[Internal Memo] Thoughts on Commerce

A couple of weeks ago, after an active conversation around one of our investments, I threw together the below e-mail to my team here at Chicago Ventures. I’ve never done this before but I thought it would be interesting to put it out there on the blog. It’s important to note that my team definitely did not agree with everything I wrote which is fine (the most pushback I got was around “digital marketing is dead.”) I wrote it quickly and mostly shooting from the hip, but I think that’s reflective of a lot of offhand internal dialogue within venture firms.

I think both for founders looking to pitch investors and junior investors at firms, it’s important to ask the right questions to understand their internal fund biases and thoughts. One of the reasons I write notes like this – even if it’s a pain to read/respond to all my tl;dr stuff – is so that if any partner at our firm meets an entrepreneur touching on one of the bullets below, they’ll quickly reference our note & know where we stand.


Hi All,

Monday’s conversation around [portco] made me realize that it’s been a while since I’ve typed out some of my thinking around commerce & I thought it would be helpful to have a set of principles we’re thinking abt when looking at these businesses. I’ve broken this into three sections, each builds on the other.

I think it’s impt to have this conversation. Especially with [venture partner] attached to our fund, our deal flow & knowledge should enable us to punch beyond our weight class here. But we want to make smart bets.

Part 1: Paid Digital Marketing is a Dead End.

Google/FB are just a dead end. Every retailer just hits a wall on these channels. Zulily hit a wall at scale. Wayfair hit a wall at scale. But with increased competition in every vector, the wall is happening a lot earlier now. Traditional, brainless digital marketing is an expensive dead end = as we know, distribution is so so key. Two primers are:

– My article on VB: Moving Beyond Spam where I outline “Connected” commerce & the content commerce playbook.

– Josh Hannah’s article on Pando: That’s a Nice $40M Biz You Have There

Part 2: Next Gen Commerce Companies Will Boast Unprecedented Leverage

A little under a month ago, an under the radar subscription cosmetics co called Ipsy raised $100M at a $900M valuation. Whatever, it’s 2015, crazy times, right? Except that Ipsy had only raised $3M to date. And had built from a $300k/mo run rate to $13M/mo RECURRING run rate in <3 years.

How the hell did they do that? Fortune profiles it here.

The answer: They leveraged Youtube & influencer networks better than anyone in the history of e-commerce.

I reached out to one of their backers. Here’s what that person told me –

“a few very clear cut things, and this is not a fluffy bubble valuation this is very real based on revenue.

(1) Few markets naturally support the QVC-on-youtube model, but cosmetics is one of them. CAC is low and LTV very high because Michelle Phan has a built-in and very engaged following.  Compare to Birchbox which has to rely on more traditional digital advertising channels.

(2) Ipsy’s CEO Marcelo is a content savant and didn’t just rely on Michelle’s clout, but also was able to create new cosmetics celebrities for various demographics and styles.  True talent in the team gained additional reach and consistency.

(3) The company was able to leverage negative working capital since they get paid up front.  This enables very fast growth fueled by internal cash flow, and clearer inventory planning.

(4) Ancillary revenues for Birchbox include upselling to full-size items, shifting into men’s products, etc.  Ipsy can flash sale, white label at 70% margins, etc. so has more attractive future potential as well.”

Imo, as the markets correct themselves, we need to be looking for opportunities with extraordinary operating leverage. Growth stage investors have seen the payback on late stage commerce rounds and the returns are flat because customer acquisition is high friction at that scale. When Birchbox has raised $75M and Ipsy $3M to get to the same run rate, the smart money will race to the higher leverage model.

Part 3: How We Identify Next Gen High Growth, Minimal Cash Businesses 

Here’s the checklist I’m using to identify these businesses. This is a work in progress & hopefully is always a living, breathing checklist that ebbs & flows with the times. I don’t know that our investments need to check every box, but it’s our rubric to judge against:

  1. Hacking New Platforms – Airbnb’s “hack” of Craigslist is fairly well known at this point & it’s what enabled them to build their early supply side liquidity. Ever since then, for the past 5 years, everyone has focused on similar Craigslist hacks. I don’t mind that, but CL is a lot diff now than it used to be. Youtube is also played out at this pt. We should be looking for companies that are hacking less targeted platforms. One of the things I like about [portco] is that they’re effectively hacking eBay enabling them to acquire customers for less than 1/5th the cost of their competitors. Other platforms I’m actively looking at to rip customers from are Nextdoor, Thumbtack, Airbnb/Homeaway, Massdrop, Alibaba, Kickstarter, etc etc. The platforms we want to look for must have (a) Transactional focus & (b) Some private messaging or e-mail scraping function. As the messengers (Line, Kik, Whatsapp, Messenger) also build out transactions these may develop into great opps for ripping customers.
  2. Negative Working Capital – I think this is more impt than 24 months ago as it’s a hedge both against capital markets tightening & drawn out fundraising processes. Of course it needs to be utilized with caution, but it can be an immense source of leverage.
  3. Scale Buster: This is one of those intangibles that is sort of hard to define. Brian has it at TrunkClub with his stylist model driving growth. The problem is: traditional customer acquisition is counterintuitive in that it actually gets MORE expensive with scale & you buy WORSE customers with lower LTVs. So how do you build a creative growth model that can predictably manufacture growth (like a marketing spend) without defaulting to traditional marketing channels. Honestly, I don’t know what this will look like. Maybe it’s some sort of brilliant referral model. Or some smart play on social selling. I don’t know, but this is one where we need to keep our eyes and ears open.
  4. Content Savvy – The more we see, the more I realize that a deep understanding of content marketing needs to be in the DNA of a team & not just bought. Even [portco] is really starting to hum because they’ve nailed a really good Facebook video content strategy that is really scaling. Here’s why we like it: (a) Very low cost because salaried (b) Scales without friction beyond traditional paid marketing spend. (c) Is shared heavily – a far more authentic play on social networks than traditional ad spend.
  5. Influencers – In the past 2 months, I have probably seen half a dozen businesses do $50k in GMV in Month 1 out of the gate. HOW? Just leveraging a core team member with established distribution/network. W/O this built in distribution, a startup can burn through $500k-1M+ EASY just trying to hit that $100k GMV month mark. We do NOT want to pay for that infrastructure & growth. We need it to be built in, especially if so many others have that advantage. My benchmark would be $20k+ in Month 1. [Edit: This can also come through a good PR strategy.]
  6. Margins – We need to be hawkish on gross margins. Greg Bettenelli at Upfront recommends 40% and I’m fine with that number. I think we should be comfortable at 20% with a clear path to 40%, with the understanding that we lose some capital leverage (but not a ton at the early stage). We also want the business to have an opportunity down the line to build a private label brand that can create blended margins in excess of 50%.

Feel free to add more, thanks.

About the author

Ezra Galston
Ezra Galston

Consumer focused hustling @Chicago Ventures, Young Entrepreneur @Foundation Capital, Class 18 @Kauffman Fellow, and Chicago Booth MBA. Former professional poker player, with 4 years experience doing marketing/biz dev in the online gaming industry. Launched a "poker hedge fund" in 2011, a record label in College, and produced a festival screened short film in 2006.

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