According to the business maxim, you can always tell who the leader is in a given market: it’s the one with all the arrows sticking out of its back.
While this axiom is applicable across the business landscape it is particularly relevant in the startup world given that most leaders in an emerging market end up taking as much incoming fire from me-too startups coming up from the rear as they do from incumbents threatened by the continued advance on their territory.
I raise this point because I’ve been surprised in recent weeks at the backlash in the media and across the venture landscape against daily deal sites, most notably Groupon and LivingSocial.
To be sure, the daily deals business has become ferociously competitive. There are now dozens of venture-backed businesses pursuing some configuration of the daily deal/social buying/demand aggregation business model. To this number add the emerging group of established web companies now brand extending into the deals business–Facebook, Yelp, Travelzoo, OpenTable, Amazon, and Google, to name but a few.
The birth of any new industry is rarely elegant, planned or pretty. With little argument, whenever one is dealing with the kind of torrid growth that both Groupon and LivingSocial have experienced one will find plenty of areas to criticize. However, I think some of this criticism is misguided. To call a marketplace with hundreds of competitors vying for consumer dollars emerging might be an oversimplification, but emerging it very much is. Let’s not forget that like the early days of social networking, the winning model in this space has not yet been fully realized. Constant iteration is underway, all being attempted at the breakneck pace one would expect in a marketplace still decidedly in its land grab phase. This means things are going to break — loudly and often. This is not altogether bad.
The daily deals space is the kind of web phenomenon we have seen before: Explosive growth, high user engagement, huge cash flow implications for the companies, lofty valuations, investors elbowing their way into funding rounds, and lots of media attention to fuel the frenzy.
In this environment, Groupon and LivingSocial have broken out as the market’s de-facto leaders and built robust businesses. Revenue growth has been nothing short of spectacular. In turn, the companies have responded by raising sizable funding rounds to further consolidate their positions and extend their reach into new markets. Investors and employees have every reason to be proud of these accomplishments. So far, so good.
This, however, is far from saying that their status as perennial leaders is a fait accompli or that they cannot be felled by either other participants or by their own strategic missteps. Indeed, it is still early days. This is perhaps why I find the latest hand-wringing over Groupon’s recent stumbles in the media somewhat disconcerting.
Massive customer churn is to be expected. Explosive growth, particularly as relates to web companies, raises the notion of the shiny new object theory. This notion should inform us that exponential growth and buzz brings huge consumer curiosity which, in turn, brings an influx of users that will try the product/service once and never return. Is this a reflection of a company that has provided a poor user experience? Or, is this simply the realization that 30-40% y/y revenue growth is likely unsustainable and that large swings in customer churn will be in evidence for a long time to come? I am in this latter school of thought.
The “churn” issue so often cited by critics is not simply a matter of consumers being fickle but one of SMBs and merchants as well. They are still trying to figure out how to work with deal sites and whether such marketing campaigns are right for their specific businesses. This will take time.
The Spaghetti Test. Additionally, daily deal sites are incented to build vast Rolodexes and cover wide areas of terrain to extend their brands. This means lots of offers are being written across broad categories of SMBs where the suitability of the daily deal model is still not thoroughly understood and where there is little historical frame of reference. While most managers are loath to admit it, the Spaghetti Test of ‘throw it against the wall and see if it sticks’ inevitably drives a lot of iteration around determining which offers resonate and which do not. This results in a lot of mediocre offers that don’t perform well which can leave merchants and consumers with a poor experience.
Work to be done. Critics are right to point out that there is still a lot of work to be done in elevating the daily deals business to deliver on the full promise of its massive potential–both for consumers and for businesses. Merchants need better post-deal monitoring and CRM-like tools to help with yield management and provide better tracking and analysis. Merchants also want more control and flexibility over how offers are created, sold and redeemed so they can maximize profits while minimizing the impact on their organization when the “crush” of redemptions comes. [Fortunately, startups are already innovating around these themes to fill precisely these voids.]
Consumers, for their part, are demanding better offer targeting, more consistency in pricing and redemptions, and less intrusive appeals in order to fight against emerging deal fatigue now evident across the space. Personalization software needs to catch up so that users can better tag offers of interest and opt-out of those that are annoying or redundant (Cupcakes? Again?) Also, Hyperlocal and Location-Based-Targeting need to demonstrate that they are more than just elegant theories. Too many service-oriented SMBs (i.e. hair salons, etc) have gotten burned in money-losing offers for premium services to out-of-town customers with whom there is no opportunity to develop a long-term customer relationship. That kind of mismatch is being corrected but hyperlocal offer targeting has a ways to go.
Ultimately, the scale that Groupon and LivingSocial have achieved has likely put them beyond the reach of most competitors. The battles ahead, therefore, will be over how best to go vertical. The winners will be those most savvy at customer segmentation and in finding unique offerings positioned against specific themes and product categories. Predictably, there are numerous companies doing precisely that — tweaking group-buying mechanics and applying them to niche, premium markets and making a successful play in those areas. In another market in another time, this “go vertical” approach may have doomed a company to a market insufficiently large to support its efforts. However, as companies such as Gilt Groupe and One Kings Lane have demonstrated, the daily deals market is large enough that even pursuing a niche approach and a narrow customer segment can prove to be enormously lucrative.
2016: The Road Ahead
29 JanBefore the last New Year’s Eve sparkler flickered out on January 1 there was already plenty of hand-wringing over the direction of the venture and technology markets and the apparent shift in mood since the heady days of, well, just a few months ago.
For the venture and technology markets, 2015 was a watershed year on many levels. The number of “unicorn” companies exploded which, by extension, gave rise to concerns that the term had lost some of its cachet since it appeared the logic behind according billion-dollar valuations had become somewhat unmoored from reality. 2015 also saw the first wave of valuation re-sets by notable and prolific venture investors and, with it, concern that this was a but a harbinger of what would become a wholesale value reappraisal across the venture landscape.
Judging from the recent gyrations in public equity markets, the first weeks of 2016 have certainly not calmed these fears. Technology stocks, and broad market indices, have taken a beating. Many seasoned observers would argue that this kind of market re-set in technology companies was long overdue and, as it happens, healthy and necessary. I would put myself in this camp. The market had gotten ahead of its proverbial skis. Many unicorns had failed to yet prove their businesses’ core fundamentals. Equity capital had been too readily available in 2015 and, thus, helped fuel “momentum investing” by some that perhaps perverted the economics of how startups should be funded, what they should focus upon, and how long-term success should be gauged.
With that preamble, here are some of my top-of-mind thoughts on what we might expect in 2016:
No bubble pop, but valuation resets abound.
I am not of a mind that we are in a valuation “bubble”, per se — at least not in a circa 2000-2001 sense of the word. I don’t think we will see the kind of wholesale collapse in valuations as we did 15-odd years ago. The macro fundamentals are simply vastly different. What I believe we will see, however, is a continued reappraisal and level-setting of valuations across the board and, with it, the failure of a few unicorns that will be both unable to sort their unit economics issues and to continue to raise sufficient capital to buy them enough time to figure them out.
A Tougher Equity Funding Environment.
Venture capital flowed freely in 2015; some might say too freely. For the highest profile companies, venture rounds were raised as if almost on a phone call. While I’ll submit that in 2016 the best companies will continue to have their pick of good venture investors with whom to partner, terms will not likely be as company-favorable, valuations will not be as rich, and the timing to close will not be as brief.
A return to traditional venture firms and processes.
Traditional venture capital firms were certainly not on the sidelines in 2015. Far from it. However, there was certainly a trend of non-traditional venture investors—I dislike the term “tourists” –taking a more prominent role than usual participating in and sometimes leading venture rounds. This often lead to sniping and charges of irrational behavior between firms. Traditional “Sand Hill Road” investors would argue that the non-traditional firms were only winning marquee deals by “paying up” since, by definition, they did not possess a strong brand nor reputation within venture to win such deals otherwise. This, in turn, raised valuations for everyone involved and forced some Sand Hill Road names out of participating in financings entirely. While 2016 is barely a month old, we are already seeing a clear pullback in the investment activities of firms not traditionally associated with backing early stage tech companies. Expect to see that trend continue in 2016, with the advantages going to the more traditional venture brands.
A ferocious focus on unit economics and core fundamentals.
In 2015, the growth of a startup in a new, exciting market–often by any means necessary–appeared to take precedence over the less sexy task of making sure a business’ fundamental unit economics were sorted. Given enough growth and enough users the hope was always that, eventually, all the right curves would intersect. But no matter how exciting a startup or its vision, one can get away with selling dollar bills for eighty cents for only so long. In 2016, while we will continue to see many well-funded startups with negative gross margins, the appetite of investors to continue funding upside down economics has likely peaked. This year expect to see a renewed–some might say, ferocious–focus on unit economics and fundamentals.
Again, these are but a few macro thoughts as we close out the first month of 2016. By and large, this is not meant to be a negative or cautionary post. I remain firm in the belief that we are in a period of intense innovation and value creation across technology. While there will be some fallen unicorns this year, we will also see some breakout stars and new markets emerge that will fuel even more innovation and market expansion. That said, every market must first digest what it has already consumed. I suspect we will see continued volatility as tech markets rightsize and as we head deeper into an election year. I will post again shortly on some of the tech trends I expect us to see in the coming year.
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