Monthly Archives: October 2017

Making sense of things with the right framework

Everything has a reason behind it.

If something doesn’t make sense to you, it’s not because it’s inherently nonsensical, but because you either don’t yet know the framework to apply to understand it, or are applying the wrong framework among those that you do know.

Armed with the right framework, what did not make sense in the past makes sense.

E-commerce brands and consumer review sites

Differentiating yourself as an e-commerce company is very challenging. The founder of Bonobos, Andy Dunn, which sold to Wal Mart for $310M, wrote as much here.

In that post, Andy identified four ways in which e-commerce sites can potentially compete with the largest horizontal players like Amazon:

  1. Proprietary pricing
  2. Proprietary selection
  3. Proprietary experience
  4. Proprietary merchandise

Bonobos is an example of the fourth.

However, even creating your own direct to consumer e-commerce brand, enabled by proprietary merchandise, isn’t necessarily defensible from competition. The reason is that, in the absence of intellectual property protection along an important product dimension, which most product categories do not have, your product features and resulting quality are likely to be replicated by competitors who discover and begin to work with your supply chain.

When the product features offered by different e-commerce brands begin to commoditize, branding becomes the key differentiator. And consumer review sites, which were initially designed to assess product features, become the target of e-commerce brands’ branding efforts.

This is a fascinating story of how mattress e-commerce brands used consumer review sites for their branding activities.

Global IT companies, avoiding trends, and defensibility

In this recent interview, Peter Thiel of Founders Fund makes several important points that I agree with:

  1. Successful IT companies, which depend on talented people, capital, and the right governance structures, will increasingly emerge from global locations rather than primarily from Silicon Valley.
  2. Investing in specific companies, led by the entrepreneurs behind them, produces better returns than investing in trends.
  3. Companies that have the potential to be one of a kind, or in other words companies which are defensible, are better investments.

I couldn’t embed the video in this post, but you can watch it here.

Horizontal service marketplaces

As Josh Breinlinger explains in his marketplace framework, in service marketplaces with a high purchase frequency like food and car ordering, or large transaction values like real estate and car buying, it makes sense to have a vertical offering. The high repeat rates in the former and the large transaction values in the latter make the unit economics work.

However, in many service marketplaces, the transaction values are less than those of purchasing a home or a car and the purchase frequency is less than that of food and taxi ordering. In order to make the unit economics work, such marketplaces needs to augment the standalone value of the first transaction which likely won’t be repeated until several months later. This requires a horizontal approach where the marketplace offers many services that meet the demands of its target customer profile.

For example, a home services marketplace benefits from offering not only cleaning but also handyman, home improvement, and moving services.

Similarly, a car services marketplace benefits from offering not only car maintenance but also repair and roadside assistance services.

Communicating to portray reality versus to sell

In earlier posts, I wrote that there are two approaches to presenting and evaluating evidence. The first is “to look for evidence along different dimensions and then draw dimension-specific conclusions based on this evidence”, and the second is “to highlight those pieces of evidence that support the product you’re trying to sell while overlooking or downplaying those pieces of evidence that could be barriers to the sale”.

The goal of the first approach is to accurately portray reality, while the goal of the second is to sell.

Every communication (written, over the phone, video, or in person) is composed of different degrees of both elements.

In order to communicate effectively, you need to know the degree to which to use each element.

And when filtering incoming communications, you need to know the degree to which the communicator’s goal is to portray reality versus to sell.

Communicating confidently and frequently

Ideally, we should judge people based on the merits of their arguments.

However, evaluating the merits of an argument takes more effort than evaluating the confidence with which one delivers an argument. We therefore often use the latter as a proxy for the former. And the latter is a function of the tone of the delivery and how often the communicator speaks in a group setting.

This human bias is unlikely to change in the near future. It’s engrained in us as the result of thousands of years of evolution.

Achieving something at large scale requires not only having the right idea based on its merits, but also convincing many people to work with you on that idea. The latter requires that a large group of people have a positive judgment of you. And that, in turn, requires communicating in a confident tone and frequently.

 

Startups, growth, and valuation multiples

When you invest in a startup, you invest at a very steep valuation multiple.

It isn’t possible to justify the valuation at which you’re investing using traditional multiples like revenue, gross margin, EBITDA, or net income. The latter two are almost always negative, and depending on the stage at which you’re investing, the first two range from small to non-existent. Your reason for investing is that you believe that the startup will grow to produce revenue, gross margin, EBITDA, and net income in the future. It is this growth that you pay for.

However, even if the startup is successful in growing to produce these figures, the relevant multiple at which it is valued in the future is very often lower than that which you invested at. The reason is that even healthy businesses are eventually valued at traditional multiples that reflect a lower growth trajectory.

As a result, for an investor to make money in a startup investment, the increase in the company’s valuation which is produced by the company’s growth needs to offset the decline in the company’s valuation which will take place as a result of the lower future valuation multiple assigned to it.

This is why growth is so important for startups. If it stops or declines, even if the company is able to manage its costs so as to achieve break-even, the decline in valuation multiples makes it very difficult to achieve a return on your investment.

Curiosity

In an earlier post, I wrote about how our son’s curiosity for and resulting fascination with everything in life reminds me that each new moment is a miracle.

In that post, the reason I gave for why we often default to living as though nothing is a miracle is that we’ve experienced many things before.

However, there’s also a second reason why we often default to this approach. And that is that most of what we’re guided to do, especially as a child, is to complete tasks in predetermined subject areas. Rather than ask the questions that interest us and follow the paths that result from our attempts to answer these questions, we’re guided to complete predetermined tasks without asking questions. In other words, we’re guided to set aside our own curiosity for what society believes we should be curious about, to the extent that society believes we should be curious about it.

Fortunately, our own curiosity does not go away. It sits there, beneath layers of externally constructed interests.

Just like our son, and just like when you were a child, you just have to have the courage to let your curiosity surface.