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.


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:

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:


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: 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”!

I recently blogged about the “Series A Crunch” and recommended ways for entrepreneurs to try to avoid its ugly clutches.

But I soon discovered a glaring omission in my recommendations.  I had addressed strategies like raising more money, structuring the round to include more institutional money and investors, cultivating these investors after the raise and resisting the temptation to raise prematurely.  But one strategy that I failed to detail was to make the money last as long as possible, affording the entrepreneurs the maximum amount of runway on which to demonstrate results.  And no company demonstrates the effectiveness of this strategy more than our most recent investment, 500px.

Oleg Gutsol and Evgeny Tchebotarev started 500px in late 2009.  They bootstrapped the business for almost two years and finally raised their first outside money in 2011—a very modest half a million dollars.  They added additional capital in 2012, bringing total outside capital in the company to a just a couple million dollars.

500px is a site for photographers to display their work, enabling it to be viewed, engaged with and even sold.  Oleg and Evgeny have been hard at work on 500px for about four years.  What did they accomplish during this time with only a couple million dollars?  Check this out:

  • 500px is one of the most visually stunning sites I’ve ever encountered.  I love photography, and I find browsing through the highest rated pictures on 500px to be a mesmerizing experience.  No more need to trek to museums; 500px brings some of the world’s best photography to you online.
  • They have experienced very rapid user growth.  The site currently has 2.5 million registered users and over 10 million monthly active users.  And these users are global.  It turns out that gorgeous, world-class photography speaks a universal language.
  • The 500px community is passionate about and phenomenally engaged with the site.  The site currently gets over a billion page views each month.  This photo of the Milky Way over the Himalayas, for example, received over 3.6 million views.  And looking at it, I think you can understand why.
  • They have started to build products that drive monetization but are highly complementary to the user experience.

This level of progress on just a couple million dollars is extremely impressive.  We can’t wait to see that they can accomplish with the additional resources from this round.

And no blog post about gorgeous photography would be complete without a bit of eye candy.  Here’s a quick homage to San Francisco courtesy of the 500px community:

We are delighted to be partnering with my very good friend Michael Dearing of Harrison Metal on this investment.  Michael will be joining the board of directors.  I can’t think of anyone better to support the efforts of Oleg and Evgeny to build one of the world’s leading photography brands.

It seems like there has been a veritable explosion of companies that are leveraging technology to build “people marketplaces” that provision various services.  On one side of these marketplaces, consumers are afforded a new channel to procure needed services.  On the other side, individuals are empowered to earn money performing the services.

These marketplaces come in two general flavors.  There are horizontal platforms like Zaarly, TaskRabbit, Gigwalk and Fiverr that let consumers find providers of a wide variety of services.  And there are vertical platforms that focus exclusively on one service vertical, such as Lyft and SideCar for hopping a ride, Homejoy for house cleaning, Instacart for grocery deliveries and DogVacay for boarding your dog.

I am a huge fan of the concept of economically empowering a community of users.  eBay has done this for 15 years in goods (and that mission is what most attracted me to the company), and these new companies are now doing it in services.  And this economic empowerment is critically important: It’s becoming obvious that the concept of permanent employment is waning, and the resulting persistently high unemployment rate creates millions of people who need economic opportunity.

After meeting with scores of these companies, we’ve been drawing a few hypotheses in the space:

Vertical vs. Horizontal Plays

While many of the horizontal platforms are doing interesting things, we tend to think that the vertical approach is resonating more with consumers.  Most of the companies that are showing early signs of breaking out tend to target one vertical.  Our hypothesis is that the horizontal plays may suffer from a potential “paradox of choice”: Consumers could be getting overwhelmed by the seemingly infinite array of potential service options presented by horizontal platforms, but consumers can easily understand the highly specialized value proposition of a company offering services in one vertical.  When you use the Lyft app, for example, it’s immediately obvious that you can get a ride from where you are to where you want to be.

My partner Chris Dixon points out that vertical approaches have additional advantages.  From a product perspective, the vertical apps can tailor their workflow to the unique characteristics of that vertical—the best way to find someone to clean your house is different than the best way to find a ride.  And from a marketing perspective, a narrow focus on one vertical lets the company do things to potentially accelerate each side of the two-sided marketplace.  For example, some companies work to jumpstart their business in a new market by initially subsidizing their early service providers to ensure that the marketplace has liquidity for consumers when it launches.

Convenience vs. Value

There seem to be two high-level value propositions emerging for these services:

  • Some position themselves as primarily a convenience and typically charge a premium for it.  There have been mobile car wash services that will come to you to wash your car, but they would typically charge you more than a physical car wash would for that convenience.
  • Others position themselves as both a convenience and a value, typically by disrupting an inefficient legacy supply chain.  YourMechanic will come to wherever your car is to perform any of a wide variety of car maintenance and repair services, and will charge you less than you’d normally pay if you were to drop your car off at a garage.  It turns out that the service department at your car dealer has become their only segment that earns decent returns, and service typically subsidizes other less profitable auto segments.  Not surprisingly, these garages then pay mechanics a very small share of what they charge consumers.  Their bills get so bloated that YourMechanic can charge significantly less than garages for a service, pay their mechanics higher wages to perform it, and still earn attractive returns.

It appears that the early breakouts in the space are those that offer both convenience and value.  It’s clear that the market size of people who are willing and able to pay a premium for convenience is much, much smaller than those who are attracted to both convenience and value.  For example, a service that charges a premium to come to you to wash your car may work well on Sand Hill Road, but it’s unlikely to have broad national appeal and disrupt the physical car wash industry.

We believe that some very interesting companies are in the process of emerging in this space, and we plan to remain active in it.

(Note: a16z has a venture investment in Lyft and is a seed investor in DogVacay, Homejoy, and YourMechanic).

The venture industry is awash with talk of the “Series A Crunch”, where it’s getting progressively more challenging for seed companies to land follow-on financing.  In my short two-year tenure as a full-time investor, I’ve seen this crunch hit very hard at a number of quality early-stage consumer companies.

Why is this happening?  A number of factors are coming together to create this crunch:

A significant supply/demand imbalance has emerged between seed and Series A financings coming out of the economic near-meltdown of 2008-2009.  In 2009, there were about the same number of seed and Series A financings, but the number of seed deals have exploded since then while the number of A-rounds grew only modestly.  In 2012, there were 2.5x as many seed financings as A-round financings, whereas historically these were more in balance.  This suggests something like 60% of seeds could be stranded.

Investor expectations have expanded substantially.  It’s become steadily less expensive to launch many consumer-oriented Net businesses over the years due to things like Moore’s law, improving programming tools, the cloud and the ability to access users from multiple large platforms.  Now we often see the kind of traction that we used to expect from Series B companies in Series A companies, and from Series A companies in seed companies.  For example, a number of our recent Series A investments built multi-million dollar revenue run rates on their seed round.  We’re getting spoiled.  Combine this with the above supply/demand imbalance and you’ve got a situation where the bar is being raised exactly when the competition for the A-round is becoming particularly fierce.

The source of seed capital has been changing.  In recent years, the amount of seed investment from non-traditional institutional sources has increased dramatically.  More and more seed capital is coming from sources like angels, “super angels”, micro-VCs and incubators.  To under-score this point, we have close to a thousand separate angels as co-investors in the consumer companies in our less-than-four-year old portfolio.  This influx of new capital has arguably had an inflationary impact on seed valuations, which obviously has an initial attraction to many entrepreneurs but can create challenges in a “crunch” scenario.  These non-institutional sources of capital are not inclined or structured to potentially help a company secure additional capital in a crunch.  And the higher valuations provide a higher hurdle that must be overcome by potential new investors in a crunched company.

The number of potential Series A investors appears to be contracting.  The venture business is showing early signs of a significant consolidation.  The amount of capital invested has trailed the amount raised for a number of years, and the capital that is being raised is increasingly consolidating among fewer, larger firms.  The number of investors who can write that Series A check is starting to fall.

The impact of these factors is playing out before our eyes.  We’re seeing more and more potentially promising companies who have spent much of their seed round to generate solid early traction, but not the kind of traction that sets them up well for a Series A financing these days given the higher bar.  These companies face a brutal situation.  They are running low on money.  Prospective new investors want more proof, particularly given the higher seed valuations.  And many of the existing investors, particularly on the angel side, become “tapped out” or “want to stay diversified” when approached for bridge financing.  These companies’ futures are rapidly called into question.  It’s been very painful to watch.

So here are a few suggestions for entrepreneurs who are trying to start consumer-oriented Internet businesses:

Raise more money in the seed round to give yourself runway to make the progress you’ll need for a Series A, along with some contingency if things don’t go perfectly along the way.  The size of seed rounds has increased substantially in our firm’s short history, from under $1 million a few years back to almost $2 million this year.  But I’d argue that even these larger new rounds are often too small given the rising Series A bar.  Increasingly, a $1 million to $2 million raise requires absolute perfection on the part of the entrepreneur.  You should consider suffering a bit more dilution early on to secure the resources to deliver the metrics that will attract the more demanding Series A investors.  Things like up-and-to-the-right user and revenue results, deep engagement, compelling cohort economics, and a proven ability to acquire users with a positive ROI on their marketing spend.

Structure your round differently.  I’d suggest getting more institutional participation in your seed round, as institutions are more likely to support a high potential but not-yet-ready-for-Series-A company in the event it encounters the crunch.  That in no way suggests that follow-on financing from institutions is a certainty or even more likely than not, but my observations suggest the odds are higher.  Similarly, consider structuring your seed deal in a way that doesn’t scare off potential new investors in the event that you’re facing a potential crunch.  Obviously these recommendations can be interpreted as self-serving given my role as an institutional investor, but my motivation for writing this is in the hopes of helping even one entrepreneur avoid the pain and suffering I’ve been witnessing by those who have been caught in the crunch.

Raise from multiple institutional investors.  This can help accomplish a few things.  First, it brings more deep pockets to the table that can fund a Series A or a bridge if needed.  Second, it can fire up the competitive juices of the participating VCs, who don’t want to risk losing out to a rival on the A round at a hot seed company in which they’re both invested.  Lastly, having multiple VCs can diminish any potential negative signaling issues down the road if an institutional investor in your seed round does not do the A.

Cultivate these institutional investors as you launch the company, updating them periodically on your progress and learning.  Some entrepreneurs do this extremely well, managing to stay top-of-mind with investors and building a relationship, a track record and credibility.  These can come in very handy with investors if you find yourself potentially entering crunch territory.

Resist the temptation to raise too early.  We often encounter companies who come to us saying that they had inbound interest from another/other firm(s) and elected to use this as a signal to start broader fundraising conversations.  But there’s interest and then there’s interest.  One of the jobs of a VC is to network broadly with potentially interesting companies, and their “interest” more often than not does not result in funding.  And if you swing and miss at an early round, it can be much harder to create positive momentum behind an A round once you go out again.  You need to be disciplined.  Wait until you have multiple months of metrics moving in the right direction before you start fundraising.  Resist the temptation to talk to every prospective investor who calls when you’re not fundraising.  Ironically, nothing piques the interest of an investor more than an entrepreneur who remains relatively inaccessible.

There are signs that the startup ecosystem is already correcting to mitigate the crunch going forward.  The number of new seed financings is down meaningfully so far in 2013, which would help to correct the supply-demand imbalance.  And capital is starting to be attracted to the gap between seed and traditional A rounds, which some term “mango seeds”.  But higher investor expectations earlier in a startup’s life are here to stay, and the smart entrepreneur will take steps to mitigate follow-on financing risk.  On each and every financing, they should ask themselves one key question: What do I need to prove in this round to get the next round?

Note: I’d like to thank my partner Chaz Flexman for his many insights on this post!

Amazon and Google are on a collision course.

When I was at eBay, we had a belief that no one was going to compete with us by replicating exactly what we were doing.  We had first mover advantages and network effects.  Amazon and Yahoo! both launched auction marketplaces in response to eBay’s strong growth, and both businesses were essentially DOA.  What did concern us was that someone would compete with us with a new, disruptive approach—a completely different take on the business.

Early on, we came to believe that Google’s emerging search business was the biggest threat that eBay faced.  eBay helped users find hard-to-find, unique products.  Google’s goal of organizing the world’s information also helped users find hard-to-find, unique products.  The mechanisms and models were different, but the overlap was clear and we came to view Google as our top competitive threat.

This thought was validated after the fact by then-Google executive Sheryl Sandberg.  We both were guest speakers at the same Intuit event a few years back, and I stayed after my talk to listen to Sheryl.  In response to a question, Sheryl said something along the lines of, “We knew early on at Google that our key competitor was eBay.”  I almost jumped to my feet shouting, “I knew it!”  It did not make me feel any better that eBay was one of Google’s very top advertisers at the time, and that we were paying them tons of money that they were in turn using to compete with us.

In Google’s case today, I am becoming increasingly convinced that their most challenging competitor isn’t another search engine like Yahoo!, Bing, Baidu or Yahoo! Japan.  It’s Amazon, which is bringing a completely different take on search—in this case, product search.

Amazon is a vertical search engine focused on helping users find products.  The overwhelmingly dominant way to find things on their site is the search box.  Users enter a keyword phrase and are presented with results that match his or her query.   The order of the search results is determined by algorithms that seek to optimize relevance and monetization.  Sound familiar?

In my personal website use, I increasingly find myself searching for products on Amazon instead of Google.  Shopping on Amazon is a superior user experience and it runs the table on the magical retailer formula of selection, price and convenience.  It has an increasingly comprehensive product assortment, with their ever-expanding direct sales supplemented by third-party merchants who sell on the platform.  Prices are almost always extremely competitive, so much so that I have pretty much stopped using Google to comparison-shop at different merchants.  And it offers the fastest and most cost effective shipping solutions, particularly in Prime (which has the interesting impact of making me want to buy goods on Amazon to make sure I get the most out of my $79/year Prime membership).  I can buy an item on Amazon in a minute, secure in the knowledge that I’m likely paying the lowest price while getting free shipping and fast delivery.

Contrast that with the shopping experience on Google.  Shopping on Google is work.  It has infinite selection…if you can manage to find what you’re looking for amidst the forest of search results.  You have to work to find the best price, typically by pogo-ing in and out of different search results to check both prices and shipping costs.  And when you find a product you want to buy from a new merchant, you need to enter all the payment and shipping information from scratch.  Buying on Google takes chunks of an hour, not an Amazon minute.

Apparently, lots of consumers are behaving like me.  Amazon is on a growth tear and is rapidly gaining share of e-commerce.  A quick calculation suggests its $35 billion of 2012 net sales in North America represented a whopping 16% market share of total North American e-commerce.  And this probably understates their true position.  Amazon’s revenue recognition policies allow them to record only the commission and shipping fees on sales by third-party merchants as revenue.  If you were to consider the actual consumer spend (comparable to eBay’s Gross Merchandise Volume number), then their share would be substantially higher.

E-commerce merchants now also have a very viable advertising alternative to Google: they can list their products for sale on Amazon through the Amazon Marketplace program.  Amazon is currently generating billions of dollars in sales for these merchants, and these third-party sales are growing significantly faster than Amazon’s direct business.  Merchants typically migrate to where customers are, and the customers increasingly are on Amazon.

This has to be a very big deal for Google.  Virtually all of Google’s revenue comes from advertising ($44 of $46 billion in 2012, excluding the Motorola acquisition), and the majority of that comes from search.  And possibly their largest advertising category is shopping.  Google doesn’t release information on their largest advertisers, but it’s become a sport for third parties to reverse-engineer the results.  Take a look at a recent effort by Wordstream in the chart below.  They report that four of Google’s largest 10 categories are different segments of retail in which Amazon competes, and that many of Google’s largest advertisers are retailers:


Given this context, it’s not surprising that Google has been hard at work on product search.  They recently completed a revamp of their product search results and have significantly enhanced its prominence.  Check out this search for a Canon EOS 7D, a high-end camera.

They have also announced new initiatives that at first blush appear atypical for a search company:

  • In the past few months, Google has launched a test of a same-day delivery service called Google Shopping Express in San Francisco.  It’s free for the first six months, and already includes merchants such as Target, Staples, Toys-R-Us and Walgreens.
  • Through Google BufferBox, Google has plans to place secure boxes in convenient locations throughout a city to which you can have parcels shipped to for easy pickup.  They just launched their first location in San Francisco, with many more likely to come.

These initiatives are not about organizing the world’s information, they’re about enhancing the shipping experience on products bought through Google.  It’s part of Google’s effort to shore up their start-to-finish shopping experience, trying to bridge their rapidly growing gaps with the hyper-aggressive Amazon and protect their multi-billion dollar advertising business with retailers.

Interestingly, this competition could be used to help explain one of what I initially considered to be Amazon’s more unusual efforts, A9.  According to their website, A9 “manage(s) critical capabilities – high availability, cross-platform, scalable products search and an advertising platform that serves advertisers and publishers alike – for our parent company Amazon and other clients.”  If I’d read this statement without the company being identified, then I’d have assumed they were describing Google.

E-commerce is clearly the future of retail and there is a growing battle brewing for dominance in this new world.  Amazon is bringing a vibrant alternative to product search and they’re threatening one of Google’s core businesses.  Google’s market cap as of this writing is $272 billion, while Amazon’s is $113 billion.  Godzilla is going to war with Mothra and it promises to be very interesting to watch!

For those of you who don’t yet know this about me, I am a basketball fanatic.  Twice a week for the past 10 or so years, I’ve organized a basketball game at Stanford.  At the end of the year each year, I ask the participants to chip in so we can buy gifts for the Stanford folks who provide the logistics that enable us to play.  And truth be told, this has been a pain-in-the-butt every year: asking people to pay, keeping track of who paid, reminding folks who haven’t yet paid. Invariably, I end up covering the shortfall from people who neglect to pay (and to make myself feel better, I stop passing the ball to them for a while as a result!).  But a while back, I realized that the shortfall wasn’t because of the monetary cost—it was because the manual process is inconvenient for all parties involved.

This experience is one of the reasons why Crowdtilt resonates so strongly with me.  It’s a simple concept, with powerful potential.

Now crowdfunding is not a unique idea, but we found Crowdtilt to have a unique approach: They are building a horizontal platform that can be used by groups for virtually any kind of fundraising.  The type of campaigns ranges widely and include day-to-day things like funding a tailgate before the football game, chipping in to buy a wedding gift, collecting for a fantasy football league or paying for concerts tickets.  But the company is also hosting campaigns that strongly reinforce the potential breadth and impact of the uniquely simple and effective Crowdtilt platform:

  • Residents of the town of Edwardsville, Illinois, helped keep the Once-Upon-A-Toy toy store open by raising $82,450—more than the $75,000 the business needed to stave off liquidation—in only two days.
  • Parents at the Weilenmann School of Discovery in Park City, Utah, raised $36,478.56 to keep the science program at the Lower School in just about a week.
  • Students at Vanderbilt University in Nashville, Tennessee, along with a few good Samaritans, raised $10,331.30 in less than 24 hours to enable their classmate Ayodele Sonupe to make a $10,000 tuition payment and continue his education in the States instead of having to return to his native Nigeria.

At a16z, there are a couple of key characteristics that we love to see in a founding team.  One is what we call “product/founder fit”—where the business is the obvious calling of the founder, so much so that we have a hard time imagining anyone else doing it.  We found James to be a poster child for this.  James studied development economics at Wake Forest due to his passion for the role that microfinance and micro-insurance could play in alleviating poverty in the developing world.  While in school, he received a research grant from Wake Forest and the Atlantic Coast Conference that enabled him to get on-the-ground experience in this area in post-conflict regions of Africa.  Upon graduation, he opted to move to South Africa and took a job as a loan officer at the Kuyasa Fund, where his job literally was knocking on doors to collect microloan repayments.  While there, he started a microfinancing blog and news aggregator called MiFi Report, which over time became the number one result for microfinance news on Google.  He eventually got the idea to apply his love of technology to his love of international development and morphed his blog into a poverty alleviation-focused, crowdfunding platform called  Unfortunately, regulatory changes following the banking crisis of 2009-2010 made that original business untenable and he had to shut it down.  He quickly returned to the States and started another crowdfunding platform with co-founder Khaled Hussein, this one with an eye towards helping any group collect money for anything.

Another key founder characteristic that we value very highly is determination, and Khaled is a poster child for this.  He grew up in Alexandria, Egypt, and first saw a computer in his senior year of high school when he was 18 years old—and he went nuts!  He started an offshore development company in Egypt before coming to the United States.  Within just five years, he earned a M.S. degree from Virginia Tech in Computer Science and Human Computer Interaction and entered their Ph.D. program.  He then put his education on hold to join a startup called that was sold to Rackspace—where he would later help lead their corporate strategy at the age of 26.  After Khaled was introduced to James, he joined him quickly to found Crowdtilt (James can be very convincing).

A third characteristic we hold dear is a big vision.  And the Crowdtilt that James and Khaled envision is massive.  Better yet, they can make you believers within just a few minutes!

We have come to share their belief that Crowdtilt has almost unlimited potential.  There are tons of places where groups and money interact in a fragmented and disconnected mix of both online and offline ways.  The Crowdtilt team recognized this, and earlier than most startups, built and released an API that allows other online services to take advantage of their collaborative payments engine.  And their small team has only scratched the surface of extending the Crowdtilt experience.  Imagine that you’re on a site where you’re planning a trip, and you’re able to to book your vacation rental with the four other friends going on the trip.  Or imagine that you’re viewing a wedding registry, and you and other guests can collaborate on purchasing an expensive item for the bride and groom.  It’s collaborative payments for an increasingly collaborative Web and world.

The company is off to a great start.  They are growing rapidly and building a killer team.  Their metrics are “way up-and-to-the right”, they are in the process of working with a number of online businesses to debut collaborative payments to their sites, and TechCrunch named them one of the five best startups of 2012.

We are thrilled to be supporting the efforts of James, Khaled and the team.  And I personally look forward to deploying Crowdtilt to collect the gift money for my hoops games.  Hey, maybe I could even use it to collaboratively fund the combined tuition payments of my twins as they enter college!  I wouldn’t be the first to use the young service in this way.

We at a16z believe we are seeing the “creative destruction” of traditional physical retailers by their online competitors.  At a high level, this is happening for two reasons.  First, e-commerce companies are substantially advantaged in terms of cost structures, particularly in areas like real estate, labor and inventory.  Second, we believe that we’re seeing an explosion in innovation among online retailers that we refer to as “e-commerce 2.0“—where companies are innovating across numerous dimensions including sourcing, curation, distribution models and social marketing.

On Thursday, Julep, a fast growing online beauty brand out of Seattle, announced that Andreessen Horowitz led their $10.3 million Series B round (here).  There’s a whole lot we like about Julep:

  • They are participating in a very attractive market: the beauty category.  The market is huge, with global sales estimated at $160 billion, and we believe it’s ripe for disruption by online competition.  Offline beauty moves slowly and is expensive.  Brands are distributed largely through department stores, where the brands must rent real estate, hire staff and fill the space with inventory.  Product refreshes typically happen twice a year, and retailers demand the brands support their products with large marketing campaigns.  Online beauty competitors are freed from these costs and constraints of their offline rivals.  Julep sources their own products and their ability to deliver new product constantly help them stay current with fashion trends.  And their direct-to-consumer relationships help them largely avoid the very expensive offline channel costs.
  • Julep is run by a very determined team.  Founder and CEO Jane Park and Chief Experience Officer and COO Kate MacDonald started the business by operating four nail polish parlors in the Seattle area to get hands-on customer knowledge and feedback.  They managed to secure physical distribution through Sephora and QVC for their early stage company to help establish their brand.  They are well along the way in building out a vibrant Web presence.  Jane and Kate are completely driven to develop a world-class beauty brand.
  • They have developed a very innovative business model, selling both subscriptions and a la carte product side-by-side.  This is hard to do.  Typically, many people won’t sign up for the commitment of a subscription if the same product is available without that commitment.  But Julep provides meaningful discounts on their products through the subscription channel relative to a la carte pricing, providing an incentive for women to delight themselves with their monthly Julep care package.

The company is off to a very strong start.  The products are great—as my 18-year-old daughter Ali tells me constantly.  Part of my diligence was bringing her home a care package of Julep products—I was a very popular father that evening!  Their brand is out-sized to the stage of the business.  For example, they were selected as one of Oprah’s “Favorite Things” of 2012, a highly coveted endorsement for any brand.  As a result, their growth trajectory has been extremely impressive.

Julep is a perfect example of an e-commerce 2.0 retailer:

  • They source their own product, which allows them to offer consumers strong value while retaining attractive margins.
  • They carefully curate the product assortment in their monthly subscriptions, tailoring them to the different style preferences of their customers.
  • They adroitly leverage the subscription business model.
  • They empower their passionate community of users to spread their enthusiasm through social channels, helping to build their brand and customer base.

We believe the next generation of great retail brands will be built online, and we believe Julep is well on their way to becoming one of these brands.

I’m also delighted to announce that Spencer Rascoff will join the Julep board.  Spencer is CEO of Seattle-based Zillow, one of the largest Internet real estate businesses.  I first met him when I served on the board of Hotwire, an Internet travel business that Spencer co-founded. He is an experienced, extremely talented Internet executive and a very good guy.  We’re delighted to have the benefit of his talents at Julep.

Online is clearly taking share from brick and mortar…this is likely to continue
—International Council of Shopping Centers, last week

America has too many malls.

I’ve recently blogged that many traditional brick-and-mortar retailers are being threatened with “economic destruction” by their advantaged online competition.  In an interview with Bloomberg TV, anchorwoman Nicole Lapin asked about the implications of this dynamic on retail real estate.  I said I hadn’t studied it, but I thought the ramifications would be very big and very negative (I believe the phrase “apocalyptic” was used).

I’ve since had the opportunity to spend some time looking at this issue, and I believe we’re seeing clear signs that the e-commerce revolution is seriously impacting commercial real estate.  Online retailers are relentlessly gaining share in many retail categories, and offline players are fighting for progressively smaller pieces of the retail pie.  A number of physical retailers have already succumbed to online competition including Circuit City, Borders, CompUSA, Tower Records and Blockbuster, and many others are showing signs of serious economic distress.  These mall and shopping center stalwarts are closing stores by the thousands, and there are few large physical chains opening stores to take their place.  Yet the quantity of commercial real estate targeting retail continues to grow, albeit slowly.  Rapidly declining demand for real estate amid growing supply is a recipe for financial disaster.

There are very few thriving physical retailers these days outside of the daily consumables markets.  I did a quick analysis on the high-level health of the National Retail Federation’s list of the Top 100 retailers in 2012, focusing on merchandise retailers that would likely be located in malls (removing grocery, drug, restaurant and online retailers).  I looked at three measures of retailer health: total sales growth, comp store sales growth and number of stores. Top 100 Retailers

The analysis doesn’t paint a very pretty picture regarding the health of the leading physical retailers in the United States.  Total sales growth is mixed and is negative for 20% of the sample.  Comp store sales growth—arguably the key measure of retailer health—is also mixed and a quarter of the sample is negative.  And note that many of these sales results include the retailers’ online segments, so the picture for their physical stores is even worse.  Lastly, store counts are simply stagnant—about as many top retailers shrank their store count as expanded it, and precious few are expanding aggressively.  The largest retailers in the U.S. do not look very healthy.  And if they’re struggling, it’s likely that their more marginal physical competitors are struggling even more.

I went back to the Top 100 retailers in 2007 to see how that crop had fared five years later and found that four of these top retailers had already gone away through Chapter 11.  Interestingly, the picture of these four doesn’t look that different than the 2012 list.

2007 chart

Source: Top 100 Retailers

This declining retailer health is directly impacting malls and shopping centers in the form of very high vacancy rates and sluggish rents—exactly what you’d expect to see where supply exceeds demand.  Both factors deteriorated quickly during the economic crisis of 2008-09, but they’ve shown virtually no improvement since in spite of improved economic conditions.  The recession was the catalyst, but competition from online retailers can only be the continued driver.  The mall business isn’t very healthy either.

Regional Mall Trends

Neighborhood and Community Center Trends

These trends are hitting the market capitalizations of most of the largest owners of retail real estate.  Simon, General Growth, DDR and Kimco between them own over 600 MILLION square feet of U.S. retail real estate, according to nreionline.  Simon’s stock has performed strongly, but the other three stocks have created virtually no value over the past decade.

Stock Performance

Source: Yahoo! Finance

Most real estate professionals understand that profound changes are afoot.  Don Wood, CEO of Federal Realty Investment Trust, says  “there is too much retail supply in this country.”  The Wall Street Journal reports “Green Street Advisor, an analysis firm that tracks REITs, has forecast that 10% of the roughly 1,000 large malls in the U.S. will fail within the next 10 years and be converted into something with far less retail.  That’s a conservative estimate; many mall CEOs predict the attrition rate will be higher”.  And Daniel Hurwitz, president and CEO of DDR, observes, “I don’t think we’re overbuilt, I think we’re under-demolished.”

I agree with the above perspectives, although I believe they likely understate the eventual impact on malls.  A report from Co-Star observes that there are more than 200 malls with over 250,000 square feet that have vacancy rates of 35% or higher, a “clear marker for shopping center distress.”  These malls are becoming ghost towns.  They are not viable now and will only get less so as online continues to steal retail sales from brick-and-mortar stores.  Continued bankruptcies among historic mall anchors will increase the pressure on these marginal malls, as will store closures from retailers working to optimize their business.  Hundreds of malls will soon need to be repurposed or demolished.  Strong malls will stay strong for a while, as retailers are willing to pay for traffic and customers from failed malls seek offline alternatives, but even they stand in the path of the shift of retail spending from offline to online.

This in turn creates further opportunity for online commerce.  If I were thinking of starting a new retail brand right now, I would unquestionably start it online.  And many very talented entrepreneurs are doing just this! I personally shop at Bonobos for pants, J.Hilburn for sweaters, Ledbury for shirts and Warby Parker for eyeglasses.  All of these brands design and source their own goods.  They historically would have started in the mall but they now are starting online, a trend that will undoubtedly continue.  There clearly will be fewer new offline retailers to take the space vacated by the disappearing brick-and-mortar chains, further pressuring malls.

And in an ironic turn, many of these online brands are experimenting with offline stores—but typically with some important twists.  Bonobos and Warby Parker have built showrooms in their New York offices where consumers can come in and try on samples.  But if the consumer wants to purchase items, then the companies fulfill the product from their warehouses—they don’t stock inventory in their “stores”.  Bonobos has expanded this concept into a few additional locations, but not mall locations.  Instead, they are selecting lower cost, non-mall locations and using emails to their online customers to drive folks to these locations.  They do this because a consumer’s purchasing typically expands after a visit to their physical store, and the costs are not high given the lack of inventory and lower rents and staffing costs.  If this trend expands, it will provide further challenges to malls.

In researching this post, I came across a fascinating (and slightly morbid) website called, a site that chronicles the tales of hundreds of already or soon-to-be dead malls.  Co-founder Brian Florence writes, “I started with my friend Peter Blackbird in 2000 when we both realized that Pete had mountains of data about dead and dying malls stuck up in his head.  Why keep this information to yourself?  And, realizing the burgeoning power of the Internet and its ability to draw in more information, the site was created to harness stories of woe and merriment from others.  It’s been a great success.”

Unfortunately for mall owners, the content on is about to expand substantially.  There just are too many malls in America, and this will only get worse.