Competition, send ‘em south.
If they’re gonna drown put a hose in their mouth
Mark Knopfler, Boom Like That

If you’re a physical retailer and you sell the same SKU’s as Amazon, you will not have a Happy Holiday this season.

Starting with the hoopla around Black Friday and Cyber Monday, the media has been full of stories on how physical retailers plan to beat back the competitive pressure from online retailers (for example, Wall Street Journal and CBS News).  They detail a number of strategies, such as expanding their hours, guaranteeing to match lower online prices, offering customized shopping apps and trying to build up their own online businesses.  Unfortunately, these strategies are destined to fail for many of these physical retailers.

The reason?  They are burdened with an inferior business model.  I’ve described in a previous blog post how creative destruction has happened in retail in recent decades, with independent retailers giving way to chain store retailers, who in turn gave way to big box retailers, who in turn are in the process of giving way to online retailers.  Physical retailers are not inept; they’re cemented to a business model that is uncompetitive.

It’s long been conventional wisdom in retail that the keys to a retailer’s value proposition are how they deliver on three core tenets: price, selection and convenience.  Let’s compare physical retailers to their online counterparts on each metric.

Price

Selling through brick-and-mortar stores is substantially more expensive than selling through online channels due to multiple factors.  Let’s compare one of the most economically efficient physical retailers, Best Buy, with its most significant online competitor, Amazon.

  • Real estate expense: Best Buy sells primarily through over 4,000 brick-and-mortar stores (as of the end of their 2012 fiscal year) that cost them billions in capital costs and over a billion a year in rent.  Amazon avoids store investment entirely.  Cost advantage: Amazon.
  • People expense: Best Buy needs to staff all of these stores with employees; their total headcount as of year-end FY2012 was 167,000.  Amazon doesn’t.  Best Buy’s revenue per employee in 2012 was $0.3 mil, whereas Amazon’s was $0.9 mil.  Cost advantage: Amazon.
  • Inventory: Best Buy needs to fill each of these 4,000+ stores with inventory, whereas Amazon keeps their inventory concentrated in a network of 70-80 fulfillment centers.  Best Buy turns their almost $6 billion of inventory an impressive 8.7x per year, but Amazon’s centralization enables them to do it at an even more impressive 10.3x.  Cost advantage: Amazon.

Each of these is a multi-billion dollar item, and Best Buy is disadvantaged on every one.  There’s no way they can compete with Amazon on price if Amazon is motivated to have the lowest price.  And Amazon is maniacally committed to having the lowest prices.  They scour their online competitors constantly throughout the day, dynamically adjusting their prices in response to competitors’ changes to make sure they are the lowest (see: New York Times).

Amazon participates in a number of business segments.  They sell physical products and digital downloads themselves, get commissions/fees on the sale of physical product by third parties, sell advertising and promotions on their site, offer Amazon Web Services, manufacture hardware like Kindles, etc.  They report a consolidated gross margin of 22%, but provide scant financial detail beyond this.  A few different equity analysts have made noble attempts to disaggregate Amazon’s reporting into its component parts.  They’ve observed that many of their ancillary businesses are quite high margin, which Amazon in turn uses to aggressively subsidize their core business.  These analysts estimate Amazon’s gross margin on physical products to be between 12-16%, an astonishingly low number.  As a point of comparison, Best Buy’s gross margins last year were about 25%, as were Wal-Mart’s.  The net result: Amazon’s gross margins on apples-to-apples products are about half of the gross margins of two of the most price competitive physical retailers.  Amazon is a brutal competitor—and I mean that as a compliment!

The strategy of physical retailers trying to price-match Amazon is absolutely doomed to fail.  A physical retailer loses lots of money charging the same price as a substantially cost-advantaged, ultra-price-competitive Amazon.  Any incremental sales will likely be offset by cannibalizing the prices paid by their “loyal” customers.  Pricing is a battle that physical retailers cannot win.

And what’s more, their higher physical cost structure completely hamstrings their efforts to compete online.  I haven’t yet met a physical retailer that is comfortable offering products at lower costs through their online channel than through their physical channel.  They are doomed before they even start.  It shouldn’t be surprising then that Best Buy’s online business in the U.S. accounts for only 5% of their total, nor that it’s 1/18th the size of Amazon’s.

Selection

A physical store is constrained in the breadth of inventory they can carry by the size of their store.  An online retailer is constrained on breadth by the size of their warehouses.  Amazon can keep a staggeringly large breadth of inventory in their 44 million square feet of fulfillment space, and they even supplement that through a network ofthird party merchants that list their inventory for sale on Amazon.  Selection advantage: Amazon.  They truly offer the “Earth’s Biggest Selection”.

The strength of the selection advantage of online retailers really hit home when we were doing diligence on our investment in Fanatics.com, a large online business that sells licensed sports apparel and merchandise.  If you search online for licensed sports stuff, you’ll likely encounter a Fanatics-owned website.  Fanatics.com has the ability to stock a vastly broader range of sports apparel and merchandise than virtually any physical retailer possibly could.  Take the example of my hometown San Francisco 49ers.  One can often buy the player jersey of a few of the 49ers stars at the local mall.  But on the Fanatics-run NFL Shop, you can buy the uniform of every player on the team—in multiple colors and most every size (see: 49er Uniforms).  They have 11 different jersey styles for star running back Frank Gore— including men’s, women’s, youth and even newborn styles!  There’s no physical store in the Bay Area that can hope to match this selection.  And if you cheer for a team from another city, you haven’t got a prayer of finding your favorite player’s jersey at physical retail.

Convenience

The one area that physical retailers have historically had an advantage over their online rivals is in convenience.  If you want or need something today, your only option has been to drive to your local store.  Physical retailers typically open multiple brick-and-mortar stores to make that drive as short as possible.  Convenience advantage: Best Buy.

But this advantage is eroding, again driven by Amazon.  With their Prime service, you get free two-day shipping and discounted one-day shipping for a flat annual fee.  Prime helps to close the convenience gap, and its share of Amazon’s sales is growing rapidly.  Other e-commerce companies are following suit, many aided by Shoprunner.com.

And online companies aren’t stopping there—they’re shooting for convenience parity.  A number of very large companies are trialing same-day delivery of online orders.  Amazon (again) is being very aggressive here, building out a distributed network of fulfillment centers near major population hubs from which they’re starting to test same-day deliveryUSPS has announced a test in San Francisco.  Other companies are trying to leverage the locally-held inventory at physical stores to also offer same day delivery.  eBay has debuted an application called eBay Now, and Wal-Mart is testing same-day delivery from their stores in a number of citiesConvenience advantage: Best Buy… for now.

Online retailers have a greatly advantaged business model, and it’s little wonder they are rapidly gaining share of the retail pie.  Early holiday sales forecasts for online retailers seem to imply year-over-year growth rates in the mid-teens.  But the overall retail pie is not growing very fast of late; most holiday sales forecasts for this year are in the low single digits.  The piece of the pie left over for physical retailers is rapidly shrinking.  And what’s worse for them, competition from their online counterparts is starting to push them towards suicidal tactics like matching the prices of competitors that have much lower costs.  For many, this might be their last holiday season.

We at a16z could not possibly be more bullish on the prospects for e-commerce, and we believe growth is poised to accelerate.

Part of the reason for this is due to competitive market dynamics.  As I’ve blogged before, e-commerce players have substantial cost advantages over their physical competitors.  They are massively more efficient in terms of real estate and labor costs in particular, and as a result hold a significant pricing advantage over physical retailers.  Online is rapidly gaining share of retail spend across the majority of specialty retailing categories, shrinking the portion of the marketplace available to physical retailers.  These physical retailers have very high operating leverage and their P&L’s cannot withstand shrinking revenue.  The result has been physical stores dramatically downsizing or going bankrupt, which we believe will only increase going forward, clearing the playing field for their online rivals.

But another part of the reason is a renaissance in innovation among e-commerce players.  At a16z, we often refer to the early development of e-commerce as either “e-commerce 1.0” or “e-commerce for nerds”.  The typical shopping experience at both is that the user enters a keyword phrase into the search box, and the company tells you what they have that matches your query.  This era ended up being dominated by two on-line behemoths, Amazon and eBay.

At a16z, we’ve been delighted of late to see a surge in e-commerce innovation that we refer to alternatively as “e-commerce 2.0” or “e-commerce for everyone else”.  Talented entrepreneurs are trailblazing entirely new approaches to e-commerce, and many of these companies are being rewarded with explosive growth.  Some examples:

Direct Sourcing

E-commerce 1.0 consisted almost exclusively of retailers that distributed other companies’ goods.  These days, more and more e-commerce companies are designing and sourcing their own goods.  Often they are collapsing inefficient legacy supply chains by cutting out multiple intermediate layers.  One of my favorite examples of this is prescription eyeglass retailer Warby Parker.  They are bypassing a bloated, antiquated industry supply chain to offer high quality, high fashion eyeglasses that they design and source themselves at a fraction of the typical market cost (the mark-up on glasses sold at physical retailer in the U.S. can be 10-20x the cost of manufacturing).  Other examples are Bonobos in men’s pants, Bauble Bar and Chloe & Isabel in women’s jewelry, and Ledbury in men’s shirts.  We believe that new retail brands going forward will increasingly be built online, not in your local mall.  It’s just so much more efficient financially.

Curation

E-commerce 1.0 players typically display their available product as a search result, typically depicted as page after page of small product snapshots.  But many of their 2.0 counter-parts are re-inventing classic physical retail merchandising into the online space.  One of the leaders in this is Fab.com, one of our portfolio companies.  They do a phenomenal job of picking beautifully designed product and presenting it in a highly compelling way and in a consistent voice.  I’m not a big shopper but I love receiving my daily Fab email, and the steady flow of boxes from them delivered to my home is a running joke among my family.  Others who do a great job on this include NastyGal for young women’s apparel and AHALife for luxury lifestyle products.

Alternative Distribution

Innovative companies are developing alternative ways of distributing their products.  Selling physical product through subscriptions is becoming increasingly common and provides retailers with a fantastic way to keep consumer mindshare each month.  Companies like Dollar Shave Club typically send you a monthly shipment of product that they design and manufacture.  Others like Birchbox or Citrus Lane include products in their monthly shipments from companies that are interested in having you sample their wares.  Alternatively, companies like Stella & Dot and J. Hilburn are distributing their product through a network of representatives, who they support with technology.

Engagement

Many e-commerce 2.0 players strive to build very strong consumer loyalty and engagement, going above and beyond the specific commerce transaction.  They seek to delight their best customers by offering free shipping and returns and doing things like providing unexpected gifts in shipments.  Many consider their consumers as a “community”, and engage with them well beyond their orders, hosting meet-ups, providing supporting content, and doing real-world promotions and events.  One of my favorite community executions is RentTheRunway’s new “Our Runway” feature.  It allows their users to upload pictures of themselves wearing the dresses they rented onto the website, where they can be browsed by new users as part of the dress rental process.  Their community members have become their models!  And lastly, all of the 2.0 players seek to have contextually relevant integrations with today’s leading social platforms—Facebook, Pinterest and increasingly Instagram—taking their content into the daily lives of their users.

Event Sales

There’s been a proliferation of companies that offer online “flash sales” events, often offering significant savings on designer brands that have surplus inventory.  French Retailer Vente-Privee is usually credited with pioneering the category about a decade ago, and aggressive retailers like Gilt Group and Rue La La quickly followed.  A number of entrepreneurs took this concept and applied it to specific target markets, like One King’s Lane in home furnishings.

We believe that all of this innovation will only improve the competitive position of online players relative to their offline counterparts, contributing to accelerating e-commerce growth.  Consistent with this belief, a16z has made a number of investments in these e-commerce 2.0 retailers, including Fab and ShoeDazzle.  And today we’re proud to announce that we’re leading an $85 million round in zulily, an event sales site that offers daily deals for moms, babies and kids.

There are a number of things that attracted us to zulily:

  • The very talented founding team of Mark Vadon and Darrell Cavens have pulled off a singular feat: They are in the process of building their second, large, highly successful e-commerce franchise.  Mark was the founder and former CEO of Blue Nile, the largest online retailer of certified diamonds, engagement rings and fine jewelry, and Darrell was his head of technology and marketing (an intriguing combination of functions that I had never before encountered as an Internet executive).  At their encore zulily, Mark is chairman and Darrell is the CEO.
  • zulily is one of the fastest growing businesses we have ever encountered.  What is even more impressive is how they have done this: The company spent minimal capital to achieve this result.  But maybe that shouldn’t surprise us—they achieved similar results at Blue Nile.
  • zulily participates in enormous markets.  They started out offering kid’s apparel that moms bought.  But as they grew, they also realized that moms were interested in women’s apparel and hardline goods (e.g. housewares), and they now sell large quantities within these categories as well.
  • We are impressed with zulily’s strategic positioning.  One reality in e-commerce today is that you want to avoid trying to compete directly with Amazon, who is hyper-aggressive in leveraging their enormous scale and cost advantage to offer the largest selection and lowest prices on the Internet.  Like Fab, zulily does this by aggregating a long tail of talented designers who typically lack extensive national distribution.  These designers offer consumers strong value, but almost always make money on their zulily sales and highly value the channel.
  • We are also impressed with zulily’s execution.  They are as data-driven as any company we’ve encountered, and use it to great advantage in both marketing and merchandising.  They leverage technology adroitly to optimize the business.  And they’ve rapidly developed operational capabilities that have enabled their hyper-growth.

We believe we’re in the early stages of a revolution in retail, where inefficient physical businesses are giving way to highly efficient, innovate online ones.  We’re delighted to have the privilege of supporting the zulily team’s efforts to build (yet another!) iconic e-commerce franchise!

Now it seems strange
How we used to wait for letters to arrive
But what’s stranger still
Is how something so small can keep you alive
Arcade Fire, We Used to Wait

It’s election season.  And since Candy didn’t use my question in the second debate, I thought I’d ask it here: “President Obama and Governor Romney, the United States Parcel Service is forecasted to lose $5.5 billion in 2012, and also has defaulted on scheduled payments of $11 billion.  What would you do to fix it?”

Since the debates are now over, let me take a shot at answering it.

We have a thesis at Andreessen Horowitz that “software is eating the world”, such that analog businesses in a wide variety of sectors are being crushed by rapid digitization.  In my last blog post, I discussed how this was playing out in retail, where market share gains by online retailers at the expense of offline retailers are threatening the long-term viability of many offline merchants due to their high operating leverage.  This same dynamic is playing out in communications.  The USPS is an analog business being rapidly consumed by digitization.

According to the Postmaster General, “The core function of the Postal Service is the physical delivery of mail and packages…to every address in America.”  Physical = analog.  Here is the USPS product mix in 2008, just four years ago:

It was an analog cornucopia.  Half of their revenue (and even more of their profits) came from first class mail, but this personal and business correspondence is being rapidly replaced by digital email, texts, social networks, and online statements and bill-pay.  Similarly, catalogs, magazines and newspapers are being replaced by commerce and content websites, supported by email marketing.  I had a front row seat at eBay as money orders started getting replaced by PayPal.  The only growth business that USPS has is packages due to the explosion of e-commerce.  But unfortunately, this business has been relatively small for them (representing only about 14% of 2008 revenue) and highly competitive vis-a-vis UPS and FedEx.

So what has happened to the volume of USPS deliveries?  It’s been decimated:

I have to give the USPS management credit—they saw pretty early on that a freight train was coming right at them.  When I was managing eBay in the early 2000’s, the USPS management team organized a session with select Valley executives on what they could do to mitigate potential disruptions to their business due to digitization (I was likely invited because the eBay community in aggregate was one of their largest customers).

Any business that encounters disruption on this scale needs to respond decisively to remain viable.  And the Postal Service is essentially a business: They are “an independent establishment of the executive branch that does not receive tax dollars for its operations.”  But unlike privately owned businesses, “…the Postal Service is nevertheless restricted by laws that limit its ability to control costs and grow revenue in the way a business would.” (2011 Annual Report)

What are some of these restrictions?  The USPS…

  • Has a “universal service” obligation that mandates the delivery six days per week to a national footprint of 151 million homes and businesses
  • Has labor agreements that specify cost-of-living wage increases and contractual benefit plans for employees and retirees
  • Faces limits in raising prices
  • Is “restricted by law from taking certain steps, such as entering new lines of business that might generate additional revenue…”

USPS management has attempted to navigate these restrictions to mitigate the financial impacts of digitization.  They have been trying to control the costs they can, rapidly consolidating mail-processing facilities and adjusting their employee counts down in line with falling mail volumes.  And they have raised prices.  Unfortunately, the biggest price increases have been in packages and shipping, their most competitive market:

So what’s the net outcome of these actions?  Massive and growing losses.  Revenue is eroding rapidly as the price increases have only partially compensated for plummeting volume.  And they’ve made very modest progress on lowering expenses:

And unfortunately, their situation is even worse than this.  The USPS historically has not accrued for the cost of retiree health benefits; they’ve booked them on an as-spent basis (governmental entities are allowed to do this, unlike the private sector).  And the costs they were spending paled compared to the costs they should have been accruing.  Congress in 2006 mandated that USPS catch up on these obligations over a 10-year period, a process called “RHB Pre-Funding” (RHB stands for Retiree Health Benefits).  They were able to make these Pre-Funding payments between 2007 and 2010, but their economic meltdown has caused them default on their recent obligations (Josh Barro of Bloomberg provides an excellent explanation of this issue here).  The $11 billion in defaults, combined with their operating loss of $5.5 billion, is resulting in the disastrous $16.5 billion 2012 deficit.

USPS management has presented a plan for how they potentially can navigate their way out of this mess (USPS “Plan to Profitability”).  It involves significant savings from changes in benefit plans, decreased service levels (e.g., moving from six to five-day delivery), some post office closures, and continued headcount reductions.  It also involves continued price increases and identifies some revenue-boosting initiatives.  It’s an ambitious plan, but it has a few big issues:

  • About half of the financial improvements require require “significant legislative change”, and Washington hasn’t been very good lately on that front.
  • It ignores the issue of the under-funded retiree health benefit costs.
  • Most importantly, it assumes that their revenue erosion moderates significantly going forward.  This just won’t happen; that digital “genie” is out of the bottle.

On the current course, we’re destined to see ever-larger losses as revenue continues to fall and expenses are only tweaked. The Postal Service is effectively becoming a taxpayer-supported entity, with ever-growing losses subsidized to maintain the “common good” of physical mail delivery.

But there are alternatives to mitigate the pain of this digital transformation:

Stem the Bleeding:

There are some very highly leveraged ways that you could improve USPS economics.  But all require political will, so they’re not likely to happen any time soon:

  • Re-invent the post office.  Operating and staffing 36,000 physical post offices is hugely expensive.  And these post offices are being hollowed out, as volume going through the average post office is down 19% in the past four years alone.  USPS needs to steal pages from the UPS and FedEx playbooks.  Most physical post offices should be closed and replaced with self-service kiosks, supported by proven technology tools.  These kiosks could be located in retailers, who would gladly trade a little space in exchange for foot traffic and possibly a revenue share. Closing post offices would save a fortune in operating and staffing costs, and the proceeds from selling the real estate could fund the benefits shortfall.
  • Deliver mail less often.  Your local mail person is delivering 23% less mail to an average location today than four years ago.  It doesn’t make sense to keep delivering progressively less mail with the same frequency.  Cutting delivery down to three days a week, say Mondays, Wednesdays and Fridays, would halve delivery trips, but the average time to deliver something would increase by only a half day.
  • Restructure comp and benefits.  Postal Service employees and retirees are expensive.  I calculate current USPS manpower costs at $84k per employee (excluding those RBH pre-funding costs), compared to $67k and $70k respectively for UPS and FedEx workers (who have a higher proportion of skilled jobs like airline pilots and mechanics).  It’s not intuitive to me why USPS labor deserve a 21-25% premium over their private sector counterparts.  An enormous 80% of USPS costs are labor-related.  If they paid the same labor rates as UPS (and that of course is a BIG “if”), their current $5.5 billion operating loss would swing to a multi-billion dollar profit.
  • Selectively raise prices.  The cost of mailing a first-class letter was in the U.S. was $0.44 in 2011; comparable figures in other countries include Great Britain at $0.74, Germany at $0.77, Japan at $1.06 and Norway at $1.63.  Giving the USPS more flexibility to raise selective prices could mitigate near-term financial pain.

Compete:

Package delivery is the only one of USPS’s market segments that is growing.  But the packages business is very competitive, and USPS is getting its clock cleaned by UPS and FedEx.  In my experience, many businesses start out using USPS given its ubiquity and low rates, but switch to UPS and FedEx as they grow due to their volume discounts and superior service.  USPS needs to focus on packages, improving their service and having the latitude to offer volume discounts.  They actually should have a cost advantage competing for an incremental package since they already make a trip to each destination each day.

Innovate:

A few private sector companies have in recent years explored trying to digitize your mailbox, providing consumers with a website that serves as a secure virtual mailbox to which mailers could send digital versions of the mail. Physical mail is very expensive for businesses—in addition to billions in postage costs, there are even larger costs in paper, printing and processing.  As a business, I’d be willing to pay a fee to deliver electronic correspondence at scale if it saved me big bucks in physical production and delivery.  And as a consumer, I would dramatically prefer to check a website for my mail than make the daily trek to the mailbox.

The challenge in building this service is the classic chicken and egg problem—it’s only interesting to consumers if many businesses use it, and it’s only interesting to businesses if many consumers use it.  USPS may be uniquely positioned to solve this chicken and egg problem with their scale, universal reach, and relationships with both consumers and businesses.  They could charge much lower “postage” rates for this service, but at higher margins as they replace the costs of physical distribution.  And they could provide related services like integrated bill payment, archiving and the like.  In the process, they also save about a zillion trees!

Privatize:

UPS and FedEx currently deliver packages to every home and business in the U.S., just like USPS.  They don’t currently go to every one of these everyday, but they are in every neighborhood every day.  And both of these businesses are operated significantly more efficiently than the Postal Service and turn a profit.  It feels like there would be massive efficiencies from combining USPS operations into one of these companies.  Alternatively, there’s a war that’s starting to brew around delivery to your home from players including Amazon and Wal-Mart, and both are world-class at logistics.  Amazon alone spent a stunning $4 billion in 2011 on outbound shipping costs; they now spend more on shipping than marketing!  Might they be interested in owning delivery to the home?

Software is eating the world, leading to the rapid destruction of many legacy analog business models.  It’s a foregone conclusion that the post office will go the way of record and book stores, as bits don’t require physical buildings to be delivered.  The Postal Service as we know it is well along the path of being obsolete.  Acting on this reality sooner rather than later will save taxpayers very many billions of dollars.

Joseph Schumpeter said in his theory of “creative destruction” that the “process of industrial mutation…incessantly revolutionizes the economic structure from within, incessantly destroying the old one, incessantly creating a new one. This process of Creative Destruction is the essential fact about capitalism.”

I believe we’re approaching a sea change in retail where physical retail is displaced by e-commerce in a multitude of categories.  The argument at a high level:

  • Online retail is relentlessly taking share in many specialty retail categories, resulting in total dollars available to physical retailers stagnating or even declining.  This is starting to put intense pressure on their top lines.
  • Physical retailers are very highly leveraged and often have narrow profit margins.  Material declines in their top lines make them unprofitable and quickly bankrupt.
  • Online retail will benefit greatly from the elimination of their physical competition and their growth should accelerate.

Let’s start with the historical context.  What’s been happening in retail in recent decades is a perfect example of creative destruction in action.  In a little over a half century, multiple generations of specialty retailing concepts have been created and subsequently destroyed.  The widespread building of large suburban shopping malls after World War II led to the development of the specialty retail chain store, at the expense of independent, sub-scale “Main Street” retailers.  A few decades later, many of these mall-based specialty retail chains were in turn crushed by the development of “big box” retailers, who had had substantial cost, pricing and selection advantages.  And currently, many of these big box retailers have been in turn devastated by the rise of e-commerce and its substantial capital and cost advantages.  E-tailers don’t need to build, rent, stock and staff a large chain of individual stores; instead, they enjoy significant efficiencies from centralization.  An example of their relative efficiency can be seen in labor: Revenue per employee for Amazon is $0.9 million per year vs. $0.2 million at Wal-Mart.

Book retail provides a good example of this evolution.  Independent bookstores gave way to mall-based chains like B. Dalton and Waldenbooks in the 1960-70’s, who in turn gave way to big box chains like Barnes & Noble and Borders in the 1980’s, who in turn are giving way to e-commerce players (particularly Amazon).  B. Dalton, Waldenbooks and Borders are now out of business, and Barnes & Noble is struggling to morph itself into an e-commerce and e-book company before its physical bookstore business evaporates.

I believe that the demise of physical bookstores is just the canary in the coalmine for all of the big box players, and that the same creative destruction will play out across specialty retail.  It’s already happened in music and video retail: Tower Records, Virgin Music and Blockbuster Video are all history.  And it’s starting to happen in other categories.

The steady, relentless share gains of e-commerce have been widely documented.  According to the U.S. Census Bureau, e-commerce had grown to 7% of total retail by 2010.  But there is wide variation in online share by category:

Source: U.S. Census Bureau, Annual Retail Trade Survey

The large “supermarket” categories of Food & Beverage and Health & Personal Care have tiny online participation, but the specialty retail categories have large and rapidly growing online shares.  And the huge category buckets reported by the U.S. Census probably obscure the magnitude of some of the share impacts.  For example, the bulky, heavy appliances in the “Electronics and Appliance” bucket probably haven’t gone online as fast as electronics, suggesting that online share in electronics is probably much higher.

And things get even more interesting when you look at this in terms of dollars, such as in the Electronics and Appliance bucket:

Source: U.S. Census Bureau, Annual Retail Trade Survey

Total category sales have stalled over the past half decade, likely impacted by the housing bust.  But the steady growth of online is causing the portion of the market available to offline retailers to be substantially pressured.  Total offline sales among all Electronics and Appliance retailers were lower in 2010 than they were in 2004!

So, imagine you are Best Buy.  They are the leading electronics retailer in the U.S., and they also sell computers, media and appliances.  They historically have been among the most innovative and successful of the big box retailers, and were named “specialty retailer of the decade” in 2001 by Discount Store News. Between 1998 and 2008, they ripped off 10 straight years of positive comp store sales growth; compounded, their comp store sales were up a staggering 75% over this period.

But as we see above, the portion of the market available to offline retailers in Best Buy’s verticals is shrinking due to withering competition from online players with substantial price and selection advantages, exacerbated by “show-rooming” enabled by mobile devices (see my previous post about Belly).  Best Buy’s amazing 10-year run in comp store sales growth screeched to a halt in 2009, and they’ve had negative results three of the past four years. Many of their offline competitors have already gone out of business, as No. 2 player Circuit City did in 2009.

You get a sense for the hurricane that Best Buy is trying to navigate when you look at their performance by category:

Two-year
Compounded
Comp Store

Ending
Revenue

Category

Change

Mix

Consumer Electronics

(11%)

34%

Computing and Mobile Phones

2%

43%

Entertainment

(37%)

9%

Appliances

13%

6%

Services

2%

7%

Other

1%

Total

(7%)

100%

Source: Best Buy

It’s flat out brutal when your #1 and #3 categories have dropped 11% and 37% respectively in just two years.

Once upon a time, I was CFO of The Disney Stores Worldwide.  One thing I learned there is that physical retail is very highly leveraged as a massive chunk of the expense structure is fixed.  Each store typically has a long-term lease with fixed rent payments and requires minimum staffing and inventory to operate.  And stores require warehouses and trucking fleets to house and transport inventory, and central staffs to manage it all.  Due to these high fixed costs, even small changes in comp store sales can enormously impact profitability.  I experienced this in vivid detail at The Disney Store.  We enjoyed record profits behind surging merchandise sales for the run-away hit “The Lion King” in 1994, but the following year’s results were hammered by anemic product sales for the much-less-successful “Pocahontas”.

Relatively small declines in comp store sales, if sustained, can quickly prove fatal to physical retailers due to this leverage.  The Circuit City example is instructive here. Their bankruptcy was preceded by just six quarters of declining comp store sales.  They essentially broke even in their fiscal year ending in February 2007; they declared bankruptcy in November 2008 and started liquidating in January 2009.  It is also notable that Circuit City’s bankruptcy has had only modest benefit to Best Buy, as did Borders’ bankruptcy for Barnes & Noble.  Not even the elimination of the largest competitor provides material reprieve from brutal market headwinds.

Here is the case for e-commerce acceleration.  Continued share gains by e-commerce players shrink the pie available to physical retailers.  Marginal physical players go bust, providing only a temporary boost to the remaining offline players and a sustaining boost to online players.  But the underlying market dynamics stay the same, and pressure again builds on the remaining physical players.  When their top-lines drift below their highly leveraged water lines, they too drown and liquidate.  At that point, e-commerce becomes about the only place where consumers seeking a broad selection of merchandise can go.  They essentially run unopposed.

This Darwinian struggle for survival has already played out in music and is in the last act in books and movies.  In electronics, Best Buy is the last man standing and the pressure is building.  They have virtually no margin for error as their operating margin is down to 2%.  When they succumb (and unfortunately for them, I believe this is a “when” and not an “if” unless they are able to pull off a radical transformation of their model), e-commerce will become the only place to find a comprehensive selection of electronic products.  And other specialty retail categories like apparel and home are not that far behind their media and electronics colleagues.

We’re extremely bullish on the prospects for e-commerce, and we’re very bearish on the prospects for offline retailers who compete head-to-head with them.  The implications are broad.  To paraphrase Schumpeter: We believe that offline retailers that cannot deliver a differentiated value proposition to consumers will be destroyed by a new generation of online retailers that is being created before our eyes.

On a final note… I’d like to thank my colleague Wei Lien Dang, who provided strong analytic support for this post.

The Net has unleashed unprecedented price transparency across both online and offline worlds.  Comparison shopping engines offer convenient price comparison for goods across online retailers, helping consumers easily discover who has the lowest prices online.  People are “show-rooming” (i.e., visiting real-world stores to physically evaluate products), but then using their smartphones to research the lowest price and often buying the item online.  And daily deal sites bring transparency to deep discounts offered by local offline retailers, helping to lure bargain-conscious shoppers attracted to bargain basement prices.

Competing simply on price is a really tough road for the vast majority of merchants.  There can only be one low cost provider in any market, and price competition can result in Darwinian struggles for survival.  A few decades ago, big box merchants like Walmart used their cost and selection advantage to severely undercut mom and pop merchants and forever change Main Street.  Some of you may remember the movie “You’ve Got Mail”, where Tom Hanks’ big box bookstore put Meg Ryan’s quaint bookshop out of business.  Well, a sequel must be brewing because Internet retailers like Amazon are using their cost and price advantage to crush those same big box bookstores…and music stores…and computer and electronic stores.  Most of the once highly competitive physical chains in these verticals are history, and the few remaining holdouts like Barnes & Noble and Best Buy are desperately fighting a pretty inevitable extinction.

Merchants are desperate to find ways to compete outside of direct price competition.  Enter the loyalty program.  All sorts of retailers have loyalty programs, be they the nearly ubiquitous punch card from your local sandwich shop or more elaborate programs from large offline and online retailers.  Some of you may recall the famous Seinfeld episode about George’s enormous wallet, which was filled with loyalty cards from half the retailers in Manhattan.

A set of new companies is seeking to bring digital efficiency to the loyalty programs of offline merchants, leveraging a combination of the Net, mobile devices and data analytics.  Instead of carrying a wad of cards from individual retailers, people carry one card or one smartphone app that can be used at multiple participating merchants.  Instead of manually tracking visits, merchants rely on smartphones and tablets to digitally record the visits.  And instead of merely redeeming paper cards, merchants tap this digital information to really understand their customer behavior and the identity of their best customers.

Andreessen Horowitz is proud to announce our most recent investment in one of the market leaders in the emerging loyalty space: Belly.  We elected to invest in Belly for the following reasons:

  • They have a talented and committed management team, led by Founder and CEO Logan LaHive.
  • Belly has built an elegant product that fully leverages emerging trends in mobility.  Every merchant has a consumer-facing iPad at their cash wrap that actively promotes their rewards through Belly, and in the mechanism through which consumers check in.  And consumers can check in at Belly using either a smartphone app or a physical card. Belly also brings an approach to loyalty that goes well beyond simple “buy x times and get y”.  They work closely with every merchant to develop rewards tailored to that merchant’s unique attributes, integrating many non-financial rewards that bring out the personality of the business.  A couple of my favorites include “name your own Slurpee” at 7-Eleven in Chicago, “cut the line” at Southport Grocery, and ”win an ice cream date with Jerry (yes, that Jerry!) from Ben & Jerry’s in Washington, D.C.”.
  • Belly is attacking the market aggressively and has already signed up over 1,400 merchants and 200,000 consumers since launching last August.  This is not particularly surprising as their original funding came from Brad Keywell and Eric Lefkofsky at Lightbank, whose investment Groupon acquired merchants at a blistering pace.  We are psyched to work with Brad and Eric on Belly.
  • We believe having a large, connected network of merchants and consumers affords interesting opportunities beyond loyalty programs down the road.

I’m proud to join Belly’s board and will be actively working with the Belly team on a rewards program for achieving their key milestones.  My current favorite: The team gets to pie our own Mr. Andreessen after adding their 10,000th merchant (an option I have yet to share with Marc—we’ll soon see if he reads my blog posts!).

We are delighted to announce that the six General Partners of Andreessen Horowitz, with our families, are all committing to donate at least half of all income from our venture capital careers to philanthropic causes during our lifetimes.

The reason is simple.  We are fortunate to work with some of the best entrepreneurs and technologists in the world, and in the process help create great and valuable companies.  That activity, done well over decades, can generate a lot of money that can then be productively deployed philanthropically back into the society that makes it all possible.  We love participating in this process, and we hope that our philanthropy can, over time, help make the world a better place.

As an initial catalyst, we are making an immediate group donation of $1 million to a set of six vital Silicon Valley-related nonprofit organizations.  Those causes, and their respective sponsors, are:

Ben and Felicia Horowitz: Via Services
Jeff and Karen Jordan: Ecumenical Hunger Program
John O’Farrell and Gloria Principe: Second Harvest Food Bank
Marc and Laura Andreessen: Fresh Lifelines for Youth
Peter and Martha Levine: Canopy
Scott and Pamela Weiss: The Shelter Network

Signed,

Ben, Jeff, John, Marc, Peter, and Scott

[popover_trigger handle=”Right-Above-It”]Facts are simple and facts are straight
Facts are lazy and facts are late
Facts all come with points of view
Facts don’t do what I want them to
—Crosseyed and Painless, Talking Heads (written by Brian Eno and David Byrne)

[/popover_trigger]

[popover_content handle=”Right-Above-It”]Artist: Talking Heads
Track: Crosseyed and Painless
Album: Remain in Light
Released: 1980
Label: Sire[/popover_content]

[single_grooveshark code=”hostname=cowbell.grooveshark.com&songIDs=247900&style=metal&p=0″ width=”150″]

Business growth at established companies tends to fall relentlessly over time in the absence of inspired innovation, an impact I affectionately refer to as “gravity”. If a CEO wants to fight this gravity and improve the long-term growth trajectory of his or her business, he or she needs to take proactive, concrete steps to make it happen.

As CEO, I was always trying to develop and test a portfolio of potential new initiatives to support business growth, targeted at both optimizing the core business as well as adding new layers of growth (see my last post on this topic about Adding Layers to the Cake). I wanted to identify completely new initiatives that would boost business growth—things we weren’t already doing. Things you are already doing are largely yesterday’s news, and their impact on future growth tends to wane over time. Implementing completely new innovations can help your business fight gravity.

At OpenTable, one of the most highly leveraged examples of an innovation to optimize our core business was developing a rigorous methodology to pursue and assess potential site improvements. A while after I became CEO of OpenTable, my predecessor Thomas Layton (who did a spectacular job positioning OpenTable for long-term success) sent me a fascinating video of a guy named Ron Kohavi talking about Amazon’s approach to something he called data-driven product development. Here’s an old link to one of his presentations (FYI, it only works sporadically): http://videolectures.net/kdd07_kohavi_pctce/.

The video details how Amazon rigorously deployed A/B testing to optimize website efficiency. Kohavi starts the presentation by showing a number of different executions of the same feature that they had tested over time, and he asks viewers to vote on which they thought had performed better. The results suggest that the folks in the audience—all website geeks—were not able to consistently pick the winning execution. That was mildly surprising. But what was astonishing was the delta between the results driven by different executions of the same feature: what often appeared to be subtle changes could drive huge improvements in performance!

In the video, Kohavi also talks about the impact of the “HiPPO” (Highest Paid Person’s Opinion) in the product development process. Not surprisingly, most HiPPOs believe that they know intuitively what will work best (spoken by the former HiPPO at OpenTable). But pretty much none of us have the product instincts of a Steve Jobs, and Kohavi makes a very compelling case for letting the data and not the HiPPO make the decision.

So we resolved to test data-driven product development as one of OpenTable’s potential core business optimization initiatives. We tasked a talented product manager, Julie Hall, to lead the effort and we procured tools to inform the effort. For the art side of the effort, we found the low-cost and highly efficacious usertesting.com service that enabled us to get qualitative user feedback literally overnight to inform what we planned to test. And for the science side, we bought the overpriced but also highly efficacious “Test & Target” system from Omniture (developed by Offermatica, now owned by Adobe) that enabled robust quantitative measurement of a number of simultaneous A/B tests.

These two tools worked together marvelously. One time, we literally stumbled upon a big “improvement opportunity” (a.k.a. a nasty usability problem on the site). We used usertesting.com to task a handful of unregistered users with making a reservation. But we watched in horror as a significant minority of the test users got trapped in our “Sign-In” functionality and couldn’t complete their online reservation. In the real world, they would probably get pissed off and simply pick up the phone (OpenTable’s biggest competitor for consumers) and call the restaurant, a disaster for our user acquisition, brand affinity and OpenTable economics.

Here is the offending page:

The problem we encountered was that non-registered users would set the radio button that said “I am a new OpenTable customer” and then fill in their email address and select a password….which sat under the “I am an OpenTable member” section. This combination caused the page to return an error message.

In response, we developed alternative treatments of our Sign-In functionality and tested them via Test & Target. The winning executions presented non-cookied users with a form tailored directly to new users, with clear visibility of a link for existing members to “Sign In”:

After the user hit the “Complete Free Registration” button, we then presented them with a popup that prompted them to register to become an OpenTable member:

These simple changes boosted our reservation success rate by 10% over the prior implementation. And a 10% improvement in the revenue stream that comprised well over half of the company’s total business due to one simple change was a monster win for the business.

Over time, the data-driven product development methodology at OpenTable matured into a highly disciplined testing regimen. Hundreds of tests have been run in the past few years. Not all were homeruns like the change above, but lots of singles and doubles supplemented the occasional home run to have a highly material impact on the business. I can’t recommend a rigorous data-driven product development process enough to managers of website businesses—it’s extremely low-hanging fruit in the pursuit of growth.

Other examples of core business optimization initiatives that helped OpenTable boost growth included:

  • Developing a new version of our enterprise software used by restaurants that improved search-to-reservation conversion by having the software better mimic the decision-making process of the person at the host stand
  • Redesigning key pages of the site to improve their efficiency, such as a complete overhaul of our search results pages (tested thoroughly through A/B testing)
  • Focusing dedicated resources on optimizing the percentage of OpenTable restaurant customers who had “make an online reservation” links on their own websites, as well as improving the visibility of those links
  • Applying concerted product and engineering efforts to boost our ranking in search engine results
  • Hiring a lot more sales people to accelerate the acquisition of restaurants using OpenTable (not product, but highly effective)

The key takeaway here is that all of the above were new, concrete initiatives that were not yet part of the company’s arsenal. Their successful deployment helped fight off the impact of gravity and led to accelerating growth for the company.

Businesses don’t grow themselves.  One of the most important jobs of a CEO is to aggressively define and pursue a growth agenda for his or her business.  Why is this important?  Growth typically improves a company’s competitive position and provides increased scale and leverage, and investors clearly value growth.

The pursuit of growth continues to be important regardless of the lifecycle of the company.  Obviously it’s critical early in a company’s life… or it won’t be a company for long.  But it continues to be important as a company develops.  Virtually all businesses, even hyper-growth ones, inevitably experience slower growth as they get larger, with their growth rates falling relentlessly back down to Earth over time.  I call this effect “gravity” and it will weigh down even the most promising of companies—unless a CEO can find a way to accelerate growth and positively change the long-term growth trajectory of the business.

The first real operating job I had was managing eBay’s U.S. business in mid-2000, which included the ebay.com website.  Virtually all the revenue—and more than all of the profits—of the eBay company came from the U.S. unit at the time, and despite the bursting of the bubble, EBAY was still trading at highly robust multiples.  So you can imagine the terror I felt when the U.S. segment failed to deliver month-over-month growth for the first time ever in my first month on the job.  The heavy weight of sky-high growth expectations was showing the first signs of a potential collision with the brutal effects of gravity.

It was clear we needed to quickly define a growth agenda that had the scale to fight gravity’s impact.  We quickly narrowed the options down to a few: spend more marketing or spend it more efficiently, innovate the product, or buy a company to help us grow.

Marketing had some leverage, but it was limited.  eBay was already one of the biggest marketers on the Internet and efforts to optimize spend were already underway.  M&A, on the other hand, felt both desperate and was controlled in a separate part of the organization.  So we quickly turned our attention to focusing on product innovation.

One of the first places we looked for growth was in buying formats.  ebay.com at the time enabled the community to buy and sell solely through online auctions.  Many in the community thought this was the magic of the site, and it clearly helped propel the company to a very strong start.  But auctions intimidated many prospective users who expressed preference for the ease and simplicity of fixed price formats.  Interestingly, our research suggested that our online auction users were biased towards men, who relished the competitive aspect of the auction.  So the first major innovation we pursued was to implement the (revolutionary!) concept of offering items for a fixed price on ebay.com, which we termed “buy-it-now”.

Buy-it-now was surprisingly controversial to many in both the eBay community and in eBay headquarters.  But we swallowed hard, took the risk and launched the feature… and it paid off big: Buy-it-now complemented auctions well, brought new users and new listings to the site, and became a very important driver of growth for many years.  These days, the buy-it-now format represents over $40 billion of annual Gross Merchandise Volume for eBay, 62% of their total.

With an initial success, we doubled down on innovation to drive growth.  We introduced stores on eBay, which dramatically increased the amount of product offered for sale on the platform.  We expanded the menu of optional features that sellers could purchase to better highlight their listings on the site.  We improved the post-transaction experience on ebay.com by significantly improving the “checkout” flow, including the eventual seamless integration of PayPal on the eBay site.  Each of these innovations supported the growth of the business and helped to keep that gravity at bay.

I came to call this process of layering in new innovations on top of the core business “adding layers to the cake”.  Much of the natural effort in the organization is spent on chasing optimization of the core business.  This makes sense, as small improvements in a big business can have a meaningful impact.  But there is huge potential leverage to adding layers of new, complementary businesses on top of the core (aka “cake”).  In the ebay.com case, buy-it-now, stores, features, checkout and PayPal integration were all new initiatives that layered on top of the core business but added something new to it.

The eBay company in its first decade is a good illustration of the impact of “layers on the cake”.  eBay U.S. was the company’s original business, and my team worked tirelessly to optimize it and add layers on top of it.  And at the company level, the eBay Inc. management team also looked to add layers.  Our first was international expansion, which started in earnest in the early 2000’s.  We followed with payments, facilitated by our acquisition of PayPal (and worth noting here that PayPal’s early growth was primarily as the payment functionality on the eBay marketplace).  Here’s what the result looked like at the company level:


Source: eBay SEC filings

eBay U.S. clearly was a fantastic business in and of itself, and it demonstrated strong, sustained growth.  At the same time, the international and payments layers grew from virtually nothing in 2000 to around 60% of the company’s revenue by 2005.  As a result, the overall company grew dramatically faster than its original core business and successfully fought off the impact of gravity for a decade.

And the market rewarded the company handsomely for this growth.  Here’s EBAY’s stock price during the period:


Source: monthly closing price for EBAY on NASDAQ

After eBay, I continued to deploy the layers-on-the-cake approach at the other Internet companies that I’ve managed.  At PayPal, the key layers we implemented there were international expansion, improving PayPal’s offerings for merchants who wanted to sell outside of the eBay platform (called “Merchant Services”), and starting to offer credit on top of our payments business.  We even trialed a text-based mobile payments product in 2006, although the market wasn’t quite ready for it at that time (I’m convinced the product’s developers and I were the only people who ever used it).

During my time at OpenTable, the key layers we introduced included building a robust set of mobile applications that expanded diner use cases, expanding internationally (again), introducing a new “Connect” product that meaningfully increased the addressable market of restaurants, and developing yield generation products that helped restaurants attract additional diners.  These initiatives helped OpenTable overcome gravity.  For example, year-over-year revenue growth rates accelerated from 23% in 2009 to 44% in 2010.

Two other illustrations of the success of this layering approach are provided by two of the most successful growth companies of the past decade: Apple and Amazon.  Steve Jobs and the Apple team relentlessly added new layers at Apple that sat on top of their original core business of computers, including the iPod, iTunes, the iPhone and the iPad.  And Amazon in recent years has innovated incredibly skillfully beyond their core physical merchandise business, adding layers such as Prime, digital goods, Amazon Web Services and the Kindle and now Fire digital devices.  These very large companies demonstrated explosive growth pretty much entirely through brilliant innovation.

Innovation clearly is THE success model on the Internet.  It explains how Google emerged as the dominant player in search, despite being relatively late to market and competing with established companies like Yahoo and Microsoft.  It explains how PayPal buried the other online payment sites that started around the same time, including billpoint.com and accept.com, despite these companies having preferred access to the massive eBay and Amazon platforms, respectively. And it explains how Facebook has come to dominate social networking, even though it was very late to market relative to Friendster and MySpace.

These winning Net companies are incredibly strong at product innovation.  They invest in it, they create cultures that support it, they prize it and they reward it.  The companies above that failed to capitalize on their early success arguably did not.  The best innovations improve and compliment the core business of a company, taking advantage of and enhancing its most valuable assets.  Diversification outside of the core business is a much more challenging strategy.  The further a company strays from its core in its innovation, the longer the odds of success.

I’m a huge believer in the potential for innovation to drive results for all companies, but particularly for technology companies.  Core to the CEO’s job is to rise above the day-to-day requirements to keep his or her vision far out on the horizon, proactively delivering new innovations today that have the impact to materially boost the long-term growth of the business in the future.

From Marc Andreessen, co-founder and general partner of Andreessen Horowitz:

Over the last several weeks, there have been erroneous reports in the press that my partner Jeff Jordan and/or I might become an operating executive of Yahoo in some capacity.

To be crystal clear, neither Jeff, nor I, nor any of our partners at Andreessen Horowitz, are in the running for, or would accept, any operating role at Yahoo, including CEO, acting CEO, chairman, or executive chairman.

Jeff and I have high regard for Yahoo, but we are fully committed to our day jobs as general partners at Andreessen Horowitz and board members of our portfolio companies.

Marc and Ben founded Andreessen Horowitz with some very explicit beliefs.  We would invest in Information Technology companies, and not in things medical, green or clean.  We would have a preference for companies with deep technical roots and innovations.  We would have one office, in Silicon Valley, and would not seek to invest in companies being incubated in places like China or India where we lacked expertise.  We would be stage-agnostic, seeking to invest in the best companies regardless of what round they were seeking.  And we would have a preference, all else equal, for companies being built in Silicon Valley.

The Silicon Valley focus is due to a couple of factors.  First, we are all believers in the power of the Silicon Valley ecosystem to incubate and grow new technology companies.  Just this week, the New York Times referred to it as “the world’s epicenter of innovation”.  We know of few places in the world that sport Silicon Valley’s combination of financial capital, intellectual capital, entrepreneurial and engineering talent and experience, and support infrastructure.  Many of the Internet’s most highly valued companies are from the Valley—Google, eBay, Yahoo, LinkedIn, Facebook and Zynga.  And the second factor is that local companies best leverage our most precious asset as investors, which is time.

Indeed, the majority of our investments have been based in Silicon Valley.  There have been exceptions—we are or have been involved in a handful of non-Valley companies such as Skype (Luxembourg), foursquare (New York) and Groupon (Chicago)—but the majority of our investments are in the Valley and all four of my Andreessen Horowitz investments (LikeALittle, Airbnb, Lookout and Pinterest) are within a 45-minute drive of each other.

With this as background, I’ve been encountering an unexpected finding as I’ve been looking at potential e-commerce investments in the U.S. (and note that I’m considering “marketplace” businesses like eBay and Airbnb as separate from e-commerce).  It strikes me that the majority of innovative new e-commerce businesses are being started outside of Silicon Valley.  There are some innovative local ones like One Kings Lane, Tiny Prints and Plum District, but the list outside of the Valley dwarfs the local list: Groupon and Trunk Club are in Chicago, ShoeDazzle and HauteLook in L.A., LivingSocial in Washington D.C., zulily in Seattle, J. Hilburn in Dallas and Hayneedle in Omaha.  And the epicenter for e-commerce innovation right now has to be New York City with companies like Birchbox, Bonobos, Diapers.com (in nearby New Jersey), Gilt Groupe, H.BLOOM, ideeli, Lot18, OpenSky, Rent the Runway and Warby Parker.  Just five months on the job and I’m already on a first-name basis with United Airlines and Virgin America crews on the SFO-JFK route.

What has driven this blizzard in e-commerce innovation in the Big Apple?  I must admit I’m not sure.  It could be because much of the nation’s fashion business is centered there, or because of Manhattan’s world-class retail infrastructure.  But it’s extremely impressive.

Given this preamble, it’s probably not a big surprise that we’re investing in an e-commerce company in New York and that company is Fab.com, a site that features daily design inspirations and sales at up to 70% off retail.  The Fab.com site was launched in June of this year and has taken off like a rocket.

We were attracted to Fab for a number of reasons:

  • The team is great.  The founder and CEO of Fab is Jason Goldberg, a talented serial entrepreneur who also founded socialmedian and Jobster.  His co-founder is Bradford Shellhammer, a fantastic merchant with a fabulous eye for design.  Their engineering function is led by Nishith and Deepa Shah, both talented technologists.
  • Their execution has been extremely impressive.  They’ve nailed the product: both the website itself and the merchandise assortment.  The site and mobile apps are beautiful and very easy to use, and Bradford’s merchandise team constantly finds beautiful, inspiring goods to offer to consumers, typically at attractive values.  They’ve leveraged social extremely effectively, sourcing over half of their users, and they leverage data as effectively as any company I’ve ever worked with—startup or not.
  • They are playing in a big market.  The umbrella of “design” allows them to offer merchandise across a wide variety of categories (such as home products, jewelry, artwork, apparel, workplace items, toys and outdoor products) and price points.  The Fab merchants scour the world to source product from a long tail of great designers who often struggle to gain national distribution, and designers love that Fab.com sales are profitable for them.
  • Their early traction is simply phenomenal.  Jason is extremely transparent with Fab.com’s business metrics and recently revealed that the company is averaging $200,000 in sales a day.  Not bad for a company that made their first sale in June.
  • They have a very big vision for where they want to take the business.

I’ve rapidly become a big Fab.com consumer, as the UPS man and my spouse can attest.  It’s as close to addicting as anything I’ve ever experienced in e-commerce.

Fab.com is an example of a new wave of highly innovative e-commerce companies; indeed, I believe there has been more e-commerce innovation in the past few years than at any time since the beginning of the Internet, and at Andreessen Horowitz, we need to update our assumption of Valley centricity, at least when it comes to e-commerce.  Fab.com joins my partner John O’Farrell’s investment in L.A.-based ShoeDazzle as examples in our portfolio of this trend.

Jason signs off on much of his correspondence with the phrase “smile, you’re designed to”.  We’re smiling from ear-to-ear at the prospect of partnering with Jason, Bradford and the Fab team to build a big, important e-commerce company.