The State of Consumer SaaS

This episode of Venture Desktop is a deep dive on the Consumer Subscription business model — or Consumer SaaS. It is an area I’ve been interested in for quite some time but I believe it is under-discussed…consider this my attempt to change that!

A few ideas and highlights from the episode:

  • How the market has evolved over the last decade and where company creation opportunities are going forward
  • Why “divine discontent” from consumers is helping accelerate the Consumer SaaS business model
  • The evolution of the capital stack and the future of M&A and PE including the opportunities at hand for Match, Spotify, and for someone to create the “Vista Equity of Consumer SaaS”

As always, I want to make sure you can check out Venture Desktop however is most convenient — you can find the Venture Desktop “video annotation” on YouTube, listen to the podcast on your app of preference, or read the fully accompanying article below. All of the links discussed in the episode can be found at the bottom of this post.

The State of Consumer SaaS

Thanks to global distribution platforms, converging consumer tastes, increasingly efficient go to market models, and emerging technologies breaking down many of the geographic barriers to reaching customers and building passionate communities, Consumer SaaS businesses are being launched and scaled around the globe in nearly every consumer vertical imaginable.

You can get a great sense for how wide ranging the impact of Consumer SaaS companies has become through this graphic which comes from a great report — the best I have seen — about the Consumer SaaS market by the investment bank GP Bullhound.

But even with this explosion, the Consumer SaaS market remains in its early days. Look at a chart of publicly traded consumer internet companies — like this one from Blossom Street Capital — and you’ll find that subscription companies and their combined impact on the public markets is quite small compared to businesses built on advertising (Facebook), commerce (Amazon), or with a marketplace transaction model (Uber).

You could interpret this as something bound to be structurally persistent or take it to mean that there is a lot of growth runway left for companies with this business model. I favor the latter point of view for a couple reasons.

First, some of the most beloved companies on that list are Consumer SaaS businesses — Netflix, Spotify, Peloton…and if you remember the framework from investor Gavin Baker that we talked about in Episode 1 of Venture Desktop it is that long term growth tends to follow early passionate engagement.

The second factor that advantages consumer subscription businesses broadly is their direct relationship and alignment with their customers. Dave Bujnowski of Baillie Gifford wrote an amazing white paper earlier this year called “The Case for Growth” that, among other things describes a shift we are undergoing as an economy from supply driven innovation —moving from tolerant consumers that take whatever companies dole out to them to an innovation curve that slopes up faster thanks to a positive feedback loop between supplier innovation and hyper-personalized demand…what Jeff Bezos has called Divine Discontent.

Divine Discontent

And while the consumer subscription model is not the only business model that can take advantage of this transformation, Consumer SaaS businesses can go to market quickly without having to solve for things like chicken and egg problems (although there are some very interesting Consumer SaaS-enabled marketplaces being built that may become the topic of a future episode). They also have a direct payment connection with consumers which accelerates the feedback loop mentioned before.

And, again per GP Bullhound, these factors are contributing to a growth trajectory that could see the average US consumer spending upwards of $100/year on digital subscription services by 2022 (up from around $10/year today).

And this gets us to the next step in understanding the Consumer SaaS landscape…how will we actually build and finance companies to fill that significant gap between consumer subscription spend today and projected spend down the road?

One thing I love noting about companies in this space — that most people miss when they see headlines about 40% of venture capital dollars being funneled to Facebook and Google ad spend — is how many companies there out there operating under the radar with very little capital raised, small teams, yet very real revenue.

Within health and fitness, one of the top categories for Consumer SaaS, two of top 5 grossing apps (as of late December 2019) applied this “Pegasus” strategy…skipping over the traditional venture track until they hit escape velocity or could raise growth capital on their own terms. This tweet from investor Dave Ambrose sums up what we’ve seen over the past couple of years well.

There is Sweat from Kayla Itsinis which, as of 2018 was doing about $80m in annual revenue with no outside capital. And there is Calm, which has now raised over $100m at a valuation greater than $1b from a top tier set of investors including Lightspeed Venture Partners…but which started off raising a modest amount of capital, got to profitability, and got aggressive with outside capital once it controlled its own destiny.

Of course, these growth paths are probably not likely ones for most companies and concerns about things like retention and long term sustainability persist thanks, in part, to the same potential for shifting consumer needs that opened up the market in the first place.

But it is clear that a large number of new brands based around the Consumer SaaS model have real potential to become long term “franchises” that finally make the leap from single product companies to businesses offering a broader range of services and experiences to customers — either by going mass market and reaching a wider swath of consumers or by driving a larger share of wallet from their core userbase. In the first episode of Venture Desktop, I used to example of Spotify and their unique business model leverage to show why even at their massive scale there is a ton of growth left.

As the market and business model continue trending towards maturity and broader understanding, it is inevitable we will see the capital stack mature alongside it — moving beyond large VC rounds focused on winning early market opportunities to systematic strategies where alpha is driven by operational excellence and global scale

Namely, we’ll start to see more targeted and sophisticated Private Equity and M&A plays emerge to support and extract value from companies reaching a certain scale.

The Evolving Consumer SaaS Capital Stack

In a previous post, I wrote about the opportunity for a firm to roll-up the At-Home Fitness market using L Catterton’s activity in the space as a guide. What is worth pulling out of that post to set a baseline is what, beyond simply more mature market dynamics, creates a roll-up opportunity in the first place.

The strategy tends to work well when the group of companies being brought together are similar enough that they can benefit from shared, scaled out fixed “infrastructure” across core business functions but are different enough (end customer demographics, positioning/brand, geography, etc.) that they don’t encroach too aggressively on one another.

Quickly, I’ll touch on three examples where different buyout or M&A models could be employed effectively in the Consumer SaaS market and how we might think about when and where we’ll see those strategies executed.

Multi-Brand Vertical Platform — Match

While I’ve noted throughout that the Consumer SaaS market — and the private equity opportunity related to it — is in its infancy, that’s not entirely true. One company (Match Group in Dating) has been early to the opportunity in building a wholly owned portfolio of Consumer SaaS companies.

Match — who owns Tinder, Hinge, and OkCupid among many others — has spent the last 20 years building up a set of brands that cater to virtually every dating desire. The depth of expertise and data Match has developed via this strategy has enabled it to understand better than anyone else what features and experiences users across the portfolio are seeking (image 2 below) while its decentralization has given individual brands like Tinder (image 3) the ability to respond with agility and innovative ideas to meet their specific set of consumers where they are.

Where else might this strategy work? My guess is that it will first be employed in the fitness space. We’ve already seen precedent in the brick and mortar boutique world with firms like Xponential Fitness expanding category by category. L Catterton’s aforementioned play in the equipment market is another indicator that this may be the next domino to fall.

Hub and Spoke — Spotify

If you follow me on Twitter or listened to earlier episodes of Venture Desktop, you’ve seen a lot from me recently about Spotify and the opportunity they have to expand beyond music to subscription offerings that more broadly address the “Spoken Word” market. By nature of owning a platform with significant consumer demand and laddering from music to their now large play in podcasts, Spotify is upstream (data-wise) of a lot of different Consumer Subscription expansion opportunities that it can capture via M&A and new internally developed products.

This might be called the “Hub and Spoke” model — leverage a core subscription userbase and then upsell additional offerings to gain a larger share of wallet from your core customers. Until recently, this option seemed out of reach for most Consumer SaaS companies struggling to simply generate enough demand to support a single product at scale. This is changing and I think we will see both at scale, independent consumer subscription companies go after this model as well as private equity firms who should start flocking in once the market becomes more predictable and tractable.

Vertical Agnostic Operational Excellence — The Thoma Bravo / Vista of Consumer SaaS

This final model is one that, to my knowledge, has not yet been deployed in the Consumer SaaS space but thanks to more experienced operators, better long term data and benchmarks, and a more mature corporate M&A market, the pure-play Consumer SaaS Buyout firm — built on operational excellence playbooks, top-tier talent networks, and a long term commitment to the business model in the mold of ThomaBravo or Vista Equity seems on the horizon.

Building out this model to start would not take a massive capital investment as the firm going after the opportunity would likely not be vying to compete to buy billion dollar companies like Calm or Blinkist. Instead, the strategy would be best focused on vertical opportunities in companies that are either:

  1. Largely founder owned via capital efficient growth (i.e. staying off the VC treadmill) where the initial product is reaching its natural growth limit and a buyout can provide founder liquidity and allow for a capital and management injection more focused on leveraging a strong brand to expand to new categories / geographies that couldn’t have been reached via organic growth.
  2. Companies overly reliant on VC funding to date without clear paths to large growth rounds or $1b+ outcomes but where a more rigid operational approach could yield a more sustainable business that — within a 3-5 year period — can be turned into an attractive asset for a corporate buyer.

While we may be a couple years out from this strategy being employed at an kind of real scale — as the market remains so nascent that most categories are still very much up in the air and long term category structures are far from being in place — it is something I will be watching closely.

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