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LP Show Preview: Consumer Investing with Benchmark GP Sarah Tavel

LP Show Preview

Limited Partner Episode

July 6, 2020
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On this preview of our most recent LP Show episode, Benchmark General Partner Sarah Tavel joins us for a master class on consumer investing. We start with why invest in consumer at all (given the inherent risks of its "hit-driven nature"), then deep dive on marketplace investing and wrap up with social, gaming and consumer transactional businesses. Big thank you to Sarah for sharing her immense knowledge on this topic, and to her partner (and fellow Acquired "master class lecturer" on enterprise investing) Chetan Puttagunta for introducing us and for making it happen!

This episode is a preview of the hour-long LP-only show. You can sign up to become an LP and get access to the full episode (and much more) at: https://glow.fm/acquired/

Links to Sarah's blog posts:

We finally did it. After five years and over 100 episodes, we decided to formalize the answer to Acquired’s most frequently asked question: “what are the best acquisitions of all time?” Here it is: The Acquired Top Ten.

Note: we ranked the list by our estimate of absolute dollar return to the acquirer. We could have used ROI multiple or annualized return, but we decided the ultimate yardstick of success should be the absolute dollar amount added to the parent company’s enterprise value. Afterall, you can’t eat IRR! For more on our methodology, please see the notes at the end of this post. And for all our trademark Acquired editorial and discussion tune in to the full episode above!

10. Marvel

Purchase Price: $4.2 billion, 2009

Estimated Current Contribution to Market Cap: $20.5 billion

Absolute Dollar Return: $16.3 billion

Back in 2009, Marvel Studios was recently formed, most of its movie rights were leased out, and the prevailing wisdom was that Marvel was just some old comic book IP company that only nerds cared about. Since then, Marvel Cinematic Universe films have grossed $22.5b in total box office receipts (including the single biggest movie of all-time), for an average of $2.2b annually. Disney earns about two dollars in parks and merchandise revenue for every one dollar earned from films (discussed on our Disney, Plus episode). Therefore we estimate Marvel generates about $6.75b in annual revenue for Disney, or nearly 10% of all the company’s revenue. Not bad for a set of nerdy comic book franchises…

Marvel
Season 1, Episode 26
LP Show
1/5/2016

9. Google Maps (Where2, Keyhole, ZipDash)

Total Purchase Price: $70 million (estimated), 2004

Estimated Current Contribution to Market Cap: $16.9 billion

Absolute Dollar Return: $16.8 billion

Morgan Stanley estimated that Google Maps generated $2.95b in revenue in 2019. Although that’s small compared to Google’s overall revenue of $160b+, it still accounts for over $16b in market cap by our calculations. Ironically the majority of Maps’ usage (and presumably revenue) comes from mobile, which grew out of by far the smallest of the 3 acquisitions, ZipDash. Tiny yet mighty!

Google Maps
Season 5, Episode 3
LP Show
8/28/2019

8. ESPN

Total Purchase Price: $188 million (by ABC), 1984

Estimated Current Contribution to Market Cap: $31.2 billion

Absolute Dollar Return: $31.0 billion

ABC’s 1984 acquisition of ESPN is heavyweight champion and still undisputed G.O.A.T. of media acquisitions.With an estimated $10.3B in 2018 revenue, ESPN’s value has compounded annually within ABC/Disney at >15% for an astounding THIRTY-FIVE YEARS. Single-handedly responsible for one of the greatest business model innovations in history with the advent of cable carriage fees, ESPN proves Albert Einstein’s famous statement that “Compound interest is the eighth wonder of the world.”

ESPN
Season 4, Episode 1
LP Show
1/28/2019

7. PayPal

Total Purchase Price: $1.5 billion, 2002

Value Realized at Spinoff: $47.1 billion

Absolute Dollar Return: $45.6 billion

Who would have thought facilitating payments for Beanie Baby trades could be so lucrative? The only acquisition on our list whose value we can precisely measure, eBay spun off PayPal into a stand-alone public company in July 2015. Its value at the time? A cool 31x what eBay paid in 2002.

PayPal
Season 1, Episode 11
LP Show
5/8/2016

6. Booking.com

Total Purchase Price: $135 million, 2005

Estimated Current Contribution to Market Cap: $49.9 billion

Absolute Dollar Return: $49.8 billion

Remember the Priceline Negotiator? Boy did he get himself a screaming deal on this one. This purchase might have ranked even higher if Booking Holdings’ stock (Priceline even renamed the whole company after this acquisition!) weren’t down ~20% due to COVID-19 fears when we did the analysis. We also took a conservative approach, using only the (massive) $10.8b in annual revenue from the company’s “Agency Revenues” segment as Booking.com’s contribution — there is likely more revenue in other segments that’s also attributable to Booking.com, though we can’t be sure how much.

Booking.com (with Jetsetter & Room 77 CEO Drew Patterson)
Season 1, Episode 41
LP Show
6/25/2017

5. NeXT

Total Purchase Price: $429 million, 1997

Estimated Current Contribution to Market Cap: $63.0 billion

Absolute Dollar Return: $62.6 billion

How do you put a value on Steve Jobs? Turns out we didn’t have to! NeXTSTEP, NeXT’s operating system, underpins all of Apple’s modern operating systems today: MacOS, iOS, WatchOS, and beyond. Literally every dollar of Apple’s $260b in annual revenue comes from NeXT roots, and from Steve wiping the product slate clean upon his return. With the acquisition being necessary but not sufficient to create Apple’s $1.4 trillion market cap today, we conservatively attributed 5% of Apple to this purchase.

NeXT
Season 1, Episode 23
LP Show
10/23/2016

4. Android

Total Purchase Price: $50 million, 2005

Estimated Current Contribution to Market Cap: $72 billion

Absolute Dollar Return: $72 billion

Speaking of operating system acquisitions, NeXT was great, but on a pure value basis Android beats it. We took Google Play Store revenues (where Google’s 30% cut is worth about $7.7b) and added the dollar amount we estimate Google saves in Traffic Acquisition Costs by owning default search on Android ($4.8b), to reach an estimated annual revenue contribution to Google of $12.5b from the diminutive robot OS. Android also takes the award for largest ROI multiple: >1400x. Yep, you can’t eat IRR, but that’s a figure VCs only dream of.

Android
Season 1, Episode 20
LP Show
9/16/2016

3. YouTube

Total Purchase Price: $1.65 billion, 2006

Estimated Current Contribution to Market Cap: $86.2 billion

Absolute Dollar Return: $84.5 billion

We admit it, we screwed up on our first episode covering YouTube: there’s no way this deal was a “C”.  With Google recently reporting YouTube revenues for the first time ($15b — almost 10% of Google’s revenue!), it’s clear this acquisition was a juggernaut. It’s past-time for an Acquired revisit.

That said, while YouTube as the world’s second-highest-traffic search engine (second-only to their parent company!) grosses $15b, much of that revenue (over 50%?) gets paid out to creators, and YouTube’s hosting and bandwidth costs are significant. But we’ll leave the debate over the division’s profitability to the podcast.

YouTube
Season 1, Episode 7
LP Show
2/3/2016

2. DoubleClick

Total Purchase Price: $3.1 billion, 2007

Estimated Current Contribution to Market Cap: $126.4 billion

Absolute Dollar Return: $123.3 billion

A dark horse rides into second place! The only acquisition on this list not-yet covered on Acquired (to be remedied very soon), this deal was far, far more important than most people realize. Effectively extending Google’s advertising reach from just its own properties to the entire internet, DoubleClick and its associated products generated over $20b in revenue within Google last year. Given what we now know about the nature of competition in internet advertising services, it’s unlikely governments and antitrust authorities would allow another deal like this again, much like #1 on our list...

1. Instagram

Purchase Price: $1 billion, 2012

Estimated Current Contribution to Market Cap: $153 billion

Absolute Dollar Return: $152 billion

Source: SportsNation

When it comes to G.O.A.T. status, if ESPN is M&A’s Lebron, Insta is its MJ. No offense to ESPN/Lebron, but we’ll probably never see another acquisition that’s so unquestionably dominant across every dimension of the M&A game as Facebook’s 2012 purchase of Instagram. Reported by Bloomberg to be doing $20B of revenue annually now within Facebook (up from ~$0 just eight years ago), Instagram takes the Acquired crown by a mile. And unlike YouTube, Facebook keeps nearly all of that $20b for itself! At risk of stretching the MJ analogy too far, given the circumstances at the time of the deal — Facebook’s “missing” of mobile and existential questions surrounding its ill-fated IPO — buying Instagram was Facebook’s equivalent of Jordan’s Game 6. Whether this deal was ultimately good or bad for the world at-large is another question, but there’s no doubt Instagram goes down in history as the greatest acquisition of all-time.

Instagram
Season 1, Episode 2
LP Show
10/31/2015

The Acquired Top Ten data, in full.

Methodology and Notes:

  • In order to count for our list, acquisitions must be at least a majority stake in the target company (otherwise it’s just an investment). Naspers’ investment in Tencent and Softbank/Yahoo’s investment in Alibaba are disqualified for this reason.
  • We considered all historical acquisitions — not just technology companies — but may have overlooked some in areas that we know less well. If you have any examples you think we missed ping us on Slack or email at: acquiredfm@gmail.com
  • We used revenue multiples to estimate the current value of the acquired company, multiplying its current estimated revenue by the market cap-to-revenue multiple of the parent company’s stock. We recognize this analysis is flawed (cashflow/profit multiples are better, at least for mature companies), but given the opacity of most companies’ business unit reporting, this was the only way to apply a consistent and straightforward approach to each deal.
  • All underlying assumptions are based on public financial disclosures unless stated otherwise. If we made an assumption not disclosed by the parent company, we linked to the source of the reported assumption.
  • This ranking represents a point in time in history, March 2, 2020. It is obviously subject to change going forward from both future and past acquisition performance, as well as fluctuating stock prices.
  • We have five honorable mentions that didn’t make our Top Ten list. Tune into the full episode to hear them!

Sponsor:

  • Thanks to Silicon Valley Bank for being our banner sponsor for Acquired Season 6. You can learn more about SVB here: https://www.svb.com/next
  • Thank you as well to Wilson Sonsini - You can learn more about WSGR at: https://www.wsgr.com/

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Transcript: (disclaimer: may contain unintentionally confusing, inaccurate and/or amusing transcription errors)

Sarah: People talk about minimum viable product. What I think for marketplaces, I call that minimum viable happiness. The idea is how do you know? We're talking about happiness. At one point I called it the hippie version of liquidity because how do you articulate? How do you measure happiness? It must be frustrating for engineers to hear that's the optimization function.

Ben: [...] NPS score?

Sarah: Don't get me started with NPS. I'm happy to talk about NPS. I have a bone to pick with it.

Ben: Welcome to this special episode preview of the Acquired Limited Partner show. As many of you know, the LP show has been focusing recently on the fundamentals of venture capital. For our latest episode, we were joined by Sarah Tavel, a General Partner at Benchmark to go deep on the topic with us. Sarah is one of the great consumer investing thinkers out there having made an early investment in Pinterest, then joining the company early in her career and early in the company, and later returning to be a VC.

We decided to create this preview of the episode with some of our favorite nuggets since the applicability is so vast and something that we think all Acquired listeners would enjoy. That and we did the same thing with her partner Chetan last year on enterprise investing so it seemed only fair. Here’s our first segment where we ask Sarah for the 30,000-foot view on why backing consumer companies or B2C companies is attractive to investors.

Sarah: There are two big things that come to mind for me with consumer. The first is just the size of the market. The whole idea of consumer is that all consumers are potential customers. When you think about building massive companies that reach a tremendous scale, there's really no bigger scale than you can ask for than consumers in terms of spending the time.

It has the potential if you can unlock an opportunity that is universal, you have the opportunity to build something really really big. The second thing is that a lot of consumer companies, at least the ones that we focus on, have a dynamic that leads to winner-take-most outcomes. That's largely thanks to network effects. The Facebooks of this world or more economies at scale, so you can think of Amazon as an example.

You bring those two attributes together where you have a company that has a massive market to go after and can escape competition. That just leads to the type of asymmetric outcomes that drive big returns and ventures. That's why we focus on those types of opportunities.

Ben: Digging a little deeper there, enormous markets that have winner-take-all or winner-take-most possibilities, there's a higher upside. Is there a higher risk? Do you think about this as a category that's higher beta than enterprise investing?

Sarah: There's a higher risk for a couple of reasons. One is that there's something that’s more about taste. We talk about capturing lightning in a bottle in consumer where it's so hard to know where a hit (as they call it) might come from where you never could have looked at a market sizing diagram or Gartner report, and then deduce from that that there should be a social network that starts with colleges and sprouts from there. You never would have thought of a company like Cameo.

There's rarely a top-down or bottom-up analysis that leads to an insight that creates an experience that captures something and leads to tremendous consumer growth. That's just capturing lightning in a bottle. It's so hard to go from there and actually reach escape velocity, unlock a monetization model. There are so many more steps or hurdles that there's a much higher rate of companies being started going after consumer opportunities. Iterating, iterating, iterating, and never quite unlocking or capturing that lightning in a bottle.

On the B2B side, Chetan, Eric, and Peter on the Benchmark team sometimes joke that they are coal diggers. There's much clearer, oftentimes, where you're digging. There's a much higher—

David: You're looking for diamonds. They’re looking for the coal byproducts.

Sarah: Yes, exactly. There's a much higher recipe for success in B2B of finding a great founder, who really knows the space, is able to get that go to market motion going and start to build equity value, whereas, on the consumer side, there's no recipe for success.

Ben: When these consumer businesses are in the business of finding something that isn't any sort of research report and then 10–20 years later, it's one of the biggest total addressable markets there is, how do you evaluate that in a venture capital context when the classic notion is we invest in big markets?

Sarah: There's so much to unpack there. One of the hard things of unpacking that is the consumer is a big umbrella. There are so many different types of consumer companies. If we're talking about a marketplace, I'll have a different answer for you. If we're talking about a social product, I'll have a different answer for you. If we're talking about a gaming company, I'll have a different answer for you.

The thing that I focus the most on is what at the earliest stages can you see in a founder, in the product they've built, in the market that they're going after that maximizes the chances that that company, that founding team will be able to go to the distance.

It's funny because a lot of the lessons that we take from that thinking are actually contrarian to what a lot of people think about in venture. As an example, you talk about a big market. Most VCs you talk to, most people think that you have to go after a big market, and founders will come in and their market sizing slide, and it will show these big hundred billion dollar market numbers.

When I see that, my eyes completely glaze over because I'd much much rather, for a market place in particular, but I think this transcends marketplaces. I'd much rather have someone have a core insight into a small market. I describe it as the [thimble] of a market and have adjacencies have the ability to expand beyond that than to be going after a big market from the beginning.

I just think if we loop back to that idea, that premise that we started this conversation with which is driving towards winner-takes-most markets, if we're going after a huge market, you're boiling the ocean. The only way to have a chance to do that is to start with something very small. But that's contrarian. That's not what you'll hear from 9 out of 10 VCs I assume.

Ben: Sarah then goes into more detail on when a simple market has the ability to expand into adjacencies versus what might be a small market with no access to that growth.

The next topic we cover is Sarah’s recent set of three epic blog posts—her hierarchy of marketplaces. What follows is effectively the director’s cut commentary of this three-part series. Here’s her take on what she calls Level 1 marketplace.

Sarah: What I talked about in the post and what I think about is I call it happiness. My point is this, GMV is not to say that it's not a useful measure, but it's not a thing you want to drive towards. If you're just driving towards maximizing GMV, you're going to end up with the scenarios that we described earlier where you're getting big numbers but you're not actually creating any enduring value.

Instead what you want to do is focus on creating what I think of as happiness. Happiness is a funny word to use. It's one that I actually hesitated a lot on. I was thinking of liquidity or value. Happiness to me is something that incorporates the holistic experience that you create for your buyers and your sellers. It's almost the delta in a way the value you create and the value you capture from your marketplace.

People talk about minimum viable product. What I think for marketplaces, I call that minimum viable happiness. The idea is how do you know? We're talking about happiness. At one point I called it the hippie version of liquidity because how do you articulate? How do you measure happiness? It must be frustrating for engineers to hear that's the optimization function.

Ben: [...] NPS score?

Sarah: Don't get me started with NPS. I'm happy to talk about NPS. I have a bone to pick with it. What I ended up coming down to is retention. My friend, Casey Winters, who I work with at Pinterest and is now the Chief Product Officer at Eventbrite—just a great marketplace thinker—said something when I was talking to him about happiness.

He told his team that product/market fit isn't when your user stops complaining. It's when they stop leaving. I think that is a great distillation of it which is that the marketplaces I've seen that have succeeded have all reached two points. One, the cohorts that they have plateaued. You get to a point where you don't have to retain everybody. You never do with a marketplace, but you get to a point where you get to some point where you're making enough of your users happy on either the buy- or sell-side that they retain. That's number one.

On the second side, I actually think that a lot of the time, you'll see one side that has actually net revenue usage retention or net usage retention that's above 100%. You have one side that has more than 100% net revenue retention and you have another side that you do have plateauing. It may not be at 100% net revenue retention, but it works well enough that you can see how the economics will work, for you to pay back your going-to-market motion and keep putting more and more into growing.

Ben: To just illustrate an example of that, if Uber one month acquires a million riders and by six months in, it's plateaued where only half of those riders are still using the service, but each one is spending more than twice as much money on the service then it satisfies that rule because the total revenue from that cohort has stayed flat or increased.

Sarah: What's interesting is that for different verticals, you have different dynamics. Uber is a great example where the net revenue retention that you're going to see above 100% is going to be on the demand side. You're going to have retention that plateaus on the supply side, the driver side, but there's a lot more acquisition you have to do on the driver side all the time.

Travel, on the other hand, like Airbnb, is actually going to have that net revenue retention occur on the supply side because the repeat usage for staying at an Airbnb is just not very high. It's not because of Airbnb's product and losing those consumers to substitutes. It's because people don't just travel that often.

You want to get as much share of wallet as possible, but you're still going to see cohorts that take a long time to show the evidence of repeat usage. It's much more about on that side of seeing some plateauing, but really it's about the net revenue retention you have on the supply side and having really scalable, ideally free sources on the demand side.

Ben: Sarah then takes us through Level 2 marketplace after minimum viable happiness when a marketplace business tips. This is when you become so much better than any substitute that the market tips in your direction, which is when it’s time to start growing systematically and in scalable ways to increase happiness, not just GMV at all costs. Now, back to the interview.

This feels like the moment that a company would start really thinking about Level 3, which I'm going to paraphrase here and it's going to be maybe too aggressive of a paraphrasing, but when you know you have an advantage, press it. Does that feel encapsulation?

Sarah: Yeah. That's a good encapsulation. I'll provide the why, which is there's this company, Schibsted, that is this online classifieds sites. They did this analysis where they looked across their portfolio of online classifieds and realized that how profitable one of their online classified sites was a function of how much bigger that site was relative to the number two in its particular market. It’s kind of back to that winner-take-most idea, which is that the bigger you are relative to the number two, the more value you're able to create and therefore capture.

To your point, Ben, if you have that opportunity, something's tipping, and you're ahead of your competition, then you've just got to double down on that and push and push and push. It's not enough to be number one. You have to be number one by a mile in order to really create the value that we all look for in these companies.

Ben: Sarah then walked us through how that value creation isn’t just for the company and its shareholders, which of course benefit, but that acceleration to be number one by a mile has value that accrues to customers and suppliers on the marketplace too.

In the rest of the episode, we do a lightning round on other consumer business models. Consumer social, content, the rare consumer SaaS business, and how gaming and social are merging into one. If you want to hear the whole episode and go deeper with us specifically on consumer investing for the full hour and get access to all of our VC fundamentals episodes, you can click the link in the show notes or become an Acquired Limited Partner.

Of course, all new members get a 7-day free trial and you’ll get access to the other LP benefits such as the book club, chats with some of our book club authors, and LP calls about once a month with David and I.

Thanks so much for listening and we will talk to you next time.

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