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1
Make the Merchant the Star
2
Anatomy of a Managed Marketplace
3
Why the Midwest Needs Silicon Valley’s Respect
4
How J.Jill’s IPO Could Help Define E-Commerce Valuations
5
Looking Out Towards 2017

Make the Merchant the Star

Last week, while speaking with a founding team building a new marketplace connecting buyers to suppliers, I mentioned offhand that it can actually be quite detrimental to actively advertise one’s platform as the cheapest. The insight took them by surprise and after some discussion, felt it was worthy of unpacking a bit in a post.

Here’s some context: a couple of years ago Bill Gurley flew down to spend the day with a company we’d invested in. They are a dual sided marketplace that connects buyers with independent merchants. I asked them what their biggest takeaway was from the day of dialoguing with a veritable marketplace expert. They responded: “he kept emphasizing to make the merchant the star.”

That advice has stuck with me for a long time. The truth is that many marketplaces – especially if they remove layers of middlemen or if they better optimize underutilized assets – are in fact materially less expensive than the competition. It’s therefore tempting to advertise one’s platform as the “cheapest” or that buyers can “save 25%,” both of which are extremely compelling value propositions.

But the problem is that merchants, who are typically comfortable with the status quo, and have conducted their business in a consistent fashion for a long time, are consequently hesitant of new selling channels. And they’re even more cautious if they feel that channel is focused on affecting the pricing and margins they’ve always needed to maintain their independence. No one wants to become a commodity.

That framework has always brought me back to Gurley’s comment: “make the merchant the star.” Specifically: what tools, products, data or reach could you provide to a merchant – whether a seller on Etsy, a restaurant on Grubhub, or a business on Yelp – that allows them to demonstrate themselves or their products on a level previously inaccessible to them.

Consumers are smart. If they’re used to spending $50 on a product that is now available for $35, they’ll quickly recognize they’re getting a bargain. Within our portfolio, we’ve seen companies outmaneuver their competitors – and win the loyalty of the supply side – by communicating to prospective buyers benefits such as convenience, breadth of product, or quality of suppliers. All of those messages are still compelling value propositions for the consumer that do not directly threaten the merchant.

All that said, marketplaces that sell a commodity experience such as Uber, or a managed marketplace that is its own seller should certainly focus on discounting as a consumer value proposition and aim to reduce take-rates to the point they can’t be undercut. But marketplaces that connect buyers to any form of unique merchant or product would be well served to make them the star.

Anatomy of a Managed Marketplace

The following article was originally published on Techcrunch on May 25, 2017.

Managed marketplaces (also known as end-to-end or full-stack marketplaces) have been one of the hottest categories of venture investment over the past several years. Recent examples of high-flying managed marketplaces include The RealReal, Opendoor, Beepi, Luxe and thredUP, which have collectively raised nearly a billion dollars. They garner a lot of press because the consumer experiences are often radically different than what’s previously been available in the market.

But there is confusion over what a true “managed” marketplace is. It’s fairly easy to spot a true managed marketplace if you know what you’re looking for. Managed marketplaces typically adhere to the following characteristics:

  • A value-added intermediary (the “management” or “service”) that provides a superior experience versus more traditional peer-to-peer marketplaces, brick and mortar or even a legacy service provider.
  • An introduction of additional risk into the business model; examples might include pre-purchasing and holding inventory or via investing in services related to the buyer/seller that are an incremental, variable cost before any profits have been realized (money goes out before it comes in).
  • A take-rate (gross margin) that is a significant premium versus other buy/sell options in the market in order to offset the premium service level or risk transfer that has occurred.

It’s important to note that many of today’s ubiquitous marketplace companies such as Uber, Airbnb, Grubhub and others are “lightly” managed, by which I mean they invest resources in quality assurance, background checks and verifying reviews. But these services are typically a de minimis expense on the company’s overall operating cost structure — often even considered as part of the customer (or merchant) acquisition cost — and therefore do not classify as a fully managed service.

For Airbnb, these “light” costs might include the costs related to verifying a user’s home address, or the customer service costs of resolving disputes. For Grubhub, the light management might include the costs related to updating menus, but they are not fully managed in that they are not taking ownership of the food or food prep themselves (although Grubhub has begun rolling out delivery, which would qualify as a managed service). This infographic shows the primary marketplace categorizations:

In order to build a successful, sustainable managed marketplace, the take-rate margins must be high enough to support that value-added intermediary and the subsequent amount of services and risk the marketplace is providing. What makes these marketplaces so powerful is that they can drop a comparable amount of contribution margin to the bottom line while investing the higher take-rate revenues into customer experience, reducing friction and product improvements.

Additionally, if, over time, these marketplaces can develop technology that significantly reduces or eliminates the costs of providing these value-added managed services, they can continue to justify higher take-rates and build high-margin businesses that are worth a premium to their traditional service provider comparables or peer-to-peer businesses.

As a primer, here’s a quick chart of take-rates in the re-commerce industry amongst both managed marketplaces and traditional marketplaces. Can you guess which ones are actively managed?

Value innovation and risk

Now that we’ve identified that managed marketplaces are effectively business model innovations, it’s useful to go through a few on a case by case basis to identify each of these innovations and be able to properly identify managed marketplaces in the future.

Opendoor is a managed marketplace in the real estate industry that is an on-demand tool for selling your home. They utilize numerous data sources to offer real-time bids on a home, typically without ever stepping foot in it. Basically: Click a mouse, sell a house. They charge the typical 6 percent brokerage commission plus a risk-adjusted service fee (about 2-3 percent extra, on average, up to 6 percent).

Value-Add Innovation: A consumer no longer has to wait to sell their home. They don’t even so much as have to engage a real estate brokerage. Opendoor reduces the friction of selling a house from possibly months (and multiple showings) down to minutes. The company will also perform all maintenance/changes demanded by a licensed inspector.

Risk Innovation: Unlike brokerages such as RE/MAX or Century 21, which take zero capital risk on a transaction but collect 3 percent from each of the buy/sell sides of a transaction, Opendoor is buying inventory and holding it on their books. The effect of this is that they can offer an extraordinarily differentiated experience to their home sellers, who traditionally rely on peer-to-peer markets (typical MLS listings, with a realtor advising).

Take-Rate: To justify this level of risk (holding inventory) and service (managing maintenance), Opendoor charges a take-rate on average 50 percent higher than in a traditional real estate transaction. While a 50 percent premium may seem marginal given the delta in other categories, the large transaction sizes in real estate mean that the take-rate premium on a $500,000 house is $15,000 of incremental gross margin. That is a significant amount of money to manage maintenance and some risk.

Case in point is the below estimation of Opendoor’s revenue and cost structure on an average $220,000 home (their sweet spot) with a 9 percent brokerage fee, a 50 percent premium to market rates:

Source: Inside Opendoor: What 2 Years of Transactions Tell Us

For Opendoor, when all is said and done, their average net profit, $8,320, or 3.8 percent of the home’s original selling price, is still greater than the 3 percent an agent at a traditional brokerage earns. And, they are able to provide a substantially differentiated experience. It’s a powerful model.

TheRealReal is a managed marketplace in the luxury consignment space focused on clothing, jewelry, handbags, even art. The experience differs from eBay, for example, in that sellers need to provide zero effort other than sending their goods to a TRR warehouse (no photography, no descriptions, no customer interaction) and buyers take comfort in TheRealReal’s quality and authentication services, which they fully guarantee.

Value-Add Innovation: Rather than having to post online listings and photographs of items, pay for a third-party authentication or even deal with shipping, TheRealReal simply collects an item from a consignor and sends them a check once it sells. For sellers, it’s a true “set it and forget it” experience and is multiples more convenient than dealing with online auctions (or even price comparing between local thrift shops).

Risk Innovation: In order to provide a frictionless experience for the seller and an aesthetic, trusted experience for the buyer, TheRealReal is forced to frontload all those costs into their own overhead. They expense per-item charges for photography, copy writing and logistics before an item sells. If the item fails to sell, TheRealReal is forced to eat those overhead costs. Therefore, if they inaccurately forecast demand for certain items, they could end up burning more money than they’re able to recoup on sales.

Take-Rate: In order to justify its cost structure, TheRealReal (and other comparable marketplaces) command take-rates of 30 percent, effectively triple what non-managed, peer-to-peer marketplaces charge as a commission to sellers.

Luxe is a managed marketplace for drivers that reduces all friction associated with parking: finding a lot, searching for a spot, returning to the lot, paying the cashier and waiting to exit. Operating as an effective always-on, mobile valet service, drivers are met at their destination by a Luxe agent who takes the keys and parks a driver’s car. Upon leaving, the driver requests their car in-app and are met by a Luxe agent who delivers their car at their exit point.

Value-Add Innovation: Luxe fundamentally reimagines parking by providing any driver with an on-demand valet who will meet them across a large radius of major cities. Unlike traditional parking or even mobile parking marketplaces such as SpotHero* (which require a driver to park their own cars), Luxe reimagines driving to be destination-focused: drive to your ultimate end-point, not a parking lot. In theory, its product could save drivers time and enable them to avoid inclement weather.

Risk Innovation: In order to provide uninterrupted, on-demand service, Luxe is forced to employ numerous valets across each geography in which it operates. Irrespective of what these valets are actually paid, it is a considerable human capital cost that Luxe is forced to bear ahead of any realized demand. This is in contradistinction to a sharing economy marketplace model such as Airbnb or Uber who are not burdened with human capital costs, but rather pay transactional commissions on any given home-owner or driver.

Take-Rate: In order to counter-act the considerable human capital expense of staffing valets across a city, Luxe should be forced to charge a material premium compared to average hourly parking rates in a particular city. It is therefore quite surprising that they advertise an average of $5/hour for their service, especially when the average hourly rate in NYC, for instance, is $11-15/hour. Several months ago, reports from San Francisco suggested that prior rates of $5/hour have now increased to $15/hour or a $45 daily maximum and, as of this month, they have suspended the valet service. Given the considerable variance in parking costs by neighborhood, it is hard to assess their exact take-rate premium, but I’d estimate it would have had to have been about 200 percent of traditional parking take-rates to be profitable.

Each of these companies is built on the vision that technology will ultimately be able to deliver increased automation and better margins. For example, that one day TheRealReal’s item authentication will be entirely algorithmic or that Luxe will be able to predict the real-time flow of drivers, thereby reducing its human capital costs. Because these representative companies are all still relatively young startups, those tech-driven narratives have mostly only begun to play out.

Beepi versus Carmax

Beepi, a managed marketplace for used cars, recently closed its doors after burning through nearly $300 million in the span of two years. Unlike eBay Motors, which is a peer-to-peer experience, offering no concierge services (although it does offer some self-service options such as free Carfax reports), Beepi was a full-service platform promising rigorous inspections on cars, a 10-day no-questions return policy for a purchased car and, for sellers, a promise that if one’s car didn’t sell in 30 days, Beepi would buy it outright for the appraised value.

The seller fees for this risk-free service? Approximately 9 percent with Beepi… versus a $125 fee for eBay motors, or about 1.25 percent on a $10,000 car, nearly an 800 percent differential.

So with a premium 9 percent take-rate, how did Beepi fail?

The best insight into their failure may come from a similar model with considerable success. It turns out that the nation’s largest retailer of used cars is also arguably one of the most recognized managed marketplaces in the world: Carmax. Give Carmax 30 minutes to inspect your car and they will buy it, even if you’re not purchasing one of theirs, with a “no-haggle,” take it or leave it offer. Thirty minutes is pretty efficient, pretty darn close to on demand.

The extraordinary thing about Carmax is that the Company’s gross profit per used car sold basically doesn’t change even when the year’s average price per car sold moves up or down by 5 percent in any given year. Which means that Carmax is actually less focused on their take-rate per car, but instead focused on their profit per car; their commission is a function of the profit they expect to earn.

Rationally, this makes sense as well — consumers value convenience but have a cognitive dollar limit they are willing to trade for that convenience. By inverting their take-rate to be a function of their profit expectations, Carmax is able to offer more for higher-end cars where a 10 percent difference between the car’s BlueBook value and Carmax’s offer would likely be too extreme for a customer to accept. For high-priced assets, a flat tax is fundamentally unlikely to work.

Used cars are curious assets in that they depreciate so quickly that even 60 days can have a demonstrable impact on value. This is where Carmax excels. In their most recent annual reporting, Carmax notes having sold more than 600,000 cars in the prior year with (then) present inventories at about 55,000. That’s a retail turn of about 11, meaning that a car moves off Carmax’s lot every 35 days or so, allowing them to more accurately price cars andmake higher offers, being less exposed to the less predictable volatility of depreciation.

In a post-mortem on Beepi, Carlypso founder Chris Coleman suggests that in addition to the noted reasons (depreciation effects, and cognitive pricing differential), the approach was inherently flawed from a customer acquisition perspective. Specifically, that while there are customers looking to simply sell their car for cash, most car owners are looking to trade-in a car, because they still need a car and there are tax benefits to doing so; a platform that has to pay marketing costs for both the buyer and seller in all transactions is at a significant disadvantage.

At the end of the day, a managed marketplace model for used cars does work. Carmax is only one of thousands of proof points: tens of thousands of dealerships across the country hold inventory, inspect cars and reap a profit. Beepi’s failings appear to be the result of poor execution, mispricings and maybe even some bad luck around a financing that fell through.

Automation and Shutterstock

Because managed marketplaces involve a heavy “service” component to improve the overall experience, one of the expectations of the sector is that as artificial intelligence and automation continue to evolve, the human capital cost of providing the service will decrease if software can assume more of those responsibilities.

But an area of struggle with managed marketplaces is that very few digital managed marketplaces are actually public companies, reducing the visibility into their overall economics and processes — and making it hard to test the assumption that service costs should come down over time. Luckily, there’s at least one: Shutterstock (NYSE: SSTK), a marketplace for photographers to sell their images, bills itself as a “trusted, actively managed marketplace,” in that “each image is individually examined by [their] team of trained reviewers.”

On the spectrum of managed marketplaces, Shutterstock is undoubtedly on the lighter end — with the financial risk from its active management being only the human capital cost of its QA reviewers. Nevertheless, it would seem like this hypothesis is an ideal one to test on a company such as Shutterstock, which isn’t dependent on an unproven technology such as self-driving cars to reduce their cost of providing a service, but could presumably leverage proven, inexpensive image recognition technologies to do much of the quality assurance, copyright detection and tagging that the human reviewers do.

Yet, that doesn’t appear to be borne out by Shutterstock’s financials. To test the automation hypothesis, I decided to look at the company’s revenue versus the cost to generate that revenue. Shutterstock defines their costs of revenue as “royalties paid to contributors, credit card processing fees, content review costs, customer service expenses, infrastructure and hosting costs…and associated employee compensation.” I would assume that credit card processing fees as a percentage of revenue are relatively flat (if not slightly reduced year over year) and that cloud-hosting fees also scale mostly proportionately to demand (revenue). I’ve defined “True COGS” below as the aforementioned expenses to providing their service, minus the contributor royalties:

Surprisingly, rather than decreasing over time, these True COG costs appear to be increasing. Meaning that the same picture that used to take 10.5 percent of revenues to process now costs nearly 15 percent.

There are a number of possible explanations here. It’s certainly possible that these increased costs are because the company is investing heavily into automation, the effects of which simply haven’t been borne out yet while they streamline their QA process. It’s also possible that the number of photos the company maintains makes it more expensive to process each incremental picture — for any variety of reasons.

The learning from this Shutterstock case study, a company which is now 14 years old, is that it’s improper to simply assume that the substantial service-related costs that managed marketplaces incur in their early stages will decrease with “scale,” either through execution or software automation. As with any company, there is always room for improvement, but the above analysis of Shutterstock would imply that it’s nowhere near as easy as flipping a switch.

Takeaways

Managed marketplaces are a quintessential venture investment, allowing entrepreneurs to recast consumer experiences while leveraging venture capital subsidies to hold much of the risk inherent in these managed models.

From a unit economic perspective, the potential automation of much of the service labor that goes into these platforms could be significant. Investors and operators need to remain sensitive that it is ultimately the technology, not heavy services, that will long-term cultivate highly desired business models and margins. But, that future automation could also lower the barriers and defensibility of these companies, allowing peer-to-peer players to launch a comparable offering with similar software.

In my mind, the sustaining managed marketplaces will not only re-imagine the experience they’re approaching, but be focused from the outset on building a data moat around their product, thereby ensuring that they remain the platform of choice, even if software innovation begins to level the overall playing field.

Special thanks to Josh Breinlinger and Rebecca Kaden for their feedback on this article.

*Chicago Ventures is an investor in SpotHero.

Why the Midwest Needs Silicon Valley’s Respect

The past couple of months have brought several visible pieces on the opportunity and strengths of Midwestern startups, and underserved ecosystems in general. From Dear Midwest: Stop Trying to Compete with Silicon Valley to The Midwest’s Healthy Fear of Failure Beats Silicon Valley’s Fail Fast Manta to my own piece that I authored with Samir Kaji of First Republic Bank, Why The Micro-VC Surge Will Drive Innovation Across America. These pieces complement some recent events such as Steve Case’s Rise of the Rest Summit which culminated last month in Washington, DC as well as Techcrunch’s recent series on Utah startups, showcasing extraordinary companies not on the Valley’s radar. The ultimate goal in these articles and efforts is to demonstrate the solvency of these secondary markets in their own right and embrace the differences   against San Francisco’s startup hub.

chicago-art-or-architecture-tour-illinois-th

For the most part, I agree with the sentiments and arguments of these efforts – yet fear they’re largely irrelevant if no one is listening, or worse, if no one cares. Too much time is being spent on publicizing the obvious – that there’s enormous entrepreneurial opportunity outside of the Valley (and I’m complicit in that as well) – and too little time is being spent on cultivating the real relationships that actually yield results. And respect.

Here’s an example: recently, there’s been a lot of dialogue around the primary role of early stage VCs, with many emphasizing their role of “packaging” companies for future rounds of funding. Although a loose term, “packaging” isn’t pure vapor. It includes helping startups methodically plan and manage burn to hit the milestones the market expects, helping them focus their operations (and vision) to stay on track, and make smart additions to the team to support a focused story. But the most important part of packaging companies for future financing is having strong enough relationships and validation with external parties that an introduction or endorsement to a future investor brings it with automatic credibility. For my money, there’s only one way to do that: a trusted relationship. And, importantly, most venture backed startups in secondary markets will need to tap non-local capital, at the latest by Series B.

I have had a lot of people ask me why myself and the broader CV team make it a point to travel so frequently to San Francisco and spend so much time with non-local investors and operators. Shouldn’t we play our own Midwestern game they ask, and not try to emulate theirs? Shouldn’t we be team players back at home?

There are two fundamental shifts happening in the venture ecosystem that demand a focus on building credibility away from home.

First, traditional growth firms up and down both coasts are being squeezed on pricing by both mutual funds and foreign investors; much has been written already on the commoditization of growth capital. These investors are consequently increasingly looking to the Midwest to gain access to a proprietary deal source that is less correlated to Valley pricing. But like most things in life, it takes years to build networks and they are constantly wondering: whom can we really trust?

Second, as information becomes increasingly democratic, the best entrepreneurs care less about local capital and more about the best branded capital. The world is increasingly connected and good founders from Indy to Omaha can get credible intros to well known Valley firms from the get-go. The truth is though, that this is a mistake. The data I’ve seen suggests that companies that raise early stage capital from local, hands-on partners, tend to outperform those that skip to distant coasts. Many of these funds who might otherwise be intrigued by a Midwest opportunity, would also prefer a local partner with a strong reputation to complement a deal. But again: whom can they trust? Who is credible?

Underserved markets typically suffer from a lack of high conviction capital. But a disconnected or weak reputation can be equally as bad. I suspect the vast majority of entrepreneurs (and investors) fundamentally misunderstand the level of conviction required for a multi-party partnership to get on a plane and travel 2,000 miles. Turn the tables and imagine being the junior partner who convinced their team to leave their families for two days – and having to answer for it if the meetings are a bust.

Building relationships doesn’t happen on an intro phone call or even video chat. It requires in person communication, finding mutual interests, mutual friends, respect. Cheerleading at home is fun, but ineffective if no one is listening. Accomplished entrepreneurs from Scott Dorsey to Godard Abel to Matt Maloney aren’t just “Midwest” entrepreneurs – their presence is strong enough to attract material interest from the national stage back to their home market. But the interest in underserved markets is greater today than I’ve seen at any point before in my 10 years in tech. So who will serve it if that interest doesn’t know where to turn?

The Midwest should be the Midwest. No doubt. But it won’t thrive if it doesn’t actively build bridges and pursue external respect.

How J.Jill’s IPO Could Help Define E-Commerce Valuations

You’d be forgiven for missing a small cap retail IPO last week in the midst of the global Snapchat mania. Last Thursday, without much fanfare, J.Jill, a nearly sixty year old former mail order catalog company selling women’s apparel, quietly went public at a nearly $900M enterprise value. And surprisingly, for the complex world of digital commerce, J.Jill’s public market reception might actually be an indicator of what all these next gen direct-to-consumer commerce businesses are actually worth.

How a Small Cap IPO Could Help Define2

In past pieces for BreakingVC during 2016, I’ve discussed Amazon’s impact on both e-commerce and retail at length, as well as the three areas I’ve observed for opportunity to penetrate Amazon’s digital commerce force-field: (1+2) In Why Amazon Has Consumer Investors Bemused and Confused I wrote at length about both off-price retail (Marshalls and T.J. Maxx, for example) as well as mid to upper tier brand opportunities that Amazon fundamentally can’t capture and (3) in The Middleman Strikes Back, I described how Amazon’s anemic commerce margins prohibit it from a service heavy assisted/concierge-commerce provider.

But for everyone else – from Warby Parker to Harry’s to Bonobos to Everlane – what are these weird, sorta digital, sorta omni-channel, sorta personalization brands actually worth? And why is a sixty year old women’s apparel business that was previously spun out of a legacy retailer, Talbots, a leading indicator of value?

As usual, the Company’s S1 is a store of insight and surprises:

Personalization and Loyal Customers

If I were reading an untitled prospectus, I would’ve bet my money that the following block of text from the Company’s S1 “Overview” described a millennial-first next gen commerce brand, with a small but growing retail footprint:

We believe we have strong customer and transaction data capabilities, but it is our use of the data that distinguishes us from our competitors. We have developed industry-leading data capture capabilities that allow us to match approximately 97% of transactions to an identifiable customer, which we believe is significantly ahead of the industry standard. We maintain an extensive customer database that tracks customer details from personal identifiers and demographic overlay (e.g. name, address, age, household income) and transaction history (e.g. orders, returns, order value.) We continually leverage this database and apply our insights to operate our business as well as to acquire new customers and then create, build and maintain a relationship with each customer to drive optimum value.

Believe it or not, that is a sixty year old company talking.

The truth is that most retail businesses are really merchandising and logistics businesses more than personalization businesses. Most big box retailers – or at least the many that I speak with – admit that closing the loop between online-to-offline transactions is amongst their largest struggles.

This is a flaw that digital first businesses – even those with a retail footprint – claim they can solve. And all the moreso, a business such as Stitchfix, which is truly a data business at its core, led by Eric Colson, Chief Algorithms Officer. Case in point, a recent Stitchfix blog entitled “Ruminations on Data Driven Fashion Design,” which noted:

For example, can statistical modeling identify when a successful blouse has an attribute that is holding it back? If so, can we suggest a mutation that replaces the underperforming attribute? To illustrate, can we identify when a parent blouse is successful despite its leopard print, and then change it to the floral print that everyone loves this season? We are also examining how we can leverage less structured types of data. For example, can we extract features from images of blouses or the text feedback that clients provide in response to a blouse?

[To be blown away, visit the Stitchfix Algorithms Tour, built by Colson. It is a wow.]

Data is powerful. But it’s goal is to yield a more engaged customer; in J.Jill’s case existing active customers [within the past five years] represent 70% of annual revenues – an awfully consistent customer who sounds pretty darn comparable to all those subscription commerce businesses that have proliferated the market. And very similar to the vision today’s D2C brands are claiming: own a customer’s wardrobe/apparel/bathroom/etc with a non-commoditizing product and they will come back to you year after year.

J.Jill also looks a lot more like a direct to consumer business than your traditional retailer, with 42% of 2016 sales (growing to 50% in 2017) coming from direct channels.

How a Small Cap IPO Could Help Define E

What about its retail footprint? As discussed in the past, many of the next gen millennial brands are launching brick and mortar stores to prove a new customer acquisition channel against an overly saturated (and unprofitable) digital marketing environment. But with a footprint of only 275 retail stores, its brick and mortar presence is at least relatively comparable to the type of presence today’s next gen retailers are aiming for (as of today Warby has 44 B&M locations, Bonobos has 11, etc.) And these stores, like the millennial brands are conceptually customer acquisition drivers, as the S1 notes: While 64% of new to brand customers first engage with J.Jill through our retail stores, we have a strong track record of migrating customers from a single-channel customer to a more valuable, omni-channel customer.”

At the end of the day, J.Jill, this under the radar retailer looks surprisingly similar to today’s D2C commerce businesses:

  • Data-first approach (97% of transactions properly attributed to customer profile)
  • Heavy direct sales focus, with stores used merely as customer acqusion tool (42%, growing to 50%).
  • Not overbearing retail footprint
  • Brand quality margins (65.9% gross margins), as compared to 42% for Macy’s, 35% for Nordstrom or 40% for Gap – effectively double the margin basis as a traditional retailer.

What’s It Worth

I like J.Jill as a comp for many of today’s e-commerce companies for two reasons. First, as proven in the prior section, I think it looks much more similar than a casual observer might guess to those businesses. But secondly, at ~$500M in annual revenues, J.Jill is surprisingly small for a public retailer. Gap posted nearly $16B in revenue in 2015, Williams Sonoma is on the small side with $4B in revenues – even Lululemon has trailing revenues greater than $2B. This looks similar to emerging commerce brands which are typically much smaller than their relative press coverage would imply: Dollar Shave Club was on a $250M revenue run rate when acquired by Unilever, Warby Parker booked an estimated ~$200M revenue in 2016, and Trunk Club was on a reported $100M revenue run rate when acquired by Nordstrom. Most of today’s emerging brands, even at triple their current size, would look substantially similar to a small cap IPO.

The first piece of very good news for emerging brands is that there was a market appetite for a small cap offering of this nature whatsoever. Although the Company ultimately priced at $13/share, just below its suggested range of $14-16/share, the good news – again – is that market interest was strong enough not to justify pulling the offering entirely.

But that’s mostly where the good news stops. J.Jill’s IPO (even based on an estimated $15/share offering) would have it placed towards the bottom of a peer set on a valuation basis. The following graphs on valuation comps were initially published on Seeking Alpha:

How a Small Cap IPO Could Help Define 4 How a Small Cap IPO Could Help Define 3

Those are sobering multiples (and, the company actually priced 10% below these estimated multiples) for a company that stacks up extremely well on most operational metrics – for example, they boast higher product gross margin that brands such as Tiffany’s, Michael Kors, Ralph Lauren or even Abercrombie. They boast a higher direct to consumer sales percentage than most of their peers. They have an exceedingly loyal customer.

The biggest knock on the company is their growth rate: 10-15%/year – and one of their biggest divergences against today’s emerging brands who are mostly growing at 50-200% annually.

Given these multiples, e-commerce brands need to bank on the following two factors to earn a premium valuation in the market: maintain strong growth rates and maintain high visibility, momentum brands. J.Jill is a fundamentally strong company – and it has stolen much of the playbook from the online brands – but it lacks both velocity of growth nor excitement around its brand proposition.

Looking Out Towards 2017

2016 was a good but challenging year for me. It was a year in which I watched family members battle serious health issues, a year where I allowed myself to become distracted and reactive at home and at work, and one where my professional insecurities often got the better of me. But, like most challenges, they make us stronger and I’m extremely confident heading into 2017.

Numerous investors have announced their predictions for 2017, notably Fred Wilson, Sam Gerstenzang, Rob Go, Glenn Solomon, among others. I’m not smart enough to play that game, but I did want to use my blog to both formalize for myself, and publicize to others, my focus in 2017.

2017-1

2017 Operations

The biggest mistakes I made in 2016 were not taking enough time for myself and allowing myself to become deeply reactive. There is no worse curse in venture than to be a reactive player; it is fundamentally impossible to be extraordinary if your days are prescribed by others.

Deeper, not taking enough time for oneself is a function of being overly reactive. When you allow your schedule to be determined by others, you are in effect conceding that your own thoughts, imagination, brainstorming, headspace are secondary. I don’t believe this to be true.

My 2017 is going to look different than 2016. I believe I am at the point in my career where I can de-prioritize my fears of missing great deals and instead focus on finding the right ones. To that end, I am going to take many fewer inbound meetings in 2017 and instead build a strong pipeline of outbound ones. I am going to chase relationships that I am passionate about, rather than the ones that are convenient or obvious.

I am going to spend less time on e-mail and more time learning, discussing and engaging. One thing I’ve done poorly in my venture career is not go deep enough into the weeds with entrepreneurs. As a writer, I am extremely enamored with stories and storytelling. The benefit of this is that it enables me to quickly parse out big, category defining ideas and hone in on them. The detriment is that I frequently focus too heavily on the vision and ignore the implausibilities and difficulties underlying the story.

2017 Investment Thoughts (not Theses)

Before getting into specifics, I think that 2017 is the year that many investors realize they need to begin learning new industries. Pure play mobile has hit crescendo and SaaS is so mature that we’re now funding SaaS to manage SaaS. In late 2012/early 2013 I decided I would learn everything I could about bitcoin. I mostly didn’t take a meeting for six weeks, but emerged from my cave slightly bearded, had taught myself to mine Bitcoin (and many alts), knew all the big personalities on Bitcointalk and became well written on the industry.

In 2017, I expect to do that again, hopefully twice, if I get my way in genomics and urbanization.

Here are some other areas I have opinions on:

  • Fintech: Over the past several years I’ve spent my energy becoming well versed in many disciplines of consumer internet from e-commerce to retail to marketplaces to bitcoin. For 2016 I put my mind to getting smart on the fintech sector – both consumer and enterprise facing – and we made two related investments over the course of the year: M1Finance and Sunbit.

I had de-prioritized fintech opportunities in 2015, believing that we were a relative late mover to the market and that many of the early winners from Lending Club to Avant to Wealthfront had strong platforms and balance sheets from which to move horizontally away from their core products into adjacent markets. Then, in early 2016 LendingClub experienced a fall from grace, it’s CEO stepped down, and the entire sector hunkered down into crisis mode. I love, love markets in chaos. The chaos reignited my interest in fintech – I was convinced there would be extraordinary opportunities overlooked as investors felt over-exposed. But what I learned in 2016 was that fintech, broadly, remains one of the largest disruptive opportunities of my generation, and I plan to hunt actively for winners in 2017.

  • E-Commerce: As a consumer, I love e-commerce. I love Amazon Prime. I love discovering new millennial brands from Everlane to Allbirds. And yet, over the course of 2016, albeit it kicking and screaming, I was forced to concede that – as one of my business school Professors taught me – “the internet… is a crappy place to have a store.”

The struggle with that statement is that the internet, in many cases, is actually a phenomenal place to acquire and retain customers. But many of the other capex costs can be prohibitive.

In 2017 I am likely to take a material step back from traditional commerce and d2c brand related opportunities while keeping an eye out for the rare few that are fundamentally recasting cost structures and/or reducing consumer friction by a factor of 10.

  • Crypto: This is arguably fintech, but in my opinion, the next generation of distributed applications – although tokenized – are often only tangentially related to anything financial. I continue to believe that distributed applications, most commonly “altcoins” represent an extraordinary opportunity. And while investing in crypto tokens is not something we have license to do at Chicago Ventures, it’s an area where I plan to spend much of my personal free attention and time (and would gladly meet any entrepreneurs building next gen distributed apps).
  • Reimagination of Cities: I spent much of 2015/2016 focused on the future of the home, reflected both in my piece Furnageddon – about how the furniture we live on is changing – and in our investment in Havenly. But as I dived deeper into urban living, meeting with several companies re-conceptualizing the types of spaces we live in, I began recognizing that technology is fundamentally changing the ways we act in our urban areas as well as their associated suburbs.

I saw a nice interview in Techcrunch with Niko Bonatsos at General Catalyst who had a similar observation, in Investing in the future of urbanization. The 2016 election reminded us that the country is a very diverse place, often with misunderstood needs and incentives. It will be a large focus of mine going into 2017.

In 2016, we invested in Predata believing that geo-political instability was increasingly impacting the bottom of lines of many large institutions, from traditional corporates to finance houses. From my vantage point, I believe that consumers also want to increasing manage the perceived risks in their lives. One example of this from 2016 is a company called Point that allows consumers to hedge their investment in their homes by pulling 10% of the value out for liquidity, with no monthly payments. One of my professors Toby Moskowitz once said to me in business school, that “buying insurance is a poor financial decision, but we all purchase it because it’s fantastic from a covariance perspective.” I’ve long felt that should yield some interesting technology driven opportunities.

  • Betting Markets: Many of you know that my background is in the poker industry, initially as a professional and later as an operator. Online poker is probably a $5-10B market, but is contracting slightly year over year. Similarly, daily fantasy sports started 2016 as an exceptionally hot space, but it turns out it wasn’t a fundamentally great business model (see my article: “Game Over: Why Daily Fantasy Has Already Been Won.”)

 Although DFS is unlikely to become the $100B industry that was predicted, betting markets are still amongst the most exciting markets to observe once they become liquid. Heck, the equity futures market is effectively the world’s largest betting market. I continue to believe eSports has an intriguing market in p2p betting and made an investment in multi-table gaming tournaments via Gunslinger.

Some other angles on p2p betting networks such as Quantopian/Quantiacs really excite me as does Numerai. There are also a lot of other areas of illiquidity that make really intriguing liquid markets – from owned assets to information. If you’re building anything in this area, I would love to chat.

I hope that’s helpful and wish everyone a happy and successful 2017. Thanks for reading.

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