Online Shopping Is Terrible At Venture Capital

I read this TechCrunch article yesterday, “ Venture Capital Is Terrible At Online Shopping” with great interest and personal experience.

The article got it wrong. It’s not that venture capital is terrible at online shopping, it’s that online shopping is currently a terrible space for venture capital.

In the U.S. and in many countries there’s a one word reason for that: Amazon.

It turns out that E-Commerce is increasingly a winner-take-all market, just like most online markets. And, Amazon has already won most of the market.

As Jason Del Rey wrote on recode recently:

Macquarie estimates that Amazon accounts for half of all sales growth in U.S. e-commerce, meaning online retailers not named Amazon are battling for around 50 cents of every new $1 spent online. As if that weren’t enough, Amazon also accounts for about a quarter of every new $1 of growth in all of retail, including brick-and-mortar sales, too.

Now, consider the size and scale of Amazon’s capital expenditures to maintain its increasingly dominant market position. Amazon’s annual cap-ex alone (investment in infrastructure, like warehouses and fulfillment) was $3.8B in 2012, $4.4B in 2013, and nearly $5B in 2014. It’s safe to assume it was another $5B in 2015.

What Venture Capitalist in their right mind would want to sign up for investing into a market where you’re fighting for 50 cents on the dollar vs. one of the top 3 (and perhaps the absolute #1) most impressive growth companies of our generation who is pumping tens of billions into growing even bigger and bigger? And, vs. a company who has a massive lock-in moat with Prime and who is just really f-ing great at what they do. Amazon isn’t slowing down, that 50 cents to fight for will quickly become 45, 40, 35, 30. My personal bet is that Amazon will capture a minimum of 75 cents on the dollar of new U.S. e-commerce spend by 2018.

If Amazon didn’t exist, and online upstarts were primarily taking on bricks-and-mortar competitors, VC’s would be pumping money into the category left and right, in search of creating the Amazon. Sorry folks, the Amazon is already here and it’s only getting stronger.

It’s no wonder that VC has shied away from taking on Amazon directly.

However, it also makes sense that VC pumped a lot of money into daily deals and flash sales the past few years.

There, it seemed, were super fast growth opportunities to carve a sizable slice of the e-commerce pie not being captured by Amazon — to not go at Amazon head-to-head on what they do best (mass market intent-based retail), rather to try to build new e-commerce models that were not Amazon. I liken flash sales vs. Amazon to QVC and HSN vs. Walmart. Daily deals and flash sales took advantage of direct access to the consumers via e-mail and mobile notifications/apps much the same as home shopping networks took advantage of TV to go directly to customers, appealing to impulse shopping vs. needs-based shopping.

It’s worth noting that HSN+QVC (before the Zulily acquisition) had combined revenue of about $10B vs. Walmart’s $480B. I believe Zulily was on about a $1.2B run-rate before the acquisition. Let’s just say the combined revenue was $12B, so about 2.5% of Walmart’s.

Is it a VC-sized opportunity to try to capture 2.5% of the E-commerce market over the next years by being the HSN/QVC of online to Amazon’s mass retailer? Absolutely. Even if Amazon captures the lion-share of new e-commerce dollars coming online that’s a $10B+/year revenue opportunity.

So, why didn’t it happen?

I think — and this part will surely be controversial, so let’s debate it — that it’s partly a structural problem with VC and private vs. public markets these days. And, I think it’s partly because none of the companies in the flash space besides Zulily developed large standalone viable businesses — by that I mean business that could generate enough operating margins to overcome the considerable costs of flash sales operations. And, I think it’s partly because there was no significant consolidation in the space.

From 2010 to 2014 flash was growing super fast and there was a sparkle of opportunity for flash to capture that 2.5% of online retail I refer to. There was so much demand for private market investments that F-company, G-company, OKL-company, H-Company, R-Company, Z-Company, all raised globs of money in the private markets. All except for Z-company remained private companies and struggled to scale the operationally intensive flash business model beyond a couple of hundred million dollars per annum. At a certain point those companies needed to invest in warehouses, inventory, and continuously in marketing and customer acquisition and retention. VC’s rightly got nervous. If a couple of hundred million dollars can’t build a sustainable unicorn in that space, how much money would it take? $500M? $1B?

Or, put another way, if you were to start a business today that will be the size that eBay is now, in 10 years, how much money would that one company need to invest in order to carve out a respectable but not winning position vs. Amazon in E-commerce?

My opinion is that just like Amazon has become a winner-take-all in mass market retail, there would have needed to emerge a single winner-take-all company in flash. And, that company would have had to encompass all of the design flash market (F company), luxury flash market (G company), home flash market (O company), kids flash market (Z company), and even more verticals. On their own, F, G, O, H, R never could achieve the scale required to execute a winner take all and emerge as a single viable HSN/QVC to Amazon’s Walmart position.

Which leads me to wonder what would have happened if the VC markets today were more like they were in 1999 and 2000 and many of F, G, O, H, R were public companies when the music stopped. They would have been forced to merge to survive. Don’t get me wrong, I’m not saying that F, G, O etc. were all ready to be viable public companies (they were not), but I am saying that F + G + O + Z would have been a heck of a valuable business together.

So, maybe it’s a structural VC / private markets problem that failed to create a single viable long term winner in flash.

Or, maybe the CEO’s in the space (myself included) should have focused first on building profitable $100M revenue companies rather than shooting for unicorns. If each were profitable at $100M, consolidation and other options would have been more possible.

Or, maybe it was just a really tough model for VC’s to invest in to try to get a single winner. I don’t blame any of the investors in F, G, O etc. for hitting the brakes. There was no clear path in sight to making those companies long term viable unicorns on their own.

Or, maybe what the flash industry really needed was a super aggressive deal-making CEO in Z, who could have rolled up the flash industry rather than selling to QVC. (I applaud Darrel and team for their huge success, I’m just wondering what if…)

What do you think?

Beyond flash, e-commerce overall remains a tough market for VC. There is potential that some pure-play vertical “full stack” ecommerce companies can develop into nice businesses and exist alongside Amazon, but there are reasonable doubts that massive e-commerce unicorns will develop without considerable investment.

A number of e-commerce startup CEO’s — of good businesses — lament to me that VC’s won’t invest in their companies. I tell them, it’s not because those companies are not potentially good companies, it’s because the chances of those companies becoming unicorns without globs of investment are so low compared to VC’s investing in less capital intensive greenfield markets without an Amazon.