By Jason Pressman, Managing Director at Shasta Ventures
First, let me be clear that Shasta Ventures is deeply committed to consumer businesses. We have a deep track record of backing amazing companies that target consumers.
These include financial technology companies like Mint and Tally, social networks like Nextdoor and Smule, branded e-commerce companies such as Dollar Shave Club, Poppin and Stance and connected hardware companies like Eero and Nest.
All of that said, VC lost their minds in consumer (again) over the past few years and I want to explain why.
The pursuit of product-market fit (PMF) has an almost mythical quality in Silicon Valley, as if it’s a noble quest that always leads to riches. The thinking seems to be that chasing product-market fit means you don’t need a business model or strong underlying unit economics.
This thinking is just wrong and dangerous.
While it is absolutely true that product-market fit is important, it’s not everything. The false belief that PMF is the be-all and end-all has caused many venture capitalists to lose their minds on consumer. It’s time to pause, take stock, and consider how this happened and why.
I’ve been in the Valley for about 20 years. I moved here during the first dot com boom when there was an explosion of investors pouring money into companies that weren’t really getting leverage from technology.
Generally, these companies were service-oriented and dealt with the physical movement of goods. This approach infamously blew up — who can forget Kozmo and Webvan?
Webvan raised $800 million from investors, $375 million in an IPO, and garnered a $6 billion valuation before going bankrupt after investors realized that the underlying economics of Webvan’s business model didn’t work.
This was a colossal failure and wakeup up call for the venture community which understandably grew wary of distribution-oriented physical companies and their lower margins.
After the tech buble burst, venture investors generally steered clear of these companies but eventually forgot the lessons of Webvan and began chasing them again around 2013. This is partly due to the “Uberification” of everything — Uber’s astounding success which triggered a flood of me-too startups promising on-demand services requested via mobile devices.
Again we started to see the same fevered investing as in the tech bubble. Homejoy was billed as “Uber for home cleaning.” Washio was “Uber for laundry.” Too many food delivery apps cropped up to count.
Shasta was not immune to the craze and invested in a company called Cherry, which offered on-demand car washes. Users requested a car wash via a mobile app and the company dispatched a person to your car to deliver the service. It was fantastic — affordable, convenient, and a great user experience.
The only problem was that the unit economics didn’t work — prices did not cover costs –and the company was losing money on every transaction, just like its Uberized compatriots. To be clear, the Cherry founders and our team at Shasta thought that over time they could increase volume and lower costs to make things work but aftera a couple years, there was no clear path to getting this to work.
There are important lessons behind these mistakes. Each of these startups found product-market fit (as defined by strong consumer demand) and convinced investors that this was the path to the promised land of a great business and huge outcome.
The challenge was that they were operating with bad unit economics. In essence, they were giving money away.
Consumers are smart and know a good deal when they see one, so of course they embrace services that deliver a great bargain. You can go out on the street and hand out $20 bills and people will love your service!
But when the economics are upside down, the chances of succeeding are slim. Certainly not all of these businesses are fundamentally flawed.
With volume and scale and a good business model, unit economics can turn around but it can be very challenging or impossible to get there.
VCs lost their mind around consumer over the past few years because they lost sight of this simple fact — unit economics matter.
For the most part, VCs should not back physical goods businesses. Instead, they should be looking at businesses with technology leverage or strong marketplace dynamics, such as those that use the internet and mobile devices to connect people rather than to move physical goods like Airbnb, eBay, Nextdoor, Smule, Turo and Uber.
These are all solid businesses because they do not give money away on each transaction, they make money on each transaction. With volume, they don’t lose more money, they make more money. The business model, unit economics, and margins are strong and sustainable.
Seems so simple, right?
Now, after yet another period of consumer euphoria, the venture community has arrived at a much more rational, healthier place. A fair number of the startups, like Cherry, Homejoy and Washio have gone out of business, and investors have largely lost their appetite for funding them once again.
There will be more failures as companies realize that giving $20 bills away on the street is exciting for the recipients but fails to generate underlying value. There is no longer the free ride of euphoric venture money to back businesses based on flawed economic models.
The core message, which was as true in the late 90s as it is today, is that understanding product-market fit may be harder than people think. True PMF is about an amazing customer experience coupled with a good business model.
At Shasta, we will continue to invest in consumer companies but look for both consumer uptake and strong underlying economics.