Disclosure: Opinions expressed are solely my own and do not express the views or opinions of my employer. I am a personal investor in Coinbase.

The Bitcoin whitepaper is one of the more elegant pieces of mathematics and computer science ever written. Satoshi Nakamoto, the infamous and anonymous author, cracked an unsolved problem in computer science known as The Byzantine Generals Problem. In layman’s terms, Satoshi figured out how to build a system for reaching consensus — and therefore transferring value — over a trustless network like the internet.

But there was an error in the code. Or more precisely, an imperfect assumption about human nature embedded in the paper. Satoshi implicitly assumed that human beings don’t want to trust a central party; that they would rather have a trustless system where they only have to trust themselves and sophisticated mathematics. The whitepaper states:

“What is needed is an electronic payment system based on cryptographic proof instead of trust, allowing any two willing parties to transact directly with each other without the need for a trusted third party.” — Satoshi Nakamoto, Bitcoin Whitepaper 2008

Brian Armstrong is a vocal fan of Bitcoin and of the whitepaper itself, but the business he built demonstrates that he also saw its limitations. The Coinbase vision and business plan is in some ways an addendum to the Bitcoin whitepaper to correct this flawed assumption.

Coinbase during its early years — and to some extent today — was controversial within the crypto ecosystem. If the central innovation underpinning blockchain technology is the decentralization of trust, the elimination of the need to trust a central counterparty like in the traditional financial system, Coinbase’s brokerage and wallet products flip that value proposition on its head: customers put their trust in Coinbase to hold and transact their funds in much the same way that they would with a traditional bank or brokerage.

What customers get in exchange for that trust is abstracting away the complexity and risks of dealing with crypto. Customers of Coinbase don’t have to worry about losing their money if they misplace a 64-character long string of numbers and letters. Instead, if they forget their password, they can go through a reset flow. Similarly, Coinbase customers can sleep well knowing that their funds will not be stolen in a hack (so far Coinbase has never had an incident where customer funds were stolen).

It turns out that the mainstream user of crypto today prefer this format of interaction with their holdings. Human beings ultimately want to be able to trust someone else. Brian and the team at Coinbase implicitly understood this dynamic.

It may be ironic that the most valuable company created within crypto — a trustless system for transferring value — is the one that asked users to give it their ultimate trust. But it is precisely because trust within the crypto ecosystem is so elusive that Coinbase has succeeded to such great extent.

In summary, Brian understood that iconic financial services businesses are always built around deep customer trust, and while crypto solved a problem in computer science, it wouldn’t change human nature.

Atari founder Nolan Bushnell once said that the best video games are easy to learn and nearly impossible to master.

I believe that a related concept holds for building foundational consumer internet companies. Two characteristics that I always look for in startups are the founder’s ability to describe what they do in less than five seconds, and a product or service that’s exceptionally hard to build well. Those two characteristics may sound as though they’re in opposition, but it turns out that the best companies can be simultaneously very easy to understand and very hard to do.

A successful consumer internet company must be easy to understand

“In a world of abundance, the only scarcity is human attention.” — Kevin Kelly, The Inevitable

Humans have short attention spans, and the competition for mindshare has never been greater. Today, the most successful products in consumer internet tend to be those that achieve high degrees of virality. Word of mouth, in particular, is an especially important driver of distribution for world-class products. Only products that are extremely simple to understand-such as DoorDash, Niantic, or Coinbase -can thrive in the telephone-chain word-of-mouth distribution channel.

Here’s an example: imagine talking with a friend about something like Doppler Labs’ Here One earbuds. Though this hardware product had standout features and was unlike other earbuds on the market, it was difficult to explain what made them special. A conversation might sound something like, “They’re kind of like headphones, but really, they’re augmented reality for audio. You can phase in and out background noise. No, it’s not the same as adjusting volume or noise-canceling… but yes, you can use them to listen to music.” It’s not hard to predict that a message like this might not easily catch on.

Compare this to a product like Robinhood. You might say something such as, “It’s an app to buy and sell stocks on your phone without paying commission.” The succinct description instantly showcases the company’s value for consumers, and it’s memorable. Most people can understand how the product works, which makes it clear why Robinhood’s message sticks and can generate strong word-of-mouth distribution.

The less obvious insight is that this phenomenon can also work in startups’ benefit to attract capital. Founders who can quickly articulate their product and business model have the advantage of appealing to a large amount of investors.

Even more, a product or startup must be hard to do

Being able to concisely describe what a company does is just one part of the blueprint for success. While having a message and value proposition that are easy to understand and talk about are critical to growth, to become extremely valuable a startup must also build a product that’s hard to do.

Some verticals, like direct-to-consumer brands, can have a large number of companies that offer a similar product even after some have reached a moderate scale. While it’s never been easier to get to market with a new product in this vertical (good), it’s also a lot less likely for a single, super valuable company to capture the entire market (bad, at least from the perspective of a venture capitalist).

In contrast, when a business builds something that is hard to do well, they effectively construct a moat, or a sustainable competitive advantage. Nearly all startup pitches include a conversation around moats and the barrier to entry, and rightfully so. Building a moat allows a company to become a compounding franchise and accrue outsized profits over the long run.

Easy to Understand, Hard to Build: A Blueprint for Success in Consumer Internet

Using this framework, companies can be classified into one of four quadrants when we evaluate whether or not they follow the blueprint for consumer success.

Easy to understand, hard to do

As described, this is the magic quadrant for consumer internet companies. Companies in this quadrant have a simple message that can be explained in five seconds or less, along with a component that’s hard to do. This may be an engineering build, regulatory approvals, cracking a network effect at scale, or building a brand that resonates.

• Coinbase: Crypto is a notoriously complex vertical to understand, but the magic of Coinbase is that it doesn’t require a person to have any specific knowledge to use the product. By abstracting away the complexities of safely buying and storing crypto, Coinbase brought crypto to the mass market. Despite the simplicity of Coinbase’s product, the infrastructure that makes it possible is one of the most sophisticated engineering builds I’ve ever seen. For instance, keeping 98%+ of crypto deposits in cold storage while enabling instantaneous transaction ability is not a straightforward feat or something that people think about, but it’s critical to the ultimate product experience. Even more, the security infrastructure is a moving target that requires Coinbase to constantly innovate. Coinbase also remains one of the few scaled crypto exchanges/brokerages that have never been hacked .
• Niantic: Niantic is a mobile game producer and the maker of Pokemon GO and Harry Potter: Wizards Unite. Niantic lands in the ‘easy to understand, hard to do’ category because the best games need little explanation; players simply open the app and start playing. Yet, there are few other companies that could successfully replicate the infrastructure that supports 100 million simultaneous instances in a single shared world geospatial game.
• DoorDash: While DoorDash offers a drop-dead simple value proposition of better food delivery, the company has actually built a highly sophisticated software and operations stack that is really a next-generation last-mile logistics backbone. Much like Fedex or UPS, which were really software companies with trucks and drivers on the front end, DoorDash software controls every step of the process, from order batching, timing of food preparation, traffic analysis, and driver availability. DoorDash has largely out-executed competition because they recognized that better software and operations unlock a better product and a better business. For example, they solved reserved parking for dashers, and partnered with national chains to expand to non-urban markets. DoorDash also had to crack sufficient density in a geo-specific three-sided marketplace (restaurants, dashers, consumers), which is no small task.

Easy to understand, easy to do

Companies that are easy to understand may be able to get widespread, frictionless distribution, but those that are easy to do fall usually short when it comes to building a moat, or genuine competitive advantage. Brilliant marketing is not enough to prevent duplication, and business models that can be copied with something as simple as contract manufacturing may soon find themselves sidelined by competitors.

• Juicero: No example comes to mind more quickly than Juicero. The Juicero Press was an expensive Wi-Fi connected device that utilized single-serving, pre-juiced fruit and vegetable packets sold via an exclusive subscription model. Juicero was easy to explain, but its technology wasn’t truly hard to do. Customers caught on to the fact that they didn’t actually need their device or Wi-Fi to make juice with the packets-they could do it with their hands by squeezing the packs. And there were significant alternatives in the market. The company shut down after 16 months in business.
• BlueSmart: BlueSmart, a smart luggage company, serves as another good example of a company that was easy to understand and had a clear use case. Unfortunately, there was little about the product that was hard to do-it faced stiff competition from other smart suitcase companies as well as incumbents. Away, for example, came to market at a similar time and was able to out-execute on brand. The final blow came when airlines began banning lithium batteries, which the company decided they wouldn’t be able to sufficiently differentiate without.

Hard to understand, hard to do

Companies that are hard to do-perhaps they offer multiple products or elaborate models-can be difficult to articulate, which often causes the message to become distorted. As a result, these companies often have low virality. They can experience the same fate when it comes to attracting capital, as only a narrow set of investors will feel comfortable understanding the scope of what they do.

• Doppler Labs: As mentioned, Doppler Labs headphones were hard to explain. They were different than any other headphones on the market and needed to be distinguished as such, but people failed to understand what set them apart and why they were valuable. While the technology to build the product may have been hard to do, that alone was insufficient to create a valuable company.
• Cryptocurrency projects: “Crypto projects” are those where the core of the product (and often the investment security) requires at least some understanding of the cryptographic math and token economics to grasp what’s special about what they’re doing. Crypto projects are naturally harder to do because the nuts and bolts of crypto are complicated. That said, some of the most articulate founders in crypto can communicate their projects as easily as one can communicate a consumer marketplace.

Hard to understand, easy to do

Companies that are hard to understand and easy to do are the least appealing to investors, as they have a message that’s hard for consumers to grasp and low virality. They will struggle to build a moat. Put simply, they lack a real competitive advantage and are difficult to grow.

• Consumer lending companies: Undifferentiated consumer lending companies often have models, investment criteria, or loan requirements that are hard for investors to understand. Though there may be moving parts, many lending companies rely on a simple funding and underwriting model that does the same thing: Checks a borrower’s credit score and/or bank account, connects to sources of capital, and then originates the loan. Without anything special to differentiate it, a lending company may be easily forgotten in a crowded space.
• Theranos: Theranos marketed itself as a new kind of healthcare company that could run lab tests with smaller amounts of blood in a shorter period of time; a paradigm shift healthcare diagnostics. The various testing devices and panels made it difficult to understand exactly what the company did-and it turned out that they were doing something that was actually quite easy. Despite claims that it had created disruptive technology, the company was running standard blood tests (and doing so poorly) that lacked innovation. While it may have been fraud that brought down the company, the reality is that even if Theranos had told the truth about what they were actually doing, it’s unlikely they would have attracted significant capital to begin with.

Consumer internet companies can set themselves up for success early on by ensuring they can clearly speak to what they do, making it easy for people to understand and share the product and its value. A thoughtful approach to building something that’s difficult to do will go a long way when establishing a competitive advantage. This will also set a startup apart, attract investors and customers, and help the company thrive in a crowded space for the long run.

Special thanks to Steve Mullaney, the CEO of our portfolio company Aviatrix, for sparking this topic. He recently brought up this great concept (easy to understand, hard to do) when we talked about enterprise, and it inspired me to explore how the idea applies to consumer internet.

Originally published at https://techcrunch.com.

Easy to Understand, Hard to Do: A Blueprint for Success in Consumer Internet was originally published in Team CRV on Medium, where people are continuing the conversation by highlighting and responding to this story.

In every generation there are a handful of companies that will change the world and as a venture capitalist one is fortunate to work with just one of these companies in a career. As a firm, CRV has been incredibly fortunate over the last 49 years to back several of these companies: Twitter, Amgen, DoorDash, Dropbox, Udacity, Airtable, and Color Genomics to name a few.

In the last several months, we’ve been exploring three efforts of this class:

• The first is a mobile game studio which in its short lifetime has already produced one of the most popular video games in history.
• The second is a platform for geospatial massively multiplayer entertainment, unlike anything that has existed before it.
• The third is a company building some of the most sophisticated augmented reality technology in the world.

But here’s the catch: these are not three separate companies. This is one company: Niantic Labs. And today I’m excited to announce CRV’s investment in Niantic’s Series C financing*.

Pokémon GO

Niantic is best known for their hit game, Pokémon GO. It is hard to overstate the success of Pokémon GO. When the game launched in July 2016 it quickly topped the charts of both the Apple App Store and the Google Play Store and even today it frequently sits atop the Top Grossing list on both platforms. Since launch it has been downloaded over 800 million times, putting it in an elite tier of consumer internet applications that have reached that scale. It is also estimated to have grossed over $2 billion since launch. While most game producers rely on large marketing budgets to support new games, the vast majority of this adoption has happened organically, which is a reflection of the inherent virality of Niantic’s real-world gaming format.

What is most impressive about the game is the level of devotion it has inspired amongst its fan base. For instance, 100,000 players attended the Pokémon GO Fest in Dortmund, Germany, 21,000 in Lincoln Park Chicago, and 65,000 in Yokosuka, Japan… and that doesn’t even include the players in the surrounding cities on those days.

Real World Gaming

Gaming is an inherently hit-driven business where success is determined in large part by the art of game creation, and Niantic’s games are no exception. However, Niantic partners with leading IP holders to build products based on franchises with known popularity, at least partially de-risking an inherently risky endeavor. On that theme, Niantic will soon launch Harry Potter: Wizards Unite. Harry Potter is one of the world’s most valuable IPs and its books are the fifth most read pieces of literature of all time (Koran is first, Bible is second, etc.). We can’t wait to play.

“We do not need magic to transform our world. We carry all of the power we need inside ourselves already.” — J.K. Rowling

But Niantic is about much more than a single game or even two games. Its real-world platform is a novel entertainment format that we believe is just getting started. Like many of the companies we invest in at CRV, Niantic’s platform benefits from a compounding competitive advantage: as more players use Niantic’s apps, they contribute to the geospatial database which Niantic, in turn, uses to improve its products, attracting and retaining more players. In the near future, Niantic will open up that platform to third-party game developers, who will be able to benefit from the strength of that platform, adding a third dimension to their competitive advantage.

At CRV, we believe that the best companies always have a fundamental impact on society. On that theme, what is most inspiring to us about Niantic’s platform is the way that it changes what it means to play video games. Traditional video games are played in a dark room in isolation often late at night; games built on Niantic’s platform instead require players to go outside and explore the real world, getting much-needed exercise and social interaction.

In 2018 alone, Niantic’s games led to 331 national parks, rivers and trails visited, 17,000 kilometers walked at social impact events, 6.8 tons of food collected for shelters and food pantries, 7 tons of garbage picked up. 40,000 people came out to support charities and their local communities and more than 3,900 items were donated to shelters. This is the kind of future we want to imagine.

Augmented Reality

It is hardly contrarian to say that AR is an important technology with the potential to be a new generation of computing platform. We are early in this journey and similar to other technological shifts, we don’t know over what time period it will happen or exactly what form it will take. But we do believe that the biggest missing piece in AR adoption is the“killer app” where AR unlocks a truly unique experience. Pokémon GO — and hopefully Niantic’s future titles — can be that killer app. And under the hood, Niantic has been hard at work building some of the leading AR technology to bring it to life.

Lastly, no thread on Niantic would be complete without a few words on the world-class management team behind the company. There are few people in the world better suited to build this company than John Hanke and Phil Keslin. John and Phil have spent their lives thinking about mapping, having founded Keyhole in 2000, which was acquired by Google and went on to become the foundation for Google Maps. Less widely known is that before Keyhole John had already built and successfully sold two gaming companies. As we talked about future Niantic titles with John, it was obvious that he has a deep product understanding of exactly what it takes to build games capable of Pokémon GO scale, and we’re excited to continue working with his team to help make that happen.

Welcome to the CRV portfolio, Niantic!

• And ICYMI, thank you Steve Jobs for the inspiration to the opening lines!

Our investment in Niantic Labs was originally published in Team CRV on Medium, where people are continuing the conversation by highlighting and responding to this story.

Virtually all startup pitches include a conversation about competitive advantage or “moats,” and rightfully so; these moats are what ultimately allow companies to become compounding franchises and accrue outsized profits over the long run.

The most commonly sought moat in consumer technology is the “network effect”, which is when the value of a product increases directly as a function of how many others use that product. There are several types of network effects consistent with this definition, such as demand-side increasing returns, marketplace effects, and platform effects.

Network effects can be one of the deepest and most enduring types of moat and many great technology companies have benefited from network effects: Facebook, LinkedIn, WhatsApp, Snap, eBay, Airbnb, and Uber to name a few. If a startup can architect network effects into the product or business model, that is worth its weight in gold, and plenty of blog posts have been written about this topic.

However, there are real world problems to be solved and businesses to solve them which, no matter how hard one spins the story, will not be candidates for a network effect approach. The nature of these problems or products simply doesn’t allow for the value proposition to be directly tied to the number of others using the product.

The decision to stay in a Marriott isn’t driven by how many other people are staying there. Tesla owners do not derive utility from how many drivers around them are also in Teslas (in fact one could argue the opposite). When subscribers turn on Netflix or Spotify, the subscriber count has little impact on their experience. Developers choose to implement Stripe because it is the easiest payment gateway, period. Investors buy stocks on Robinhood because it is the lowest cost and best designed platform for doing so. Even the “act 1” of internet giants like Google, with its PageRank search algorithm, and Amazon, with its e-commerce business, were not products where users directly benefited from more users adopting the product.

I believe that important businesses will be built in areas without hard-coded network effects and that there are ways to become extremely valuable without them. So, when I meet with founders to talk about a business that can not be built on classic network effects, rather than dwelling on that topic, I find that the more interesting conversation is to ask the question: what kind of moat can you build?

Here is a list of non-network effect sustainable competitive advantages that are relevant today:

Scale

Economies of scale are nothing new; they’ve been a feature of business building since at least the industrial revolution. But the internet magnifies the importance of scale effects in many ways; most obviously by removing the constraint of geography and reducing the capital intensity of growth. The canonical example of scale in the age of the internet is Amazon, which has used its scale to achieve market leadership first with e-commerce and then with the AWS cloud business. Scale creates several types of competitive advantage:

• Negotiating leverage. Scale allows for procurement of inputs at the lowest cost, which can be passed to the consumer in the form of lower price. The lower price attracts more consumers, which in turn increases the company’s scale and gives them more negotiating leverage, etc. MoviePass, with their all-you-can-watch movie subscription, is attempting this playbook; by subsidizing the cost of the service today, its long-term strategy is to use a large subscriber base to negotiate revenue share with theaters. Walmart is a more traditional example of using power over suppliers to drive cost advantage.
• Amortization of fixed assets. Companies with more customers can spread the cost of fixed assets over a larger base. Digital subscription businesses like Netflix are examples of this. When Netflix produces or purchases the rights to a media asset, it can spread the costs of that over their tens of millions of subscribers. It would be difficult to start a Netflix clone today because the economics of buying or producing media would be far less attractive than they are for Netflix.
• Product density. In some product verticals, larger scale makes the product fundamentally more attractive, all else being equal. This phenomenon is similar to marketplace network effects but is not unique to marketplaces. The dockless bike and scooter startups (Ofo, and Mobike in China, LimeBike, Jump, and Bird, in the US) do not have traditional network effects, but are better products for users than smaller competitors because they have higher density of vehicles, which makes the service more convenient.

Economies of scale do not affect all industries equally. In fact, some industries exhibit dis-economies of scale, and have remained cottage industries for this reason. So, it’s important to think through the effect of scale on business model carefully to determine if there is sufficient operating leverage to justify scale as a moat.

Brand

Brand is one of the longest standing sources of defensibility. I believe that the internet has increased, rather than decreased, the importance of brand. Traditionally brands were built through advertising, word of mouth, and shelf placement at major retailers, all of which made it difficult for startups to compete on brand. The internet elevates the importance of trust in brand, which explains why social media (i.e., what are my friends and role models using?) has become an important channel in which to amplify brand.

Coinbase’s brokerage product is an example of how brand drives defensibility. An online brokerage business does not have classic network effects because it is built on top of exchanges (like GDAX, which Coinbase happens to own) where liquidity consolidates, so value is not directly tied to the number of users on the platform. But trust, and therefore brand, is extremely important in financial services generally and crypto specifically. By developing a trusted brand and reputation in an otherwise murky space, Coinbase has become the de facto way to access digital currencies. (disclosure: Greylock is an investor in Coinbase.)

The concept of brand can appear to be an obstacle (i.e., strong brand of incumbents) to a startup as opposed to a future competitive moat. That’s why some of the most successful startups have focused on creating a brand in a category where there was previously none.

WeWork, the 8-year old co-working startup which was recently valued at $20 billion, is an example of this strategy. WeWork’s business model lacks traditional network effects, but by becoming the category-defining brand in co-working they have been able to create an extremely valuable company.

Non-network Switching Cost

Switching costs is the one-time inconvenience or expense a user incurs to change over from one product to another. The strongest form of switching cost comes from network dynamics — other users being on a platform. But even in non-networked products, there are several forms of switching costs:

• Personal data. Some products are architected in a way where users build data within the product over time. Data has gravity and the more data a user generates within a product, the harder it will be for the user to switch. Strava (ignoring the social functionality) is an example of this phenomenon. After having used Strava for several years, switching to a new fitness app would mean orphaning my fitness history.
• Habit. Products that are used with high frequency tend to exhibit habit formation and once habit is formed, users are reluctant to switch. For instance, there is a shockingly small percentage of users that switch from either iOS to Android or vice-versa when they get a new phone, in part because users habituate to navigating a particular operating system. Because of user preference for the status quo, to replace a habitual product a new entrant must be vastly, perhaps even an order of magnitude, better, which translates to a moat.
• Embedding. This is a phenomenon whereby a product becomes integrated with a user’s other products and workflow. This type of moat is most often seen in enterprise software products; many enterprise software giants get their defensibility from high switching costs. Arguably the large cloud platforms like AWS and Microsoft Azure have embedding lock in. But embedding can work in consumer products as well. For instance, consumer finance products often exhibit embedding since users connect their bank accounts and payments cards to other applications.

The above is not a comprehensive list of sustainable competitive moats; others include regulatory, technical advantage, and cornered access to limited supply. But the takeaway is that, while network effects remain a powerful driving force of defensibility, they are not the only source of competitive moat. Founders should stay focused on solving a problem that they are passionate about and building defensibility as they scale.

Nearly three years ago, Saar Gur and I wrote about how early-stage consumer product companies were overlooked by venture capitalists, but had the potential to create breakout success. At the time, VCs largely shrugged off the category by pointing to the lack of sizable outcomes in the consumer vertical and the difficulty of predicting which brands would be successful.

Since that post, Unilever bought Dollar Shave Club for $1 billion, Walmart bought Bonobos for $310 million, Kellogg bought RXBar for $600 million, and Purple Mattress effectively went public for $1 billion. None of these companies had yet celebrated their tenth anniversaries. Others including Warby Parker, Daniel Wellington, Glossier, and Allbirds remain independent but are reportedly doing $100’s of millions in sales after just a few years in the market.

These startups are taking advantage of not only the changing habits of millennial consumers, but also the ability to reach those consumers and build brand awareness through under-exploited digital marketing channels. As Amazon replaces brick-and-mortar store shelves and social influencers replace television stars, newer brands are not only taking advantage of these channels, but also are architecting their products and business models around them.

Unsurprisingly, success in the sector has spawned companies attacking nearly every imaginable product vertical. However, not all products are well-suited for disruption from tech startups. Andy Dunn wrote a terrific post outlining The Rise of Digitally Native Vertical Brands, but how does one know which “DNVBs” have the highest chance of success?

Friction Of Incumbent Channel And Unique Digital Enablement

A defining feature of DNVBs is that they are sold online. Selling online makes the most sense when there is a built-in friction associated with purchasing through the existing offline channel.

For instance, Dollar Shave Club took advantage of the fact that razors and razor blades are available in convenience stores, but are often behind a protective plastic or behind the counter, requiring the involvement of a store associate. Warby Parker thrived on the fact that eyewear shops often have to turn away or delay patients without a prescription. Nurx and Roman are building off of the friction of getting prescriptions for medications that people are sometimes uncomfortable talking about.

Irrationality of price can be another form of purchase friction. For instance, when buying a mattress from offline stores, it can be almost impossible to price compare, because manufacturers fragment their product line such that each store has slightly different SKUs. Startups like Casper and Purple Mattress were able to draw on that inefficiency.

Prescription acne medication is another example of a product that is priced exorbitantly relative to the costs of production, largely because of the way medications are prescribed, purchased, and paid for today. Curology was able to offer those same active ingredients in their own product online for a fraction of the cost.

A somewhat obvious part of digital enablement is the ability for the product to ship well. To sell something online, its physical dimensions and economics need to work with shipping. One of the important, but overlooked, reasons for Casper’s success, is that their mattresses are made of foam and compress into a relatively standard and compact box. At the same time, there is no work required of the customer, since the mattress takes form upon exposure to air. If instead Casper had to ship fully formed mattresses, the shipping logistics would be more complicated and require a higher sales price.

Another way to think about digital enablement is when something about selling direct-to-consumer over the internet allows for a type of product design or economics not feasible in the traditional channel.

For instance, Grove Collaborative sells household cleaning products in concentrate form (i.e., without water) to dramatically reduce shipping weight and cost. Incumbent competitors like Windex are designed around optimizing shelf-space in physical retail stores, so can not feasibly make the same product innovation.

Frequency Of Purchase Or High Average Order Value

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, or repeated smaller, less profitable purchases.

Consumer products that have recurring or highly repetitive purchase behavior are particularly interesting. These businesses 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. Many of the very successful consumer brand startups over the last decade have had this feature. Subscription or high repeat businesses like Ritual, Dia & Co., Lola, and Hubble are just a few recent examples.

Yet there are a host of brand startups selling highly infrequent purchases. Furniture and jewelry are good examples here. These startups instead focus on having high average order value, and associated profit, such that they can recoup marketing investment in the first sale. While possible, going for the one-time high order value is generally a more challenging way to build a big business, as the lack of subsequent interaction with the customer does not afford opportunities to introduce other products.

High Margins On The Product And For The Retailer

Another important feature to consider is the product margins in the category. What constitutes “high” varies considerably based on the category. But generally speaking, products that have 70%+ gross margins are particularly attractive because they exhibit many of the same characteristics as software businesses, especially when they also have high purchase frequency as discussed above. In fact, the income statement of a company selling these types of products could easily be mistaken for those of a software business. Most consumer products have gross margins of 30–50%, but there are a few categories where 70% margins have been sustainable, such as skin care, cosmetics, and vitamins.

Because DNVBs usually sell direct-to-consumer, it’s also important to consider the category retail gross margins. Some categories, such as grocery, have notoriously thin retail margins, whereas others, such as luggage, apparel, and eye care have much higher margins.

A common myth is that new brands can succeed by going direct-to-consumer because they cut out the retail margin. Nothing could be further from the truth. Brands are simply taking on the burden of distribution themselves, rather than offloading it to a larger retailer, which if anything can usually manage distribution more efficiently because of economies of scale.

As a result, consumer brand startups will have to take on retail costs, such as managing an e-commerce platform, customer service, and most importantly customer acquisition. These startups shouldn’t count on gross margins being higher than incumbents for a long time, so need to enter a category where those margins are sufficiently high from the beginning to support marketing costs.

Propensity To Share Via Social Media Or Garner Earned Media

The best brands are those which make their customers proud to be associated with them, which happens when a brand can become associated with a customer’s identity. Brands whose customers effectively market on their behalf — either by word of mouth or more recently via social media — have a built-in advantage in the form of dramatically lower customer acquisition costs.

Daniel Wellington now has 3.5 million Instagram followers, which is a good example of a brand that used social media sharing instead of traditional advertising to build a $250 million revenue business in a few short years. Glossier, which stated that 70% of their online sales comes via peer referrals, is another example.

Even if customers themselves don’t post selfies using a product, earned media can fill the gap. Earned media is when reporters and bloggers write about the product. It can be a cost effective marketing channel for the right products. Companies with compelling missions and founding stories are often able to capture outsized earned media. Toms, the footwear and apparel brand that donated a pair of shoes to a child in need for every one purchased, is a company that continually receives earned media given the important social mission. Having celebrities involved in the company is another way to generate outsized earned media.

One way to evaluate whether it’s possible to achieve this type of marketing advantage is to consider the historical importance of brand in a category. For instance, brand has mattered in products like shoes and apparel for a long time, but is less important in verticals like mattresses and furniture. But it can also be dangerous to assume that the future will be just like the past. Some of the best consumer startups have been those that were able to create an important brand in a category where there was formerly none.

Timelessness Of The Product

Certain categories, such as apparel, are subject to rapidly changing fashion cycles. Starting or investing in these types of businesses is particularly difficult because one has to underwrite the success of the current generation of products while continually anticipating consumer’s future preferences. And brands that stand for something may very well find it difficult to evolve effectively if preferences shift against their brand ethos.

Volatility and difficulty of predicting changing preferences is a common reason why investors do not back in 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 by the season. For example, products like household goods, personal care, and over-the-counter medications stay consistent.

Conclusion

The above is not a fully comprehensive look at what drives success in consumer product startups. There are certainly examples that violate many — if not all — of these rules, yet have found tremendous success regardless. Allbirds is a recent example that does not fit neatly into many of the criteria above, yet seems to be finding great success.

Historically, in each generation there have always been a handful of new consumer brands that emerge that later become household names. What’s unique about our current environment is that new brands now have the potential to directly reach their target customers without the restraints of the wholesale channel, and therefore can scale quickly.

Of course, many new consumer brand startups will not succeed. That’s just the nature of the game. But the odds are now better and for those that can break through, and the prize is now sufficiently large that founders and investors should pay attention.

Originally published at techcrunch.com on November 26, 2017.

When you ask a VC what they look for in investments, you’re likely to get a response that involves going after a large “TAM,” or “total addressable market.” TAM is defined as “the existing revenue opportunity available for a product or service,” and it’s often calculated by taking the existing top-down market size and whittling down segments of the market that are not addressable.

On the surface, the use of TAM as a key investment criteria makes perfect sense. To build a business that goes from very little to very large in a short amount of time, you must attack a very large market, right?

The only problem is that if you had applied the TAM framework over the past 25 years, you would have passed on most of the best venture investments of all time. A cursory examination of these companies in their early years highlights the danger of too heavily weighting TAM. In fact, at the time of their Series A rounds, many of the very best venture investments would have had relatively small — or even undefined — TAMs.

Let’s examine Uber. At the time the Series A was done in 2011, Uber’s product was a substitute for premium car services like black cars and limousines, not a taxi substitute. At that time, the total U.S. car service market was $2 billion in annual revenue, which would yield a $400 million TAM assuming a 20 percent take rate for Uber.

Later on, Uber launched Uber X, a lower-cost alternative that made it a true taxi substitute and made its global ambitions more apparent. But even in 2014, if you had considered the broadly defined global taxi and car service market of ~$100 billion, the $20 billion TAM would have still understated the magnitude of Uber’s opportunity. In fact, one famous economist did just this when he concluded that Uber could not possibly be worth $17 billion due to the TAM of the taxi and car service markets.

WhatsApp is another example. At the time of the Series A in early 2011, there were ~500 million people with smartphones worldwide. Facebook, which eventually bought WhatsApp, was earning $6 per user annually. So an optimistic estimate for WhatsApp’s TAM would have been $3 billion. For what it’s worth, WhatsApp is still essentially pre-monetization six years later, but it has 1.2 billion users and clearly Facebook saw much greater potential in the platform when it paid $19 billion to acquire it in 2014.

Coinbase is a more recent example (Disclosure: I am involved as an investor). When the Series A was done in May 2013, the total market cap of Bitcoin was ~$1 billion and the daily trading volume was <$5 million. Assuming a 2 percent commission rate, the annual TAM for Coinbase would have been $36.5 million. Hardly the type of TAM that venture capitalists seek. Today, there is a >$100 billion market cap for crypto-currencies, and daily trading volume often surpasses $4 billion. Needless to say, when I wrote Greylock’s investment memo for Coinbase, I did not use the term TAM.

The best companies always fundamentally change the markets in which they operate.

If TAM can be directionally misleading in the early years, how should founders and investors think about weighing the importance of market size? Of course, the eventual size of the market opportunity is paramount. There are several other factors to consider — in addition to the strict measurement of TAM — when trying to assess size of market opportunity:

• TAM expansion: The best companies always fundamentally change the markets in which they operate. They do this in many ways: removing friction, increasing convenience, enabling new use cases and lowering price. By doing so, they can dramatically expand the size of their markets. Airbnb, in which Greylock is an investor, did this to the short-term rental market by smoothing the trust barrier associated with renting out your home or staying in someone else’s. In doing so, they expanded the TAM of short-term rental.
• Credible adjacencies: In other cases, a startup’s initial product or service is merely an entry wedge into a larger opportunity. For instance, Amazon started with selling books because the category had a large number of SKUs, shipped well and had near universal appeal. In retrospect, books were just the entry wedge in to selling everything online. The art here is understanding when proposed adjacencies are real and when they are fiction.
• Nascent market potential: Successful startups often ride the wave of a new market that is small today, but will be big in the future, with or without that startup. WhatsApp with the smartphone revolution and Coinbase with crypto-currency are two examples. In many technology businesses, there is a tremendous advantage of being the first to scale in an emerging category. Starting or investing in the early player in a developing category can be a great bet.
• Frequency of use: As a general rule in consumer technology, the frequency with which users interact with a given product or service tends to correlate with the size of the opportunity. Something that becomes a regular behavior with a large swath of the population generally has an opportunity to build a big business. Ofo and Mobike, the Chinese bike-sharing companies, are early examples of this phenomenon. The bike-sharing TAM is still relatively small, and they only collect cents for each ride, but investors see opportunity in something that people use 2–3x per day for the critical task of commuting.

By all means, founders and investors should continue to think about the size of the market they serve. Doing so helps prioritize development, understand customer segmentation and uncover non-obvious insights. But take it with a grain of salt; and if you see an opportunity, don’t let a TAM number stop you from building something great.

Featured Image: snapgalleria/Shutterstock

Originally published at techcrunch.com on September 5, 2017.

When the internet was first created in the 1970’s and 1980’s with the introduction of the ARPANET, its early years were focused on the development of infrastructure and protocol — beyond the knowledge and far away from the consciousnesses of the general public.

The establishment of that foundational protocol allowed for a subsequent wave of application layer innovation in the late 1990’s and early 2000’s that has come to dominate the public consciousness (e.g., Google, Facebook, Amazon, etc.). Even though technology at the protocol layer created a ton of value, the application layer has ultimately captured most of the mindshare and the value.

Meanwhile, the television industry has seen a different, but related, phenomenon play out. For many years, cable operators and telcos served as intermediaries between consumers and content. They bundled packages of cable networks and sold them as monthly subscriptions. But with the proliferation of high-speed internet in the household, companies like Netflix began to instead sell and deliver content directly to the consumer, avoiding cable distribution entirely. This has become known as “over-the-top” television and is increasingly driving an unbundling of content.

The same patterns are emerging in financial services. New consumer-facing financial applications are being built on top of old banking infrastructure, while other startups are going around financial infrastructure altogether. Together, they are unbundling the roles of banks and other financial incumbents.

In recent years, financial services architecture has opened up in a way that we have never seen before. Data APIs like Yodlee, Plaid, and Quovo now make it easy for developers to pull user financial data. SDKs like Card.io make it easy to onboard payment cards into mobile apps, financial market APIs like Xignite pull live stock prices, and payments APIs like Braintree and Stripe make it simple for developers to accept payments.

The development at the infrastructure layer coupled with what my colleague Sarah Tavel notes as the growing distrust of traditional financial institutions has created an “unbundling” opportunity for fintech startups similar to what happened with internet and television. Fintech startups can create application layer companies that capture mindshare and value without having to innovate at the infrastructure layer themselves.

And while some of these startups may piggyback on open financial architecture, others avoid traditional pipes altogether and go completely “over-the-top”. In fact, the next billion dollar fintech startup may not look like a traditional fintech company at all.

Here are a handful of areas where I expect we’ll see these patterns play out:

P2P Money Transfer

Transferring money between two parties was one of the earliest problems to plague peer-to-peer commerce on the web. Paypal was the first breakout success in this category when it created a payment system that enabled transactions on eBay, and it remains an important part of financial infrastructure today. With the advent of mobile, a new crop of startups emerged to enable p2p money transfer beyond commerce: Venmo in the US, Verse in Europe, and Toss in Korea, to name a few.

These applications have not only created sticky social networks, but also have habituated consumers to exchanging value back-and-forth via mobile. In doing so, they have created an opportunity for a third wave of innovation within social finance.

For example, Tilt enables users to collect money from friends in a simple, friction-less way. Tilt didn’t have to rebuild the financial piping it was able to build on top of Stripe and focus its innovation on user experience and social functionality.

Splitwise allows individuals to split expenses and exchange value via a shared cloud-based ledger. Splitwise takes p2p money transfer over-the-top: like Bitcoin, it enables users to exchange value with bits (debits and credits to a ledger) instead of financial pipes, and unlike the p2p money transfer apps can be global from day one. But what about settling into real money? Rather than rebuild payment pipes, Splitwise allows its users to settle via its integrations with Venmo and PayPal, which are increasingly open architecture themselves.

Wealth Management

In the past, creating a new wealth management offering required some heavy lifting: new entrants would have to build a clearing firm, connect to market exchanges, build and become licensed as broker-dealers, and then establish relationships with Registered Investment Advisers to secure distribution for the product.

But recently, this ecosystem has been vastly simplified and startups no longer need to develop the entire stack themselves. Apex opened their clearing firm and onboarding tech to other broker-dealers, enabling startups like Robinhood and (our portfolio company) Wealthfront to launch new financial offerings.

And now there is a second wave of infrastructure development simplifying the wealth management stack even further: broker-dealer APIs. Companies like Tradier and Third Party Trade enable startups to avoid building the broker-dealer altogether and focus on developing a differentiated customer experience.

Another example is Trigger, an app that sets “if this then that” rules for trading. Interestingly, Trigger doesn’t have any financial infrastructure at all — it’s a rules engine that sits on top of brokerage accounts, yet it is quickly becoming a primary trading window for its users.

Insuretech

Among financial service verticals, insurance stands out in its ability to resist change. Yet even here there has been an opening of the industry architecture that has begun to allow for a new wave of innovation.

For instance, re-insurers like MunichRe and SwissRe have begun to partner with startups using Managing General Agent (MGA) structures. In an MGA the re-insurer maintains the balance sheet while the startup focuses on customer acquisition, experience, and product design. Such structures have enabled the emergence of startups like Ladder in life insurance, Hippo in home insurance, and Jetty in renters insurance.

On the other hand, several startups are utilizing p2p networks to, at least partially, go over-the-top of traditional insurance balance sheet providers altogether. Lemonade here in the US and Friendsurance in Europe are examples of this approach. By doing so, they create greater alignment of incentives, reduce fraudulent claims, and save money for their policyholders.

Bitcoin

The most striking example of over-the-top fintech is Bitcoin. By design, it is a system of record that avoids intermediation by traditional financial institutions and instead allows for value transfer directly between two parties.

But Bitcoin itself is a protocol that, as my partner Reid Hoffman points out, could enable an entirely new wave of innovation in the years to come. Just as users of Facebook or Google don’t need to know anything about TCP/IP or HTTP, users of Bitcoin in the future may not have to think about it to benefit from it.

One early example is Abra, which enables money transfer between any two mobile phones in the world by utilizing Bitcoin on the back end. Users of Abra never need to know they are using Bitcoin to send money to friends and family.

2017 is a unique time to be a founder in fintech. The opportunity to improve financial services has always existed, but founders today can get to market much more quickly by leveraging existing infrastructure or circumventing it altogether. It’s no surprise that I am seeing so many talented entrepreneurs flock to fintech and I’m confident there will be more to come.

Featured Image: Valerie Everett/Flickr UNDER A CC BY-SA 2.0 LICENSE

Originally published at techcrunch.com on January 15, 2017 as “Innovation under the hood will rev the engines of a fintech revolution”

According to a 2014 study by Google, 74 percent of leisure travelers relied on the internet for travel planning. That’s not surprising; it’s generally understood that most consumers make travel plans online. But that same study found that 77 percent of business travelers also started their journey online. Similarly, 78 percent of business travelers used a smartphone during travel planning, versus 67 percent for leisure travelers.

Yet in many companies, booking travel still involves emailing or calling an actual travel agent, who then books with the airline or hotel. For executives, it often involves first telling an assistant, who then communicates with a travel agent, who then communicates with the airline or hotel. Unsurprisingly, this process has lengthy reaction times, is prone to errors and loses traveler preferences along the way.

So if business travelers are turning to new digital channels at an equal or even greater rate than leisure travelers for planning, why is business so far behind leisure in the migration of actual booking to digital? Among the many reasons that companies cite for using travel agents are: simplifying the booking experience for employees, saving money and enforcing corporate travel policies.

But it is now possible for digital tools to outperform travel agents on even those criteria for which they were once preferred. The proliferation of mobile, improvements in user interface design and the ability of computers to ingest and analyze large amounts of data have changed the game.

Good interface design outperforms call centers

Having direct control of travel booking can result in a vastly better experience than having an agent book on one’s behalf. There are several reasons for this.

Firstly, making changes is more complicated when the reservation is booked through a third party. Anyone who has made a hotel or airline reservation via an Online Travel Agency (OTA) is all too familiar with the experience of trying to make a change directly with the provider, only to be told that only the booking agent can do so. The same restrictions apply when bookings are made through corporate travel agents. Of course, if one needs to make a change, response times via agents can be slow, because they are limited by the availability of human beings.

Secondly, important traveler information and what I’ll call “micro-preferences” often get filtered out by intermediaries. For instance, not getting TSA PreCheck because the travel agents didn’t include a Known Traveler Number or because he/she did so in a way that didn’t get ingested by the airline system. Similarly, while we can tell a travel agent about our basic preferences (e.g. window versus aisle, high floor versus low floor, etc.), it is unreasonable to expect another person to internalize our specific and subtle value trade-offs. Would you prefer a window seat toward the back of the plane or an aisle seat toward the front? Would you prefer a room in a low-quality hotel one block away from the office or a high-quality hotel one mile away?

It is sometimes easy to forget that a company is actually just an organized group of individual consumers.

Business travelers can avoid the headaches of dealing with human travel agents, but to do so they require a highly simplified and frictionless booking experience. The appeal of using an agent is not having to waste time planning travel rather than doing one’s actual job.

Amazon has done a fantastic job of building an e-commerce platform with the view that, as David Jaffe wrote, “the best customer service is no service.” In other words, every instance of needing to speak to a human represents a bug. Over time, Amazon has refined the interface such that the vast majority of customer service issues can be dealt with by the average user within the digital platform.

Unlike travel agents, computer servers don’t mind working 24–7, and they have near instantaneous response times. New corporate travel platforms can leverage best-practice designs from e-commerce and consumer travel to simplify complex decisions and reduce the need for human intervention. For instance, changing or canceling a reservation on the Booking.com mobile app is easier than sending an email to an agent. Even in drastic situations like a flight cancellation, new consumer travel apps like Freebird demonstrate how computing power and a good interface outperform agents.

The myth of better prices

One often perpetuated reason for the benefit of using a travel agent is that doing so results in cheaper rates than by booking individually. The logic goes something like this: Travel agents aggregate demand and therefore can negotiate better rates from the providers.

The reality is quite different. While travel agents do aggregate some demand, their scale pales in comparison to that of the travel providers: giant airlines and hotel chains. Moreover, in both hotel and air, the industry standard of “rate parity” means that providers offer the same rates across different channels. Corporate travel agents book via one of three Global Distribution Systems (Sabre, Amadeus and Travelport), the same sources used by consumer-facing OTAs.

In some cases, rate parity can be broken, if done so behind a pay or membership wall, and in that way, travel agents can in fact access “unpublished rates.” But those rates are no better than what consumers can get individually via OTA loyalty programs like Booking.com’s “Genius” program.

Additionally, corporate travel agents make money by charging $10–50 booking fees on top of existing prices. While that may not sound like a lot, it can add up, especially when agents charge by interaction rather than by itinerary.

Out with rules, in with incentives

Travel agencies are an easy tool for companies to enforce travel policies and generally control travel expenses. But the opportunity to empower the employee and incentivize him/her to save money is more powerful than any set of rules could ever be.

When a company sets a dollar limit for a given flight route or hotel night, it must do so at a sufficiently high level, such that only a relatively small percentage of cases leads to an exceptions process. But by doing so, the company is leaving money on the table.

New corporate travel startups are finding ways to save companies money by motivating employees to choose cheaper options. For example, startups like Rocketrip and TravelBank use data from real-time price analysis to determine cost benchmarks and split savings with the employee. Startups like Upside Travel reward customers for choosing less expensive options by offering travel credits and perks.

The use of incentives to unlock hidden savings could be the killer feature driving adoption of consumerized corporate travel apps.

Mobile and big data are the key enablers

The incentive of saving money has always motivated individuals, but only with advances in big data over the last several years have computers gotten smart enough to reliably calculate fair cost benchmarks. Without being able to ingest and quickly analyze real-time prices, it would be hard to imagine a computer determining what one should spend for a trip.

Over the last five years, consumers have become accustomed to having the power of the internet in their pocket at all times. They have come to expect mobile airline tickets, booking hotels at the last minute from their phones and planning their next trip while commuting to work. These same consumers are now carrying those expectations into the workplace. It is sometimes easy to forget that a company is actually just an organized group of individual consumers.

The time has come for startups capitalizing on these advancements to consumerize the $1 trillion global corporate travel market.

Featured Image: ipopba/iStock/Getty Images

Originally published at techcrunch.com on December 17, 2016.

Android already commands over 80 percent of the mobile OS market share globally, and just under 60 percent in the US. But you wouldn’t know it here in Silicon Valley — almost everyone I know has an iPhone. As the consumer technology landscape evolves over the next five years however, there are a number of reasons to believe that Android, and the Google stack more broadly, could take an even greater share and become the platform of choice, even here.

Loosening of the Apple ecosystem lock-in

Anecdotally, one of the most frequently cited reasons among iPhone users for staying with iOS is that they love the “blue bubbles.” iMessage, and its clever and seamless integration with iOS’s native SMS application, is an incredibly sticky feature of iOS.

Over-the-top (OTT) messenger applications have many advantages over SMS. The assurance of knowing that one’s message has been delivered and the synchronous knowledge that the other user is typing add a deeper level of intimacy and immediacy to the conversation. The ability to easily share media, the lack of a character limit, the seamless continuation of a conversation while switching between desktop and mobile, and the lack of per-message international charges all add to OTT messaging’s appeal.

But most importantly, OTT messenger platforms are valuable to users to the extent that one’s peers are also on the network. Since iMessage is built into the native SMS application on iOS, users also don’t ever have to switch to a third party application, and are automatically drawn into the network. No change in behavior is required. So OTT messaging in general and iMessage in particular exhibit powerful network effects. Hence the draw of the “blue bubbles.”

Does this story sound familiar? A mobile hardware manufacturer with a proprietary OS and a captive OTT messenger application? Research in Motion, now known as Blackberry, had exactly this positioning with its popular Blackberry smartphones. One of the big draws of Blackberry, outside of the corporate environment, was Blackberry Messenger (BBM). But ultimately BBM wasn’t a strong enough draw to keep people on an inferior OS and third party developers created cross-platform messengers such as WhatsApp. Today, Blackberry OS has only a 0.2 percent market share.

WhatsApp just crossed 1 billion users. It is not inconceivable that OTT messaging applications like WhatsApp could replace SMS entirely. Alternatively, the migration of SMS to the Rich Communication Services (RCS) standard could bring all of the advantages of messenger applications to texting. In either case, the network effect of iMessage would be significantly diminished, greatly lowering the barrier for those wanting to leave the Apple ecosystem. iMessage is not invincible.

While iMessage may be the most important example of Apple ecosystem lock-in, there are many other products where Apple lock-in could similarly be weakened. For example, the emergence of Google Photos as an application across Android and iOS significantly reduces the lock-in of Photos, the emergence of Spotify reduces the lock-in of iTunes, and the emergence of Drive and Dropbox reduces the lock-in of iCloud.

Gradual reduction of Android fragmentation

One of the biggest problems with the Android ecosystem is fragmentation: every hardware OEM can operate different versions of Android and can significantly slow down the release of software updates. Fragmentation is frustrating both for developers and for users. At the time of writing, I still cannot get Android Marshmallow on my Droid Turbo, despite Google’s release of the OS in October. In fact, as of April 2016, only 4.6 percent of Android phones globally had the latest Android Marshmallow OS installed.

In contrast, Apple can push out a new OS to all of its devices as soon as it is ready; the only gating factor is how quickly users choose to install the update. App developers often choose to release on iOS first specifically because releasing on Android requires tweaking the code separately for all of the different versions in the market.

But fragmentation is not solely the result of different versions of Android operating simultaneously. Many hardware OEMs, and even carriers, install their own software applications and layers on top of Android to customize the OS.

When a customer uses the iPhone for the first time, he/she gets the identical interface to everyone else with a new iPhone. The same cannot be said for an Android phone, where the default calendar, SMS, email, keyboard etc. could just as likely come from Samsung or Verizon, despite the fact that Google itself offers all of these products. Without the integration of the Google suite of products, the relative attractiveness of Android over iOS is diminished.

However, there is a possibility that in the coming years this fragmentation will be significantly reduced. Some OEMs, such as Motorola and HTC, are continually reducing the level of software customization on their latest models, bringing them closer and closer to stock Android.

Another driving force for the reduction in fragmentation could be the Nexus suite of phones and tablets. While these phones are still manufactured by third-party OEMs, such as Motorola, LG, and Huawei, they are done so in close cooperation with Google and come with stock Android featuring only Google software. Nexus phones get Android software updates immediately, because they are controlled by Google. To the extent Google is successful in proliferating these Nexus phones, it can mitigate the problems of fragmentation. Nexus could also represent an opportunity for Google to build a brand cache around its devices, making them more competitive with Apple at the high end of the market.

Decoupling of phones and plans

As of 2016, most US carriers have finally eliminated two-year service contract plans; going forward, Americans will pay for their smart phone and their plans separately. One of the unique features of the US mobile market in the past was a relative price-insensitivity of consumers to devices since they typically didn’t pay for their devices or paid a highly subsidized price. In fact, on many cell phone plans, if a member chose to upgrade to a lower cost device instead of a higher one, he/she would not receive any of the economic benefit.

This paradigm certainly encouraged individuals to purchase highly priced phones. But in a world where individuals buy their own phones at full retail price, they are likely to be much more price-sensitive. The current base price of an iPhone 6s, before any upgrades, tax, or Apple Care is $649. In contrast, the average Android phone can be purchased all-in for well below $250.

The emergence of Google as a desktop OS

Many may not even be aware that Google actually offers their own desktop OS, known as Chrome OS, which competes with Microsoft’s Windows and Apple’s OS X. Chrome OS today has less than 3% market share of desktops globally, which is not a critical mass to attract the attention of app developers. But there are a number of emerging trends which could mean that Google, rather than Microsoft or Apple, could be the desktop OS of the future.

Firstly, the relevance of software applications themselves is becoming less important as more applications move to the cloud. Even the dominant MS Office suite can now be accessed from the web browser with Office 365. With native software development becoming less important, and the browser becoming more important, the lack of scale in Chrome OS will not matter as much, since native applications are not necessary. Also, because Chromebooks are designed to leave most of the software and storage in the cloud, they have less expensive hardware components and sell for a fraction of the cost of Macbooks and most Windows computers as well.

Perhaps the larger catalyst is Google’s alleged plans to fold Chrome OS into Android within the next year. Doing so would instantly bring the world’s largest app ecosystem to Google’s desktop OS and would provide an even stronger value proposition for users to opt into an Android mobile phone.

Of course, owning the desktop OS is not as strategically important today as it once was, and will likely become even less so going forward. But owning a customer relationship across all devices and all technology use cases is more important today than ever. In a sense, Google as a desktop OS is the missing link in the picture: with a competitive desktop OS, Google could offer customers a consistent experience across all of their devices, further supporting the Android ecosystem and threatening Windows, OS X, and iOS.

Looking ahead

Apple is the world’s most valuable brand and has consistently been at the forefront of device innovation over the last two decades. But as consumer technology evolves, software and Internet integration is gaining ever increasing importance over hardware. As the presence of the Internet continues to permeate more of our lives and the technology itself starts to “disappear,” the battle for the consumer may tilt in favor of the world’s largest Internet company over the world’s best designer of hardware.

Featured Image: Bryce Durbin

Originally published at techcrunch.com on May 1, 2016.

In March 2014, The Economist published Banking without banks, declaring that peer-to-peer (P2P) lending platforms were set to disrupt banks and other traditional sources of capital by directly connecting borrowers to individual lenders.

In the past few years, the so-called P2P lending industry has certainly experienced tremendous growth, with origination volume doubling annually, reaching $24 billion globally in 2014.

Morgan Stanley forecasts that global originations will grow at a 51 percent CAGR and reach a staggering $290 billion by 2020. P2P lending startups also have attracted an enormous amount of attention from venture capitalists: According to Dow Jones VentureSource, U.S. lending startups raised $2.4 billion in the first three quarters of 2015 alone. Yet despite all this excitement, there are many things that are misunderstood about the industry.

“P2P” is a misnomer

While the earliest lending platforms (e.g., Prosper, LendingClub) began with true “peer-to-peer” models, the majority of lending capital is now provided by institutional investors, such as hedge funds, insurance companies and, yes, even banks. Institutional investors have been drawn to the asset class by strong unlevered yields and highly predictable credit performance across a large portfolio of loans. In 2014, 81 percent of LendingClub’s loan originations came from institutional and managed investors.

This shift explains why many participants now refer to the space as “marketplace lending,” reflecting the wider range of investors. As the capital supply is now more concentrated with institutional investors, the two-sided “network effects” boasted in the early years of P2P lending may not be as important today.

This phenomenon — the shift of suppliers from many small providers to fewer large ones — is not unique to P2P lending. The same trend can actually be seen on many other types of Internet marketplaces. For example, on eBay, power sellers control a disproportionate percentage of transaction volume, and a recent report found that on Airbnb in New York City , the 6 percent of hosts with more than three rooms (i.e., commercial users) accounted for almost 40 percent of transaction volume.

Technology-enabled lending, not “marketplace” funding, is the driving force

The term “marketplace lending” implies a meeting place where investors and borrowers can be freely matched. But new lending platforms actually employ two new business models: technology-enabled lending (a new distribution and underwriting model) and 100 percent off-balance-sheet financing through a “marketplace” (a new funding model).

These two models are often conflated, and many new lenders actually have traditional sources of capital, but use the Internet as a distribution channel to issue new loans. While platforms such as LendingClub, Prosper, Peerform and CircleBack are actual marketplaces, other platforms coined as marketplace lenders, such as SoFi, Earnest and Avant, are for the most part traditional lenders using their balance sheets or similar credit facilities.

The characteristics that enabled success for the first-movers in P2P lending are not the same as those which will determine the next generation of successful startups.

The success of those businesses using traditional funding models points to the fact that the explosive growth is due more to the strength of the new distribution and underwriting models. Originating installment loans (a much better product than credit cards for long-term, higher-balance lending) through an online channel (a much more convenient option that traditional lenders offer) has meant a much stronger value proposition to the consumer versus existing unsecured consumer finance products.

The marketplace funding model is also valuable, because it allows a single platform to serve more customers (wider range of risk tolerances among investors) and grow more quickly (less capital-intensive model), but, ultimately, the technology-enabled distribution and underwriting has been the predominant driving force.

Point-of-sale financing is the biggest opportunity

Most marketplace lending today, at least on the major platforms, is for refinancing old loans, not issuing new ones. For example, about 70 percent of origination volume on LendingClub is for refinancing or paying off credit card debt.

With most consumer lending platforms addressing refinancing, an enormous opportunity exists for emerging platforms to focus on the even larger market for purchase finance (i.e., directly helping consumers to finance new spending), where today, credit cards are the status quo.

Startups have begun to emerge to address this opportunity across many verticals of consumer spending: e-commerce (Affirm, Bread), elective medical procedures (PrimaHealth Credit), coding academy tuition (Climb, Earnest, LendLayer), automotive financing (AutoFi) and weddings (Promise Financial — in which I am an investor).

The point-of-sale opportunity is also specifically suited to marketplace lending in a way that refinancing is not; retailers need high approval rates, which the marketplace lending model is uniquely suited to offer because of its ability to find investors for a broad range of borrower credit profiles. “Purchase financing is a logical evolution of marketplace lending,” says Brad Vanderstarren, co-founder of Promise Financial.

“Marketplace lending allows a single platform to make financing offers to a wide variety of borrowers by operating a marketplace of credit investors with various risk/return preferences. This is critical for point-of-sale lending, where it’s important to have high approval rates to meet the needs of retailers.”

Lastly, point-of-sale borrower acquisition channels may also be more defensible in the long-term than the channels used in consumer refinancing, such as Google AdWords, Facebook ads and direct mail.

Looking forward

P2P startups have enjoyed enormous success over the last 10 years. Looking forward, the evolution of the market implies new opportunities and challenges. There are now deeply entrenched platforms, rising interest rates are putting pressure on refinancing activity and it is much more difficult for smaller players to attract borrowers.

The characteristics that enabled success for the first-movers in P2P lending are not the same as those which will determine the next generation of successful startups. Instead, look for companies with a differentiated borrower channel strategy addressing needs beyond refinancing.

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Originally published at techcrunch.com on January 24, 2016.