“Being ‘right’ doesn’t lead to superior performance if the consensus forecast is also right.” — Bill Gurley
On Wall Street there once existed a very popular diagram, the 2x2 Contrarian Matrix.
The obvious takeaway here is that if you are wrong as an investor, you don’t make any money. Of course nobody goes into an investment believing that they are wrong.
The real beauty of the chart is that even if you are right in your decision, there is a chance that you will not generate any meaningful return. When you invest into something that the rest of the market also believe in, that consensus has already been priced into the investment. When prices are too high, you run the risk of wiping out any arbitrage you expected from your insight. Even if you are right on one or two consensus investments, over a portfolio, this is an expensive strategy to undertake.
Let’s walk through a few examples:
Wrong & With the Crowd: In 2011, serial entrepreneur Jason Goldberg pivoted his way into a design-focused e-commerce site called Fab.com. The company skyrocketed. Within three years, Fab had raised more then $330m, grew to 10m users, and was valued at $1B+. Fab reached 5m users faster than even Facebook and had the most prestigious Silicon Valley names – Andreesen Horowitz, First Round Capital, even Ashton Kutcher – as investors.
In 2013, the company got over its skis. It faced copycats in Europe and tried to compete against them. The premature expansion without a playbook cost the company $60–100M. In order to deliver products faster, Fab held inventory and purchased warehouses. By scaling products and abandoning the flash sale model, the the company ballooned from 1,000 monthly SKUs to over 11,000 within a year. With increased product coverage came diminishment of its originality. Differentiation takes years to build and days to wither away.
Fab’s core customer base and its main growth driver fell in love with Fab for having a quirky selection that could not be found anywhere else. Three years in, 80–90% of its products could now be found on competing sites like Amazon, at lower prices and faster shipping times. Piles of inventory were left, untouched. The company burned spent $200m of its $300m in cash in two years. The purse strings around investor pockets suddenly closed shut.
Not even a high flyer like Fab could escape the forces of gravity. By December 2014, what remained of Fab was sold for $15M.
Right & Against the Crowd: While many investors between 2008 to 2013 chased the allure of Fab, few dared to venture into the music category. The reasons were obvious. Napster shut down overnight from copyright issues. Pandora struggled as a comparable company. Music labels were notoriously greedy around licensing their content. Margins were thin. Consequently, most investors shied away from the category.
That’s why when Spotify raised its Series A in 2008, few bothered to hop on the bandwagon. Creandum, and Northzone, two relatively small venture firms in Sweden, were the types of names that music startups could attract. These firms wrote the first institutional check into Spotify at a time when everyone else leaned out. Eleven years later, Creandum would make $370m on its $4.5m investment and return its fund 10,000%.
That’s not to say Spotify never had Silicon Valley names on its investment roster. A few years later, Spotify would raise a $100M Series D led by Kleiner and Accel, albeit at a $1B pre-money valuation. By the time a company becomes popular enough that most others also believe is a winner, you end up paying a premium.
Wrong & With the Crowd: In 2012, meal delivery startups took over the venture capital zeitgeist. Within a year, they raised nearly $350M across the category by most name-brand VC firms.
Making the unit economics work turned out to be tough. In particular for the vertically integrated players, the challenge would be on both delivery and food preparation.
With all this overfunding, suddenly the ecosystem became much more competitive. Every company had to offer the best food, the fastest delivery times, at the lowest price – the reality is you can only choose two. No food business was immune from having to make these compromises.
By 2017 the game of musical chairs approached its end. Munchery shut down after having raised more than $125M. Sprig closed in 2017 after raising over $50M. Others join this list: Maple, Spoonrocket, Bento, and Pronto. Out of the dozens that were once hot and sexy in this space, less than a handful remain. These have been companies that focused on one or the other, between food preparation and on-demand delivery, not both.
Ironically enough, the biggest beneficiaries of this venture capital subsidy (aside from consumers) will be the retailers — the same retailers the startups promised to disrupt. The fire-sale market for cheap delivery and food prep infrastructure would have not been enabled without venture funding. Over the past few years, the industry saw more food delivery mergers & acquisitions than the years of 2012–2014 combined.
Right & Against the Crowd: Compared with the excitement around food delivery, adtech is a sleepy category. Investors often dismissed adtech entirely, while some entrepreneurs even started calling their business martech to avoid the stigma.
In 2010, Jeff Green realized the ad industry created a problem where ad units were bundled and sold in blocks. Two ads targeting two different demographic profiles could end up being sold together as a bundle, thus resulting in wasted ad spend. He founded The Trade Desk to help large ad buyers understand what units they are buying and in an efficient manner.
Adtech at the time was at time an underfunded category. The Trade Desk (TTD) would only raise a total of $4M by its Series A. It skipped most mainstream venture rounds and went straight to a more conservative round with Hermes Growth instead, at which time it was EBITDA positive. TTD did not raise any additional equity capital after the Series B. It was far away from the Silicon Valley hype. Oh, and it was headquartered in Venture, CA — a city with a little over 100,000 population. Few investors paid attention to that geography.
The company raised such little dilutive capital that by the time the company went public in 2016, even the early stage investors that wrote relatively small checks at the Seed and Series A cashed out big time. At the time of TTD’s IPO at a $1.15B valuation, Wellington owned 12%, Founder Collective owned 14%, and IA Ventures owned 20% of the company’s value.
None of this could have been accomplished without strong unit economics and thoughtfulness around how to balance growth with capital efficiency. The year that TTD went public, it grew EBITDA 6x from $6M to $40M in a single year. If you are investing into an underfunded category, understand when the lean playbook is necessary. Be patient — hype is cyclical in nature.
If you find yourself chasing a ‘shiny object’, know that you are paying an opportunity cost in value somewhere. As my partner Rich Melmon once said, “a too common way to try to make money in venture is to have even more irrational people invest after you do.” Exercise caution when you are the last one to be invited to the party.
Most VCs do not pay enough attention to this principle.