Finding Genius

by Kunal Mehta

  Meanwhile, we saw many closures of physical stores in the US — this phenomenon was coined by many as “The Retail Apocalypse.” However, the truth of the matter was that retail wasn’t dying — it was evolving. In fact, total retail spend has continued to grow steadily in the US, from $4.35 trillion in 2012 to $5.35 trillion in 2018. One metric that people often overlook is that while online retail has been growing rapidly, even today it still only accounts for 10% of total retail spend (up from 6% in 2014.) Physical retail wasn’t undergoing a one-dimensional apocalypse; it was just evolving to meet the needs of the changing consumer, so certain formats were beginning to decline as they were no longer relevant for the modern consumer. Consumers no longer needed to seek assortment in stores when they could easily find endless options online (especially with two-day shipping by Amazon.) Instead, the role of stores began shifting to be about experience, brand, and emotional connection.

  Steph Korey, CEO of Away, calls her physical stores “physical billboards.” The next generation of physical stores are no longer simply places to find assortment or restock on goods — they are physical expressions and stories of culture. For example, Winky Lux’s beauty pop-ups are referred to as “The Museum of Ice Cream” for beauty — not only are consumers willing to pay an entry fee to enter the stores, they inadvertently assume the role of “nano-influencers,” Instagramming their experiences within the stores and sharing the brand with their peers on social media. For brands expanding into physical “experiences,” the number of Instagram mentions and tags per store is a critical store metric in context of customer acquisition. These brands are creatively addressing the problem of rising customer acquisition costs (CACs) on social media by building creative concepts that double as indirect ways to advertise on Instagram via user-generated content.

  What we saw in store closures was also a bifurcation of retail, which was likely a direct reflection of increasing income bifurcation in the US. What this means is that over the last few years, retail at both ends of the spectrum (premium and price/value-centric) have continued thriving while retail in the middle has declined. Premium grew 80% and price-based grew 37%, but “balanced retail” only grew 2%. It is unfortunate that over 40% of Americans today struggle to cover a $400 emergency expense, which enables value-centric retailers like Walmart to continue growing and thriving across America. Walmart has also been investing heavily in new technology innovation and experiences — from incubating new brands, making transformative eCommerce acquisitions, launching in-store tech, to creating new shopping experiences in virtual reality Internet of Things (IoT), as well as creating verticalized experiences for different categories.

  Going forward, we will continue to see retail transform. More spend will continue shifting online. Direct-to-consumer brands will be able to cater to specific customer needs and preferences. Outdated, assortment-focused retail experiences will keep declining, as experience-based retail formats rise. Many d2c brands are already experimenting with and setting up new store fronts — from Winky Lux’s “Museum of Ice Cream for Beauty” pop-ups, to Neighborhood Goods, which is building a next generation of shopping malls, to Casper’s storefronts with nap pods delivering an “experience” around sleep, to Floravere’s first-of-its-kind bridal concept store… the list goes on.

  Where’s my Uber? The need for instant gratification and the rise of on-demand

  The dramatic adoption of mobile led to new consumer expectations of “instant gratification.” The phone was the new magical device for near-instant fulfillment of information, products, and services. Hyper-connectivity enabled marketplaces to self-organize quickly and effectively, creating network effects and resulting in the success of on-demand service startups like Uber, Postmates, Instacart, and Wag.

  The increased transparency of everyone being online shifted the consumer expectation and definition of ownership, forming a new type of “sharing economy.” While one may have never felt comfortable with getting in a stranger’s car or sharing your house with other people a decade ago, now it would feel totally strange to live in a world without Uber or Airbnb. Today’s consumer has grown comfortable with sharing someone’s car (Uber, Lyft), opening up her home (Airbnb, Homeaway), sharing living space (Common, Bungalow), letting others in your home (Amazon Keys, Wag), to sharing people’s homes for childcare (Weecare, Wonderschool). Successful startups in this space have focused on protecting trust, prioritizing customer support, and growing and balancing supply/demand while focusing on unit economics and business fundamentals.

  How many followers do you have? The rise of the social media influencer

  As consumers began spending exponentially more time on their phone, a new concept of our “digital identities” formed. The Internet became an open place for us to not only find information, but also to connect, create, and share via social media. Facebook had 1 million monthly users in 2014, growing to 2.3 billion in 2018 — representing every 1 in 3 people on the planet. Instagram had 30 million users when Facebook acquired it for $1 billion in 2012 — today, it has over 1 billion active users. An average American spends a whopping 2 hours and 22 minutes per day on social apps like Facebook, YouTube, Instagram, and Snap. These platforms have become critical channels for brands to talk directly to their customers.

  Social media influencers have become the new curators of today’s generation, capable of building powerful and direct relationships and emotional connection with millions of loyal followers. Influencer-led brands like Emily Weiss’ Glossier, Kylie Jenner’s Kylie Cosmetics, and Rihanna’s Fenty Beauty have demonstrated unique capabilities to scale extremely quickly, by leveraging the theme of “people as the new brands” and by delivering an authentic voice and relationship with their loyal, cult-like following. (As a point of reference, Kylie Cosmetics reached $420 million in sales in 18 months directly through her Instagram account.)

  Can I subscribe to that? How subscription businesses automate buying and replenishment

  There is a “subscription” you can get for most things these days — whether it’s for personalized product discovery (Stitch Fix, Ipsy, FabFitFun), replenishment (Dollar Shave Club, Blue Apron, Function of Beauty, Farmer’s Dog, Simple Contacts), or content access (Netflix, Spotify, Hulu, Calm, Headspace).

  From an investor’s standpoint, the advantage of subscription (or subscription-like) business models implies highly recurring and predictable revenue, and that brands only need to spend money to acquire a customer once for multiple downstream purchases (assuming strong retention.)

  Successful companies in the space have adopted subscription as a primary business model not because it makes the most business sense from a recurring revenue standpoint, but because it actually turns out to be the preferred way of shopping for consumers they serve — a means to an end, not the end itself. As Kirsten Green of Forerunner Ventures said, “I have never invested in a subscription company. I have only invested in companies where subscription turned out to be the best way to serve the customer.”

  Key Challenges Consumer Startups Face Today

  Rising online CACs and the need to diversify customer acquisition channels

  While it has become easier than ever to start a new consumer brand, distribution has become a new challenge for startups in the last few years.

  The first wave of consumer startups was able to rise quickly by taking advantage of under-exploited digital marketing channels (e.g. Facebook/YouTube/Google) a decade ago. As a result, we saw the explosive growth of brands like Warby Parker, Glossier, Allbirds, etc. that reached $100+ million in revenues within only a few years.

  However, today’s consumer startups are experiencing a more matured landscape marked by new industry dynamics. Facebook and Google have duopolized online advertising spend — combined they captured 60% of total spend and contributed 90% of total advertising growth in the US last year. The combination of the explosion of d2c brands and increasingly concentrated channels means that the cost of reaching customers through these d
igital platforms has increased dramatically. While channels like Google and Facebook were “frontier channels” a decade ago, today they are becoming increasingly competitive, resulting in less effective ad spend. (For reference, Facebook CPM was $0.25 in 2014. In 2018, it grew to $12+). There were around 1 million advertisers on Facebook in 2014 — today, Facebook estimates there are 7 million advertisers on the social platform.

  As a result, it is now easier than ever to start a brand, but costlier than ever to acquire customers on the dominant digital channels, and harder than ever to establish differentiation from category competitors while protecting defensibility from Amazon.

  To succeed in this current landscape, thriving brands are thinking outside the box, diversifying marketing channels and exploring new frontier channels. For example, many GenZ-focused brands are finding success on less-exploited channels like Twitch and TikTok. Many are seeing success diversifying into the offline world — from podcasts, billboards, TV, to offline “Instagrammable stores.” Successful founders need to treat customer acquisition as a data science problem constantly balancing and testing new channels.

  Establishing product differentiation in a tidal wave of d2C brands

  Besides the rising cost of customer acquisition on dominant digital platforms, the explosion of direct-to-consumer brands in each category has made establishing product differentiation more challenging. A quick scroll through your Instagram will surface dozens of similar direct-to-consumer brands in all different categories — from plants (The Sill, Bloomscape), vitamins (Ritual, Care/of, Zenamins), birth control (Pill Club, Nurx), fresh pet food (Farmer’s Dog, NomNomNow, Petplate), shampoo (Function of Beauty, Prose), deodorant (Oars and Alps, Hawthorne, by Humankind, Miro), among numerous startups in other categories. Paying for customers on social media is no longer an effective way to scale a consumer business, as it is increasingly important to have true differentiation via unique customer value proposition, emotional connection, and community.

  How to defend against Amazon

  As mentioned before, Amazon dominates eCommerce today, accounting for ~50% of online retail spend in the US. It’s hard for startups to compete based on price, assortment, or convenience against Amazon. However, it’s also important to note that while Amazon is a meaningful threat, the giant also creates many opportunities for startups. This is because as Amazon innovates, it continues to educate and lift consumer expectations in terms of what is possible, as well as what/how they can buy online (e.g. 1-2 day shipping, 1-click buy, voice shopping through Alexa.) In time, this creates opportunities for brands as the consumer is constantly evolving and asking for more. While Amazon has been successful in bringing categories online and pushing the limits of what can be bought online, the opportunity for startups is well captured in this quote from Emily Weiss, CEO of Glossier: “I think Amazon really solved buying, but it killed shopping in the process.” Shopping is not just about convenience and certainly not one-size fits all. As Amazon graduates into a mature incumbent (soon to be 26 years old), there is significant room for innovative founders and brands to re-imagine how shopping can be done in this new era.

  Investor Perspectives: Areas of Opportunity

  Below are a few areas of opportunity that investors in the space have been actively pursuing:

  1. Underserved demographics

  GenZ: The GenZ population is expected to comprise ~40% of total US consumers by 2020 — the size of this demographic is larger than millennials, and their spending power has come of age, holding $143 billion in direct buying power. While most consumer brands that have been built to date have been focused on millennials, this younger demographic is different in many ways. They grew up not knowing a life without phones, they don’t like incumbent brands, they care deeply about social justice and gender equality / human rights and sustainable products. They’re also on different channels (Instagram, TikTok, Twitch), shop at different places (Riley Rose, Urban Outfitters), and they resonate with different ways of storytelling/building a brand that incumbents cannot do themselves.

  Examples of startups: Blume (personal care + mental health), Co—star (astrology app), Winky Lux (beauty), Downtoshop (mobile shopping)

  Investor perspectives: GenZ consumers have an inherent distrust of incumbent, opaque brands and love co-developing products with brands. “Companies like Blume tap into their loyal communities to co-create new products in ways that incumbent CPG brands like P&G and Unilever cannot do themselves” — Victoria Treyger, Partner at Felicis Ventures

  Seniors: In the US, the number of Americans 65+ is projected to double from 50 million to close to 100 million by 2060. One in five Americans are expected to be in retirement in the next 10 years. This has also been an overlooked demographic for startups with unique needs and preferences for consumer products and services.

  Startup Examples: Mon Ami (matches seniors with college students for tasks and companionship), Honor (at-home care), ElliQ (robots), Togg and SafelyYou (sensors for senior care facilities), Totemic Labs (wearables)

  Investor perspectives: “We need to think about the population in a more nuanced way in regard to products and services for seniors and ask questions such as — Who is making the purchase decision? How do they purchase differently? Who is using the product? How do they live and consume products differently?” — Nicole Quinn, Partner at Lightspeed

  2. Consumer health

  As telehealth regulations become increasingly laxer in the US, several telemedicine startups have emerged, making healthcare products more accessible. Simultaneously, there is an ongoing de-stigmatization of traditionally taboo categories. The healthcare industry is seeing a similar trend to commerce — the consumer is becoming increasingly empowered. There is a lot of opportunity to build trusted brands in this space focused on transparency, trust, accessibility, and experience.

  Startup examples: Hims/Hers (prescription telemedicine), Pill Club/Nurx (birth control), Modern Fertility (at home fertility tests), Genneve (menopause care)

  Investor perspectives: On modern fertility, “women spend much of their lives thinking about one of two things: how not to get pregnant or how to get pregnant. At the same time, these thoughts are often laced with nervousness, fear, confusion, and embarrassment. For the first time, armed with more insights and knowledge, women should be able to make more informed decisions, adjust the timing of these choices, and feel more confident in their reproductive and health journey.” — David Wu, Partner at Maveron

  3. Mental health

  The topic of mental health is becoming increasingly important in the US. Today, 1 in 5 people have a diagnosable mental illness, and 1 in 20 people struggle with severe mental health in their everyday life. In the meantime, the stigma around mental health is dropping as millennials have driven the focus towards defining wellness as both physical and mental health. Many startups are helping to tackle this challenge — from diagnostics, therapeutics, to many consumer products and services.

  Startup examples: Calm/Headspace (meditation), Octave/Two Chairs (next-generation therapy clinics), Woebot (CBT chat bot), Talkspace (online therapy), Alma Campus (WeWork for therapists)

  Industry perspectives: “It does feel like a major societal shift. Just a few years ago no one talked about mental health, it was very much in the shadows. As more politicians talk about it, as the media treat it as something normal and healthy to do, more and more people step out of the shadows and into the light. We realize the brain is pretty much the most complex thing in the known universe, it’s not surprising it goes wrong every now and then. To be able to talk about that and understand it is a very healthy and positive thing. It just feels like we’re at the start. Fifty years ago, the wave began around physical fitness, jogging, aerobics, and now we’re at the start of this new wave.” —Acton Smith, co-founder of Calm

  4. Pets

  There are 75 billion dogs and 85 billion cats in the US. More households in America have a dog than a kid, and Americans spend $75 billion on pet
care in the US every year. Dogs have become seen as family, and since many millennials are getting married older, they are adopting pets almost as “starter children.” The industry is dominated by various incumbents (for example — pet food is dominated by Mars and Nestle, both 100+ year old companies.) Many categories are being re-imagined.

  Startup examples: Good Dog (marketplace for breeders/shelters), Farmer’s Dog (fresh subscription pet food), Rover/Wag (on-demand pet marketplaces), Fi (GPS dog collar), Small Door (next-gen vet clinic)

  Investor perspectives: “Dogs have become a more and more important part of our culture, and, frankly, our day-to-day happiness, over the past few decades. Over $20 billion is spent on pet food annually in the US, and there is a trend towards healthy, premium food over the last decade. But the industry is plagued by issues with food safety and false marketing.” — Nikhil Trivedi, Partner at Shasta Ventures

  Impacts of Frontier Technologies

  Perhaps because many investors seem to be waiting for the next platform/technology wave for the next wave of great consumer businesses to be built, AI assistants and virtual reality (VR)/ augmented reality (AR) seem to have been slower to see mass adoption than what some had hoped. That said, our AI assistants (Google Home, Alexa, Siri) are getting smarter, and while friction still exists, it’s not hard to imagine a future where Alexa can enable zero-touch replenishment of everything we need in the home — either by us speaking to her or just by Alexa integrating with IoT devices within the home to automatically detect when things need to be restocked. More than 100 million Alexa devices have been sold to date. Startups like BluTag are building an AI platform that allows brands to build voice-commerce experiences. If voice does take off as a dominant platform for shopping, it will be interesting to think about how brands can better thrive in this ecosystem still controlled by the same giants — Amazon, Google, Apple — with a much narrower discovery funnel, given search results on voice will be more singular and precise versus surfacing a breadth of products.