than one percent over four years. The e-commerce players increased their cumulative sales in these categories by $35 billion over the time period. This means that the cumulative sales of brick-and-mortar retailers shrank by $30 billion in just four years!

The result of these macro shifts is a Darwinian struggle playing out in the malls of America among physical retailers. Some recent retail news:

  • It’s getting hard to find a physical bookstore, music store or video store these days. In books, Borders has closed, and Barnes & Noble has reported continuing declines in comp store and total retail sales in its second quarter. All major music retailers are out of business. And the Dish Network recently announced that it would close its remaining 300 company-owned Blockbuster stores in early 2014.
  • Office-supply retailers are under pressure, as the paperless office is finally arriving. Office Depot and OfficeMax recently completed their merger, and will likely consolidate stores. Staples reported a four percent decline in comp store sales in their most recent quarter, and has closed 107 stores in the past year.
  • Electronics retailers are facing enormous pressure. Circuit City has closed. Best Buy recently declared that “show-rooming is dead,” as it offers to match the prices of 19 online retailers and all offline retailers. The next day, it warns of potential profit shortfalls from the hot promotional environment. And all of the computer superstores are long gone.
  • Apparel retailers serving the youth market are facing big headwinds. The “Three A’s” (American Eagle, Abercrombie & Fitch and Aeropostale) are all performing poorly, with declining sales and stock prices. It feels pretty likely that a key factor in these declines is early-adopter teenagers turning to online alternatives like Nasty Gal and Stitch Fix.
  • The general-merchandise department store is under siege. Sales at Sears have declined for 27 straight quarters (for you keeping score, that’s almost seven years). And it just announced that it is spinning off its Land’s End subsidiary, following its divestitures of Orchard Supply Hardware and Sears Hometown and Outlet business. Says Brian Sozzi, chief executive of Belus Capital: “Sears is in a steady state of decline. … They’re essentially selling their body parts so they stay alive today.” J.C. Penney continues to be in the intensive-care unit, with declining sales and substantial losses, and the SEC just launched a probe “requesting information regarding the company’s liquidity, cash position, and debt and equity financing.”

The stark reality for brick-and-mortar retailers is that there currently are just too many stores. Remember, these retailers have very high levels of operating leverage, and a meaningful decline in sales can quickly render them unprofitable and eventually unviable. And $30 billion in lost sales is most definitely a meaningful decline in sales. It’s not surprising that few retailers are opening new locations, and that a large number are shuttering existing ones.

The retail world is changing, and we’re seeing creative destruction play out before our eyes. And the speed at which it is happening is absolutely stunning. UPS and FedEx had better start building out their fleets, big time — these trends are only accelerating.

This post originally appeared in Re/code.

A big investor mantra over the past few of years has been “SoMoLo”, an acronym for the mega-trends “Social, Mobile, and Local”.  How have these trends been performing for investors?  Social clearly has been delivering huge, as evidenced by the very strong performance of the Facebook, LinkedIn, and Twitter IPOs.  Mobile has arrived with a vengeance, with smartphones and tablets already generating more traffic for many consumer online businesses than PCs.  But at this time last year the bloom looked to be off of the “local” rose, due at least in part to the very poor performance of Groupon as a public stock.  It got so bad that a company that I know in the local space who was looking to raise a round was told by multiple venture firms to look elsewhere for capital as they “don’t do local”.

But I’d argue that local in the past year has flourished as an investment category.  A good chunk of the consumer Internet businesses that have gone public of late focus on local, and these businesses have traded strongly as public companies.  OpenTable probably opened the door here in 2009, but other high quality local companies quickly followed suit including Yelp, Zillow, Trulia, and Angie’s List.  Even Groupon, just last year the poster child of the demise of Local, has enjoyed a resurgence and now sports a market capitalization of $6 billion—a valuation that rivals the price of their oft-ridiculed non-sale to Google a few years back.

marketcapitalization

Source: CapitalIQ

When I talk about local here, I’m focusing primarily on technology businesses that power online to offline commerce.  They typically are two-sided marketplaces, with offline local businesses on one side and consumers on the other.  They typically roll out on a city-by-city basis, and require a sales effort to sign up small businesses to populate and/or monetize the marketplace.

It’s clear that mobile is helping these local businesses dramatically.  The geo-location capability of the smartphone means the computers that all of us are carrying around in our pockets are location-aware.  The resulting killer application is “show me information on businesses that are close by to where I am now”.  Using OpenTable as an example, “show me which restaurants around me have open tables that I can reserve right now”.

Building a local technology business is not all easy, due to three related features:

  • The need to expand by executing a city-by-city rollout.  It can be hard enough to make a business work in one market.  But once a local tech company has proven out its concept in one market, it then needs to roll it out to multiple cities very rapidly or risk losing them to competitors or clones.  And as the world has gotten flatter, this has become even more challenging as fledging startups in many international markets scan the globe for businesses to clone in their home region.  The local food delivery space is an example where no one company has taken their market, at least initially.  Multiple businesses have been competing in the U.S., with different companies winning different markets.  GrubHub is in the process of rolling up their U.S. competition, having acquired CampusFood and SeamlessWeb.  And there is an entirely different competitive set of companies in Europe battling it out among each other for market supremacy.
  •  The need to build up both sides of the two-sided marketplace in each market, aggregating local offline businesses on one side and consumers on the other.  And the skills required to build the two sides of the market are typically different, one with a sales motion and the other with a consumer marketing motion.
  •  A high level of operational complexity that requires armies of people, largely due to the need to sell and service tens or hundreds of thousands of local businesses.  For example, Groupon has over 11,000 employees and Yelp has almost 2,000, resulting in annual revenue per employee of just over $0.2 million and $0.1 million, respectively.

As a result of these challenges, building out a national or even a global footprint tends to take a long time and require a lot of capital:

cumulativevc
But while building local-focused tech companies can be very challenging, it can also be highly rewarding.  Successful businesses in this space tend to have strong “winner-take-all” characteristics that can lead to very strong market positions that tend to endure:

  • Winning companies often sport strong (and largely local) network effects.  I’ve had the privilege of being involved in a number of network effects businesses, and none had a stronger network than OpenTable.  The more restaurants OpenTable has in a city, the more useful it is to diners.  And the more diners in that city use it to make reservations, the more valuable it is to restaurants.  In our IPO roadshow, we made the statement that we believed it was financially irrational for a restaurant to use a different reservation service, even if it was free, as they’d lose access to incremental diners and thus dollars from the OpenTable dining community.  This has subsequently been born out as a number of aspiring competitors, many giving their service away for free, have come and quickly gone.
  • Winning companies also typically achieve scale advantages that are very difficult for aspirants to match.  Critical to every two-sided network is signing up local businesses to use your service.  The market leader quickly has the largest team recruiting these businesses.  Their team is typically the most productive, both because of accrued learning as well as the fact that it’s easier to sell the service that boasts the most consumers in its network.  New entrants typically suffer both scale and productivity disadvantages, which in turn often results in investor skepticism that creates capital disadvantages.

The chart below, generated by my colleague Sebastian Cua, shows the strong premiums that fast-growing local companies are commanding in the market:

EBITDA

Source: CapitalIQ, Wall Street Research Estimates

There is a growing pipeline of late-stage private companies that will become the public companies of tomorrow, including Uber, GrubHub Seamless, MindBody and ZocDoc.  And a newer generation of local-focused companies is showing rapid growth including HomeJoy, DogVacay, Lyft, and Belly (the latter two are a16z venture investments).  We strongly believe that opportunities in local will continue to spawn great technology companies.

I would argue that the winner-take-all characteristics of local businesses create what investors crave in companies: strong “competitive moats”.  Public market investors clearly have developed an appreciation for the moats that surround the public, local-focused tech companies above given their recent stock market performance.  And it’s interesting to see exactly what these public market investors are valuing above all—GROWTH!

I’ve had Amazon on my mind lately, part of which is due to my reading Brad Stone’s very interesting book, The Everything Store: Jeff Bezos and the Age of Amazon.

I’ve described in earlier blog posts how Amazon is a brutal competitor for brick and mortar merchants due to their large and growing cost advantages and a maniacal commitment (at least most of the time) to having the lowest prices anywhere.  (You can read more about it here.)  These same drivers also make Amazon a heavyweight competitor for e-commerce companies as well.

Much attention has been paid to the concept of “show-rooming” in the context of brick and mortar stores, where customers use their smart phones to compare the cost of a product on a physical store’s shelf against online competitors—typically Amazon.  But show-rooming is also a fact of life for e-tailers due to the ease of comparing online prices.  As a result, Amazon is a monster competitor for online merchants as well.

Amazon enjoys scale economies far beyond that of their online competition that they can use to support hyper-aggressive prices and fast, cheap shipping.  Here is a simple illustration of their scale, using data from Internet Retailer:

top 50 e-retailers

Amazon is larger than the next dozen largest e-tailers—COMBINED!  Its resulting scale advantages are staggering.  And they aggressively re-invest the benefits of this scale into even lower prices and faster, cheaper shipping that in turn lead to growth and further scale advantages.  When we consider an e-commerce investment at a16z, we always strive to carefully evaluate the risk of competition from Amazon.  They’re not just a heavyweight—they’re the heavyweight champion of the world!

So how do you compete with Amazon?  Here are some strategies that we’re seeing in the market from both offline and online retailers.  Not all are mutually exclusive—i.e., many companies deploy multiple strategies:

Sell differentiated product:

Amazon’s sales skew very heavily towards “hard-lines”, things like media, electronics, home & garden, and toys.  Most best-selling hard-line products are produced by large manufacturers who market them heavily and distribute them broadly through multiple retail channels.  They are essentially commodities, identified by a standardized Universal Product Code (aka, U.P.C.).  An example is a Canon digital camera; once Canon’s ads convince you that you might want a Canon camera, you know you can shop for it pretty much anywhere.  And for most commodities, price is the key differentiator.  Consumers know that Amazon almost always has the lowest prices, along with free and fast shipping.

Many retailers try to “hit ‘em where they ain’t” and sell in categories where Amazon is less dominant.  Soft-lines is an obvious one; while Amazon is trying to build up this business, they have not achieved anywhere near the dominance that they have on the hard-line side.  Online companies like NastyGal and Zappos (before their acquisition by Amazon) and offline companies like Nordstrom and Neiman Marcus have successfully pursued soft-line strategies and have managed to weather competition from Amazon relatively well.  Another example is home improvement retailers, where a combination of products that “I need today” and/or bulky or heavy items are less suited to online distribution.

A related strategy is to feature products from companies that typically are not distributed or searched for on Amazon.  a16z has two investments in companies that primarily sell goods from a long tail of designers that lack extensive national distribution.  zulily does this in kids’ and moms’ apparel, and Fab does this in design.  These designers’ unique products are typically not found through Amazon’s search engine as they lack broad awareness.

Develop your own products:

Many retailers seek to compete with Amazon by developing their own products.  These products can be largely insulated from direct price comparison as they are proprietary and the producing company can elect not to have them sold by other online retailers.  A number of the best performing offline chains pursue this strategy including Lululemon and Victoria’s Secret.  It is also being pursued by a new breed of online retailers such as Chloe & Isabel in jewelry, Julep in cosmetics, ShoeDazzle in women’s shoes and Poppin in office goods (note: Andreessen Horowitz is an investor in Julep and ShoeDazzle).  While it’s clearly much more work to design and source your own product, retailers who do are often rewarded with higher gross margins as they both cut out expensive middlemen and avoid head-to-head price competition.

Merchandise product differently:

Amazon.com at its core is a search engine for products.  They are strongest where consumers know pretty much exactly what they are looking for, and the predominant way to find that on Amazon is the ubiquitous search box.  Merchandising on Amazon is almost completely algorithmic—things like others searching for ‘x’ also looked at ‘y’ and ‘z’.  I know of very few folks who browse Amazon in the traditional merchandising sense of the word.

One tactic a number of companies are employing to compete with Amazon is to build a great browse experience, showing consumers a targeted assortment of attractively displayed products. Offline retailers historically have done this through beautiful window displays and their in-store end caps.  And a new breed of online merchants is doing this, too, although it’s often referred to as “curation”.  And price is not typically top of mind during these impulse purchases.

Deploy alternative distribution strategies:

A number of online retailers are trying to put themselves directly in front of consumers before they think to consider searching for that product on Amazon. “Flash sales” companies like One Kings Lane and The Clymb send a daily email that merchandises a compelling assortment of goods at attractive prices.  Other companies like Birch Box or Trunk Club are employing a subscription model that sends you a highly curated selection of product, typically on a monthly basis.

Leverage unique advantages:

Brick and mortar retailers are disadvantaged with respect to costs relative to Amazon due to higher real estate, labor and inventory costs.  But a number of merchants are trying to flip this disadvantage on its head and leverage their network of local stores.  Wal-Mart for a while has enabled consumers to pick up online orders at their local store on the day it was ordered.  Last holiday season, they launched a test of same-day delivery for online orders from their stores in a number of cities.  Both take advantage of Wal-Mart having inventory in geographically dispersed stores.  And in a creative twist, they are considering crowdsourcing their local, same-day delivery to their customers, who would receive discounts on their shopping bill in exchange for their efforts.  Alternatively, Williams-Sonoma has used both their store locations and their catalogs to aggressively build their online business.  They have been willing to cannibalize themselves, believing rightly that someone else will do it if they don’t.  Over 40% of their revenue now comes through the online channel.

It’s clear that e-commerce is highly advantaged vis-à-vis offline retail and will continue to gain share.  The more interesting question to me is how e-commerce companies will compete with the heavyweight champ Amazon.  Amazon will always be able to pummel other e-tailers on price and probably on shipping as their scale advantages are virtually unassailable.  Companies that hope to compete with them successfully have to adopt different tactics.  Similar to when Cassius Clay (now Muhammad Ali) prepared to fight the then reigning heavyweight champion Sonny Liston, they’re going to need to “float like a butterfly, sting like a bee”!

Follow

Get every new post delivered to your Inbox.

Join 2,876 other followers