The Valuation Bible

Facebook valuation image

After many years of successfully picking public and private companies to invest in, I thought I’d share some of the core fundamentals I use to think about how a company should be valued. Let me start by saying numerous companies defy the logic that I will lay out in this post, often for good reasons, sometimes for poor ones. However, eventually most companies will likely approach this method, so it should at least be used as a sanity check against valuations.

When a company is young, it may not have any earnings at all, or it may be at an earnings level (relative to revenue) that is expected to rise. In this post, I’ll start by considering more mature companies that are approaching their long-term model for earnings to establish a framework, before addressing how this framework applies to less mature companies. The post will be followed by another one where I apply the rules to Tesla and discuss how it carries over into private companies.

Growth and Earnings are the Starting Points for Valuing Mature Companies

When a company is public, the most frequently cited metric for valuation is its price to earnings ratio (PE). This may be done based on either a trailing 12 months or a forward 12 months. In classic finance theory a company should be valued based on the present value of future cash flows. What this leads to is our first rule:

Rule 1: Higher Growth Rates should result in a higher PE ratio.

When I was on Wall Street, I studied hundreds of growth companies (this analysis does not apply to cyclical companies) over the prior 10-year period and found that there was a very strong correlation between a given year’s revenue growth rate and the next year’s revenue growth rate. While the growth rate usually declined year over year if it was over 10%, on average this decline was less than 20% of the prior year’s growth rate. What this means is that if we took a group of companies with a revenue growth rate of 40% this year, the average organic growth for the group would likely be about 33%-38% the next year. Of course, things like recessions, major new product releases, tax changes, and more could impact this, but over a lengthy period of time this tended to be a good sanity test. As of January 2, 2018, the average S&P company had a PE ratio of 25 on trailing earnings and was growing revenue at 5% per year. Rule 1 implies that companies growing faster should have higher PEs and those growing slower, lower PEs than the average.

Graph 1: Growth Rates vs. Price Earnings Ratios

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The graph shows the correlation between growth and PE based on the valuations of 21 public companies. Based on Rule 1, those above the line may be relatively under-priced and those below relatively over-priced. I say ‘may be’ as there are many other factors to consider, and the above is only one of several ways to value companies. Notice that most of the theoretically over-priced companies with growth rates of under 5% are traditional companies that have long histories of success and pay a dividend. What may be the case is that it takes several years for the market to adjust to their changed circumstances or they may be valued based on the return from the dividend. For example, is Coca Cola trading on: past glory, its 3.5% dividend, or is there something about current earnings that is deceptive (revenue growth has been a problem for several years as people switch from soda to healthier drinks)? I am not up to speed enough to know the answer. Those above the line may be buys despite appearing to be highly valued by other measures.

Relatively early in my career (in 1993-1995) I applied this theory to make one of my best calls on Wall Street: “Buy Dell sell Kellogg”. At the time Dell was growing revenue over 50% per year and Kellogg was struggling to grow it over 4% annually (its compounded growth from 1992 to 1995, this was partly based on price increases). Yet Dell’s PE was about half that of Kellogg and well below the S&P average. So, the call, while radical at the time, was an obvious consequence of Rule 1. Fortunately for me, Dell’s stock appreciated over 65X from January 1993 to January 2000 (and well over 100X while I had it as a top pick) while Kellogg, despite large appreciation in the overall stock market, saw its stock decline slightly over the same 7-year period (but holders did receive annual dividends).

Rule 2: Predictability of Revenue and Earnings Growth should drive a higher trailing PE

Investors place a great deal of value on predictability of growth and earnings, which is why companies with subscription/SaaS models tend to get higher multiples than those with regular sales models. It is also why companies with large sales backlogs usually get additional value. In both cases, investors can more readily value the companies on forward earnings since they are more predictable.

Rule 3: Market Opportunity should impact the Valuation of Emerging Leaders

When one considers why high growth rates might persist, the size of the market opportunity should be viewed as a major factor. The trick here is to make sure the market being considered is really the appropriate one for that company. In the early 1990s, Dell had a relatively small share of a rapidly growing PC market. Given its competitive advantages, I expected Dell to gain share in this mushrooming market. At the same time, Kellogg had a stable share of a relatively flat cereal market, hardly a formula for growth. In recent times, I have consistently recommended Facebook in this blog for the very same reasons I had recommended Dell: in 2013, Facebook had a modest share of the online advertising, a market expected to grow rapidly. Given the advantages Facebook had (and they were apparent as I saw every Azure ecommerce portfolio company moving a large portion of marketing spend to Facebook), it was relatively easy for me to realize that Facebook would rapidly gain share. During the time I’ve owned it and recommended it, this has worked out well as the share price is up over 8X.

How the rules can be applied to companies that are pre-profit

As a VC, it is important to evaluate what companies should be valued at well before they are profitable. While this is nearly impossible to do when we first invest (and won’t be covered in this post), it is feasible to get a realistic range when an offer comes in to acquire a portfolio company that has started to mature. Since they are not profitable, how can I apply a PE ratio?

What needs to be done is to try to forecast eventual profitability when the company matures. A first step is to see where current gross margins are and to understand whether they can realistically increase. The word realistic is the key one here. For example, if a young ecommerce company currently has one distribution center on the west coast, like our portfolio company Le Tote, the impact on shipping costs of adding a second eastern distribution center can be modeled based on current customer locations and known shipping rates from each distribution center. Such modeling, in the case of Le Tote, shows that gross margins will increase 5%-7% once the second distribution center is fully functional. On the other hand, a company that builds revenue city by city, like food service providers, may have little opportunity to save on shipping.

  • Calculating variable Profit Margin

Once the forecast range for “mature” gross margin is estimated, the next step is to identify other costs that will increase in some proportion to revenue. For example, if a company is an ecommerce company that acquires most of its new customers through Facebook, Google and other advertising and has high churn, the spend on customer acquisition may continue to increase in direct proportion to revenue. Similarly, if customer service needs to be labor intensive, this can also be a variable cost. So, the next step in the process is to access where one expects the “variable profit margin” to wind up. While I don’t know the company well, this appears to be a significant issue for Blue Apron: marketing and cost of goods add up to about 90% of revenue. I suspect that customer support probably eats up (no pun intended) 5-10% of what is left, putting variable margins very close to zero. If I assume that the company can eventually generate 10% variable profit margin (which is giving it credit for strong execution), it would need to reach about $4 billion in annual revenue to reach break-even if other costs (product, technology and G&A) do not increase. That means increasing revenue nearly 5-fold. At their current YTD growth rate this would take 9 years and explains why the stock has a low valuation.

  • Estimating Long Term Net Margin

Once the variable profit margin is determined, the next step would be to estimate what the long-term ratio of all other operating cost might be as a percent of revenue. Using this estimate I can determine a Theoretic Net Earnings Percent. Applying this percent to current (or next years) revenue yields a Theoretic Earnings and a Theoretic PE (TPE):

TPE= Market Cap/Theoretic Earnings     

To give you a sense of how I successfully use this, review my recap of the Top Ten Predictions from 2017 where I correctly predicted that Spotify would not go public last year despite strong top line growth as it was hard to see how its business model could support more than 2% or so positive operating margin, and that required renegotiating royalty deals with record labels.  Now that Spotify has successfully negotiated a 3% lower royalty rate from several of the labels, it appears that the 16% gross margins in 2016 could rise to 19% or more by the end of 2018. This means that variable margins (after marketing cost) might be 6%. This would narrow its losses, but still means it might be several years before the company achieves the 2% operating margins discussed in that post. As a result, Spotify appears headed for a non-traditional IPO, clearly fearing that portfolio managers would not be likely to value it at its private valuation price since that would lead to a TPE of over 200. Since Spotify is loved by many consumers, individuals might be willing to overpay relative to my valuation analysis.

Our next post will pick up this theme by walking through why this leads me to believe Tesla continues to have upside, and then discussing how entrepreneurs should view exit opportunities.

 

SoundBytes

I’ve often written about effective shooting percentage relative to Stephen Curry, and once again he leads the league among players who average 15 points or more per game. What also accounts for the Warriors success is the effective shooting of Klay Thompson, who is 3rd in the league, and Kevin Durant who is 6th. Not surprisingly, Lebron is also in the top 10 (4th). The table below shows the top ten among players averaging 15 points or more per game.  Of the top ten scorers in the league, 6 are among the top 10 effective shooters with James Harden only slightly behind at 54.8%. The remaining 3 are Cousins (53.0%), Lillard (52.2%), and Westbrook, the only one below the league average of 52.1% at 47.4%.

Table: Top Ten Effective Shooters in the League

table

*Note: Bolded players denote those in the top 10 in Points per Game

Ten Predictions for 2018

In my recap of 2017 predictions I pointed out how boring my stock predictions have been with Tesla and Facebook on my list every year since 2013 and Amazon on for two of the past three years. But what I learned on Wall Street is that sticking with companies that have strong competitive advantages in a potentially mega-sized market can create great performance over time (assuming one is correct)! So here we go again, because as stated in my January 5 post, I am again including Tesla, Facebook and Amazon in my Top ten list for 2018. I believe they each continue to offer strong upside, as explained below. I’m also adding a younger company, with a modest market cap, thus more potential upside coupled with more risk. The company is Stitch Fix, an early leader in providing women with the ability to shop for fashion-forward clothes at home. My belief in the four companies is backed up by my having an equity position in each of them.

I’m expecting the four stocks to outperform the market. So, in a steeply declining market, out-performance might occur with the stock itself being down (but less than the market). Having mentioned the possibility of a down market, I’m predicting the market will rise this year. This is a bit scary for me, as predicting the market as a whole is not my specialty.

We’ll start with the stock picks (with January 2 opening prices of stocks shown in parenthesis) and then move on to the remainder of my 10 predictions.

1. Tesla stock appreciation will continue to outpace the market (it opened the year at $312/share).

The good news and bad news on Tesla is the delays in production of the Model 3. The good part is that we can still look forward to massive increases in the number of cars the company sells once Tesla gets production ramping (I estimate the Model 3 backlog is well in excess of 500,000 units going into 2018 and demand appears to be growing). In 2017, Tesla shipped between 80,000 and 100,000 vehicles with revenue up 30% in Q3 without help from the model 3. If the company is successful at ramping capacity (and acquiring needed parts), it expects to reach a production rate of 5,000 cars per week by the end of Q1 and 10,000 by the end of the year. That could mean that the number of units produced in Q4 2018 will be more than four times that sold in Q4 2017 (with revenue about 2.0-2.5x due to the Model 3 being a lower priced car). Additionally, while it is modest compared to revenue from selling autos, the company appears to be the leader in battery production. It recently announced the largest battery deal ever, a $50 million contract (now completed on time) to supply what is essentially a massive backup battery complex for energy to Southern Australia. While this type of project is unlikely to be a major portion of revenue in the near term, it can add to Tesla’s growth rate and profitability.

2. Facebook stock appreciation will continue to outpace the market (it opened the year at $182/share).

The core Facebook user base growth has slowed considerably but Facebook has a product portfolio that includes Instagram, WhatsApp and Oculus. This gives Facebook multiple opportunities for revenue growth: Improve the revenue per DAU (daily active user) on Facebook itself; increase efforts to monetize Instagram and WhatsApp in more meaningful ways; and build the install base of Oculus. Facebook advertising rates have been increasing steadily as more mainstream companies shift budget from traditional advertising to Facebook, especially in view of declining TV viewership coupled with increased use of DVRs (allowing viewers to skip ads). Higher advertising rates, combined with modest growth in DAUs, should lead to continued strong revenue growth. And while the Oculus product did not get out of the gate as fast as expected, it began picking up steam in Q3 2017 after Facebook reduced prices. At 210,000 units for the quarter it may have contributed up to 5% of Q3 revenue. The wild card here is if a “killer app” (a software application that becomes a must have) launches that is only available on the Oculus, sales of Oculus could jump substantially in a short time.

3. Amazon stock appreciation will outpace the market (it opened the year at $1188/share).

Amazon, remarkably, increased its revenue growth rate in 2017 as compared to 2016. This is unusual for companies of this size. In 2018, we expect online to continue to pick up share in retail and Amazon to gain more share of online. The acquisition of Whole Foods will add approximately $4B per quarter in revenue, boosting year/year revenue growth of Amazon an additional 9%-11% per quarter, if Whole Foods revenue remains flattish. If Amazon achieves organic growth of 25% (in Q3 it was 29% so that would be a drop) in 2018, this would put the 3 quarters starting in Q4 2017 at about 35% growth. While we do expect Amazon to boost Whole Foods revenue, that is not required to reach those levels. In Q4 2018, reported revenue will return to organic growth levels. The Amazon story also features two other important growth drivers. First, I expect the Echo to have another substantial growth year and continue to emerge as a new platform in the home. Additionally, Amazon appears poised to benefit from continued business migration to the cloud coupled with increased market share and higher average revenue per cloud customer. This will be driven by modest price increases and introduction of more services as part of its cloud offering. The success of the Amazon Echo with industry leading voice technology should continue to provide another boost to Amazon’s revenue. Additionally, having a large footprint of physical stores will allow Amazon to increase distribution of many products.

4. Stitch Fix stock appreciation will outpace the market (it opened the year at $25/share and is at the same level as I write this post).

Stitch Fix is my riskiest stock forecast. As a new public company, it has yet to establish a track record of performance that one can depend upon. On the other hand, it’s the early leader in a massive market that will increasingly move online, at-home shopping for fashion forward clothes. The number of people who prefer shopping at home to going to a physical store is on the increase. The type of goods they wish to buy expands every year. Now, clothing is becoming a new category on the rapid rise (it grew from 11% of overall clothing retail sales in 2011 to 19% in 2016). It is important for women buying this way to feel that the provider understands what they want and facilitates making it easy to obtain clothes they prefer. Stitch Fix uses substantial data analysis to personalize each box it sends a customer. The woman can try them on, keep (and pay for) those they like, and return the rest very easily.

5. The stock market will rise in 2018 (the S&P opened the year at 2,696 on January 2).

While I have been accurate on recommending individual stocks over a long period, I rarely believe that I understand what will happen to the overall market. Two prior exceptions were after 9/11 and after the 2008 mortgage crisis generated meltdown. I was correct both times but those seemed like easy calls. So, it is with great trepidation that I’m including this prediction as it is based on logic and I know the market does not always follow logic! To put it simply, the new tax bill is quite favorable to corporations and therefore should boost after-tax earnings. What larger corporations pay is often a blend of taxes on U.S. earnings and those on earnings in various countries outside the U.S. There can be numerous other factors as well. Companies like Microsoft have lower blended tax rates because much of R&D and corporate overhead is in the United States and several of its key products are sold out of a subsidiary in a low tax location, thereby lowering the portion of pre-tax earnings here. This and other factors (like tax benefits in fiscal 2017 from previous phone business losses) led to blended tax rates in fiscal 2015, 2016 and 2017 of 34%, 15% and 8%, respectively. Walmart, on the other hand, generated over 75% of its pre-tax earnings in the United States over the past three fiscal years, so their blended rate was over 30% in each of those years

Table 1: Walmart Blended Tax Rates 2015-2017

The degree to which any specific company’s pre-tax earnings mix changes between the United States and other countries is unpredictable to me, so I’m providing a table showing the impact on after-tax earnings growth for theoretical companies instead. Table 2 shows the impact of lowering the U.S. corporate from 35% to 21% on four example companies. To provide context, I show two companies growing pre-tax earnings by 10% and two companies by 30%. If blended tax rates didn’t change, EPS would grow by the same amount as pre-tax earnings. For Companies 1 and 3, Table 2 shows what the increase in earnings would be if their blended 2017 tax rate was 35% and 2018 shifts to 21%. For companies 2 and 4, Table 2 shows what the increase in earnings would be if the 2017 rate was 30% (Walmart’s blended rate the past three years) and the 2018 blended rate is 20%.

Table 2: Impact on After-Tax Earnings Growth

As you can see, companies that have the majority of 2018 pre-tax earnings subject to the full U.S. tax rate could experience EPS growth 15%-30% above their pre-tax earnings growth. On the other hand, if a company has a minimal amount of earnings in the U.S. (like the 5% of earnings Microsoft had in fiscal 2017), the benefit will be minimal. Whatever benefits do accrue will also boost cash, leading to potential investments that could help future earnings.  If companies that have maximum benefits from this have no decline in their P/E ratio, this would mean a substantial increase in their share price, thus the forecast of an up market. But as I learned on Wall Street, it’s important to sight risk. The biggest risks to this forecast are the expected rise in interest rates this year (which usually is negative for the market) and the fact that the market is already at all-time highs.

6. Battles between the federal government and states will continue over marijuana use but the cannabis industry will emerge as one to invest in.

The battle over legalization of Marijuana reached a turning point in 2017 as polls showed that over 60% of Americans now favor full legalization (as compared to 12% in 1969). Prior to 2000, only three states (California, Oregon and Maine) had made medical cannabis legal. Now 29 states have made it legal for medical use and six have legalized sale for recreational use. Given the swing in voter sentiment (and a need for additional sources of tax revenue), more states are moving towards legalization for recreational and medical purposes. This has put the “legal” marijuana industry on a torrid growth curve. In Colorado, one of the first states to broadly legalize use, revenue is over $1 billion per year and overall 2017 industry revenue is estimated at nearly $8 billion, up 20% year/year. Given expected legalization by more states and the ability to market product openly once it is legal, New Frontier Data predicts that industry revenue will more than triple by 2025. The industry is making a strong case that medical use has compelling results for a wide variety of illnesses and high margin, medical use is forecast to generate over 50% of the 2025 revenue. Given this backdrop, public cannabis companies have had very strong performance. Despite this, in 2016, VCs only invested about $49 million in the sector. We expect that number to escalate dramatically in 2017 through 2019. While public cannabis stocks are trading at nosebleed valuations, they could have continued strong performance as market share consolidates and more states (and Canada) head towards legalization. One caveat to this is that Federal law still makes marijuana use illegal and the Trump administration is adopting a more aggressive policy towards pursuing producers, even in states that have made use legal. The states that have legalized marijuana use are gearing up to battle the federal government.

7. At least one city will announce a new approach to Urban transport

Traffic congestion in cities continues to worsen. Our post on December 14, 2017 discussed a new approach to urban transportation, utilizing small footprint automated cars (one to two passengers, no trunk, no driver) in a dedicated corridor. This appears much more cost effective than a Rapid Bus Transit solution and far more affordable than new subway lines. As discussed in that post, Uber and other ride services increase traffic and don’t appear to be a solution. The thought that automating these vehicles will relieve pressure is overly optimistic. I expect at least one city to commit to testing the method discussed in the December post before the end of this year – it is unlikely to be a U.S. city. The approach outlined in that post is one of several that is likely to be tried over the coming years as new thinking is clearly needed to prevent the traffic congestion that makes cities less livable.

8. Offline retailers will increase the velocity of moving towards omnichannel.

Retailers will adopt more of a multi-pronged approach to increasing their participation in e-commerce. I expect this to include:

  • An increased pace of acquisition of e-commerce companies, technologies and brands with Walmart leading the way. Walmart and others need to participate more heavily in online as their core offline business continues to lose share to online. In 2017, Walmart made several large acquisitions and has emerged as the leader among large retailers in moving online. This, in turn, has helped its stock performance. After a stellar 12 months in which the stock was up over 40%, it finally exceeded its January 2015 high of $89 per share (it reached $101/share as we are finalizing the post). I expect Walmart and others in physical retail to make acquisitions that are meaningful in 2018 so as to speed up the transformation of their businesses to an omnichannel approach.
  • Collaborating to introduce more online/technology into their physical stores (which Amazon is likely to do in Whole Foods stores). This can take the form of screens in the stores to order online (a la William Sonoma), having online purchases shipped to your local store (already done by Nordstrom) and adding substantial ability to use technology to create personalized items right at the store, which would subsequently be produced and shipped by a partner.

9. Social commerce will begin to emerge as a new category.

Many e-commerce sites have added elements of social, and many social sites have begun trying to sell various products. But few of these have a fully integrated social approach to e-commerce. The elements of a social approach to e-commerce include:

  • A feed-based user experience
  • Friends’ actions impact your feed
  • Following trend setters to see what they are buying, wearing, and favoring
  • Notifications based on your likes and tastes
  • One click to buy
  • Following particular stores and/or friends

I expect to see existing e-commerce players adding more elements of social, existing social players improving their approach to commerce and a rising trend of emerging companies focused on fully integrated social commerce.

10. “The Empire Strikes Back”: automobile manufacturers will begin to take steps to reclaim use of its GPS.

It is almost shameful that automobile manufacturers, other than Tesla, have lost substantial usage of their onboard GPS systems as many people use their cell phones or a small device to run Google, Waze (owned by Google) or Garmin instead of the larger screen in their car. In the hundreds of times I’ve taken an Uber or Lyft, I’ve never seen the driver use their car’s system. To modernize their existing systems, manufacturers may need to license software from a third party. Several companies are offering next generation products that claim to replicate the optimization offered by Waze but also add new features that go beyond it like offering to order coffee and other items to enable the driver to stop at a nearby location and have the product prepaid and waiting for them. In addition to adding value to the user, this also leads to a lead-gen revenue opportunity. In 2018, I expect one or more auto manufacturers to commit to including a third-party product in one or more of their models.

Soundbytes

Tesla model 3 sample car generates huge buzz at Stanford Mall in Menlo Park California. This past weekend my wife and I experienced something we had not seen before – a substantial line of people waiting to check out a car, one of the first Model 3 cars seen live. We were walking through the Stanford Mall where Tesla has a “Guide Store” and came upon a line of about 60 people willing to wait a few hours to get to check out one of the two Model 3’s available for perusal in California (the other was in L.A.). An hour later we came back, and the line had grown to 80 people. To be clear, the car was not available for a test drive, only for seeing it, sitting in it, finding out more info, etc. Given the buzz involved, it seems to me that as other locations are given Model 3 cars to look at, the number of people ordering a Model 3 each week might increase faster than Tesla’s capacity to fulfill.

Re-cap of 2017 Top Ten Predictions

I started 2017 by saying:

When I was on Wall Street I became very boring by having the same three strong buy recommendations for many years…  until I downgraded Compaq in 1998 (it was about 30X the original price at that point). The other two, Microsoft and Dell, remained strong recommendations until I left Wall Street in 2000. At the time, they were each well over 100X the price of my original recommendation. I mention this because my favorite stocks for this blog include Facebook and Tesla for the 4th year in a row. They are both over 5X what I paid for them in 2013 ($23 and $45, respectively) and I continue to own both. Will they get to 100X or more? This is not likely, as companies like them have had much higher valuations when going public compared with Microsoft or Dell, but I believe they continue to offer strong upside, as explained below.

Be advised that my top ten for 2018 will continue to include all three picks from 2017. I’m quite pleased that I continue to be fortunate, as the three were up an average of 53% in 2017. Furthermore, each of my top ten forecasts proved pretty accurate, as well!

I’ve listed in bold the 2017 stock picks and trend forecasts below, and give a personal evaluation of how I fared on each. For context, the S&P was up 19% and the Nasdaq 28% in 2017.

  1. Tesla stock appreciation will continue to outpace the market. Tesla, once again, posted very strong performance.  While the Model 3 experienced considerable delays, backorders for it continued to climb as ratings were very strong. As of mid-August, Tesla was adding a net of 1,800 orders per day and I believe it probably closed the year at over a 500,000-unit backlog. So, while the stock tailed off a bit from its high ($385 in September), it was up 45% from January 3, 2017 to January 2, 2018 and ended the year at 7 times the original price I paid in 2013 when I started recommending it. Its competitors are working hard to catch up, but they are still trailing by quite a bit.
  2. Facebook stock appreciation will continue to outpace the market. Facebook stock appreciated 57% year/year and opened on January 2, 2018 at $182 (nearly 8 times my original price paid in 2013 when I started recommending it). This was on the heels of 47% revenue growth (through 3 quarters) and even higher earnings growth.
  3. Amazon stock appreciation will outpace the market. Amazon stock appreciated 57% in 2017 and opened on January 2, 2018 at $1,188 per share. It had been on my recommended list in 2015 when it appreciated 137%. Taking it off in 2016 was based on Amazon’s stock price getting a bit ahead of itself (and revenue did catch up that year growing 25% while the stock was only up about 12%). In 2017, the company increased its growth rate (even before the acquisition of Whole Foods) and appeared to consolidate its ability to dominate online retail.
  4. Both online and offline retailers will increasingly use an omnichannel approach. Traditional retailers started accelerating the pace at which they attempted to blend online and offline in 2017. Walmart led, finally realizing it had to step up its game to compete with Amazon. While its biggest acquisition was Jet.com for over $3 billion, it also acquired Bonobos, Modcloth.com, Moosejaw, Shoebuy.com and Hayneedle.com, creating a portfolio of online brands that could also be sold offline. Target focused on becoming a leader in one-day delivery by acquiring Shipt and Grand Junction, two leaders in home delivery. While I had not predicted anything as large as a Whole Foods acquisition for Amazon, I did forecast that they would increase their footprint of physical locations (see October 2016 Soundbytes). The strategy for online brands to open “Guide” brick and mortar stores ( e.g. Tesla, Warby Parker, Everlane, etc.) continued at a rapid pace.
  5. A giant piloted robot will be demo’d as the next form of entertainment. As expected, Azure portfolio company, Megabots, delivered on this forecast by staging an international fight with a giant robot from Japan. The fight was not live as the robots are still “temperamental” (meaning they occasionally stop working during combat). However, interest in this new form of entertainment was incredible as the video of the fight garnered over 5 million views (which is in the range of an average prime-time TV show). There is still a large amount of work to be done to convert this to an ongoing form of entertainment, but all the ingredients are there.
  6. Virtual and Augmented reality products will escalate. Sales of VR/AR headsets appear to have well exceeded 10 million units for the year with some market gain for higher-end products. The types of applications have expanded from gaming to room design (and viewing), travel, inventory management, education, healthcare, entertainment and more. While the actual growth in unit sales fell short of what many expected, it still was substantial. With Apple’s acquisition of Vrvana (augmented reality headset maker) it seems clear that Apple plans to launch multiple products in the category over the next 2-3 years, and with Facebook’s launch of ArKIT, it’s social AR development platform, there is clearly a lot of focus and growth ahead.
  7. Magic Leap will disappoint in 2017. Magic Leap, after 5 years of development and $1.5 billion of investment, did not launch a product in 2017. But, in late December they announced that their first product will launch in 2018. Once again, the company has made strong claims for what its product will do, and some have said early adopters (at a very hefty price likely to be in the $1,500 range) are said to be like those who bought the first iPod. So, while it disappointed in 2017, it is difficult to tell whether or not this will eventually be a winning company as it’s hard to separate hype from reality.
  8. Cable companies will see a slide in adoption. According to eMarketer, “cord cutting”, i.e. getting rid of cable, reached record proportions in 2017, well exceeding their prior forecast. Just as worrisome to providers, the average time watching TV dropped as well, implying decreased dependence on traditional consumption. Given the increase now evident in cord cutting, UBS (as I did a year ago) is now forecasting substantial acceleration of the decline in subscribers. While the number of subscribers bounced around a bit between 2011 and 2015, when all was said and done, the aggregate drop in that four-year period was less than 0.02%. UBS now forecasts that between the end of 2016 and the end of 2018 the drop will be 7.3%. The more the industry tries to offset the drop by price increases, the more they will accelerate the pace of cord cutting.
  9. Spotify will either postpone its IPO or have a disappointing one. When we made this forecast, Spotify was expected to go public in Q2 2017. Spotify postponed its IPO into 2018 while working on new contracts with the major music labels to try to improve its business model. It was successful in these negotiations in that the labels all agreed to new terms. Since the terms were not announced, we’ll need to see financials for Q1 2018 to better understand the magnitude of improvement. In the first half of the year, Spotify reported that gross margins improved from 16% to 22%, but this merely cut its loss level rather than move the company to profitability. It has stated that it expects to do a non-traditional IPO (a direct listing without using an investment bank) in the first half of 2018. If the valuation approaches its last private round, I would caution investors to stay away, as that valuation, coupled with 22% gross margins (and over 12% of revenue in sales and marketing cost to acquire customers), implies net margin in the mid-single digits at best (assuming they can reduce R&D and G&A as a percent of revenue). This becomes much more challenging in the face of a $1.6 billion lawsuit filed against it for illegally offering songs without compensating the music publisher. Even if they managed to successfully fight the lawsuit and improve margin, Spotify would be valued at close to 100 times “potential earnings” and these earnings may not even materialize.
  10. Amazon’s Echo will gain considerable traction in 2017. Sales of the Echo exploded in 2017 with Amazon announcing that it “sold 10s of millions of Alexa-enabled devices” exceeding our aggressive forecast of 2-3x the 4.4 million units sold in 2016. The Alexa app was also the top app for both Android and iOS phones. It clearly has carved out a niche as a new major platform.

Stay tuned for my top 10 predictions of 2018!

 

SoundBytes

  • In our December 20, 2017 post, I discussed just how much Steph Curry improves teammate performance and how effective a shooter he is. I also mentioned that Russell Westbrook leading the league in scoring in the prior season might have been detrimental to his team as his shooting percentage falls well below the league average. Now, in his first game returning to the lineup, Curry had an effective shooting percentage that exceeded 100% while scoring 38 points (this means scoring more than 2 points for every shot taken). It would be interesting to know if Curry is the first player ever to score over 35 points with an effective shooting percentage above 100%! Also, as of now, the Warriors are scoring over 15 points more per game this season with Curry in the lineup than they did for the 11 games he was out (which directly ties to the 7.4% improvement in field goal percentage that his teammates achieve when playing with Curry as discussed in the post).

How much do you know about SEO?

Search Engine Optimization: A step by step process recommended by experts

Azure just completed its annual ecommerce marketing day. It was attended by 15 of our portfolio companies, two high level executives at major corporations, a very strong SEO consultant and the Azure team. The purpose of the day is to help the CMOs in the Azure portfolio gain a broader perspective on hot marketing topics and share ideas and best practices. This year’s agenda included the following sessions:

  1. Working with QVC/HSN
  2. Brand building
  3. Using TV, radio and/or podcasts for marketing
  4. Techniques to improve email marketing
  5. Measuring and improving email marketing effectiveness
  6. Storytelling to build your brand and drive marketing success
  7. Working with celebrities, brands, popular YouTube personalities, etc.
  8. Optimizing SEO
  9. Product Listing Ads (PLAs) and Search Engine Marketing (SEM)

One pleasant aspect of the day is that it generated quite a few interesting ideas for blog posts! In other words, I learned a lot regarding the topics covered. This post is on an area many of you may believe you know well, Search Engine Optimization (SEO). I thought I knew it well too… before being exposed to a superstar consultant, Allison Lantz, who provided a cutting-edge presentation on the topic. With her permission, this post borrows freely from her content. Of course, I’ve added my own ideas in places and may have introduced some errors in thinking, and a short post can only touch on a few areas and is not a substitute for true expertise.

SEO is Not Free if You Want to Optimize

I have sometimes labeled SEO as a free source of visitors to a site, but Allison correctly points out that if you want to focus on Optimization (the O in SEO) with the search engines, then it isn’t free, but rather an ongoing process (and investment) that should be part of company culture. The good news is that SEO likely will generate high quality traffic that lasts for years and leads to a high ROI against the cost of striving to optimize. All content creators should be trained to write in a manner that optimizes generating traffic by using targeted key words in their content and ensuring these words appear in the places that are optimal for search. To be clear, it’s also best if the content is relevant, well written and user-friendly. If you were planning to create the content anyway, then the cost of doing this is relatively minor. However, if the content is incremental to achieve higher SEO rankings, then the cost will be greater. But I’m getting ahead of myself and need to review the step by step process Allison recommends to move towards optimization.

Keyword Research

The first thing to know when developing an SEO Strategy is what you are targeting to optimize. Anyone doing a search enters a word or phrase they are searching for. Each such word or phrase is called a ‘keyword’. If you want to gain more users through SEO, it’s critical to identify thousands, tens of thousands or even hundreds of thousands of keywords that are relevant to your site. For a fashion site, these could be brands, styles, and designers. For an educational site like Education.com (an Azure portfolio company that is quite strong in SEO and ranks on over 600,000 keywords) keywords might be math, english, multiplication, etc. The broader the keywords, the greater the likelihood of higher volume.  But along with that comes more competition for search rankings and a higher cost per keyword. The first step in the process is spending time brainstorming what combinations of words are relevant to your site – in other words if someone searched for that specific combination would your site be very relevant to them? To give you an idea of why the number gets very high, consider again Education.com. Going beyond searching on “math”, one can divide math into arithmetic, algebra, geometry, calculus, etc. Each of these can then be divided further. For example, arithmetic can include multiplication, addition, division, subtraction, exponentiation, fractions and more.  Each of these can be subdivided further with multiplication covering multiplication games, multiplication lesson plans, multiplication worksheets, multiplication quizzes and more.

Ranking Keywords

Once keywords are identified the next step is deciding which ones to focus on. The concept leads to ranking keywords based upon the likely number of clicks to your site that could be generated from each one and the expected value of potential users obtained through these clicks. Doing this requires determining for each keyword:

  • Monthly searches
  • Competition for the keyword
  • Conversion potential
  • Effort (and possible cost) required to achieve a certain ranking

Existing tools report the monthly volume of searches for each keyword (remember to add searches on Bing to those on Google). Estimating the strength of competition requires doing a search using the keyword and learning who the top-ranking sites are currently (given the volume of keywords to analyze, this is very labor intensive). If Amazon is a top site they may be difficult to surpass but if the competition includes relatively minor players, they would be easier to outrank.

The next question to answer for each keyword is: “What is the likelihood of converting someone who is searching on the keyword if they do come to my site”. For example, for Education.com, someone searching on ‘sesame street math games’ might not convert well since they don’t have the license to use Sesame Street characters in their math games. But someone searching on ‘1st grade multiplication worksheets’ would have a high probability of converting since the company is world-class in that area. The other consideration mentioned above is the effort required to achieve a degree of success. If you already have a lot of content relevant to a keyword, then search optimizing that content for the keyword might not be very costly. But, if you currently don’t have any content that is relevant or the keyword is very broad, then a great deal more work might be required.

Example of Keyword Ranking Analysis

Source: Education.com

Comparing Effort Required to Estimated Value of Keywords

Once you have produced the first table, you can make a very educated guess on your possible ranking after about 12 months (the time it may take Google/Bing to recognize your new status for that keyword).

There are known statistics on what the likely click-through rates (share of searches against the keyword) will be if you rank 1st, 2nd, 3rd, etc. Multiplying that by the average search volume for that keyword gives a reasonable estimate of the monthly traffic that this would generate to your site. The next step is to estimate the rate at which you will convert that traffic to members (where they register so you get their email) and/or customers (I’ll assume customers for the rest of this post but the same method would apply to members). Since you already know your existing conversion rate, in general, this could be your estimate. But, if you have been buying clicks on that keyword from Google or Bing, you may already have a better estimate of conversion. Multiplying the number of customers obtained by the LTV (Life Time Value) of a customer yields the $ value generated if the keyword obtains the estimated rank. Subtract from this the current value being obtained from the keyword (based on its current ranking) to see the incremental benefit.

Content Optimization

One important step to improve rankings is to use keywords in titles of articles. While the words to use may seem intuitive, it’s important to test variations to see how each may improve results. Will “free online multiplication games” outperform “free times table games”. The way to test this is by trying each for a different 2-week (or month) time period and see which gives a higher CTR (Click Through Rate). As discussed earlier, it’s also important to optimize the body copy against keywords. Many of our companies create a guide for writing copy that provides rules that result in better CTR.

The Importance of Links

Google views links from other sites to yours as an indication of your level of authority. The more important the site linking to you, the more it impacts Google’s view. Having a larger number of sites linking to you can drive up your Domain Authority (a search engine ranking score) which in turn will benefit rankings across all keywords. However, it’s important to be restrained in acquiring links as those from “Black Hats” (sites Google regards as somewhat bogus) can actually result in getting penalized. While getting another site to link to you will typically require some motivation for them, Allison warns that paying cash for a link is likely to result in obtaining some of them from black hat sites. Instead, motivation can be your featuring an article from the other site, selling goods from a partner, etc.

Other Issues

I won’t review it here but site architecture is also a relevant factor in optimizing SEO benefits. For a product company with tens of thousands of products, it can be extremely important to have the right titles and structure in how you list products. If you have duplicative content on your site, removing it may help your rankings, even if there was a valid reason to have such duplication. Changing the wording of content on a regular basis will help you maintain rankings.

Summary

SEO requires a well-thought-out strategy and consistent, continued execution to produce results. This is not a short-term fix, as an SEO investment will likely only start to show improvements four to six months after implementation with ongoing management. But as many of our portfolio companies can attest, it’s well worth the effort.

 

 

SoundBytes

  • It’s a new basketball season so I can’t resist a few comments. First, as much as I am a fan of the Warriors, it’s pretty foolish to view them as a lock to win as winning is very tenuous. For example, in game 5 of the finals last year, had Durant missed his late game three point shot the Warriors may have been facing the threat of a repeat of the 2016 finals – going back to Cleveland for a potential tying game.
  • Now that Russell Westbrook has two star players to accompany him we can see if I am correct that he is less valuable than Curry, who has repeatedly shown the ability to elevate all teammates. This is why I believe that, despite his two MVPs, Curry is under-rated!
  • With Stitchfix filing for an IPO, we are seeing the first of several next generation fashion companies emerging. In the filing, I noted the emphasis they place on SEO as a key component of their success. I believe new fashion startups will continue to exert pressure on traditional players. One Azure company moving towards scale in this domain is Le Tote – keep an eye on them!

Will Grocery Shopping Ever be the Same?

Will grocery shopping ever be the same?

Dining and shopping today is very different than in days gone by – the Amazon acquisition of Whole Foods is a result

“I used to drink it,” said Andy Warhol once of Campbell’s soup. “I used to have the same lunch every day, for 20 years, I guess, the same thing over and over again.” In Warhol’s signature medium, silkscreen, the artist reproduced his daily Campbell’s soup can over and over again, changing only the label graphic on each one.

When I was growing up I didn’t have exactly the same thing over and over like Andy Warhol, but virtually every dinner was at home, at our kitchen table (we had no dining room in the 4-room apartment). Eating out was a rare treat and my father would have been abhorred if my mom brought in prepared food. My mom, like most women of that era, didn’t officially work, but did do the bookkeeping for my dad’s plumbing business. She would shop for food almost every day at a local grocery and wheel it home in her shopping cart.

When my wife and I were raising our kids, the kitchen remained the most important room in the house. While we tended to eat out many weekend nights, our Sunday through Thursday dinners were consumed at home, but were sprinkled with occasional meals brought in from the outside like pizza, fried chicken, ribs, and Chinese food. Now, given a high proportion of households where both parents work, eating out, fast foods and prepared foods have become a large proportion of how Americans consume dinner. This trend has reached the point where some say having a traditional kitchen may disappear as people may cease cooking at all.

In this post, I discuss the evolution of our eating habits, and how they will continue to change. Clearly, the changes that have already occurred in shopping for food and eating habits were motivations for Amazon’s acquisition of Whole Foods.

The Range of How We Dine

Dining can be broken into multiple categories and families usually participate in all of them. First, almost 60% of dinners eaten at home are still prepared there. While the percentage has diminished, it is still the largest of the 4 categories for dinners. Second, many meals are now purchased from a third party but still consumed at home. Given the rise of delivery services and greater availability of pre-cooked meals at groceries, the category spans virtually every type of food. Thirdly, many meals are purchased from a fast food chain (about 25% of Americans eat some type of fast food every day1) and about 20% of meals2 are eaten in a car. Finally, a smaller percentage of meals are consumed at a restaurant. (Sources: 1Schlosser, Eric. “Americans Are Obsessed with Fast Food: The Dark Side of the All-American Meal.” CBSNews. Accessed April 14, 2014 / 2Stanford University. “What’s for Dinner?” Multidisciplinary Teaching and Research at Stanford. Accessed April 14, 2014).

The shift to consuming food away from home has been a trend for the last 50 years as families began going from one worker to both spouses working. The proportion of spending on food consumed away from home has consistently increased from 1965-2014 – from 30% to 50%.

Source: Calculated by the Economic Research Service, USDA, from various data sets from the U.S. Census Bureau and the Bureau of Labor Statistics.

With both spouses working, the time available to prepare food was dramatically reduced. Yet, shopping in a supermarket remained largely the same except for more availability of prepared meals. Now, changes that have already begun could make eating dinner at home more convenient than eating out with a cost comparable to a fast food chain.

Why Shopping for Food Will Change Dramatically over the Next 30 Years

Eating at home can be divided between:

  1. Cooking from scratch using ingredients from general shopping
  2. Buying prepared foods from a grocery
  3. Cooking from scratch from recipes supplied with the associated ingredients (meal kits)
  4. Ordering meals that have previously been prepared and only need to be heated up
  5. Ordering meals from a restaurant that are picked up or delivered to your home
  6. Ordering “fast food” type meals like pizza, ribs, chicken, etc. for pickup or delivery.

I am starting with the assumption that many people will still want to cook some proportion of their dinners (I may be romanticizing given how I grew up and how my wife and I raised our family). But, as cooking for yourself becomes an even smaller percentage of dinners, shopping for food in the traditional way will prove inefficient. Why buy a package of saffron or thyme or a bag of onions, only to see very little of it consumed before it is no longer usable? And why start cooking a meal, after shopping at a grocery, only to find you are missing an ingredient of the recipe? Instead, why not shop by the meal instead of shopping for many items that may or may not end up being used.

Shopping by the meal is the essential value proposition offered by Blue Apron, Plated, Hello Fresh, Chef’d and others. Each sends you recipes and all the ingredients to prepare a meal. There is little food waste involved (although packaging is another story). If the meal preparation requires one onion, that is what is included, if it requires a pinch of saffron, then only a pinch is sent. When preparing one of these meals you never find yourself missing an ingredient. It takes a lot of the stress and the food waste out of the meal preparation process. But most such plans, in trying to keep the cost per meal to under $10, have very limited choices each week (all in a similar lower cost price range) and require committing to multiple meals per week. Chef’d, one of the exceptions to this, allows the user to choose individual meals or to purchase a weekly subscription. They also offer over 600 options to choose from while a service like Blue Apron asks the subscriber to select 3 out of 6 choices each week.

Blue Apron meals portioned perfectly for the amount required for the recipes

My second assumption is that the number of meals that are created from scratch in an average household will diminish each year (as it already has for the past 50 years). However, many people will want to have access to “preferred high quality” meals that can be warmed up and eaten, especially in two-worker households. This will be easier and faster (but perhaps less gratifying) than preparing a recipe provided by a food supplier (along with all the ingredients). I am talking about going beyond the pre-cooked items in your average grocery. There are currently sources of such meals arising as delivery services partner with restaurants to provide meals delivered to your doorstep. But this type of service tends to be relatively expensive on a per meal basis.

I expect new services to arise (we’ve already seen a few) that offer meals that are less expensive prepared by “home chefs” or caterers and ordered through a marketplace (this is category 4 in my list). The marketplace will recruit the chefs, supply them with packaging, take orders, deliver to the end customers, and collect the money. Since the food won’t be from a restaurant, with all the associated overhead, prices can be lower. Providing such a service will be a source of income for people who prefer to work at home. Like drivers for Uber and Lyft, there should be a large pool of available suppliers who want to work in this manner. It will be very important for the marketplaces offering such service to curate to ensure that the quality and food safety standards of the product are guaranteed. The availability of good quality, moderately priced prepared meals of one’s choice delivered to the home may begin shifting more consumption back to the home, or at a minimum, slow the shift towards eating dinners away from home.

Where will Amazon be in the Equation?

In the past, I predicted that Amazon would create physical stores, but their recent acquisition of Whole Foods goes far beyond anything I forecast by providing them with an immediate, vast network of physical grocery stores. It does make a lot of sense, as I expect omnichannel marketing to be the future of retail.  My reasoning is simple: on the one hand, online commerce will always be some minority of retail (it currently is hovering around 10% of total retail sales); on the other hand, physical retail will continue to lose share of the total market to online for years to come, and we’ll see little difference between e-commerce and physical commerce players.  To be competitive, major players will have to be both, and deliver a seamless experience to the consumer.

Acquiring Whole Foods can make Amazon the runaway leader in categories 1 and 2, buying ingredients and/or prepared foods to be delivered to your home.  Amazon Fresh already supplies many people with products that are sourced from grocery stores, whether they be general food ingredients or traditional prepared foods supplied by a grocery. They also have numerous meal kits that they offer, and we expect (and are already seeing indications) that Amazon will follow the Whole Foods acquisition by increasing its focus on “meal kits” as it attempts to dominate this rising category (3 in our table).

One could argue that Whole Foods is already a significant player in category 4 (ordering meals that are prepared, and only need to be heated up), believing that category 4 is the same as category 2 (buying prepared meals from a grocery). But it is not. What we envision in the future is the ability to have individuals (who will all be referred to as “Home Chefs” or something like that) create brands and cook foods of every genre, price, etc. Customers will be able to order a set of meals completely to their taste from a local home chef. The logical combatants to control this market will be players like Uber and Lyft, guys like Amazon and Google, existing recipe sites like Blue Apron…and new startups we’ve never heard of.

When and How to Create a Valuable Marketing Event

Azure CEO Summit
Snapshots from Azure’s 11th Annual CEO Summit

A key marketing tool for companies is to hold an event like a user’s conference or a topical forum to build relationships with their customers and partners, drive additional revenue and/or generate business development opportunities. Azure held its 11th annual CEO Summit last week, and as we’re getting great feedback on the success of the conference, I thought it might be helpful to dig deeply into what makes a conference effective. I will use the Azure event as the example but try to abstract rules and lessons to be learned, as I have been asked for my advice on this topic by other firms and companies.

Step 1. Have a clear set of objectives

For the Azure CEO Summit, our primary objectives are to help our portfolio companies connect with:

  1. Corporate and Business Development executives from relevant companies
  2. Potential investors (VCs and Family Offices)
  3. Investment banks so the companies are on the radar and can get invited to their conferences
  4. Debt providers for those that can use debt as part of their capital structure

A secondary objective of the conference is to build Azure’s brand thereby increasing our deal flow and helping existing and potential investors in Azure understand some of the value we bring to the table.

When I created a Wall Street tech conference in the late 90’s, the objectives were quite different. They still included brand building, but I also wanted our firm to own trading in tech stocks for that week, have our sell side analysts gain reputation and following, help our bankers expand their influence among public companies, and generate a profit for the firm at the same time. We didn’t charge directly for attending but monetized through attendees increasing use of our trading desk and more companies using our firm for investment banking.

When Fortune began creating conferences, their primary objective was to monetize their brand in a new way. This meant charging a hefty price for attending. If people were being asked to pay, the program had to be very strong, which they market quite effectively.

Conferences that have clear objectives, and focus the activities on those objectives, are the most successful.

Step 2. Determine invitees based on who will help achieve those objectives

For our Summit, most of the invitees are a direct fallout from the objectives listed above. If we want to help our portfolio companies connect with the above-mentioned constituencies, we need to invite both our portfolio CEOs and the right players from corporations, VCs, family offices, investment banks and debt providers. To help our brand, inviting our LPs and potential LPs is important. To insure the Summit is at the quality level needed to attract the right attendees we also target getting great speakers.  As suggested by my partners and Andrea Drager, Azure VP (and my collaborator on Soundbytes) we invited several non-Azure Canadian startups. In advance of the summit, we asked Canadian VCs to nominate candidates they thought would be interesting for us and we picked the best 6 to participate in the summit. This led to over 70 interesting companies nominated and added to our deal flow pipeline.

Step 3. Create a program that will attract target attendees to come

This is especially true in the first few years of a conference while you build its reputation. It’s important to realize that your target attendees have many conflicting pulls on their time. You won’t get them to attend just because you want them there! Driving attendance from the right people is a marketing exercise. The first step is understanding what would be attractive to them. In Azure’s case, they might not understand the benefit of meeting our portfolio companies, but they could be very attracted by the right keynotes.

Azure’s 2017 Summit Keynote Speakers: Mark Lavelle, CEO of Magento Commerce & Co-founder of Bill Me Later. Cameron Lester, Managing Director and Co-Head of Global Technology Investment Banking, Jeffries. Nagraj Kashyap, Corporate VP & Global Head, Microsoft Ventures.

Over the years we have had the heads of technology investment banking from Qatalyst, Morgan Stanley, Goldman, JP Morgan and Jeffries as one of our keynote speakers. From the corporate world, we also typically have a CEO, former CEO or chairman of notable companies like Microsoft, Veritas, Citrix, Concur and Audible as a second keynote. Added to these were CEOs of important startups like Stance and Magento and terrific technologists like the head of Microsoft Labs.

Finding the right balance of content, interaction and engagement is challenging, but it should be explicitly tied to meeting the core objectives of the conference.

Step 4. Make sure the program facilitates meeting your objectives

Since Azure’s primary objective is creating connections between our portfolio (and this year, the 6 Canadian companies) with the various other constituencies we invite, we start the day with speed dating one-on-ones of 10 minutes each. Each attendee participating in one-on-ones can be scheduled to meet up to 10 entities between 8:00AM and 9:40. Following that time, we schedule our first keynote.

In addition to participating in the one-on-ones, which start the day, 26 of our portfolio companies had speaking slots at the Summit, intermixed with three compelling keynote speakers. Company slots are scheduled between keynotes to maximize continued participation. This schedule takes us to about 5:00pm. We then invite the participants and additional VCs, lawyers and other important network connections to join us for dinner. The dinner increases everyone’s networking opportunity in a very relaxed environment.

These diverse types of interaction phases throughout the conference (one-on-ones, presentations, discussions, and networking) all facilitate a different type of connection between attendees, focused on maximizing the opportunity for our portfolio companies to build strong connections.

Azure Company Presentations
Azure Portfolio Company CEO Presentations: Chairish, Megabots & Atacama

Step 5. Market the program you create to the target attendees

I get invited to about 30 conferences each year plus another 20-30 events. It’s safe to assume that most of the invitees to the Azure conference get a similar (or greater) number of invitations. What this means is that it’s unlikely that people will attend if you send an invitation but then don’t effectively market the event (especially in the first few years). It is important to make sure every key invitee gets a personal call, email, or other message from an executive walking them through the agenda and highlighting the value to them (link to fortune could also go here). For the Azure event, we highlight the great speakers but also the value of meeting selected portfolio companies. Additionally, one of my partners or I connect with every attendee we want to do one-on-ones with portfolio companies to stress why this benefits them and to give them the chance to alter their one-on-one schedule. This year we managed over 320 such meetings.

When I created the first “Quattrone team” conference on Wall Street, we marketed it as an exclusive event to portfolio managers. While the information exchanged was all public, the portfolio managers still felt they would have an investment edge by being at a smaller event (and we knew the first year’s attendance would be relatively small) where all the important tech companies spoke and did one-on-one meetings. For user conferences, it can help to land a great speaker from one of your customers or from the industry. For example, if General Electric, Google, Microsoft or some similar important entity is a customer, getting them to speak will likely increase attendance. It also may help to have an industry guru as a speaker. If you have the budget, adding an entertainer or other star personality can also add to the attraction, as long as the core agenda is relevant to attendees.

Step 6. Decide on the metrics you will use to measure success

It is important to set targets for what you want to accomplish and then to measure whether you’ve achieved those targets. For Azure, the number of entities that attend (besides our portfolio), the number of one-on-one meetings and the number of follow-ups post the conference that emanate from one-on-one are three of the metrics we measure. One week after the conference, I already know that we had over 320 one-on-ones which, so far, has led to about 50 follow ups that we are aware of including three investments in our portfolio. We expect to learn of additional follow up meetings but this has already exceeded our targets.

Step 7. Make sure the value obtained from the conference exceeds its cost

It is easy to spend money but harder to make sure the benefit of that spend exceeds its cost. On one end of the spectrum, some conferences have profits as one of the objectives. But in many cases, the determination of success is not based on profits, but rather on meeting objectives at a reasonable cost. I’ve already discussed Azure’s objectives but most of you are not VCs. For those of you dealing with customers, your objectives can include:

  1. Signing new customers
  2. Reducing churn of existing customers
  3. Developing a better understanding of how to evolve your product
  4. Strong press pickup / PR opportunity

Spending money on a conference should always be compared to other uses of those marketing dollars. To the degree you can be efficient in managing it, the conference can become a solid way to utilize marketing dollars. Some of the things we do for the Azure conference to control cost which may apply to you include:

  1. Partnering with a technology company to host our conference instead of holding it at a hotel. This only works if there is value to your partner. Cost savings is about 60-70%.
  2. Making sure our keynotes are very relevant but are at no cost. You can succeed at this with keynotes from your customers and/or the industry. Cost savings is whatever you might have paid someone.
  3. Having the dinner for 150 people at my house. This has two benefits: it is a much better experience for those attending and the cost is about 70% less than having it at a venue.

Summary

I have focused on using the Azure CEO Summit as the primary example but the rules laid out apply in general. They not only will help you create a successful conference but following them means only holding it if its value to you exceeds its cost.

 

SoundBytes

The warriors…

Last June I wrote about why Kevin Durant should join the Warriors

If you look at that post, you’ll see that my logic appears to have been born out, as my main reason was that Durant was likely to win a championship and this would be very instrumental in helping his reputation/legacy.

Not mentioned in that post was the fact that he would also increase his enjoyment of playing, because playing with Curry, Thompson, Green and the rest of the Warriors is optimizing how the game should be played

Now it’s up to both Durant and Curry to agree to less than cap salaries so the core of the team can be kept intact for many years. If they do, and win multiple championships, they’ll probably increase endorsement revenue. But even without that offset my question is “How much is enough?” I believe one can survive nicely on $30-$32 million a year (Why not both agree to identical deals for 4 years, not two?). Trying for the maximum is an illusion that can be self-defeating. The difference will have zero impact on their lives, but will keep players like Iguodala and Livingston with the Warriors, which could have a very positive impact. I’m hoping they can also keep West, Pachulia and McGee as well.

It would also be nice if Durant and Curry got Thompson and Green to provide a handshake agreement that they would follow the Durant/Curry lead on this and sign for the same amount per year when their contracts came up. Or, if Thompson and Green can extend now, to do the extension at equal pay to what Curry and Durant make in the extension years. By having all four at the same salary at the end of the period, the Warriors would be making a powerful statement of how they feel about each other.

Amazon & Whole Foods…

Amazon’s announced acquisition of Whole Foods is very interesting. In a previous post, we predicted that Amazon would open physical stores. Our reasoning was that over 90% of retail revenue still occurs offline and Amazon would want to attack that. I had expected these to be Guide Stores (not carrying inventory but having samples of products). Clearly this acquisition shows that, at least in food, Amazon wants to go even further. I will discuss this in more detail in a future post.

Lessons Learned from Anti-Consumer Practices/Technologies in Tech and eCommerce

One example of the anti-consumer practices by airline loyalty programs.

As more and more of our life consists of interacting with technology, it is easier and easier to have our time on an iPhone, computer or game device become all consuming. The good news is that it is so easy for each of us to interact with colleagues, friends and relatives; to shop from anywhere; to access transportation on demand; and to find information on just about anything anytime. The bad news is that anyone can interact with us: marketers can more easily bombard us, scammers can find new and better ways to defraud us, and identity thieves can access our financials and more. When friends email us or post something on Facebook, there is an expectation that we will respond.  This leads to one of the less obvious negatives: marketers and friends may not consider whether what they send is relevant to us and can make us inefficient.

In this post, I want to focus on lessons entrepreneurs can learn from products and technologies that many of us use regularly but that have glaring inefficiencies in their design, or those that employ business practices that are anti-consumer. One of the overriding themes is that companies should try to adjust to each consumer’s preferences rather than force customers to do unwanted things. Some of our examples may sound like minor quibbles but customers have such high expectations that even small offenses can result in lost customers.

Lesson 1: Getting email marketing right

Frequency of email 

The question: “How often should I be emailing existing and prospective customers?” has an easy answer. It is: “As often as they want you to.”  If you email them too frequently the recipients may be turned off. If you send too few, you may be leaving money on the table. Today’s email marketing is still in a rudimentary stage but there are many products that will automatically adjust the frequency of emails based on open rates. Every company should use these. I have several companies that send me too many emails and I have either opted out of receiving them or only open them on rare occasions. In either case the marketer has not optimized their sales opportunity.

Relevance of email

Given the amount of data that companies have on each of us one would think that emails would be highly personalized around a customer’s preferences and product applicability. One thing to realize is that part of product applicability is understanding frequency of purchase of certain products and not sending a marketing email too soon for a product that your customer would be unlikely to be ready to buy. One Azure portfolio company, Filter Easy, offers a service for providing air filters. Filter Easy gives each customer a recommended replacement time from the manufacturer of their air conditioner. They then let the customer decide replacement frequency and the company only attempts to sell units based on this time table. Because of this attention to detail, Filter Easy has one of the lowest customer churn rates of any B to C company. In contrast to this, I receive marketing emails from the company I purchase my running shoes from within a week of buying new ones even though they should know my replacement cycle is about every 6 months unless there is a good sale (where I may buy ahead). I rarely open their emails now, but would open more and be a candidate for other products from them if they sent me fewer emails and thought more about which of their products was most relevant to me given what I buy and my purchase frequency. Even the vaunted Amazon has sent me emails to purchase a new Kindle within a week or so of my buying one, when the replacement cycle of a Kindle is about 3 years.

In an idea world, each customer or potential customer would receive emails uniquely crafted for them. An offer to a customer would be ranked by likely value based on the customer profile and item profile. For example, customers who only buy when items are on sale should be profiled that way and only sent emails when there is a sale. Open Road, another Azure company, has created a daily email of deeply discounted e-books and gets a very high open rate due to the relevance of their emails (but cuts frequency for subscribers whose open rates start declining).

Lesson 2: Learning from Best Practices of Others

I find it surprising when a company launches a new version of a software application without attempting to incorporate best practices of existing products. Remember Lotus 123? They refused to create a Windows version of their spreadsheet for a few years and instead developed one for OS/2 despite seeing Excel’s considerable functionality and ease of use sparking rapid adoption. By the time they created a Windows version, it was too late and they eventually saw their market share erode from a dominant position to a minimal level.  In more modern times, Apple helped Blackberry survive well past it’s expected funeral by failing to incorporate many of Blackberry’s strong email features into the iPhone. Even today, after many updates to mail, Apple still is missing such simple features like being able to hit a “B” to go to the bottom of my email stack on the iPhone. Instead, one needs to scroll down through hundreds of emails to get to the bottom if you want to process older emails first. This wastes lots of time. But Microsoft Outlook in some ways is even worse as it has failed to incorporate lookup technology from Blackberry (and now from Apple) that always allows finding an email address from a person’s name. When one has not received a recent email from a person in your contact list, and the person’s email address is not their name, outlook requires an exact email address. When this happens, I wind up looking it the person’s contact information on my phone!

Best practices extends beyond software products to marketing, packaging, upselling and more. For example, every ecommerce company should study Apple packaging to understand how a best in class branding company packages its products. Companies also have learned that in many cases they need to replicate Amazon by providing free shipping.

Lesson 3: The Customer is Usually Right

Make sure customer loyalty programs are positive for customers but affordable for the company

With few exceptions, companies should adopt a philosophy that is very customer-centric. Failing to do so has negative consequences. For example, the airline industry has moved towards giving customers little consideration and this results in many customers no longer having a preferred airline, instead looking for best price and/or most convenient scheduling. Whereas the mileage programs from airlines were once a very attractive way of retaining customers, the value of miles has eroded to such a degree that travelers have lost much of the benefit. This may have been necessary for the airlines as the liability associated with outstanding points reached billions of dollars. But, in addition, airlines began using points as a profit center by selling miles to credit cards at 1.5 cents per mile. Then, to make this a profitable sale, moved average redemption value to what I estimate to be about 1 cent per point. This leads to a concern of mine for consumers. Airlines are selling points at Kiosks and online for 3 cents per point, in effect charging 3 times their cash redemption value.

The lesson here is that if you decide to initiate a loyalty points program, make sure the benefits to the customer increase retention, driving additional revenue. But also make sure that the cost of the program does not exceed the additional revenue. (This may not have been the case for airlines when their mileage points were worth 3-4 cents per mile).  It is important to recognize the future cost associated with loyalty points at the time they are given out (based on their exchange value) as this lowers the gross margin of the transaction. We know of a company that failed to understand that the value of points awarded for a transaction so severely reduced the associated gross margin that it was nearly impossible for them to be profitable.

Make sure that customer service is very customer centric

During the Thanksgiving weekend I was buying a gift online and found that Best Buy had what I was looking for on sale. I filled out all the information to purchase the item, but when I went to the last step in the process, my order didn’t seem to be confirmed. I repeated the process and again had the same experience. So, I waited a few days to try again, but by then the sale was no longer valid. My assistant engaged in a chat session with their customer service to try to get them to honor the sale price, and this was refused (we think she was dealing with a bot but we’re not positive). After multiple chats, she was told that I could try going to one of their physical stores to see if they had it on sale (extremely unlikely). Instead I went to Amazon and bought a similar product at full price and decided to never buy from Best Buy’s online store again. I know from experience that Amazon would not behave that way and Azure tries to make sure none of our portfolio companies would either. Turning down what would still have been a profitable transaction and in the process losing a customer is not a formula for success! While there may be some lost revenue in satisfying a reasonable customer request the long term consequence of failing to do so usually will far outweigh this cost.

 

Soundbytes

My friend, Adam Lashinsky, from Fortune has just reported that an insurance company is now offering lower rates for drivers of Teslas who deploy Autopilot driver-assistance. Recall that Tesla was one of our stock picks for 2017 and this only reinforces our belief that the stock will continue to outperform.