Where Subscriber Lifetimes Outlive Funds
Hidden Opportunities in “Software-Driven Systems”
As an investor, I don’t know if I love anything more than backing a new set of physical products or experiences that integrate a subscription model to deliver value for consumers.
I gravitate towards businesses that broadly fall into two buckets: (1) the creation of a new market (eg. PlayStation Plus) or (2) the application of a new business model to improve an old market or service (e.g. Alarm.com, or Dadi):
While I am lucky to be a Board Member or institutional investor in many of these, I got involved because I deeply believe these businesses have some of the most compelling unit economics I’ve seen in my career. AND YET, they were underappreciated and ignored by investors for the majority of their early-stage lives, and, in some cases, through their IPOs!
But it is not often you see implied subscriber lifetimes outlast a fund’s life. When I do, I lean into it.
As a point of comparison, consider the overwhelming majority of mobile consumer subscription apps alongside the group above. Many a la carte applications have raised hundreds of millions in preference (individually!), but often these businesses have significantly worse fundamentals (e.g. churn, pricing power) and do not achieve enduring success.
The thread that ties the companies above together is that their subscriber base is centered around hardware or a physical experience. Importantly though, these are not businesses which simply slap a subscription on top of an existing offering (which we see a lot of in this market), but intentionally designed products that integrate software to create value across high frequency interactions or emotionally sensitive purchasing decisions.
And while investors have had an aversion to hardware-centric subscription models, it’s clear that not only can the retention dynamics be better than many segments of pure-play consumer apps, but so can the moats, purchase psychology, and long term FCF yield.
Many VCs don’t believe it and some are even skeptical after I walk them through the numbers like the above. I welcome that.
As Fred Wilson likes to say, this is how new funds outperform — avoid “me too” investing.
Lastly, I share this as an example of why I believe it is critically important for emerging investors to develop a nuanced thesis – ideally one refined through experience, and overlooked by the market. This is the only way I’ve found it’s possible to (a) gain the domain expertise needed for a sustainable investment advantage, (b) cultivate the open-mindedness required to see opportunity others won’t and (c) have conviction where others don’t.
When I look to the coming year, I am particularly interested in finding software driven systems within health & wellness, gaming and sustainability. I strongly believe the best businesses in these spaces will not be standalone mobile applications, but rather full-stack systems often with a physical or experiential component. I welcome the skeptics, just as we did in financing Dadi, Peloton and Latch, from Series A through IPO.
Founders who are building in this full-stack approach benefit from working with an investor who has walked the factory floors in Taiwan, knows complementary go-to-market channels, and has the product sensibilities in both hardware and software to drive increasing value for the customer each month.
Ultimately, customers are the voting machine, and they speak with retention. And as the data above suggests, an elegant “software-driven system” may be the best approach.
If that resonates with you, get in touch on Twitter.
Special thanks to @Joanne Schneider DeMeireles @Brett Bivens @Ian D’Silva @Nikhil Basu Trivedi and @Eric Crowley for helping crystalize my thoughts, the entrepreneurs I’m so fortunate to work with, and my partners over the years who enabled me to find my game and take smart risks in the businesses above. Originally published at https://marcodemeireles.substack.com.
Investing in “Confusion”
A key principle I’ve picked up from Jim Breyer over the years is to “invest in confusion.”
Massive confusion in growing markets represents an enormous arbitrage opportunity.
Confusion in this context can refer to a newly available technology, or to changes in the economics of supply, production and/or distribution of a good or service. It can also be driven by regulatory changes, changes in a competitive landscape and so much more.
While confusion manifests itself in different ways, it’s clear that not only are these the moments in time that are uniquely positive for emerging businesses, they are the cornerstone of my most successful investments.
This holds true across sectors. Consider:
- Databricks successfully commercializing Apache Spark in the face of legacy vendors with larger sales forces and larger spark investments (IBM)
- The ballooning impact of Facebook, Pinterest, Twitter, Reddit, et. al on our communities in contrast to Yahoo’s inability to move into social networks
- Netflix and Hulu’s clear victory delivering a streaming offering that captures, serves and delights subscribers before legacy media got there
I could share a list of 100 more examples, but you get the point. Massive confusion of legacy players often renders them unable to compete, and paves the way for a new set of enduring companies.
Often, the only option for these established businesses is to buy into the market, but they rarely pioneer a market when confusion runs high. This is partly why the NYSE did not build Coinbase, and Splunk did not build Confluent.
For investors, confusion presents an added benefit of making it less likely that the market is appropriately pricing related investments. Often, it is because these companies don’t fold into a simple existing total addressable market definition, and/or have elements (including business models) that not many have underwritten in the past.
The best way I’ve been able to navigate this is to (1) dig deep into the platform shift by speaking with every participant (customers, competitors, industry analysts, founders and operators) (2) actually listen intently – with “Dumbo Ears!” and (3) force yourself to tune out the crowd. I can’t tell you how many times I heard “No one makes money in media,” “Crypto is a fad,” or “Hardware is hard; it doesn’t scale” before backing teams proving folks wrong.
Do you believe there are certain shifts happening that established market leaders are confused about? Get in touch. I’d love to talk with you about it.
Why Now
A key question you hear in many investing conversations — but not enough!—is “why now?” Over the last 10 years, I’ve focused on becoming more disciplined in answering this question every time I map out a new market or explore a new business.
“Why now” could be that a newly-available technology enables a new service, such as the introduction of Broadband and subsequent roll-out of 5G, which catalyzed the widespread adoption of streaming-services like Netflix into homes and devices around the world. Or that patent expiry, like Invisalign’s, which cleared the way for Smile Direct Club, Candid, and Uniform Teeth to improve upon a dated approach with superior service and pricing. Or large behavioral shifts like the destigmatization of mental health, and related self-care movement, which paved the way for digital tools like Headspace to be a service consumers are proud to download and employers tout as a benefit rather than a fringe or shameful need.
Often, the simplest “Why Now” examples to understand are regulatory, which is what I’m going to focus on in this post. I’ll cover other angles in future posts.
To understand the power of getting the timing right, consider the following two examples:
US Consumer Finance: The Rise of Mobile Neobanks
- The Credit Card Act of 2009: Banned marketing of credit cards on college campuses, increasing the average age of credit card acquisition and leaving more young people in the last decade to depend on other means (ie. debit).Debit card users don’t want to overdraft, let alone incur related fees while working with a UX that left much to be desired. This interplay spurred a number of downstream consequences, including the increased adoption and engagement of personal financial management tools which can track spending in real time (among other functions).
- The Durbin Amendment of 2010: Reduced debit interchange rates for banks >$10B of assets from 155 bps + $0.04 to 5 bps + $0.21. This minimized the historically sizable profit pools that made servicing “low-value” checking accounts interesting to these types of banks. Thus, a legislative change disincentivized large incumbents from serving this population segment as they were precluded from charging sizeable fees to a large swath of accounts.What was the net result? Multiple segments of the market (young people, “underbanked” populations) began looking for better alternatives and upstarts like the Cash App, Chime, Varo Money, Moneylion, were able to cost-effectively take and better serve these customers.The timing of these two regulatory catalysts, coupled with a number of other factors, drove a strong “why now” for a large segment of fintech businesses. These businesses have seen strong product-market fit and billions of enterprise valuation creation.
US Telemedicine
Historically, the establishment of a “valid doctor-patient relationship” precluded the growth and penetration of telemedicine across the states.
Just 10 years ago, remote methods for establishing a valid relationship remained in legal limbo. Texas was the last US state to allow for remote validation following a landmark ruling involving Teladoc, and more recent regulation (ie Ryan Haight Act) has catalyzed the ability to facilitate online treatments and services across new use cases.
Now of course with the current pandemic climate, we are seeing even more widespread relaxing of these regulations which we can expect to pave the way for even greater use cases.
And this is what makes our job as investors and founders so interesting. It’s a constant exercise in understanding how changes to our world will enable greater innovation and usher in significant value creation. And how we capture that.
“Why now” unlocks this conversation.
Are you in the early stages of building something and have a compelling “why now?” If so, get in touch with me on Twitter. I’d love to talk with you about it.
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