When Tailwinds Vanish (The Internet in the 2020s)

John Luttig, 2020-04-23

Nice Numbers and Observations

  • At 20%+ CAGR incumbents can’t catch up, leaving room for newcomers.

  • SaaS spend of 50%+ can make lots of startups profitable and big.

  • Assumptions of growing valuations in 2020+ are based on expanding multiples of FTM (forward twelve months) revenues, which are based on continuing market expansion.

  • Internet companies spent 20+ years capturing opportunities with the highest margins, lowest operational complexities and strongest market pull [demand side]: search, social networks, CRMs, ecommerce.

Questions to Ask Yourselves

  • While people can’t spend 100%+ time/$ on the internet, who to steal revenue/users from other than incumbents?

  • Since the market pull is gone (customers got what they wanted already), are incumbents suddenly in a better position as their incremental spend buys more users/higher margins?

Acceleration of Zero-Sum Games

  • The number of internet companies grows, the number of addressable market segments shrinks. A typical recipe for a zero-sum game.

  • And yes, collective internet company revenue becomes fixed. The split is what’s interesting.

  • With massive economies of scale blitzscaling [very fast growth to #1] works to catapult companies to the top.

  • Tech ecosystems now have diseconomies of scale (supply side): increasing staff, office and customer acquisition costs.

  • First to scale may mean first to fail (Uber?).

Hiring: R&D —> SG&A [selling, general and admin]

  • Core driver now: SG&A due to CAC [customer acquisition cost] inflation

  • Startups now deal with higher complexity, marginal costs, CPC prices and lower gross margins. [MK: Aviasales’ average revenue per booking fell 2x between 2014 and 2019. The volumes grew 10x+, though]

  • In the past millions of users in consumer space could be achieved with a few tens of staff, and hiring was after the growth.

  • Now the core spending is on SG&A, not R&D. Creating favourable conditions (sales, marketing) is not free anymore. Businesses are no longer R&D-driven anymore.

  • Increased premium on cross-functional SG&A roles vs pure R&D.

What if You Let 50% of Staff Go?

  • Google: less reliance on people, more – on software [Cat 4-5], will be fine for a while

  • Enterprise software: less account/success managers —> less sales, slow decline

  • Physical marketplace – falls apart as it’s human-driven.

On a Bright Side

  • [MK: If you haven’t read the Predictable Revenue book, do it now]

  • Investing in SG&A makes revenue/profit drivers (incl. LTV) more predictable.

  • [MK: the assumption is that there can be a model than takes into account the inputs, including people, and spits out the believable outputs]

  • Adding people or funds to R&D may not be useful (diminishing returns on R&D) —> companies prefer holding on to cash instead.

  • Consumer internet: user growth —> fundraise —> invest into R&D

  • Labour-driven marketplaces and Enterprise software: fundraise —> invest into SG&A —> user growth.

  • Lower CAPEX is offset by inflation in OPEX (labour, operations, distribution), growth is becoming more expensive.

  • Investments with predictable yields commoditize —> companies spend as much as they can.

  • Growth requires operationalizing; C-Level must make ROI tradeoffs across divisions to maximize outcomes.

Finance to the Rescue

  • Non-VC financial layer: real-time debt offering based on operating KPIs, securitization of recurring software revenue, retail investor-facing SaaS bonds.

  • Goal: divorcing companies’ financial strategies from operational.

  • As a result, VC dollars will be used for R&D, not S&M or G&A. (earlier stage)

  • Late-stage: VC funds will be used for secondary investments into growth companies, not primary [important shift].