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Ecommerce

Dollar Shave Club and the bull case for eCommerce

By | Ecommerce, Uncategorized | No Comments

The cue for this post was Harry Stebbing’s 20MinuteVC interview with David Pakman, the partner at Venrock who led the Series A and Series B rounds at Dollar Shave Club and recently had his faith justified with a $1bn exit to Unilever.

He said that when he made those investments in 2012 and 2013 eCommerce wasn’t a hot sector with VCs and that remains the case now, but here at Forward Partners we’ve made a number of ecommerce investments and, like David and his partners at Venrock, think there will be more Dollar Shave Club scale exits going forward. We are happy investing in sectors where we see opportunity, even if others don’t.

If you poll investors for reasons not to invest in eCommerce you will generally hear three things: low margins, low multiples on exit and high working capital. Some will also throw in the threat of competition from Amazon for good measure.

These are all great points. There are plenty of eCommerce companies where these characteristics are risks and realities. Great care is advisable before investing in them. Without some extra bit of magic they will be unlikely to achieve huge exits.

But there are also eCommerce companies that escape some or all of these issues and many of them are good investment prospects. Here are three reasons why:

  • Consumers are hungry for direct relationships with the brands they buy. That’s part of the story behind Dollar Shave Club, Nike, Apple and many other iconic brands today. However, most traditional brands (think P&G, Unilever, much of traditional fashion) have never dealt directly with their customers and don’t know how. Meanwhile sales through their traditional retail channels are falling fast: creating the opportunity for upstart brands to steal significant market share. These direct-to-consumer eCommerce brands are often able to leverage their relationships and data to win on the basis of superior product. Example companies: Dollar Shave Club, Bonobos, Warby Parker and amongst our partners Spoke and Lost My Name.
  • Few traditional retailers are nailing it online. Their skills of supply chain management, curating a catalogue of product to fill their shops and in store merchandising are less important in the current online and omnichannel era. Today, inventory can be an order of magnitude larger and there are huge opportunities for curation and re-imagining supply chains. All the while, declining High Street revenues and high fixed cost bases are starving them of cash to invest in innovation. In their place what you might call eCommerce 2.0 businesses are offering consumers compelling personalised selections from massive inventories with marketplace, no-stock or stock-light models. They are able to scale rapidly and go global quickly. Amazon is the proto-typical example in this category, others include Jet.com, ASOS and amongst our partners Thread.comLive Better With, Hubbub and Patch.
  • Consumers have a range of preferences, styles and budgets and it’s hard to picture a future in which we don’t buy from a range of online retailers. Shoreditch locals don’t want to shop in the same places as investment bankers a mile south of here. As you might have read on this blog I have a ton of respect for Amazon but they aren’t going to take the whole market. In particular they aren’t good at the product categories where people don’t know what they want and traditionally look to retailers to help them make choices.

Online penetration of retail is now pushing 20% in the UK, so there is still a long way to go in this market. In his interview David said that after little interest in Series A and Series B rounds at Dollar Shave Club the Series C and Series D rounds were hotly contested. I think we will see a similar turnaround in investor appetite for eCommerce more generally.

E-comm opportunity – Surfacing products that consumers don’t even know they want

By | Ecommerce | One Comment

Benedict Evans recently published a post noting that there’s no Facebook of ecommerce. He notes that we get our news from sites like Facebook that direct us to articles we might find of interest from all over the world, but that when it comes to products there’s nothing similar. All we have is Amazon, which is amazing, but only when we know what we want.

As Benedict points out the main barrier to people buying things online now is knowing about them. If you know they exist you can find them on Amazon, or maybe Google. If you don’t know they exist then Amazon and Google won’t help you – you can’t search for things you haven’t thought about.

The analogue in traditional retail is walking into a shop because they have interesting things in the window, and then coming out with something you didn’t necessarily know you wanted. In this scenario the shop has generated the (foot) traffic and created a sale through curation and/or recommendation.

So, as Benedict says:

Someone needs to do the [online] demand generation – to tell you there’s something you might want.

In other words – they need to curate and/or recommend products that people don’t know, or aren’t sure, they want. That’s the broad middle of products that aren’t well known enough to be searched for but have wide enough appeal to be worth curating.

Forward Partners (and others) have been investing on this thesis for a bit now with two broad strategies:

  • Multi-brand retailers who build a loyal audience through recommendation and/or curation across a large range of SKUs. The key for these businesses is to have collections that resonate enough for customers to sign up for emails, notifications or other regular reminders to come back and check the service. This was the thing that Fab.com got very right – everybody loved receiving their Fab emails and clicked through to the site to see other cool stuff. Examples from our portfolio include Thread.com, Patch, and Snaptrip.
  • Vertically integrated single brand retailers who build an audience loyal to their small range of products. The key for these businesses is to have products that are strong enough to generate brand loyalty. Once again email is a powerful tool to drive repeat custom. There are many good sized US businesses with this approach – Bonobos and Warby Parker are two of the better known. Interestingly there are fewer in the UK and Europe. Examples from our portfolio include Spoke and Makers Academy.

The concept of the ‘broad middle’ points to other markets that might be interesting to build businesses that won’t have to compete with Amazon. In general it’s industries where there’s no dominant brand and online penetration is low – say sub 10%.

From a venture perspective the opportunities are investable if they can generate huge returns, and that’s a function of the number of people in the target market, how much they might spend with the service and the margin on that spend.

Physical retail in trouble as shoppers continue to move online

By | Ecommerce | One Comment

New data out from BRC-KPMG shows online sales of non food products grew 13.7% in the year to May 31st, taking online penetration of non-food to 21.2%. Physical retail of course went the other way decreasing 1.6% in the three months to the end of May. During that period we also saw the collapse of BHS and Austin Reed – both bastions of the UK high street.

Retail analyst Diane Wehrle from Springboard is now predicting that retail footfall is in permanent decline and CityAM are running headlines saying 2016 set to be year of retail failures.

At Forward Partners we’re all about creating innovative, new businesses and it’s never nice when industries suffer, but the continued demise of non-food physical retail has an air of inevitability about it. The number of shoppers is declining and prices are under constant pressure and that will leave an increasing number of shops unable to generate sufficient sales to cover their fixed costs. This is likely to be an accelerating trend as each new failure further reduces footfall.

It’s a different story online though, where new retailers are coming to market with innovative products and services. The erstwhile physical retail shopper has moved online because the services are more compelling. That’s sometimes about price, but more often it’s about product selection, personalisation and convenience.

79% of non-food sales are still offline and at current rates of decline that will be 69% in three years. UK retail spend was £339bn in 2015, so that equates to £34bn of business moving online. That’s an opportunity!

Whilst the short term is all about retail market share moving from offline to online many of the more forward looking companies have blended clicks-and-mortar models and I expect that is what will dominate over time.

What is vertically integrated ecommerce and when is it appropriate?

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Andy Dunn, the founder of Bonobos and one of the most thoughtful writers I know on ecommerce, penned a good piece yesterday entitled Digitally Native Vertical Brands. He was talking about what most of us describe as vertically integrated ecommerce, and gave the following definition:

  1. The primary means of interacting, transacting, and story-telling to consumers is via the web.
  2. It’s a brand, and that brand is vertical. The name of the brand is on both the physical product and on the website.
  3. The DNVB [vertically integrated ecommerce company] is usually maniacally focused on customer experience and on customer intimacy. The experience tends to be three-part bundle of physical product, web/mobile experience, and customer service that collectively become the brand in the consumer’s imagination.

He had a fourth point which added that there’s usually an offline extension to the brand. I agree that’s usually true, but isn’t a necessary condition.

He went on to say that vertically integrated ecommerce makes sense:

where there is some differentiation in the core physical product made possible by the DNVB nature of the model (and this is the key thing entrepreneurs get wrong in starting DNVBs the world doesn’t need)

For me this is key. If the product is the same as available via other channels then the only basis for differentiation is distribution and that’s unlikely to be enough for a startup to achieve success. Personalisation is a common way for vertically integrated ecommerce companies to differentiate their physical product (e.g. our partner company Lost My Name) and carrying a wider range of SKUs than will work in physical retail is another (e.g. our partner company Spoke).

The alternative model of multi-brand ecommerce makes sense when products are commoditised (e.g. Amazon) or when selection and choice are problematic (e.g. our partner companies Thread and Live Better With).

Andy says we are “in the first decade of a multi-century trend” towards vertically integrated ecommerce. I think we he’s right in that we will see more and more of it as new technologies open up new possibilities for customisation. Lost My Name, for example, because possible in 2013 after HP released a printer that could cheaply print high quality bound books with a production run of one. However, there’s an implication in Andy’s post that multi-brand ecommerce is on the way out. I’m not sure that’s true. Over the last three years Forward Partners has invested in both types of ecommerce business and I don’t expect that to change in the next three years.

The state of now – new Adobe data shows mobile almost matching desktop

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Shareovisitsday-by-day

With all the talk about mobile taking over the world it’s easy to forget that there’s still more traffic on the desktop. This holiday season just released by Adobe shows that on some days there was more traffic on mobile than desktop, but that mostly the desktop is ahead. If you turn to sales rather than visits then the desktop remains totally dominant with 73% of transactions.

Some of our companies see as much as 90% of their traffic on mobile I’m sure we will see more of that as devices and networks continue to improve, but this data shows us that having a well functioning website is still important for most ecommerce and marketplace businesses.

Forecasting ecommerce multiples at exit

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Ecommerce multiples

Mahesh Vellanki from Redpoint put up an interesting post yesterday about ecommerce valuations. His major point is that revenue multiples aren’t that high, largely because the market is highly competitive and margins are low – often because of Amazon.

As you can see from the chart above, in Mahesh’s sample most of the companies have revenue multiples in the 1-2x range. Etsy is arguably more of a marketplace than an ecommerce company and marketplaces have higher margins, more defensibility and hence attract higher multiples, so I would discount them. Similarly at the bottom end Groupon and Overstock are troubled companies that we can safely ignore on the assumption that any of our businesses that achieve big exits will be succeeding.

The major drivers of multiples are growth and margin. Fitbit enjoys a 3.3x revenue multiple because it’s strong on both these metrics. They reported 168% YoY revenue growth in the Q3 earnings report and their EBITDA margin is 19%. 1-800 Flowers, meanwhile is valued at 0.6x revenues because growth is much lower – forecast at 5-7% next year, and their EBITDA margin is 8%.

Apologies for getting a bit finance-geeky, and you may want to skip this paragraph, but a bit of corporate finance logic can explain the link between revenues, growth, and margins. At the end of the day a business is worth the net present value of future cash flows, EBITDA is a good proxy for cashflows, and future EBITDA is a function of revenues today, revenue growth and EBITDA margin. Hence the revenue multiple is directly linked to growth and margin.

For ecommerce startups assuming that if the business is successful the revenue exit multiple will be in the region of 1-2x is the way to go. Faster growth, and particularly higher margins will get you to the top of the range. Coupling this analysis with a view on market size and likely market share generates an exit value which in turn should determine the financing strategy. Most good VCs only want to invest in ‘fund returners’ which means that the exit value multiplied by their stake should be around the same size as their fund.

Evaluating markets for ecommerce category killers

By | Ecommerce | 2 Comments

Alex Malorodov (@amalorCBS), an MBA candidate at Columbia University who recently completed a summer internship at Gotham Ventures penned a great post about ecommerce category killers on CBInsights last week. His conclusions came from analysing seven top ecommerce category killers: Dollar Shave Club, Harry’s, Warby Parker, Frank & Oak, Bonobos, Casper and Helix Sleep.

The bit I liked best is that Alex found they all operated in markets with favourable conditions, which he lists as:

  • Total Addressable Market > $2B in US: offers opportunity for new entrant to gain share and build brand prior to incumbent retaliation;
  • High Concentration: > 50% of the market is controlled by ≤4 incumbents;
  • Limited Brand Allegiance: existing companies focus on selling product rather than lifestyle;
  • 3rd-Party B&M channels: incumbents typically distribute their offerings primarily via brick-and-mortar locations of other brands; little focus on e-commerce distribution;
  • High Headcount: > 60,000 employees each for the incumbents; and
  • High Price Point: the incumbents generally enjoy high margins and distribution involves several middlemen — a structural mitigator to lower prices.

The first one of these says that the market must be big enough, and the next five are characteristics of markets open to disruption.

The only thing I would add is that the incumbents offer a ‘so-so’ product. That’s arguably captured in the limited brand allegiance point, and Alex goes on later to say that the seven companies he analysed all offer great customer experiences and have high Net Promoter Scores, showing the importance of offering great product. ‘Great product’ is a relative concept though and unless there’s space to be way better than the competition life will be difficult. That difference can be price point – e.g. Dollar Shave Club and Warby Parker –  or it can be product quality – e.g. Frank & Oak and Harry’s.

Alex’s analysis ports well to the UK and Europe, and the biggest challenge we have from a venture perspective with many ecommerce ideas is potential market size. If a market is $2bn/£1.3bn in the US then if we pro-rata based on population is will be $400m/£265m here, which, depending on margins, is on the small side to build a £100m+ business. (10% net margin on a 10% market share yields profit of £2.65m – a good business, but probably not a £100m exit.)

Hence we either look for larger UK markets or the ability to expand internationally.

Two areas of opportunity in ecommerce

By | Ecommerce, Forward Partners, Startup general interest | No Comments

Kara Nortman of Upfront Ventures has just published an interesting and well grounded post on the future of ecommerce which got me thinking about where we see opportunities. I think there are two broad areas (Kara lists four, but I merged her four into two).

Brandtech – new brands that change stodgy industries

Simplified formula for success:

  1. target a large and valuable segment with poor product or unsustainably high margins
  2. deliver a great product and brand

As Kara notes this formula has played out well for numerous companies, including Warby Parker, Transferwise, Made.com, Just Eat and many others, but there are still many verticals with space for innovation, including food, soft home goods, furniture, toys, and educational products.

Forward Partners investments in this area include Lost My Name, Spoke, Zopa, Wool and the Gang, and Makers Academy.

Modern merchandising – new services that revolutionise how we shop

Simplified formula for success:

  1. target a large and valuable segment with a poor customer experience
  2. deliver a wow customer experience

This formula has also played out well for numerous companies, including Netflix/Lovefilm back in the DVD days, MoneySupermarket, Confused.com, Uber, and many others. Once again there are other verticals that are still ripe for disruption, including many of the ones listed as open under Brandtech.

Forward Partners investments in this area include Thread.com, Top10, Appear Here, Edge Retreats, Snaptrip, Live Better With, and The Gifting Company.

There’s obviously a lot more to building a business than the two simple steps I’ve listed hut the themes of great and/or radically cheaper product and radically better customer experience are big ones for Forward Partners.

 

Volume of global ecommerce exits growing nicely

By | Ecommerce, Startup general interest, Uncategorized | No Comments

CB Insights posted this chart on Twitter today. As you know at Forward Partners we’re ecommerce and marketplace investors, so we like to keep tabs on all aspects of the ecommerce market.

Historically there haven’t been many exits in ecommerce, so it’s good to see the number rising. I think this trend has some way to go because ecommerce penetration is still only in the low teens in the UK and US and is lower still in many other countries.

To really kickstart the exit market we need a few more huge ecommerce businesses to compete with Amazon. That would unlock the sort of strategic exits we’ve seen in software and consumer internet over the years.

Until then it’s important to make sure the fundamentals of a company add up so that they will be able to make substantial profits once they hit scale.

The UK is still hot for ecommerce

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Us Brits are famously a nation of shoppers, and that’s translated into being a nation of online shoppers. For a while we’ve spent more online per head than other developed economies and created more than our fair share of ecommerce winners as a result.

New data out from eCommerce Europe shows the picture hasn’t changed and that there’s still a lot of growth to come:

  • in 2013 the UK spent $142bn on eCommerce, third in the world on a gross spend basis behind the USA and China which have much larger populations. Germany, the next European country on the list, was two places behind the UK with $84bn spend. Germany has a population of 81m and the UK has 64m people.
  • Global eCommerce is forecast to grow at 23% 2013-2014 and 18% 2014-2015. Within that the UK eCommerce is forecast to grow at 17% 2013-2014.
  • There are 7.4bn people in the world of which 4.2bn are online and only 1.0bn are e-shoppers. The equivalent figures for Europe are population: 881m, online: 564m, e-shoppers: 331m.

Lots of eCommerce markets have now been ‘done’ from a venture perspective, but there’s still lots of opportunity ahead of us.