On Consumer Metrics

CJ: We were talking to one of the growth leaders at Hulu, and he mentioned that net dollar retention wasn’t part of his vocabulary. It did make me think that there’s a whole different set of efficiency metrics for consumer businesses.

JOHN: For retention, it’s not all created equal. I don’t know the specifics of Hulu, but there’s a difference between linear and nonlinear retention. A lot of consumer businesses have very heavy churn in months one through three, one through six, because – to use the Hulu example – you want to watch the Handmaid’s Tale, so you subscribe, you watch it, you binge, and then you’re gone.

But what’s really important is that you see that nonlinear retention curve, where some subset of the user base really values the subscription, and is going to stay forever. It’s the same concept as enterprise subscription where you’re stacking cohorts over time. You just have to get through some noise in those cohorts to get to that steady base of users.

And so with a lot of our companies, again, we spend more time focused on the tail of retention and what that looks like when you’re at say, renewal in month 12, month 24, month 36. Are you seeing some retentive characteristics there that are going to enable you to build a really strong base of business? That becomes super, super important.

And then listen, with consumer businesses, I would argue it’s kind of all about top of the funnel and how you efficiently reach new customers. There’s a myriad of ways that you could do that. But I think that’s where consumer businesses really mark their differentiation and find a way to succeed.

And then you have to have a big enough TAM, right? You can’t have, say, a hundred customers that you’re selling to, because you’re going to go through those pretty quick. But the thing about consumers is: you’re selling to the entirety of the human population. So in most instances, that means a really big TAM, and then you got to marry the price you pay for the asset to the TAM that’s available. So it’s not totally surprising to me to hear the Hulu guys say that NDR wasn’t a huge metric. But I do think you’ve got to have some retention to build a good business.

On Churn and Retention

CJ: In consumer businesses…you might have an onboarding problem where it wasn’t a good fit – they tried it out and didn’t like it, or they didn’t see the value. That’s where you see them drop off like within the first 30, 60 days. And then there’s actually a content value problem – did I actually binge all of the Handmaid’s Tale, to use your example, and I have no catalog left to watch? Those are two fundamentally different problems.

JOHN: For sure. WIth a lot of consumer businesses, there’s parts of churn you will never be able to change. And I’ve seen countless companies bust their pick and spend tens, hundreds of millions of dollars trying to fix parts of retention. You can’t change human psychology, you can’t change certain human needs. There’s no point.

You’ve got to embrace different users where they are –yes, somebody may come in and binge a show, but that’s okay. Did they leave with a good experience? Did they leave some sort of stored value in the product? Is it easy for them to reactivate? And making things easier for people to come back – that’s important as well. So you’ve got to bifurcate churn and understand what’s solvable and what’s not. One of our investments was in SurveyMonkey, where a lot of people just had to send one survey and that was totally fine. We were never going to change that.

And I wouldn’t have gotten rid of those customers because that drove more virality for the product. It drove more top of funnel for us. But it did make churn look worse. But again, there wasn’t much you could do about it. But if you stored the survey answers in SurveyMonkey, if you did various things, it provided these on roads for people to come back and spend time with it again. So we’ve seen that across our consumer portfolio.

CJ: I think it was Shopify – they cater to this micro business owner where by design, a lot of them fail or they move on to a new idea. And I think they were asking the Chief Product Officer, how do you think about churn in that instance? Because the wider you go, the more it’s actually going to suck. And he said, I actually don’t pay attention to it because I look at the churn as an at-bat that we may not have had anyway. It’s all about the GMB that I can get. And if I have to churn a bunch and it’s just part of the nature of doing business, that is what it is. Looking at it that way blew my mind as a person who just came from B2B software.

JOHN: And some people talk about it as a necessary customer acquisition cost for your good customers. I talk about it like a farm system in baseball where you’ve got to get all these prospects in. You hope that some are good. You have the hypotheses on why someone is going to be better than others. But at the end of the day, you don’t totally know. And so you just have to fill the pool with your prospect system, with a bunch of people, and then some graduate up and some don’t. And that’s just the nature of the business.

Shopify, for example, if you looked at their logo retention, it would be terrible by enterprise standards. But again, that’s what makes their business work so well – they get these businesses early on, they’re not generating very much GMV, and then something catches fire and it’s a great customer for them. So that very high churn that they see at the beginning is just a necessary part of doing business.

On TAM in Consumer Business

CJ: Do you think being honest about the TAM is even more important for consumer businesses than it is for B2B? Because to your point, if you can’t expand the customer past a certain point, you need a lot of customers or a lot of runway.

JOHN: Yeah, I think you have to spend a lot of time focused on TAM. And in a lot of instances, I actually think people get TAM wrong where they think it’s too small. And so you need to really push your thinking: If the TAM at obvious first glance is X, could it become Y? And that’s where I think you create real value.

CJ: Can you say more about that? I think Uber is like the most canonical example of like thinking that TAM is one thing, but it’s really even bigger.

JOHN: We led an investment in a company called Teachers Pay Teachers, which was a marketplace where teachers bought and sold content from each other. And we were fascinated by how big that business was able to become, because not only were they monetizing the obvious stuff where teachers were selling to each other; we were then unable to unlock schools, able to access school budgets – and that increased the TAM.

The way the business might be working today may not be how the business is working in five years. The other example I’d give you is with a lot of like “prosumer” businesses. I’m invested in a business called Otter.ai, which does voice transcription. You know, a lot of times it starts with an individual, so you’re underwriting an individual TAM, but you’re able to then grow into the enterprise. A lot of consumer businesses using PLG are able to latch on and grow into the enterprise, even with their consumer roots. So that would be another way to make TAM bigger.

CJ: I think Canva is an example of that. A lot of investors looked at first like, this is a cute little tool for like moms to make birthday cards for their kids. And then next thing you know, they’re worth $32 billion and they’re selling enterprises.

JOHN: Yeah, and they’re competing with Adobe. So that’s a perfect example.

On Defensible Competitive Advantages

CJ: Are there any metrics that you look to in consumer businesses that you’re like, this is the most important thing to get right?

JOHN: I mentioned TAM, but that’s not really a metric, so I’ll put that to the side. But the metric I look at the most with consumer businesses is funnel health. How much traffic are you attracting, and then more importantly, how are you attracting that traffic? Is it paid? Is it organic? Is it branded search? Is it non-branded search? Is it your customers pumping the product? There’s a lot of nuance in that.

We spend a lot of time going deep on the funnel and understanding what’s defensible in it and what’s not. And I think for consumer businesses to be successful, you have to have an unfair advantage there – something in your funnel that’s driving a flywheel, that’s driving good organic customer acquisition. And that could be brand. But having something that’s making your user acquisition very, very, very efficient is a key for consumer businesses and probably what I spend the most time on.

CJ: So if you look at the pipeline, and you’re seeing that most of it’s coming from paid demand gen, is that a potential red flag?

JOHN: Huge red flag for me. It’s good while it’s good, and then it’s terrible when it’s not. Those economics could just erode really fast. I think they could be vital to get a business going, where you’re spending on paid to build your brand, get the flywheel going, get your first customers.

But if you’re overly reliant on paid acquisition, particularly at scale, boy, that can move against you super fast. And unfortunately, I’ve seen that on numerous occasions where a new entrant enters the market, Google decides they want to do something… there’s just a lot of ways that can break. And once it does, there ain’t much you can do about it. So you’re in a really tough spot.

CJ: Do have to have a pretty good grip on your CAC payback period at the stage that you’re investing in, or is it more about like user activity and if they’re coming back? Are you able to actually look at the unit economics at that level when you’re investing early in a business?

JOHN: We are – we’re growth stage investors so our companies are at least $10M in revenue, something north of there.

CJ: So they have real numbers on the users at that point.

JOHN: Exactly. So there’s enough “there” there. If we were more in the venture world, you probably have to take a bit more of a bet. But yeah, we’re able to really see what the unit economics look like and are able to underwrite that. We’ve passed on plenty of deals because it was too early.

Like I remember we passed on the first Headspace round that another firm ended up doing because they actually hadn’t been through a renewal cycle. We loved everything about it, like “Man, something’s really working here. There’s a brand that’s evident.”

All the economics looked good, but they’d had like four cohorts that had been through a renewal cycle, and that just wasn’t enough for us to underwrite. And so we ended up investing a couple of years later, but that was just too early for us to feel comfortable.

CJ: You mentioned having an unfair advantage. What do you think of some of these consumer brands that have partnered with celebrities like Honest Tea, or the 50 things that Kylie Jenner is selling these days, or Mr. Beast Feastables? Do you think that’s an actual competitive moat or does that get diluted over time?

JOHN: I think it can be a competitive moat. How sustainable it is, that’s the big question. I mentioned Headspace earlier – we were the leader in the market and Calm was coming up behind us. And I remember they got Harry Styles and Matthew McConaughey – who wouldn’t want Matthew McConaughey to read you to sleep? It seems silly, but it actually drove an enormous amount of customer acquisition for them.

Now, eventually we wised up to it and started bringing some celebrities on our platform and some different voices. And so again, it was a great advantage for them, but it was a pretty short window. You can close those pretty quickly if you go out and get influencers on your platform as well.

On the evolution of Consumer Business Models

CJ: You’ve seen a number of evolutions in business models for consumer businesses. When you look back over the last 10 years, what’s changed in the way that these companies monetize?

JOHN: That’s a really good question. I said earlier that all that’s old is new again – I’m feeling that way right now with monetization. If you think about the early days of the internet, it was all ad driven. You couldn’t get anybody to pay for subscriptions. And then people became disillusioned with that as a revenue model, and liked the predictability of subscriptions, so everybody pivoted over to subscriptions.

Now I think there’s a consumer fatigue with subscriptions – you see advertisements now for companies that will help you cut your subscriptions down. So that’s not a good macro to be against.

I actually feel like ads have come back into the fore again – we’re seeing more and more companies realize, “Hey, we might have a big free user base, and we might have different tiers of users, some that will pay a subscription, some that are moderately active or who we monetize with ads or with digital commerce.” Companies are starting to become more creative. I think we’re in the pretty early days of that.

And truthfully, think investors are just starting to get their heads around it – they got so used to underwriting subscription models, so we’re like “How do we underwrite some of these other revenue models as well?”

CJ: I have this theory that at scale, all B2C marketplaces will eventually just become advertising businesses.

JOHN: Yeah, for sure. Take Amazon – their ad business is absolutely enormous. And once you have the eyeballs of the customer and have real deep engagement with the customer, you’re then able to intercept that customer demand and send it numerous different places. Your discovery for food or your discovery of different goods and services might’ve used to start on Google, but now it’s starting on Amazon, starting on DoorDash, starting on Instacart. And advertisers want to be at that point of intercept to reach the customer at the right time. So I think you’re spot on.

CJ: Well, to bring it back to what you were saying, John, it was spot on about like pipeline health. If you’re able to put the advertiser, the person, the company selling a good on your marketplace further down the funnel at a spot where it’s going to meet the consumer, where they want to transact, why would you want to pay Google AdWords to be out in the ether, versus being further down the funnel?

JOHN: That’s exactly right. And you will also start to see that if that’s such a preferred path for commerce or for merchants, they’ll then start pumping your channel themselves. So you get flywheels – I don’t want to send traffic to Google where I’m competing with four other keywords; I want to send it to this place or that place.

And with a lot of our marketplace businesses – again, you saw this at Seamless, you saw this at Teachers Pay Teachers – your users are pushing the site for you, and that was our unfair advantage. We’d have stickers in restaurants that said “Go to seamless.com to order,” or Teachers Pay Teachers creators would say, “Hey, come to Teachers Pay Teachers to get my content.” That reinforcing mechanism just made the marketplace stronger. And then we were able to layer some ad businesses on top of that.

On Consumer Brand

CJ: From some of the companies that you’ve invested in, if you could wrap your hands around brand and be like: “This has some heft to it” – which of those companies have the strongest brand?

JOHN: Headspace probably had the strongest brand at the time we did the investment. The reach that they were getting, the earned media they were getting…I mean Andy Puddicombe, the founder of that business, he was on Oprah and The Today Show and we weren’t paying for those placements. They just wanted a piece of Andy. And that was pretty incredible at the time. I don’t think I’ve ever seen anything quite like that. So that had a very strong brand, at least nationally.

We’ve had other investments with a local brand that was really strong. I worked on our investment in a company called Seamless, which then became Grubhub, the online food ordering platform. Seamless was huge in New York and got its start, interestingly enough, more on the B2B side where investment bankers, lawyers, people staying too late at the office were using Seamless to order food at work and it was subsidized by their employer. And they had such a great experience doing it digitally versus with paper menus, that they’re like, “we’d love to use this at home.”

And so this created a really big brand there – a juggernaut in New York, that then created cash flow that enabled us to go expand into other markets. And ultimately we ended up merging with Grubhub to create the largest delivery business in the US at the time. But the brand in New York there was incredible.

On Teachers Pay Teachers

CJ: Can you talk about Teachers Pay Teachers? I was looking into your portfolio and that was one of the most fascinating models. Can you just explain how that worked again, and maybe any cool stories that came out of the investment?

JOHN: Teachers Pay Teachers was a marketplace where teachers bought and sold their content and curriculum from each other. You’ve got really young kids, but maybe when they’re a couple of years older, you’ll walk into a classroom and you’ll be like, “Holy cow, what’s all this stuff on the walls?” They’re doing different activities every day. A teacher in the classroom has to come up with all that stuff. And that’s a ton of work, particularly for a new teacher who’s entering the profession.

And so the idea behind Teachers Pay Teachers – and lot of this is what I love about the internet – is democratization of content. Think about what Wikipedia did, think about what any podcasting has done, you can find expertise anywhere. And so the idea was, let’s let teachers who create great content, share that with the world and then monetize that. Teachers Pay Teachers was a marketplace that enabled that to happen.

Want to hear more? Listen to the full episode of Run the Numbers on Spotify here.