Why Tesla will never be Apple

I regularly argue with my partners about how amazing Tesla is or isn’t. We all agree Tesla’s technology and product are a leap forward, but the question is whether the company will become a significant or even dominant worldwide auto player (and justify its orbital valuation).  Despite its buzz, Tesla has only a bit more than 1% of the US auto market, though ~40% of the US electric car market. It is easy to analogize Tesla to Apple with the latter’s incredible iPhone tech and product, which consistently holds a 30% to 40% market share after initially creating the smart phone market (and killing the feature phone market).  To perfect the analog, the story would play out like this: most of the 98% of the US market that is now gas or hybrid will become electric in 10 years, and Tesla will continue to be a dominant player. Suddenly Tesla’s 51B market cap looks like a pittance!

Both Tesla and Apple have a superior technology, better products, better user experience and better buying experiences. So how could this not be a “fait accompli”?

Before I answer that, some background: I’ve recently been reading about genetics and its effects on human physical and social evolution. Why? Because I didn’t know crap about genetics, and it seemed a rather gaping hole in my collection of the lots of things I know just a tiny bit about (life of a VC).  If you are interested, read Violinist Thumb and Before the Dawn, in either order.

There is a lot of similarity between genetic evolution and technology evolution – perhaps not a surprise, as genetics is in the broadest sense the most natural of all technologies. So here are a few definitions in lay terms and their analog to technology evolution. Then we’ll get back to Tesla.

Natural selection: Some genes help people live longer or increase fertility, thereby increasing the chance that said gene gets passed on through carriers yielding more offspring than non-carriers.

Sexual selection: A certain type of natural selection where a gene creates a physical (phenotype) or social characteristic in the host making them more attractive to mates, leading to more offspring than for non-carriers.

Genetic drift: The natural fluctuation of versions of a gene in a population through generations when no version (called an allele) provides significant natural or sexual selection benefit over the other. It turns out that with time, genes within a small population and with a set of initial gene variations will tend to converge through generations to a single version because of the effect of early deaths and non-procreation. For finance geeks, the analog in finance is the “random walk”.

Genetic sweep: The rapid dominance of a gene version across a population over just a few generations because of very strong positive natural or sexual selection.

The analog: Technology evolution is like genetic evolution in that customers/consumers make choices between technologies and companies in moments of truth akin to sexual selection. Meanwhile certain technologies and accompanying business models may be more likely to survive longer (less capital intensive, stickier network effects, etc), a natural selection that allows longer survival to then be selected by more customers – a harmonious cycle. When technologies and business models are truly superior, they can literally “sweep” through a population of users, like the iPhone. This is increasingly likely when there are network effects, as the iPhone had with its app store, and virality, which the iPhone had as a fashion and status accessory (admit it).

In this analog, however, we must also account for the role of chance. Even when there isn’t a particularly better functioning or serving technology, certain conditions (last mover advantage, first mover advantage, influential customer, etc) and path dependency can lead to dominance of one technology from a small set of technology choices, a la genetic drift or a random walk.

The big difference between genetic and technology evolution is the time scale. Genetic changes are measured over millennia and across thousands of generations, whereas technology evolution is measured in years or decades. While gene variations can wait for eons to dominate, companies and especially startups don’t have that luxury. A consumer might make a choice about a new phone every two years, a business about an ERP every ten years, and a human being about a mate once in a generation (or so). Modern technology moves much faster than genetics, or at least natural genetics.

The key insight with regard to Apple and Tesla is that the longer decision cycles and product life cycles are, the more time competition has to compete and catch up between consumer decisions. When Apple introduced the smartphone, it was so superior to feature phones that smartphones in the form of the iPhone “swept” through the US phone market in only a few years and ultimately maintained a large 30 to 40% share for Apple itself. I’m an Android guy, but even I can admit that Apple kept a technology lead for almost 10 years – 6 or 7 “generations” of one to two year phone decision cycles. The speed of the market allowed Apple’s initial technology advantage to buoy it in the lead through a number of generations because it was too hard for competition to catch up quickly both with its technology and viral and network-based business model.

The auto market is different. I drive a fourteen year old Subaru, but I’ve purchased at least six phones in that same period. Granted, that is a long hold for a car, but even assuming the national 6.5 year average, that is simply a long time for competitors to have between consumer decisions to catch up. This is true both for consumer decisions between gas/hybrid/electric and for consumer decisions on brand within electric.

Gas and hybrid technologies continue to improve, and even if total cost of ownership for electric is reaching or surpassing parity, most of these calculations don’t account for unnaturally high human discount rates in decision making when considering electric’s higher upfront cost. This effectively slows the growth of Tesla’s electric market sandbox within the overall auto category, giving yet more time for competitors to catch up. By the time electric is a significant portion of the auto market, Tesla may well find itself in a state of “genetic drift” doing the same random walk for a few points of market share here and there – much as Ford, Chrysler and GM did for decades – and likely against those same brands.

What could change this? As far as I can tell, while there is some virality in Tesla’s business model as a fashion and status accessory (admit it), the network effects are more nuanced. So far, your Tesla does not make my Tesla or Tesla experience that much better. While it’s true that the more Teslas on the road, the better self driving features get with additional driving data, but I don’t think Tesla’s current autopilot features are the main buying reasons versus 100% electric, awesome design, status, etc. Tesla’s charging network is its strongest claim on network effects so far, but I would expect this to be fleeting as gas stations, c-stores and QSRs implement their own open networks in the coming decades given the clear opportunity to sell sugar and salt to waiting consumers. Major market share is still possible for Tesla, however, if it truly delivers on the promise of driverless autonomy and establishes a proprietary self-driving network that drives “sweeping” adoption through network effects. We haven’t heard as much talk of this lately.

Moving a startup from bottom third to top third (it’s the people, silly)

The common wisdom of venture is that you lose all your money in the bottom third of your companies, score singles to triples in the middle third, and drive the vast majority of value in your top third. A “Midas Lister” we know astutely refines this saying, “It’s actually the top third of the top third where you make all your money”. This seems to resonate with another startup rule of thumb that 1 in 10 investments is a home run.

The problem with these rules of thumb is that a few years into a fund when you are making new investments, following on in existing ones and looking for patterns to determine where to invest time and money before winners are obvious, after-game learnings don’t help you see the future.

It turns out there is a pattern of early warnings we’ve seen in the fifty companies we’ve worked with. The roadsigns to understanding how the thirds **may** break down can be summarized as follows:

  • Top third: Top third companies are the ones where everyone is in the same room together (founders/mangement, board, investors), talking about how well sales are going and figuring out how to pour more money on.
  • Middle third: Middle third companies are the ones where sales are not going swimmingly, but everyone is still in the same room together discussing how to make them better, either through product, go-to-market or team adjustments.
  • Bottom third: Bottom third companies are ones where sales are not going swimmingly, and everyone is in different rooms (calls, coffees) talking about everything except sales.

Upon reading this, entrepreneurs and investors will immediately know where their compan(ies) stand. Don’t worry, I use the word “roadsign” intentionally. This trio of forewarnings allows time to course correct. So how do you do it?

Top third companies are incredibly rewarding for everyone (sometimes fun, sometimes challenging, sometimes stressful… but always rewarding). Revenue is beating plan, talent is flocking in and VCs keep calling. But you can still screw it up. The common modes of failure include: not hire experienced functional leaders to manage scale; not building market leadership, integration and distribution among other key market players; over-focusing on top-line to the detriment of other key metrics like churn and unit economics (eg, growth at all cost); and generally getting over-confident. Even if you avoid these potholes, ultimately landing in the top third of the top third is still highly dependent on market timing and often pursuit of a non-consensus thesis – not just perfect execution.

Middle third companies are really a fat middle, typically representing 50% of a portfolio. Most VCs have lots of these investments, and most entrepreneurs are running one. Things aren’t going perfectly, or sometimes they are going poorly, but everyone is working hard together to figure it out. Getting into the top third from the middle third is about executing well on product and go-to-market strategy in your current market or finding a riper adjacent market space. If these course corrections don’t work with some time, then the next step may be a change in functional or CEO leadership. The latter is traumatic, time consuming and capital consuming. It is a last resort, but in middle third companies when it is done, it is done smoothly with open dialogue between founders, other managers, investors and board members. You continue to row together.

Bottom third companies (actually often about 10-20% of a portfolio) look very similar to middle third companies –  ranging in growth profile from slightly downward or flat to moderate growth – with the additional challenge that some combination of people aren’t getting along. This creates significant distraction to solving the root growth issue.

And since the theme of this post is threes, there seem to be three modes of such people challenges:

  • Founder – founder: We’ve seen a number of companies handicapped by founder-founder problems, sometimes due to performance issues but more usually personality conflict. If they can’t be worked out, then board members or investors need to quickly help arbitrate – sometimes with the result that one founder moves on.
  • Investor/board – management: These scenarios typically result from company under-performance that leads to investors or the board “moving on” a CEO… or the CEO thinking they will. There are also more nuanced instances where performance is good, but there are disagreements over personnel, strategy or ethics. Because investor/CEO relationships can be accompanied by baggage from prior financing negotiations or fear of VCs “stealing my company,” we’ve found that independent board members are critical in helping a company through these times. Independents can play an objective referee and build consensus around a leadership decision, helping the company move to a new chapter whether with that CEO or a different one. Of note, many startups have independent seats on their board that are not filled. This is one reason among many that it is worth filling them ASAP.
  • Everyone – everyone: Call this a complicated love triangle without the love, where some investors don’t agree on a key issue with other investors, whom in turn don’t agree with management and independents, etc. Factions form. These are really tough situations (often related to leadership or financing) and require a strong CEO, independent director or Chairman to call bullshit, get everyone in a room together and hash it out. Such fractures generally arise from a difference in economic position or differences in perspectives on people or market – all valid business views. In the end, parties need to commit to eating a little crow and moving forward. The other solution is to sell the company – effectively a divorce – but this is easier said than done. Selling a company requires development of consensus on process and takeout price, no easy feat when people aren’t getting along.

Why are these situations so destructive? Time and emotion are the key factors. A complete set of 1:1 side conversations for a board of five people takes 10 times as much time as a single group conversation (see math below). These conversations are often emotional and exacting, reducing confidence in the company and belief in the opportunity for each individual and VC partnerships involved. Above all, they distract from the underlying issue the company has – usually growth. Growth can’t be fixed unless it has everyone’s focus and a mutually trusting team to pursue it.

As with so many ailments, diagnosis is the first step to recovery. If you and your team/board/investors can recognize a bottom third issue, then you can work to get back into the middle third and eventually to the top!

Fun math on side conversations:

10x.png

Meet eTurns: Marshalls + eCommerce Returns

I am a Marshalls shopper. For most utility purchases ranging from socks to sheets to olive oil, Marshalls is my go-to. I am not alone. My regular visits see a line of 10-20 shoppers (often families) waiting to check out against a long row of 5-10 cashiers, all ringing up $X00 basket sizes. With TJX’s (Marhsalls and TJMaxx’s parent) stock up 35% in the last year, it’s clear their model works… an amazing feat in the face of amazon and amidst hundreds of waffling retailers.  The WSJ attributes TJX’s contrarian success to great prices, skillful merchandising and the temporal nature of an ever-changing inventory that drives consumers to buy on sight. The Journal also notes that off-price retailers are visited about twice as often per year as department stores, have a fifty percent higher purchase likelihood per visit and benefit from a short 25 day inventory hold versus the 100 day industry norm. TJX is truly the bright spot in the brick and mortar blight.

At the same time, given HPVP’s activity in the logistics space (FourKites, Shipbob, Roadsync), I’ve been mulling the ever-growing returns problem for e-commerce companies. Estimates are that up to 30 to 40% of e-commerce purchases are returned (versus 8% across all of retail), creating a cost structure that nearly matches the costs of bricks and mortar. Wow, that is what eCommerce companies were trying to avoid in the first place! “Free returns” can cost an online retailer as much as $15 per return in shipping and handling, and the returned merchandise itself is often liquidated for pennies or dimes on the dollar. This is the dark spot in eCommerce’s halo.

Dark spot, meet bright spot. If you put the two together, there is a great opportunity for a Marshalls-like retailer that deals only in eCommerce returns. I am calling it eTurns. Like any budding entrepreneur, I did Google research looking for competitors:

Marshalls/TJX: Certainly TJX could do this itself, but it would have to grow its sourcing to include e/retailers instead of just brands, where it currently sources most of its product directly. This may be a challenge for TJX as most other full-priced home goods and clothing retailers view TJX as an unwelcome discount substitute to their struggling sales.

Happy Returns: Happy Returns is one of a few leading startups addressing the returns issue. They partner with brick and mortar retailers to accept eCommerce returns in person for a variety of online brands and etailers, promising more foot traffic to the brick and mortar and lower returns shipping costs to online brands and etailers. After receiving returns through Happy Returns, etailers resell or disposition returned products as they normally do. I love Happy Returns’ marrying of online and offline retailer needs, but the approach still means an extra forward and reverse shipment for a returned item to reach ultimate sale. Meanwhile, time lost in Happy Returns’ supply chain increases the carrying costs and obsolescence risk of returns.

Optoro: Optoro is another startup making strides in this space. Optoro takes ownership of e/retailer reverse logistics, receiving returns to its own warehouses, assessing quality and remarketing at reduced prices on Amazon, Ebay, and its own site Blinq for ~20-70% off retail. Remnants are then sold in bulk at its own site Bulq for pennies or dimes on the dollar. Certainly this service helps e/retailers outsource the headache and distraction of reverse logistics while monetizing returned merchandise, but it still relies on multiple extra round trips and a longer obsolescing supply chain.

The missing link in these models is speed to (re)market to avoid obsolescence and forgoing additional shipping and handling. If these two problems are solved, more value can be captured from returned merchandise.

Meet eTurns! (no, not that eTurns)

eTurns is a brick and mortar retail concept carrying only merchandise from “local” eCommerce returns. Returns are collected from eTurns bins around a city or neighborhood, as well as at eTurns locations, for a timely refund from the original etailer. eTurns takes the merchandise on consignment and revenue shares the proceeds with the original seller. Like TJX, eTurns is a discount retailer of unique name-brand items with fast inventory turns, reducing obsolescence and increasing  consumers’ propensity to buy on sight.

With retail rents declining and billions of dollars in returned merchandise supply increasing with the market at more than 20% a year, the model could really have legs. It is also self-merchandising. An eTurns location would be a bit smaller than the average 28,000 square foot TJX, servicing concentrated urban neighborhoods where consumers are likely to order (and return) items that others in their neighborhood are also likely to want.  This increases the chance of finding a returned item’s “next best buyer” through common geography.

There are certainly holes to poke in this model – imagine the glut of inventory from Holiday returns – but it feels worth the try. If shipping round trips and time-in-supply-chain are minimized, the drag of returns on e-commerce could be greatly reduced. And who doesn’t love a good deal? Okay, so it doesn’t exist yet. If there is a tenured entrepreneur out there interested in giving this a run, let me know!

Fixing things and building people – why we invested in Fixer

We recently announced our investment in Fixer, led by Founder Collective and including Chicago’s Impact Engine. Fixer is a service that fixes anything in your home reliably, on-time and at a fair price – founded by a contingent of Grubhub’s early employees, including Grubhub co-founder and long-time exec, Mike Evans. Fixer is also our first investment in a Public Benefit Corp (PBC).

For a fund that mostly invests in B2B SaaS and some marketplaces, this direct-to-consumer investment was a unique investment for HPVP. Past is prelude. I grew up in a home that had been pieced together over two centuries by industrious New Englanders. It turns out the first New Englander wasn’t expecting the last one (my dad) to build two new stories on the bespoke structure – too much for the original foundation posts. My Dad and I spent the next few years replacing the main structural posts in the crawl space. Re-leveling a home requires slow and periodic screw jack adjustments so walls don’t crack – like periodic visits to the orthodontics – except that this was in a 2 foot crawl space with centuries of dust, mouse droppings and a 50 ton house above. Naturally, I was the only one who fit… and now we know why parents have kids.

With many stories like this, I’ve long appreciated and enjoyed the handy things in life. But it turns out that many people don’t, creating an increasingly ripe market opportunity. There are two reasons for this. First, handiness and amateur craft skills are being mass-cultured away, while families simply have less time. Generations ago when family homes were passed from generation to generation, maintenance and repair of both home and the things in them (furniture, clothes, fixtures) was like cooking – everyone did it. Now, just as the crossover of consumer food spending from majority-in-home to majority-out-of-home portends the death of ubiquitous home cooking in favor of restaurants, my generation was the last to have shop class. We now seeks these skills in purchased services. Meanwhile other generational mega-trends – majority dual income families, constant digital tethers to work and overscheduled children – leave no time for fixing things ourselves.

Enter Fixer! But wait, how about Thumbtack, Handy, Angie’s list and all the others? That is exactly what I asked Mike when we first discussed Fixer last year. He pointed out a key insight to the Fixer model: when a consumer has a broken faucet, the problem they are trying to solve is “I need my faucet fixed”, not the intermediate problem of “I need to find a plumber”. Most existing platforms solve the latter before the former, and that’s an interim step that creates unnecessary time, frustration, cost and friction in the process. If you’ve ever used Thumbtack or Handy, you’ll find yourself with a bunch of leads for providers but still in the frustrating “yellow pages” vortex of contacting each one and judging for quality, timing and cost. No thanks.

Instead, fixer has built a scalable set of training, process and technology to repeatably deliver a quality experience and outcome, hitting the core consumer need head-on. As evidenced by Fixer’s Yelp and Thumbtack reviews, users love the service. My HPVP partners are regular users, and we’ve also used Fixer in our office, a sign of a B2B opportunity that could be big for Fixer.  Both accidental and intentional landlords spurred by the 2008 financial crisis and Airbnb’s arrival, respectively, have created a whole new economy of residential and commercial property owners and managers. Fixer is finding a widening vein in reliably solving their maintenance needs too.

Great service, but why a PBC?

When Mike and I were talking about financing late last year, he said “we’re going to be a PBC, which isn’t for everyone.” The main difference between C-corps and PBCs is that PBC boards of directors are obligated to account for the impact of decisions on all stakeholders, not just shareholders. This includes employees, customers and the broader community. With some thought, I realized I wouldn’t want to be involved in a company that didn’t consider all stakeholders. In fact, just as rewarding as the financial returns of being an investor is seeing companies create jobs, careers and happy customers. In this sense, venture capital investing has a near perfect alignment with PBCs. Indeed, the decline of trade skills presents a perfect storm to solve a consumer problem AND build a new generation of skilled handypeople who can learn and exercise a trade with strong pay and benefits. You need both to make the model work right.

Scaling a tech enabled service like Fixer won’t be easy, but we’ve got a lot going for us. With a massive market, the right generational macro trends and one of the best teams we’ve ever seen, we’re excited for the journey and the impact it can have for consumers and a new generation of Fixers. Give fixer a try!

How much do you want to sell for?

As our portfolio matures, I increasingly see the importance of the question “how much do you want to sell for?” From initial investment decision, to bringing on new follow-on capital partners, growing teams and ultimately exiting, this is a critical question for founders and investors to ask each other at each step to optimize ultimate liquid outcomes.

Some say, ”focus on building a really big business and worry about how much you sell for later.” The problem here is everyone has a different definition of “big”, so how do you know you are aligned with the investors and talent you add along the way? The “how much” question is akin to asking “how many kids do you want?” when courting your spouse! Better to address these life changing questions early.

Asking “how much” engenders valuable discussions between founders, investors and potential investors. It surfaces views on how much each party thinks the company is worth now, how much they think it can be worth, whether incentives and goals are aligned and discovery of everyone’s risk disposition. I think of risk disposition as a founder or investor’s willingness and perceived self-capability to bring a company from what it’s worth now to something bigger or much bigger later. These variables inform the conversation differently, depending on the stage of a company:

At early stage, first investment: I was recently meeting with an entrepreneur who had done a phenomenal job launching his company and getting to nearly $1M in revenue run rate. Given the dynamics of the market and the vibes from the team, it wasn’t clear they believed they could (or wanted to?) build a really big business. For simplicity in venture, I’d call a really big business one that gets to at least $25M in revenue and has the potential to sell for $250M. So I asked them. “What do you want to sell for?” One founder said, “well, I think this round will be valued at $10M, so if someone offered me that, we would seriously consider it.” The other founder nearly choked on his tongue.

These two founders had not discussed how many kids they wanted to have, and the discussion revealed big differences in belief and risk disposition. The first founder thought his business was worth $10M now, and he was open to cashing in versus trying to make something bigger – clear risk aversion. The other founder felt differently. The answer also made clear to me that the first founder questioned either the market potential or his own potential to build a big company. Both make the opportunity a non-started for us, and nor would they want us involved if a small exit is their goal. Why sell 20-30% of your equity if you think you might exit the company soon for a modest number? We would also have welcomed the question being flipped – it is surprising how rarely entrepreneurs ask us what we are trying to achieve in outcomes.

When bringing on your next investor: Inevitably, follow-on rounds bring up the discussion of what a business is worth now since valuation is a key metric in fundraising. But asking the “how much” question is even more important than in your first round, simply because there are soon to be more and more parties that can get misaligned. For example, a company doing $10M in ARR doubling each year may have several types of choices for a new investor. A multi-stage venture fund may be looking for a 10x opportunity, put in 25M on $100M and want to sell for >$1B – and be willing to take the extreme growth and scaling risks to achieve that. A growth stage fund might instead be looking to do $25M on $80M (with another $20M in secondary) and in order to achieve 3-5x via a $400M exit. This is a much less risky path that also allows early founder and investor liquidity. If your existing board is aligned with the first more aggressive partner but chooses the second instead for nice liquidity, expect a lot of pushback at your first board meeting to planned spending and ramp. In reverse, the first investor will quickly tire of a management team that does not prove to execute aggressively enough. Often these financing decisions will be further complicated by a potential acquirer suddenly making the “how much” question very real…

When approached by an acquirer: This is where the rubber meets the road – creating value is critical, but capturing it is how you get paid. Whether near a financing event or otherwise, how a board manages a potential acquisition must start by asking “how much do we want to sell for?” This will reveal any recent changes in founder and investor views and help define a reservation price at the bottom and reach goal level at the top. We have seen management teams engage deeply with acquirers on valuation before this type of board discussion, a huge mistake that puts the management team out on a limb in negotiating with the acquirer, risking having to backtrack.

 

There are other important realities and insights surfaced when asking “how much” at each of the stages outlined above:

  • Peoples’ answers are always changing, so you need to actually ask the question and not make assumptions during “life events”. Most people’s answers will continue to go up (sometimes rapidly!) when things are going well. When things are going poorly, investors’ answers drop much faster than entrepreneurs’. This latter point creates tension when it comes time to “finding the company a home” or “recovering capital”.
  • Asking “how much” gives you more variables to play with in reaching a favorable financing or acquisition deal. Basic negotiation theory says the more variables you have to move, the more optimal a deal can be for more people. For example, in a situation where a company is deciding between being acquired or raising another round of financing, asking the sale price question may surface investors who have a lower price expectation (perhaps actually lower expectations for the company) and can be offered liquidity via a secondary in a financing. That leaves the believers left to keep building towards the larger outcome. Likewise, if you find a founder’s takeout price is lower than investors, it may be a good time to discuss some founder liquidity to increase their willingness to take risk or increase openness to hires that can take the company even further.
  • There is often confusions among entrepreneurs why an acquisition price now is usually higher than a financing price now. In other words, if the acquirer is offering me $100M, why are investors only giving me a pre-money of $60M? There is plenty of economic theory on this – liquidity preference, control preference, etc – but the bottom line is it is the case most of the time, so don’t be surprised.

 

While discussing sale price should only be a rare distraction from building a company, there are times when it makes all the difference in the world. Happy building and happy selling!