The Definitive Guide to Building Investable Consumer and Digital Lifestyle Brands
Bonus: Take a quiz to find out if you have a VC-fundable brand
It’s never been a more exciting time to build a consumer brand. Consumers are hungry for products and stories that resonate with who they are and they have little loyalty for incumbents.
Technology has advanced to the point where the ability for brands to reach consumers directly is possible and preferable. Legacy brands that have traditionally sold through third parties are realizing that they don’t know their customers and are being undercut by new entrants that significantly improve the product and customer experience.
Amazon may have no plans for slowing down, but there’s also a lot of evidence that it is possible to build powerful consumer brands. Amazon is convenience and selection. But it’s not community and experience. For a large segment of the market, Amazon is an enabler, not a competitor.
I believe the same forces that drove companies like Warby Parker, Bonobos, Dollar Shave Club, and Away will transform a wide variety of consumer categories. Identifying and helping entrepreneurs build the next generation of consumer and digital lifestyle brands has become my passion and mission.
But with a “Warby Parker for X” popping up every day, how do investors decide what companies are truly solving problems?
How do they tell which are simply brands in search of problems?
As investors, we can’t control what happens with the companies we invest in nor the outcomes, but we can control how we make the investment decisions. We can control the process.
The goal for exposing this framework is two-fold — first, to arrive at a more rational investment decision myself and secondly, to bring more transparency to founders, who have little to no visibility regarding how VCs make investment decisions.
TL,DR: If you are building a consumer brand and want to figure out if we may be the right investment partners for you, click here.
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TEAM
1. Purpose and Founder/Market Fit.
The best predictor of whether a startup will achieve product/market fit is whether it has founder/market fit. Founder/market fit means the founders have a deep understanding of the problem they are solving, the market they are entering, and personify the product and company.
Building a company is hard and requires persistence and purpose. Founder/market fit ensures that founders have a deeper mission that fuels them and will allow them to continue pushing through even if it is difficult, because their motivation matters more than the suffering brought on by the pursuit of the goal.
2. Operational Chops.
Manufacturing and sourcing product, convincing customers to buy it, and then dealing with the shipping (and returns) hassles that are necessary for a great customer experience all demand time, money, and an incredible focus on the details. Without a capable operator, any commerce venture is doomed for mediocrity.
3. Mastery of digital communication and the intangibles of building a brand.
The idea of building strong consumer brands seems like a nebulous concept to most people. Strong consumer brands such as Glossier and Casper have a soul that is not easy to quantify and an ability to cut through the noise and build a brand that emotionally resonates that is hard to replicate.
A better grasp on the inherent dynamics of the internet — everything from how the power of SEO compounds over time to how to create an organic, viral infographic — is critical to the success of today’s consumer brands.
If the founders are not digitally savvy or aesthetically minded people, then they need to show willingness and ability to hire talent that is. While these roles can be outsourced, there needs to be someone internally championing the conversation around design, visual identity, user interface, narrative, and brand.
CPG companies don’t typically enjoy the same network effects of pure software companies, so brand is one of the longest standing sources of defensibility in consumer brands.
4. Visionary with strong product instincts.
A product can have a great operator and great marketing team but still not achieve product/market fit if the founding team either didn’t pick a problem worth solving or built the wrong product for the problem.
A strong product leader obsessively understands the customer they are solving for and can make the right product choices. Great visionaries are able to keep their eye on the horizon, balancing out short term needs with long term goals.
I suspect many of today’s consumer brands will die because they were one-hit wonders unable to forge new paths for today’s ever evolving consumer.
PRODUCT
1. Clear customer need + enhanced narrative and brand.
Every week, I see a new entrepreneur pitching a ‘Warby parker for X’. From a marketing perspective, I understand this. It’s easier to grasp an idea that is similar to something we already understand. But the vast majority of these companies are lacking the soul and the authenticity that was critical to the success of early vertical commerce brands.
The world doesn’t need another DNVB, what the world needs is better and more affordable products, simpler and more delightful customer experiences, clearer and more inspiring narratives.
I believe that the best companies will tap into a clear and deep emotional need and build a resounding customer experience around it. BestBuy could offer electronics classes for the tech illiterates, BabyGap could offer baby care classes for the expectant parent.
There are ways for retail to save itself, but the truth is that new entrants that understand their customer and are much more nimble will continue to displace incumbents by creating more profound customer experiences.
2. Digitally or tech enabled enhancement.
Over the past half decade, the tech advancements of companies like Eight (Smart mattress technology), AllBirds (Merino Wool shoes) or Stitch Fix (Powered by big data) have come to define each brand uniquely. Each company comes with varying degrees of actual R&D investment required.
The “bed-in-a-box” concept isn’t just about making shipping easier or cheaper — it also improves the experience for the customer. The customer can now able to order without worrying because of free returns.
Aligning your brand with new technology creates an interesting early value proposition and ingrains innovation as part of the company brand and culture.
The technology can be in the product, as is the case in Eight Sleep (full disclosure, I am an investor), but it can also be in the operations.
Using technology to improve your customer acquisition or retention, your online/offline integration, the returns process, where usage data and ML can improve the product over time. Best also to solve for last mile delivery is extremely valuable too.
The point is that companies that have a deep relationship with the technological forces that are affecting their industry are more likely to succeed.
AR, 3D Printing, iOT, and AI all offer lots of promising potential for consumer brands of the future. What’s important is to incorporate technology for the sake of improving the experience for people, not for the sake of technology.
For consumer brands, defensibility is tricky. Having strong IP and tech-enabled enhancements is a great way to build a moat around your brand.
3. Category is unlikely to be Amazoned.
Amazon can go almost indefinitely broad, but not deep. Amazon’s size and focus on mass-market put the company at a disadvantage when it comes to building values-driven brands, personalized experience, or experiential commerce.
Monica + Andy (full disclosure: I am an investor) has built a devoted following through it’s community of moms and in-store experiences, bringing everything from baby storytelling classes for the new mom to ‘what is a doula’ sessions for the expectant mother.
Similarly, values driven brands such as soon to launch For Days, of which I am an early fan, are very unlikely to be Amazoned due to their authentic focus on sustainability.
Amazon has a wealth of data on customers and can personalize the online shopping experience by making tailored recommendations, but it likely can’t personalize products without sacrificing some of its mass-market efficiency.
4. Timelessness of the Product.
Brands are hard to build and even harder to span across generations. You can do everything right and still fail because customers don’t want to be associated with products of their parents’ generation.
Volatility and difficulty of predicting changing consumer preferences is a common reason why investors shy away from early-stage consumer products. But there are many categories in which consumer preferences are stable and change only over the course of decades rather than seasons.
What’s important is to underwrite the success of the current generation of products while anticipating future demand fluctuations.
5. Frequency of Purchase or high AOV.
Just as with software, successful consumer businesses generally have high customer lifetime values (LTV). There are two ways to achieve high LTV: a single but large and profitable purchase (i.e. mattress), or highly recurring smaller purchases (i.e. tampons).
Consumer products that have recurring or highly repetitive purchase behavior can afford to spend more on acquiring a new customer because once that customer is acquired, the company will continue to earn revenue for a long period of time.
If you are going for the one-time high order value, it’s important to think about how to develop subsequent interaction with the customer and whether there are opportunities to introduce other products in your category that are more ingrained in daily habits.
If you are going with a product that has repeat purchasing behavior, ideally it should be consumable in nature (i.e. razors) or children’s clothes (they outgrow it!).
6. 10x better and cheaper.
Better and more expensive is nothing new — I am far more interested in companies leveraging technology to rethink incumbent cost structures and democratize access.
A product that is 10x better and saves people money is the common thread running through dozens of companies that have achieved success. But in order to provide a cheaper product, something about the industry economics has to be broken.
In the case of Warby Parker, the industry was charging too much for glasses because there was a consolidation of power within the industry that has been built up over decades. Most industries don’t have those same structural inefficiencies.
7. Limited Inventory Risk.
Physical goods companies have inventory and working capital risks that software companies simply don’t have. Companies that have on-demand manufacturing capabilities, limited SKUs, and efficient inventory management strategies can mitigate these risks more effectively.
On the contrary, companies with thousands of SKUs and fickle customers have a lot of supply chain risk.
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MARKET
1. High friction incumbent channel with low NPS.
If an industry is not inefficient enough, a direct to consumer model will not work. Startups need a significant improvement to displace incumbents. I believe the winning brands will reinvent a category, not just offer small incremental changes.
Companies in categories where incumbents sell only through retailers and have no direct relationship with their customers are easier to disrupt because there are structural inefficiencies with incumbent models.
2. Opportunity to expand the market.
Instead of a large market, I look for companies that offer an opportunity to expand the market. This is particularly true for companies simplifying and demystifying products that were previously inaccessible, fragmented or hard to understand.
When you try to work out the market potential for something new, it’s important to look past what it is now and think about who would buy the product once it is better, cheaper, more accessible, etc…
As Benedict Evans put it, “saying that you’re aiming for x% of a $ybn industry is unambitious — great companies change the y, not the x.”
3. Why now/ macro shift supports this process.
Timing is everything. The VC industry is full of examples of companies that didn’t work because they were too early or too late. Before the current wave of VR and AI, there were at least 3 other waves.
Why is now different? Understanding whether there are unique macro enablers that support a business or shift is critical. Uber would not have been possible before mobile GPS technology was widely available.
Similarly, a lot of the successful vertical commerce brands would not have been possible without Instagram as an advertising channel.
4. Opportunity for strong margins.
No matter how much customers love your product, if the unit economics don’t work — the revenues and costs associated with selling a product — the company won’t work.
While it’s possible to compress manufacturing costs as a company grows, economies of scale rarely increase margins by enough, and hiking prices to improve the margin later on is nearly impossible without alienating your customer base.
What constitutes “high margins” depends on the category, but generally speaking, products that have 70 percent+ gross margins are very attractive. They exhibit many of the same characteristics as software businesses, especially when they also have high purchase frequency.
Categories with few incumbents dominating an industry likely means market costs are inflated and there is room to price cut.
5. Distribution Advantage.
Winning on product alone is a rarity. Great brands have both a great product and a distribution advantage.
A common myth for vertical commerce brands is that they succeed by going direct-to-consumer because they cut out the retail margin. The reality is these brands are simply taking on the burden of distribution themselves, rather than offloading it to a larger retailer.
Because of this added distribution challenge, successful consumer brands need to have a distribution advantage and proprietary, sustainable distribution channels that justify incremental costs (managing an e-comm platform, customer service, customer acquisition).
For Glossier, that was Into the Gloss. For many of the early DNVBs, that was Instagram. I suspect many emerging brands will complement owned with traditional channels, using retailers as profitable acquisition channels.
But with digital acquisition costs getting more saturated and expensive, this is no longer the case. As Daniel Gulati from Comcast Ventures put it, “CAC is the new rent and Facebook and Google are the new middlemen.”
In other words, for companies reliant on paid marketing, their digital customer acquisition cost is a lot like paying for brick-and-mortar stores in the old model, or selling wholesale.
Finding new, repeatable, and defensible acquisition channels is one of the most important factors to consider when building brands.
CAPITALIZATION
1. Sound capitalization strategy and valuation
VC has become the default, sexy option for startups seeking funding but the reality is many consumer brands that raise VC funding shouldn’t be VC backed.
Founders often misunderstand that raising venture capital completely changes the expectations of their business, often in ways that don’t align with their personal life goals
Understanding what kind of company you want to build and aligning your capital raise and roadmap with that that vision is key is a critical yet understated part of the investment outcome.
For example, if your idea can only monetize at scale (i.e. platform with network effects), then money matters.
But for many companies, too much capital creates a culture that substitutes cash for creativity and operational discipline. Consumer brands need to be especially mindful of this.
Unlike software businesses, they don’t have many billion dollar consumer exits, revenue multiples are lower, and the exit environment is finite.
As was very smartly articulated in Startups need to respect the laws of retail physics, “many founders are negotiating huge funding rounds at eye-popping valuations without taking the time to understand what that valuation entails.”
By doing so, they are giving up optionality and prematurely scaling burn rate in the name of fundraising glory.
Having a sound capitalization and a clear sense of why and where to deploy capital has important implications for the outcome of your business.
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— Want to test this framework on your own company? Click here.
— If you score above 50, please reach out at sari@level.vc, I’d love to chat.
I hope this post brings a little more transparency into the VC decision making process.
If you put two investors in separate rooms and pitch the same idea, the only thing that is guaranteed is that they’ll have different opinions.
So while you need to listen to feedback and keep reading posts like these, you also need to be careful not to let it get to your head. VCs are wrong most of the time.
Today, we celebrate founders who raise huge VC rounds, but founders need to remember that the magic in business isn’t raising money, it’s making money.
