Cracking the consumer investing code: High-risk, high-reward

I offer a framework for why consumer investing is not for the faint of heart. But for the brave souls that enter the fray, the upside could be astonishingly large with winner-take-most dynamics.

Over the past few weeks, the VC community has been abuzz with reports of investors pivoting away from consumer investing toward an enterprise focus. Some firms have allegedly dissolved or reduced their consumer teams. In a sign of the times, this momentum comes hot on the heels of enterprise giant Microsoft overtaking consumer titan Apple as the world’s most valuable public company. VC twitter (unsurprisingly) swung into action, with shots fired from all angles:

Source: VC Twitter accounts (January 2024)

I’ve only ever been a B2B investor and operator, so I don’t particularly have a bone to pick in this hullabaloo. But I thought I would share some perspective on why I, as a B2B investor, hold a ton of respect for consumer VCs and founders. This reverence doesn’t just stem from the fact that the consumer tech community is “cooler” than us “boring” enterprise software folks, but as I’ll outline below, scoring a consumer win is often much harder than a B2B win. That said, a larger prize could await investors and entrepreneurs who do find success in picking or building consumer winners, which perhaps compensates for some of this risk. 

Change has been brewing for several years now

To be clear, this shift in interest did not happen overnight. A few weeks ago, Aileen Lee and Allegra Simon from Cowboy Ventures published a report illustrating how the pendulum had swung over the past decade. In 2013, consumer companies accounted for ~80% of the unicorn club value. Fast forward a decade, consumer companies now only account for ~20% of value:

Source: TechCrunch, “Welcome back to the unicorn club, 10 years later” (1/18/24)

In their report, the Cowboy team presents several hypotheses for this momentum shift, including better predictability of B2B businesses and more exit outcomes. The point on exit potential is supported by my consumer-focused Bessemer colleague Talia Goldberg who found that M&A activity for >$500MM companies was significantly greater in B2B than in consumer due to reasons such as regulatory nuance as well as increased PE interest in enterprise software businesses:

Source: Talia Goldberg, “Consumer internet: get rich or die tryin’?” (2/22/23)

A pareto pattern in consumer returns 

While I’m aligned with these lines of reasoning, my main take is that the risk-reward profile for consumer investing is simply different from that of enterprise investing, and this may not appeal to all investors.

Analyzing VC-backed public listings on the NYSE & Nasdaq worth >$1B and all VC-backed M&A exits worth >$500m since 2001 (which excludes Apple and Amazon since they went public in 1980 and 1997 respectively), Bessemer’s consumer gurus Talia Goldberg, Kate Walker, Alexandra Sukin, and Jeremy Levine, published findings last year highlighting the extreme power law dynamic in the consumer landscape — the top 5 consumer companies account for 88% of cohort value while the top 5 enterprise companies account only for 31% of cohort value. Within the consumer cohort, the top company alone represented 52% of value versus the top B2B company only representing 11% of value:

Source: Talia Goldberg, “Consumer internet: get rich or die tryin’?” (2/22/23)

Furthermore, my colleagues found that the total market cap of consumer companies was ~2x greater than B2B companies despite accounting for roughly half the listings (chart below). Only the biggest and best make it in consumer since survival rates are notoriously brutal. History is written by the victors — consumer winners like Google and Facebook are household names and have even become official dictionary terms, but let us not forget companies such as Lycos, Yahoo!, Infoseek and Excite that were buried in the Search Wars of the early 2000s, and early movers such as Friendster and MySpace that did not survive in the race for social media dominance. 

Source: Talia Goldberg, “Consumer internet: get rich or die tryin’?” (2/22/23)

Underpinning these trends is that consumer winners tend to capture outsized market share compared to their B2B peers. For instance, Google is estimated to own over 90% of the search market. In another example, Uber is estimated to capture 75% of the US ride-sharing market, with second-place Lyft taking the remaining 25% of the pie:

Source: Bloomberg Second Measure, “Uber vs. Lyft: Who’s tops in the battle of U.S. rideshare companies” (1/8/24)

In contrast, on the B2B side, the top CRM player Salesforce only has less than a quarter of a fragmented market (chart below), and Zoom has only captured less than half of the enterprise video conferencing opportunity. 

Source: Salesforce, “Salesforce Ranked #1 CRM Provider for 10th Consecutive Year”(4/25/23)

The implication here for investors is that there is little room for error in consumer investing — if you’ve missed investing in the #1 company in a consumer category, then you’ve likely missed the entire boat. That said, the potential prize for the winner in a consumer category is likely to be very large, and this asymmetric upside could be sufficiently compelling to investors. Conversely, with markets more fragmented in B2B, enterprise investors have more margin of safety since the #2 and #3 players could still capture enough share to drive a decent return. 

What explains this winner-takes-all/winner-takes-most dynamic in consumer categories?

I love studying market structures, and Professor Thomas Eisenmann’s research on platform structure in networked markets has always resonated with me since I first explored his work as an MBA student. Prof Eisenmann purports that there are four factors that influence the odds of whether a market will be served by a single platform (i.e. winner-take-all):

1. A “natural monopoly” defined by minimum efficient scale in excess of mature market size. Natural monopolies are rare, so the subsequent factors likely have more influence.

2. High multi-homing costs which are the sum of costs incurred when a user affiliates with multiple platforms. This is slightly different from switching costs which tends to refer to expenses or inconveniences incurred by users when abandoning one platform in favor of the other.

3. Strong network effects which encompass users valuing the platform positively due to the ability to interact with large numbers of other users.

4. Low requirements for feature differentiation due to relatively homogeneous user needs.

In general, I’ve observed that consumer markets tend to embody a higher degree of these factors compared to enterprise landscapes, which make them more prone to a winner-take-all/winner-take-most dynamic. Some thoughts:

• Consumer subscription services such as Spotify or Netflix are a good example of high multi-homing costs at play due to monthly fees as well as nuisances with managing multiple apps for the same service on consumer devices. In contrast, enterprises are more open to procuring best-in-class point solutions or niche solutions for different teams even if it means redundancy in the stack (although I note that vendor consolidation and unbundling can be cyclical).

• Network effects are a well-observed phenomenon in the consumer world and iconic consumer businesses have leveraged the power of such flywheels to win their markets. Examples include social media platforms such as Facebook, Snapchat, Twitter, Pinterest, LinkedIn, Instagram, etc. where users are incentivized to join and create content to interact with others on the platform, consumer marketplaces such as Airbnb, eBay, Uber, Lyft, DoorDash, StubHub, etc where buyers and sellers transact, and gaming-driven platforms such as Discord, Rec Room, and Roblox where communities are key. Virality through network effects are also present in B2B businesses (I’ve written about this phenomenon previously from the lens of product-led-growth companies), but certainly seem less deterministic than in the consumer world.

• With regard to feature differentiation, most consumers have relatively universal Maslovian needs and motivations versus the enterprise landscape being much more heterogenous, with organizations demanding bespoke features, unique governance controls, or custom requirements.

Play hard games, win big prizes

Consumer investing is certainly not for the faint of heart, which may explain why many VCs are shying away from this category. But for the brave souls that choose this pursuit, the upside can often be remarkably large. Many of today’s top consumer businesses such as Apple, Amazon, and Meta, have dominated for several decades now. A changing of the guard is long overdue, so I salute my consumer VC peers and the founders who are ushering in the next generation of category-defining consumer startups.

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