10 for 10…Billion that is

Ten in a row. That is, it was the tenth consecutive quarter that VC firms put at least $10 billion into startups. High value rounds by companies like Uber, Snapchat and Didi Chuxing, led the quarter’s investment in dollar amounts, as well as setting a new record – the $3.5 billion deal for Uber represents the biggest venture capital deal of all time.

Caution and Optimism

Brexit overshadowed the global markets in Q2, ushering in a period of caution. Adding to this feeling were the upcoming U.S. presidential election, the potential for interest rates to increase here in the U.S., and signs of economic slowdown in China. It’s not all doom and gloom however, there are strong indications that venture market activity will rebound heading into the second half of 2016 and the start of 2017. FOMO (“fear of missing out”)  has been replaced by “wait and see,” or as the Gipper would say “trust but verify.”

Check Please

In the face of an anemic IPO market, Twilio’s wildly successful June IPO helped renew interest in IPOs heading into the latter half of 2016. For many of today’s late stage companies, as valuations go higher, an IPO becomes the only viable exit option. The challenge today’s large unicorn companies like Uber and Airbnb face, will be the pressure to eventually go public. Twilio’s success on the NYSE may pave the way for more tech companies to access liquidity, and bring some life back into the IPO market.  (Full disclosure we own shares of Twilio through a secondary purchase and are quite happy with the ~$55/share price as of this writing.)

On the other end of the exit spectrum, we’re seeing the lending environment continue to be very strong in North America, with banks aggressively funding acquisitions with debt. At the same time, larger companies are making their presence felt more than ever. With many large companies sitting on cash reserves, some numbers put the total cash holding by U.S. non-financial companies at $1.5 trillion, investors are demanding they either use the money or give it back to shareholders. This has led to significant M&A activity, an example being Microsoft’s most recent $26 billion acquisition of LinkedIn. And while seven of the top 10 cash holding firms are tech companies, another trend is shaping up to further drive the M&A landscape.

Who’s down with CVC?

Corporate venture capital has been on a resurgence as of late, investing early and often in the private markets. In fact Q2 marked the second straight quarter in which corporates and CVCs participated in over 25% of deals. With this activity, more large companies are setting up CVC arms and maintaining activity in private markets.

Software is Eating the Boardroom

The company profile of venture-backed M&A acquirers is shifting. We’ve long talked about the “Big 10,”  the household technology names responsible for a disproportionate amount of the M&A activity within tech. These are the Google’s, the Facebook’s, the Cisco’s, the IBM’s, the Apple’s, of the world, companies that have long utilized M&A as to secure their position in their respective categories.

The Rise of the Non-Technical, Tech Buyer

But they are not alone. More and more, large non-technology corporates are using cash and equity as a strategic asset to buy new innovation and technology, rather than building capabilities in-house. 2016 has been an unusually strong year for this group, with Dollar Shave Club and Jet.com becoming the fourth and fifth, $1b+ plus acquisitions by a non-tech player this year. Compare that to just two years ago, when the aforementioned tech giants made up five of the six acquirers of U.S. venture-backed companies for $1b+, being up (WhatsApp, Nest Labs, Oculus, and Datalogix). So what’s changed to shift the profile of buyer’s? And more importantly what’s driving the shift in e-commerce?

Dollar Shave Club acquired by Unilever

To begin the summer of ecommerce acquisitions, Unilever PLC led the $1b+ acquisition of Venice, CA based, Dollar Shave Club. For those not familiar (full disclosure I shaved this morning with these razors), the four year old startup with 3.2 million members provides a mail-order service that ships out disposable razors and other grooming products for a flat monthly fee. And while the startup had revenue of $152 million last year and is on track to exceed $200 million in 2016, according to Unilever, Dollar Shave Club is not currently profitable. What it is however, is a data machine. Yes, the acquisition gives Unilever an entry into the shaving market dominated by Gillette (Procter & Gamble), but it’s Dollar Shave Club’s direct-to-consumer business model that Unilever really wants. According to Kees Kruythoff, president of Unilever North America, Unilever gets “unique consumer and data insights.” Consumers and Data…remember that theme you’ll see it again shortly.

Jet.com acquired by Walmart

Not to be outdone by the Dutch (ok Dutch/British multinational), Walmart threw its hat in the ring with the $3.3 billion acquisition of Jet.com, early this August. If that number sounds large, it’s because it is, in fact this deal was largest purchase of a U.S. e-commerce startup, ever. Jet.com by no uncertain terms is a young company, barely a year old, but they set out on the ambitious goal of underpricing Amazon by building a vast marketplace that would rely more on suppliers than warehouse inventory. That strategy did not come cheaply and required a significant amount of capital to build out the marketplace and market itself. According to WSJ, Jet.com has been signing up nearly half a million shoppers monthly, and at the end of its first year was on pace to sell $1 billion worth of merchandise annually through its website. Compare that to Walmart.com, now fifteen years old, with e-commerce sales last year reaching nearly $14 billion, or just 3% of its $482 billion in annual revenue. Amazon’s sales hit $107 billion last year, including its web-service business. But here is where you’ll see the similarity with Dollar Shave Club. Through the purchase, Walmart gains access to a larger group of young, wealthy, urban shoppers. Add to this the Jet.com approach was a data driven approach to commerce, their software helps it sell at lower prices by taking into account how customer choices hit profits, including basket size and the proximity of the merchandise. Consumers and Data, there you have it.

What’s happening in e-commerce?

We recently sat down with Brett Northart and Rakesh Tondon, co-founders of Le Tote, a portfolio company of the firm, to understand what these acquisitions represent within the larger ecommerce world.  When asked about the Dollar Shave Club deal, “our view is that this was less about the revenues and more about a brand that had an appeal for a customer that was not their existing customer and a technology platform that they could not build in house,” said Brett. Adding, “the ability for a large CPG like Unilever to create a brand inhouse whose tagline is ‘Our Razors are F*ck*ng Great!’ was never going to happen.” In Dollar Shave Club, Unilever bought a brand they could never create internally, with a millennial customer base built in, and the data and technology to execute at scale.

When it came to the discussion of Walmart, Rakesh, viewed the deal as “a key talent acquisition, play”, in Jet.com’s CEO Marc Lore, as well as the rest of the team. Lore, who co-founded Diapers.com, Soap.com, and Wag.com (all under the parent corporation Quidsi, Inc), sold the company in 2009 to Amazon for $545M and then stayed on with Amazon an additional two years. “Walmart has been battling it out with Amazon for more than a decade and they have not been able to out innovate Amazon”, said Rakesh. Lore’s intimate knowledge of Amazon did not go unnoticed, nor his demonstrated success in being able to build loyal online customer base, as he did at diapers.com. As part of the acquisition, Lore will take on a senior leadership position on the e-commerce side of Wal-Mart.

But there are larger changes being felt across ecommerce. In a recent Medium post, Bonobos CEO Andy Dunn introduced the rise of what he calls digitally-native vertical brands (DNVBs). As Dunn writes, “Vertical brands were a huge part of the last era of retail (Zara, Ikea, Gap), aka the offline one, and now they become the driving story in the future of digital retail. The moving parts in the shifting retail landscape are right in front of us to see.”

According to Dunn, the shift within retail and CPG is still “incredibly early,” but accelerating quickly. What strikes us as VC’s is how difficult it is for these categories to innovate. In fact, the largest CPG companies continue to underspend on R&D relative to marketing budgets. For us to place bets on startups, we see an unfair advantage, because startups can, as demonstrated by Dollar Shave Club and Jet.com, quickly steal marketshare, and more importantly, monopolize the data. And maybe it’s this reality that has shifted mindsets at large retailers and CPGs, representing a neo-R&D, as Unilever’s CEO Paul Polman, readily admitted in the firm’s’ latest earnings call.

You would think that these large brands, feeling pressure from startups would double down on research and development but the truth is, their allocation goes mainly to marketing, which serves to further undermine their future. And maybe that’s the underlying issue, large brands view these changes as something they need to adjust their message to, not their underlying business.  On average retail and CPG companies spend just 1.6% of revenue, less than one eighth of their average marketing budgets, according to collaborative fund.

But Dollar Shave Club and Jet.com point to a new trend, the outsourcing of R&D by acquiring smaller brands once the model is proven out. And the Dollar Shave Club acquisition and the Jet.com acquisition beg the question, “who’s next?” We see tremendous opportunities in early-stage consumer startups because of the unique window of time we’re currently in. Millennials are becoming a dominate force in the economy, representing close to $200 billion of purchasing power. Yet their behavior is vastly different than other generations, incorporating values-based decision making, and questioning the basic concepts of what it means to “buy” or “own.” Startups are ultimately better equipped to innovate to meet these consumers needs, while incumbent brands are caught unaware. This is why you see large shift in market share in what used to be hard-fought trench warfare.

Le Tote and The Future of Fashion…and Commerce

Recent exits are proving that large established retail and CPG players are willing to invest in next generation commerce and logistics platforms for two reasons: customers and data. We think this is part of a larger move around what we call the consumer experience. Tastes and behaviors are also fundamentally changing and the disconnect between consumers and established brands is growing wider every day. This trend is what led us to invest in Le Tote two years ago. Often times described as “Netflix for women’s fashion,” the concept of rentable fashion often distorts the larger underlying trend, the transformation of how we think about commerce and fashion. Le Tote is sitting not only on massive amounts of rich data, but they’re growing their customer pace at a strong clip.

In fact, Time magazine recently featured Le Tote in its piece “One Size Fits None, talking about the disparity in women’s clothings sizes over the years and by brands. What’s been called “vanity sizing” is a trend that’s been happening since the industrialization of clothing, as populations and norms change, brands have been quietly adjusting sizing to stay relevant. But with $240 billion worth of apparel being purchased online each year, sizing problems have become a source of waste and inefficiency. Reports suggest that customers return an estimated 40% of what they buy online, the leading culprit? You guessed it, sizing issues.

So how does Le Tote solve a problem this…ahem, large? (sorry I had to). Data. Massive amounts of data in fact. When a user signs up, they spend a few minutes at the beginning taking their own measurements with a measuring tape. That information is then sent to Le Tote, which uses that as the client’s actual size, not an arbitrary or vanity numerical one. This data is matched with Le Tote’s  massive database of clothing measurements.

“The algorithm behind it all is called Chloe, and it’s more encyclopedic than any human salesclerk. In addition to tracking my shape, Chloe can track my likes and dislikes. If I get a pair of boyfriend jeans that hang too loose, for example, I can tell Chloe I don’t like that style, even though it technically fits. Next time Chloe will know to size down.” – Eliana Dockterman, Time Magazine

The result is a box of curated outfits that actually fit their users. No small effort as the return data suggest, and the algorithm is getting better every day. The space they play in, the customers they’ve won, and the data they leverage through machine learning and AI has begun to catch the attention of global retail leaders.

Just remember, customers and data…

 


 

Written by Bill Malloy and Patrick ONeill