Venture investment skews heavily towards technology. Internet and mobile accounted for 67% of venture capital invested in Q3’15, according to our Venture Pulse: Global VC Report. And many VCs would be quick to cite strong network effects and near-zero marginal costs as to why they’d invest in software and internet companies over a consumer brand.
But are these tech companies really a better early-stage investment than a future consumer giant like Tory Burch or Lululemon?
A recent deck, “Challenging conventional wisdom about consumer product investing,” by Saar Gur and Matt Heiman at CRV (Charles River Ventures), argues the facts don’t fully support the idea that consumer categories — such as packaged food, beverages, restaurants, apparel, and consumer electronics — are poor bets for VCs.
Here are main takeaways from the 54-slide deck:
- Consumer businesses can achieve the scale, margins, and market shares to be sound investments. For example, consumer categories can reach 6X-25X the global market size of popular tech verticals. Also surprising: some consumer markets can be winner-take-most like in software (e.g. Nike and Fitbit have >60% market share).
- Arguably, consumer brands outperform retail “aggregators” like Amazon, Overstock, and Zulily, which have narrow margins. Overstock, for example, has only 1% EBIT margins (earnings before interest and taxes), whereas a luxury brand like Michael Kors can see 30%.
- And retail’s public market performance can be weak; Amazon’s 10-year return on invested capital was only 5%. Only 3 retail aggregators have returned more than 5x over the last 10 years or since IPO, according to the authors.
- Apparel and accessories is an attractive vertical for early-stage investment because they’re relatively capital-light and have attractive margins. Plus, brands are able to capture more revenue with the rise of direct-to-consumer e-commerce. Apparel “brand value” is the fastest-growing consumer vertical at 30% growth, and luxury is still a growth leader at ~16% growth.
- However, not all consumer categories look that promising. Consumer electronics is a tricky space as software-driven products begin to dominate. A data point in this vein is that the mega-hit GoPro only yielded a 1.3X multiple for its 2011 venture investors.
Consumer goods unicorns
In certain respects, Gur and Heiman argue, consumer products have better business fundamentals than some of the most high-flying tech companies.
They first point out that some consumer categories have yielded as many or more billion dollar-valuation companies as the big tech verticals. While it’s not shocking that consumer products has its share of unicorns, conventional wisdom often holds that they simply can’t scale like software can.
For that reason, brands like Old Navy, Office Depot, and Beats by Dre aren’t thought to be in the same league as “blitzscaling” tech startups. But in fact all of those companies took fewer years to hit $1B in sales than tech’s biggest success stories including Facebook, Twitter, and Salesforce.
Next, it turns out that consumer companies are pretty competitive with tech companies, especially when it comes to EBIT margins. For reference, Google has a 26% EBIT margin, whereas Dunkin Donuts and Applebees have margins of 43% and 33%, respectively. (It should be noted that these margins are a result of their franchise business models, but that further demonstrates the power of a consumer brand.)
Lastly, says CRV, today’s consumer product IPO class has built larger businesses per dollar of VC investment than their technology counterparts. A slide that was made using CB Insights data supports this idea. Consumer companies like Krave beef jerky and Dollar Shave Club built bigger businesses relative to their startup capital than database companies like MongoDB, though a software company (Zendesk) was the most efficient from a revenue/capital ratio perspective.
The consumer electronics minefield
Consumer electronics is just as brutally competitive as the rest of the consumer goods space but also typically suffers from limited margins. Not to mention that the space is rapidly being disrupted by smartphones. Amazon’s Kindle, Flip video cameras, Garmin GPS and Texas Instruments’ graphic calculator have all lost traction with the advent of the smartphone. Garmin’s stock took a very clear dive since the introduction of the iPhone, currently trading at about half its value from 2007. Specialty consumer electronics are being crowded out by multi-purpose mobile devices and apps.
Take a look at one of the biggest consumer electronics hit of all time, GoPro. The chart below, also made using CB Insights data, shows how its 2011 venture round only yielded a 1.3X multiple for investors:
Fitbit’s recent IPO was far more successful for venture backers (91.6X for Foundry Group), but that may be because of Fitbit’s profile as a health device, as well as its app- and data-centric suite of supporting products for its wearables. In other words, it’s as much a software company as it is a gadget manufacturer.
Again, to view the whole deck, click through to Saar Gur’s post on Medium.
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