Nikhil Basu Trivedi (Next Big Thing) - Why Investing in Consumer Subscription Businesses Has Become The Next Big Thing, and The Reasons Physical Goods and Software Businesses Aren't That Different

Hey folks, before we get started, I wanted to tell you about the Consumer VC Summit. The Consumer VC Summit is a three day virtual event that is focused on E commerce, retail and innovation. This is all happening February 23rd through 25th, 2021. Mark Nathan and I have really poured our souls into it. During the day is a mix of talks and panel discussions with some incredible founders and investors that focus on these sectors. In the evenings we're going to be throwing networking events and if you're a founder, you'll also have access to mentoring sessions, which means you'll meet three investors or industry professionals for feedback about your business. All of our talks and panels will also be available for replay with a ticket. Please check out summit.theconsumervc.com and enter consumer VC for a 20% discount. This is also located in the Show Notes. We look forward to seeing you there. Now onto the episode. Hello and welcome to the Consumer vc. I am your host Mike Gelb and on this show we talk about the world of venture capital pertaining to consumer facing startups that's both consumer technology and physical goods. We're interested in learning what the world's leading VCs look for in founders and opportunities as well as learning From Venture backed B2C founders who have grown their businesses to incredible heights. Thank you Ezra Galston for introing me to today's guest, Nikhil Basu Trivedy. Nikhil previously was the Managing Director of Shasta Ventures and writes the Next Big Thing, which is an awesome online publication that I highly recommend you check out. Some of his investments include Literati Tali, Canva, Farmer's Dog and the Pill Club. His focus has been on consumer particularly consumer subscription business models which was the main focus in today's conversation. In the Show Notes we have links to his three essays about consumer subscription which I highly recommend you check out. Without further ado, here's Nikhil. Nikhil, thank you so much for joining me today. How are you?

I'm well, thanks Mike. Thanks so much for having me.

Oh it's an absolute pleasure. Thanks. I really appreciate you taking the time so you've recently written this series of posts about consumer subscription business and how you're very bullish about consumer subscription business that they're the future, your frameworks when analyzing opportunities and you made the argument that marketplaces and advertising type businesses were a dominant business model in the first 20 years of the Internet. But what are some of the shortcomings of these two models and why has it taken this long for consumer facing subscription businesses to really take off.

Yeah, it's a great question, Mike. As you mentioned in my post about consumer subscriptions, I wrote about how subscriptions have become the dominant business model of the Internet today. But that hasn't been the case for that long. If you look at the huge consumer businesses that have been built over the last 20 years, a bunch of them are advertising based businesses and a few of them are marketplace business models. Now I think there are shortcomings to each of those models. If you take advertising for instance, there can often be a lack of alignment between the business's objective of generating revenue and maximizing revenue and the consumer's objective of having an amazing consumer experience. And so if you think about platforms like Facebook, I think one could reasonably argue that the ads have actually been detrimental to the end user experience, particularly as you consider privacy, the data usage required for businesses like Facebook to serve up targeted ads. So I think that lack of alignment is the core issue with the advertising business model. And then on marketplaces I think the big shortcoming is just the cold start problem. They take a long time to get to scale to scale both supply and demand and they also take a lot of capital to scale both supply and demand with subscriptions. I think what was challenging up until the last probably five to 10 years is that the payment rails weren't built such that both businesses and consumers could really trust the subscription to work and to not cheat either side. And so that's been a key enabler. And I think compared to the advertising business model, for instance, there's really strong alignment with a subscription business model between a consumer and the business that makes.

A lot of sense. Thanks so much for explaining it. And I really by the way, enjoyed reading all three of your pieces about this. And you talk in one of your pieces about your ten factors framework which we're going to be including links to as well as your website as well in the show notes. But what's one factor that you think is often overlooked when founders are thinking about starting a subscription business business?

Yeah, it's a great question, Mike. So real quick on the 10 factors. I described 10 factors to consider when you evaluate a consumer subscription business. And those 10 factors are number one, is it a must have versus a nice to have? Number two, is it an existing recurring behavior versus a new recurring behavior? Number three, conversion from free tier or trial to paid subscriber. Number four, the subscription gross profit. Number five, the cohort retention. Number six, the payback period. Number seven, the total addressable market for the Act 1 which is the initial subscription offering, number eight, the attachment and bundling potential to Act 2, Act 3 and beyond, number nine, win back potential, and number ten, network effects. And the reason I just wanted to lay those out quickly for your listeners is all 10 of these factors are important. And the reason I wrote the post was that I believe you have to take into account sort of all 10 of them as you build one of these businesses or as you think about investing in one of these businesses. Now to your question of which one of them is perhaps the most overlooked? I think for a venture backable consumer subscription business, the one that is perhaps most overlooked is sort of that transition from the initial subscription offering, the Act 1 to the Act 2, and the Act 3 and beyond. I think a lot of people think about that initial wedge of what their subscription business is going to be. But in reality, when you think about most successful consumer subscription businesses, they've had an act two, they've had an act three. And I think the sooner you start to think about that, the better off you'll be as both the builder of one of these businesses and as an investor in them.

No, that makes a lot of sense. I mean, it's interesting because we did a previous episode as well with Mike Ghaffari about marketplaces and investing in marketplaces, and he thought that because he also built a marketplace, that one of the things that he overlooked was unique distribution strategy, for example. So I always love just hearing about what founders might not focus on immediately so much and try to pick that apart. So that's really helpful, thank you. So when you say subscription, I know you mean it quite broadly in terms of the actual products, you know, physical goods I know you wrote about, and also software. And you know, with physical goods you're always going to have marginal costs where in software marginal costs can be minimal, even in subscription businesses. When you mention, you know, evening the playing field, how do you look at physical subscription businesses and software businesses? Are they more closely related than you think?

Yeah, that is my perspective. You know, a lot of folks who've written about consumer subscriptions have been very specific to writing about consumer subscription software. And one of the reasons why I wanted to write these pieces is I've invested in both, both digital subscription businesses such as Canva, ClassDojo, Achasta, we invested in Zwift and a number of others, as well as physical subscription businesses. The third part of my subscription series is about the farmer's dog, which is this fresh pet food investment that I led at the series A in 2017, which offers a physical product delivered to folks as a subscription. And in my experience, there are actually a lot of similarities between these two different types of subscription businesses, physical and digital. And so I think that's perhaps something that I believe that others don't. And even when you think about a characteristic such as gross margins and marginal cost, interestingly, if you look at Netflix, which is arguably the greatest pure consumer subscription business, and of course a digital subscription business, Netflix's gross margins are in the 40% range, which actually make them lower than the gross margins of a number of physical subscription businesses. Now, the difference is that Netflix has a zero marginal cost of adding a new subscriber because a lot of their cost is fixed versus variable. So that is a difference. But my argument is that both physical and digital subscription businesses can be enormous businesses and venture scale outcomes.

No, absolutely. It reminds me of a conversation I had previously with Sunny Dhillon at Signia Partners and what he was saying, how he thinks that, for example, the beauty industry is very much overlooked and he compared it almost to a SaaS company in terms of margins, because in beauty you can get up to 80% when it comes to margins. So I certainly agree with your sentiments.

By the way, one other thing to mention on this is if you look at a business like Amazon, which started in physical Athens, in a category like books, which is consumable and quite recurring in nature, the fascinating thing about consumer businesses today is that they can be both physical and digital. Look at Peloton too, which is a hybrid physical and digital subscription. And so I just think the lines are blurring enough that I wanted to speak about both through these pieces.

Absolutely. It makes a lot of sense. And I wanted to also touch on as well and about how you see important something that I think about is the freemium model versus the trial period, focusing I guess, mainly on like software businesses per se. What are some questions that founders should ask him or herself to help decide what would be best option in terms of trying to give a potential customer an idea or a touch point with their business?

Yeah, look, I think this question of freemium versus free trial is a really important question. And at some point I think I should probably write a post on this and I'm sure someone else has written a high quality one on it. But to me, the first question, the actually more important question is do you offer anything for free at all? Because for a lot of businesses, dangling something out for free can actually lead to a very different consumer psychology than if everything is just gated and paid. And so I Think probably the more important question is do you offer anything for free? And I think a lot of entrepreneurs don't think maybe hard enough about that question because once you offer something for free, it's actually very hard to remove that and go back. And then on freemium versus free trial specifically, to me the big question is does the trial and the time limit accomplish something by sort of limiting the duration of which you get to try something out? And then for freemium, I think the key question you have to have as a builder of one of these consumer subscription businesses is are there a clear enough set of features to justify the difference between the free version of the product and the paid version of the product? And I think a good example is something like Spotify where the free version is advertising based. And so the justification is actually there's a revenue model there, so it's justified from a business standpoint. It's not as great of a consumer experience. And so the premium version can be easily justified for the consumer. And I think you have to have a very, very clear understanding of what that difference is.

Yeah, that makes a lot of sense. Thanks for touching on it. Wanted to also touch on too going a little off script here about pricing as well and how you think about pricing because and I actually heard this that got me thinking about it on a podcast episode on Invest like the Best, which I absolutely love that podcast. I forget the guest's name, but they touches on how in a subscription business, if an entrepreneur comes to you and says, or a founder comes to you and a company's scaling, we're able to increase prices and we haven't seen a big churn rate. In some ways that's obviously a good thing. But as well that means that maybe then there's not as much growth in terms of new customers wanting your business and you're actually almost limited by growth. I was just curious on how you think about price increase when it comes to subscription.

Well, I think the best subscription businesses have a lot of pricing power. They're such a must have, they become so fundamental to consumers needs such that they have the ability to increase prices. And I think again Netflix is best in class here where they've done multiple price increases increases over the years. They've been very deliberate about their pricing strategy. They've also been able to only do monthly and not even offer an annual product, which is by the way another big consideration as builders think about pricing, which is do you have a monthly and an annual option? Often an annual option is actually better for lock in but there's some limitations. They perhaps don't maximize LTV by offering an annual discount. So there's a lot of thought that I think needs to go into pricing. To me, what I encourage the founders that I work with to do is to also experiment to understand how much pricing power you have from the earliest days and use that to your advantage over time. But you have to keep growing. And if I had to prioritize subscriber growth versus pricing maximization, I would prioritize growth for a very long period of time against pricing moves, against price increases.

Right, yeah, got it. And in terms of the earliest stages, what are some of the creative ways that entrepreneurs can test their pricing?

A number of founders that I've worked with on this have just one day decided to raise prices across the board. It depends on the type of subscription product you have. In some cases you are able to isolate a test group and do an A B test on pricing. You can certainly test conversion very simply without even locking folks into a higher price before you change it. So there's a number of different ways. Again, maybe something that I should write about down the road.

No, that's great.

That's great.

I love it. And one of the things that I get curious about, you know, I had on Eric Paley, who I absolutely love that episode. And Eric's fascinating. And Eric said that, you know, VCs, because I know you touched on market size a bit as well in your piece. VCs get market size and addressable markets notoriously wrong in many cases since a lot of the big winners come from, you know, blue oceans or markets that really have developed yet. Just putting your investor hat on. How do you think about blue oceans and new markets when you're analyzing opportunities?

Yeah, look, I think first of all, Eric is absolutely right. When I look at some of the mistakes that I've made that I've seen others make. Probably the hardest thing to gauge in the early stages is just how big a market's going to be 10 years from now, which is when you actually are getting to an outcome for a lot of venture backed businesses. And the very best companies create their own markets and create their own opportunity to enable the market to be big enough to build a really big business. And so what I look for is if there are rabid signs of customer love from the earliest stages, if some of those key factors that I discuss in the middle of the ten factors post, such as subscription annual gross profit being high, cohort retention being high, payback period being low, if those things are present, then the market could actually surprise you on the upside at how big it is. And that's kind of how I tried to invest at the series, a stage in consumer subscription businesses where, look, the farmer's dog, which I talked about in the third piece in the series, is a great example of a company that a lot of people overlooked based on market size in the early days, including my own partnership, had the most pushback for me in that area. The reality is that there were so many early, early signs of product market fit. And today their Act 1 business in fresh human grade pet food has scaled to hundreds of millions in revenue. And that premium segment of the market, the healthy segment of the market, has grow as well during that period by a significant amount. And so if you look at examples like the farmer's dog, if you look at examples like Peloton, I think what you'll find is that the market could have been overlooked size wise in the earliest days, but there was so much customer love and that's kind of what created the huge opportunity.

Yeah, I'm glad you mentioned Peloton. When I had on Mike Duda, who was an investor in Peloton, he was like, mike believes that market sizing is very much overrated in terms of of as a vc. And he was saying on that episode when Peloton was first starting out, what was the market size? How do you even do market sizing for that business backing up? We'd love to learn obviously more about you. I know we jumped right in here, but what was your initial attraction to venture capital and technology?

Yeah, I moved from the UK to Silicon Valley when I was a teenager. My parents jobs brought us to the Bay Area when I was in eighth grade. And that completely changed my life. I mean, I'd used the Internet, of course, I had an interest in computers when I lived in England. But getting to be in the heart of Silicon Valley during high school and just being able to see sort of what was happening in this area in the sort of 2002 to 2007 timeframe, post.com, boom and bust with the growth of businesses like Google and Facebook, which I got when I was in high school at LinkedIn and others that were sort of scaling during that period, it just blew me away. And I got to also learn computer science in high school from still one of my favorite educators of all time, my high school computer science teacher, Mr. Thibodeau. And so the combination of learning CS in high school, being in Silicon Valley, in the heart of it, got me Excited to start working on startups from basically day one in college.

That's awesome. Thanks for giving us a glimpse about that transformative experience about moving from London to Silicon Valley. During these times of COVID everyone's remote. How important do you think, think nowadays it is for a founder to actually be in Silicon Valley?

I think it's changed so fundamentally in the 18 years since I first arrived in Silicon Valley to today. And so to answer your question directly, I think it's less important than ever before because there are success examples everywhere you look. There are some phenomenal technology businesses being built in every corner of the world. And the amazing thing is that the democratization of information which used to be siloed in Silicon Valley and in a few other places has just been incredible over the last decade in particular. I mean, even when I was working on a startup during college, there were not that many blog posts about all the things to do and not to do as a founder from the earliest stages. I mean, there was barely any talk of product market fit, for instance. And now that term has been defined and every angle and aspect of it has been analyzed. If you just look at substack writers, for instance, you'll sort of find an incredible set of work analyzing, I think every area of building a business. And that to me is the fundamental thing that's, that's changed over the last 10 to 20 years. And it means that anyone, anywhere can build a high growth, massive technology business.

How comfortable are you investing in companies that are fully distributed even post Covid will still be fully distributed and kind of all around the world.

Yeah, I feel comfortable about it. Again, the meaning of the office has changed and it was changing for some time, but the acceleration of that change has happened due to COVID 19. I think the question still remains around culture. I think culture hard to build in person, in some ways it's harder to build remotely. And so I think when I analyze fully remote teams, my level of questioning on the culture and sort of the analyzing of the founder's thoughtfulness when it comes to building the team and building culture is just higher than an in person team because we're still kind of figuring out exactly what this remote model looks like. And I think entrepreneurs who are able to, number one, figure out how to hire high quality talent without having any sort of constraint of location, and number two, think really thoughtfully about culture and have a set of principles around that are way better positioned to succeed in a fully remote world.

Yeah, I absolutely agree. You know, especially the early stages, culture is absolutely Crucial, if not the most important thing and figuring out ways to try to have culture while everyone's remote. It's a very difficult task to have even though we're now seeing all these incredible products come out for new ways to chat and everything, but still very, very difficult. It's hard to replace that in person experience. When you're meeting with founders, are you finding it more difficult to establish conviction with them since you're having to meet with them remotely?

I'm honestly surprised that it hasn't been that hard. But if I reflect on it, I think one of the reasons is if you already have some context about the founders, if it's come through a warm introduction, if you have a number of connection points, then it's just way easier to build a relationship. And so what I do think is hard is getting conviction about someone who just don't have any prior context around. You don't have sort of a warm connection around. And so I do worry that that leaves out a set of found just aren't as well connected from raising money during this time. That's been my observation.

Yeah, that makes a lot of sense because of course also when you're building rapport, you've at least had the commonality there as well, which is also very crucial. What's your favorite question to ask founders when you're meeting with them for the first time?

Yeah, I love to ask what's not going well and what's keeping you up. And the reason I like to ask that is I want to understand is a founder self aware? Is she or he able to sort of diagnose quickly what's really important to focus on and what's really important to prioritize because oftentimes those are the things that should be the things that are really keeping a founder up. And so I use that as a way to analyze a founder and also be able to have an open and honest conversation hopefully around something that's not working as well in the business. Because once we do get into business together, post investment, that's a lot of what we're going to spend time on.

That's a really, really great point. So what's one thing you would change when it came to venture capital?

I think that the main thing that I hope to change and have some legacy around 20 plus years from now is diversity and inclusivity in our industry. I think we certainly need more underrepresented minorities in venture capital. We should be a gender equal industry. And I hope that 20 plus years from now I've had an impact on this and made it more diverse and more inclusive. So that's the number one thing that I hope to change.

No, I appreciate that. What are some of the things in order to increase diversity in venture capital that you'd like to see, maybe other investors do or are currently doing and to help create the ecosystem more inclusive?

Well, I think it starts from there are very real hiring decisions you can make as the leader of a venture firm. Of course, the problem is not just confined to decision makers in the venture industry, but the types of founders who we're investing in. And it's also about the companies that we invest in taking diversity seriously. And finally, I would say we can't leave limited partners out of this conversation. I think the more diverse limited partners are and the more that they care about diversity in our industry, the more GPs and firms will just have to change and have to adapt. And so to me, there isn't a silver bullet here. It's sort of a number of constituents in the system making this a priority. And I think we have seen real progress, progress on this dimension over the last several years, but it's still got a long way to go.

Yeah, I think that there's all really good points. I mean, it's similar to my conversation when I had Saraya Darabi on. She was saying how if you really want to see a lot of change, it starts from the top. So it starts with the LPs and pension funds and some institutional investors that actually pave the way to invest in underrepresented investors. So what's one book that inspired you personally and one book that inspired fired you professionally?

This is such a hard question. I think on the personal side, if I pick one that continues to ring in my mind a lot, it's between the World and Me by Ta Nehisi Coates. Just an incredible personal essay about being black in America and what that means and just a super powerful book that has stayed with me since I read it, I think four or five years ago. On the professional side, again, this is really difficult. But Leading, which is co authored by Sir Michael Moritz of Sequoia Capital and Sir Alex Ferguson, the longtime manager of Manchester United, is right up there as one of my all time favorites. And the reason is that those two are heroes of mine. I've been a longtime Man U fan since I was a kid and of course Sir Michael is arguably the greatest venture capitalist of all time. And so that book was, I mean, I was so excited when it came out and had to very quickly read it and continue to have it close at hand today.

No, thanks so much for mentioning I'm a big Tottenham Hotspur fan so. I know, yeah, I know, I know we gave you some trouble, I think.

Last weekend, but that was painful. That was really.

But yeah, I'll certainly have to check both out. I mean the between the world and me sounds really fascinating as well as leading and also even though I'm a Tottenham fan, I mean you have to admire what Sir Alex did with Manchester United. It was pretty unbelievable, the amount of championship and just year over year it was almost a given that his team was going to win the league. So what's one company that's on your anti portfolio and what was the reason why you passed?

Yeah, I mean one that continues to haunt me is Robinhood because of course it's I think worth $12 billion today. Something like that. And I had Baizhu and Vlad come in at the Series A stage. They'd already raised a seed round. We're thinking about the A and I think the main story here is that we overanalyzed the company on a number of dimensions. We looked priors such as Zeco, which tried to do free stock trading back in the web 1.0 era and it didn't work. We talked to several others in the industry who were very skeptical. And yet mobile had really changed the game. And you could tell in that Robinhood experience from the earliest days that there was something magical about being able to trade stocks so simply on your phone. And the other thing is that they did have an incredible wait list of users. Again, I think we discounted that because it was just a wait list versus hundreds of thousands of existing active users. But it turned out that that waitlist demand was real. It turned out that mobile was really a game changer. It also turned out that they were able to have a business model over time, which was another question that we had in the earliest days. And they've just executed supremely well. So hats off to them. And it's obviously one that I regret not having done.

Well, if it makes you feel any better, Robinhood was the same response of a Connie Machabela as well.

Connie's a lot of information, so that does make me feel a little bit better.

So my final question for you is, first of all, I encourage everyone to read all three of Nikhil's pieces about consumer subscription businesses. But if you had to say, what's one piece of advice for founders building subscription businesses, what would it be?

I'll cheat, I think, and try to Give two. So the first is I think there isn't one silver bullet. As I mentioned earlier, the reason I wrote this post is that I think every single one of these factors is really important. And you can't just only think about one, you've got to think about all. And these businesses take time to build. They take a lot of iteration, they take a lot of creativity. And so that's why I wanted to put this set of factors out there. But if you really pressed me on, hey, what's that one thing that you have to think about? I continue to come back to retention and a business's potential to have customers for decades as the single most important factor to consider with these businesses. And it's hard to sometimes tell if that's going to be the case in the early days. But I think you as a founder building one of these companies has to believe you're building something that can live with people for 10, 20, 30 years if you get it right. And I think if you have that mentality from the earliest days, you have a high probability.

No, I think that those are really great points. There's not a one size fit all for really any business. And I appreciate you always the founder has to be looking about this as the long term and not the short term. So that's that is really helpful. Well Nikhil, this has been such a pleasure. Thank you so much for your time. This has been fun.

Thanks a lot Mike. Thanks for having me and keep doing great work. Really love your podcast.

And there you have it. It was such a pleasure chatting with Niko. I highly recommend following him on Twitter, Twitter nbt, as well as checking out his amazing blog, the Next Big Thing. If you could please leave a review on the Apple Podcast app as it helps other folks find it, that would really be helpful. If you have a question you'd like to hear VCs or founders answer on the show, you can DM me and follow me on Twitter ikegelb. You can also follow for episode announcements at Consumer VC. For all episodes, please visit theconsumervc.com thanks again for listening folks and please stay tuned.

Safe.