The world feels split into three buckets:
· Stuff that’s definitely in trouble: like movie theaters and live events
· The majority of the world that’s a total black box, still: BDCs, Real Estate, etc.
· The few corners of the world where real conviction can be built: tech stocks, E-Commerce, new media
The problem is that since the pockets where conviction can be built are so limited, they’re crowded. It’s obvious to express conviction in tech by purchasing Zoom, AMZN, FB and NFLX. And so they’ve become expensive to own.
But while the list of names capturing value through COVID has become limited, the way to get exposure to those ideas have become greater in breadth.
We’ve noticed a handful of themes that are starting to crystalize for our investment team:
(1) The world of small businesses is moving off of main street, and into platform-based economies
(2) Value capture is moving away from the platforms themselves, and to the commercial actors of those platforms
(3) Platform economies are not created equal, and offer varying levels of “investability”
(4) It might be better to invest at the atomic level, rather than in the shares of these tech stocks
(5) The commercial actors on platforms are getting better
(6) Certain platforms have magical superpowers
Part 1 | The world of small business has moved off of main street, and into the platform-based economies
Throughout the Great Financial Recession, and the COVID-19 Pandemic the government has proven it’s good at saving big companies and bad at saving small ones. This will cause many small businesses to shutter or realize that they need help.
And many others will realize they need to attach themselves to large companies who offer them commercial viability even when the rest of the world feels like it’s on fire. The Shopify seller, the Amazon seller, the YouTuber etc. are all feeling less pain than the rest of the small business economy.
These large platforms offer a lifeline during the most difficult times. But beyond that, they also often a variability of operating costs. On their own, small businesses are responsible for far more fixed costs than if attached to a platform that offers much of the expensive infrastructure at scale. For example, It allows these platform-based operators to be more malleable during good and bad times. Amazon third-party sellers don’t need to rent a whole warehouse, but can rather just utilize Amazon’s resources on a variable basis. What Amazon did for cloud computing, it’s doing for physical storage.
Finally, it’s just easier to launch on one of these platforms. They require less immediate financing, and many of them have discovery tools such as ad-like products that can help encourage discoverability to a new business. It’s just natural that entrepreneurs will spin up on one of these platforms that have an easier onboarding process than plunging an entire life’s savings into a more traditional small business expensive to set up.
Part 2 | Value capture is moving away from the platforms themselves, and to the commercial actors on those platforms
Some common criticisms of these platform economies (often expressed as platform risk) are being mitigated:
· “Don’t the platforms capture all the value?”
· “Doesn’t the platform have the ability to express arbitrary governance subject to change?”
The value capture still asymmetrically rests with the platform itself, but value has started to shift towards the commercial actors on the platforms themselves. This will continue to happen as (i) the platforms compete with each other for talent and (ii) the new small businesses take audiences initially captured via a platform, use the audience to build a brand, and start generating organic traffic.
Competition across the platforms has started to result in “industry standard” type rules that are hard to break, since they’ve been adopted by multiple parties.
For example, YouTube splits revenues with its video creators at a 55/45 ratio. Other platforms like Snapchat have started to adopt the policy — doing otherwise would be “uncompetitive” and makes it harder for a platform to unilaterally change the rules in an adverse way towards its constituents.
And companies are beginning to build out offerings that make them attractive for their constituents compared to other available options. Companies like Shopify and Etsy keep Amazon honest by offering competing tools and by becoming more attractive as platforms themselves. Amazon will have to continue finding tools to make their offering not just better for the shopper, but rather for the third-party seller. Shopify’s app store, or Shopify Capital are examples of offerings Amazon now has to compete with. Outside of e-commerce, companies like Spotify are starting to work on tools for their artists to be discovered through Marquee for Artists. And so platforms are starting to offer help by:
· Driving down the initial set up costs of starting a business
· Operating a business with more variable costs
· Making businesses easier to discover
· Offering financing to small businesses less readily available from normal financial services firms.
All trends that make being a small business on one of these platforms more viable.
And the other major driver of value-capture will rest in brand value created by platform businesses. For example, YouTubers have significant brand loyalty from many of their channel subscribers and are just beginning to drive followers to their own proprietary experiences, but still rely on YouTube for a majority of their traffic. Spotify artists build very brand-centric relationships with their audience, giving them more negotiating power over Spotify. But sellers on Amazon rarely have significant brand affinity with their audience.
Can you name the brand you bought your last Amazon item from? Or did you view it as just “shopping on Amazon?” If the latter, that Amazon seller has less a chance of shifting its audience off of Amazon as a platform, giving Amazon more of the power. And with more power comes more economics.
In short — platforms used to capture all the value and now they capture less. We expect that shift to continue unevenly from platform-to-platform.
Part 3 | Platform economies are not created equal, and offer varying levels of investability
Different platforms will offer economic value to their constituents via a list of binary characteristics. For example, as noted just before — whether or not platforms help drive brand affinity for the businesses in their ecosystem matters.
But beyond that, each platform offers varying benefits. For example:
· Does the platform drive traffic? In the case of Amazon: yes. In the case of Shopify: not really.
· Does the platform monetize on behalf of the small business? In the case of YouTube, yes — because the programmatic ads create revenue for the YouTuber who only needs to entertain an audience. In the case of Instagram, “not yet,” since programmatic ads with creator revenue share have not been rolled out at scale to Instagrammers.
· Does the platform offer existing financing options? Shopify sellers may become less attractive to fund if Shopify Capital becomes too aggressive. But will sellers want a financial relationship with their technology provider? It’s yet to be seen.
· Does the platform offer competitive advantages over time? Perhaps more significantly, platforms that offer moats are incredibly powerful. In the case of YouTube — for every video that is completed, the video gets recommended to further since YouTube assumes it’s high quality, and so on, making the video harder to compete with. In the case of Amazon sellers, more sales and more reviews equals a higher ranking, which equals more sales, and so on.
We spend a lot of time trying to understand how each platform ranks along these binaries, and which ones have reached the maturity needed to finance.
Part 4 | It’s better to invest at the atomic level, rather than in the shares of these tech stocks
Rather than own FB shares, we’d rather own Instagram accounts. Rather than owning Amazon stock, we’d rather own a bunch of third-party selling merchants. And rather than owning Google stock, we’d rather own YouTube libraries.
Why? Because all the tailwinds that make those stocks interesting to own are, in part, shared by the commercial actors on their platforms. And yet capital markets largely haven’t flowed into those spaces yet. Many traditional funds are not set up to finance these platform constituents. On top of that, many of the economic ecosystems on these platforms are newly mature, and so there are not pre-existing models to figure out how to value each asset.
From our point of view, this makes these assets not just “mis-priced,” but largely “unpriced.” A trait we obsess over. It lets us define the pricing and build our own mental models of how they should be valued, with excess room for error since we’re not competing against other bids.
We believe we’re investing into high conviction areas, but are able to do so at low prices not by looking at something different, but by expressing the same trade in a new way.
Part 5 | The commercial actors on platforms are getting better
Many successful businesses within these platform economies have been successful “despite,” not “because of,” themselves. They’ve simply been in the room while these platforms have taken off, offered better tools, and made commercial activity available.
But more recently there has been a professionalization of these platform economy businesses. They have gotten larger, more professional, and because the revenues have increased they’ve attracted better talent. And third-party economies are being built around them… talent agencies focused on TikTok influencers are an early example.
Best practices are starting to become established.
On top of that, User-Generated-Content (“UGC”) platforms are beginning to shift towards media companies. I bet my future kids will never think of Facebook or Snapchat as “social media companies,” but rather as media companies where a majority of the content they watch will be professionally made by channels they like. The channels built on Insta, Snap and TikTok will end up replacing the ESPNs and CNNs of the world as the channels build brand affinity, trust, and are in the feed of users. And as these channels do better, they’ll make more money, letting them invest in better content and so on.
It’s starting to happen with meme accounts, and via platforms built by Overtime, Barstool and our portfolio company, Wave.tv.
Part 6 | Some of these platforms have magical superpowers
There are a small handful of magical superpowers that exist in certain platform economies. I’ve alluded to them earlier in the post, but I want to highlight them here:
(a) Free, luxury real estate:
If I were building a small business and I wanted have a lot of foot traffic — I may take out a lease on Park Avenue. It would certainly generate more visibility than if I was on 8th avenue — but it would cost more.
On top of that, I might lease a space that looked nice. It would have big windows, fancy countertops or whatever else people think is nice. And that would cost even more. Why do I want it to look nice? To give some level of validation — not only did you see my store, but it was full of expensive stuff, which signals success and quality.
But in the platform economies, it costs no more to be ranked #2 in a search than #9 in a search. And so you get more foot traffic than normal without even having to pay for it.
On top of that, you don’t have to pay for fancy windows… instead a lot of these platforms have things like reviews, rankings, or other status symbols applied to sellers or creators. Some examples include:
· Amazon’s 5 star ranking, or “Amazon Recommended” products
· Spotify’s “number of plays” or showing up on a powerful playlist like Rap Caviar
· YouTube’s “YouTube Select” program, or how many views you have on a video
· Instagram’s number of followers
· And so on…
These free competitive advantages lead to higher gross margins than you might otherwise expect from a small business.
This real estate (in the form of page ranking) in many ways has the “equity value” of prime real estate — just buying the user account is worth something, because it’s similar to owning land on a well trafficked corner, or owning a popular domain name.
(b) Compounding Moats
Certain platforms have compounding moats, which means that every time they pursue an action, they earn a greater competitive advantage. For example: on Amazon, every time you sell something you get ranked higher, making it easier to sell, and then helping your ranking and so on. Very few traditional small businesses have this advance.
(c) Variable costs
A larger percentage of the costs in platform economies are variable. For Snap creators, Snap provides the sales team to serve ads against the content. This beats being a small media company that needs to find sponsorship and ad dollars themselves. For Amazon, they handle the warehousing, shipping and returns of inventory. And so on…
Platform businesses can toggle their costs up and down more easily as needed, creating resiliency.
(d) Power laws
It used to be that every town needed its own “soap business.” Or “home goods business.” Etc. But now — since many people from different towns can all shop from the same seller — there doesn’t need to be a “one store per town” dynamic. This allows the platform businesses with strong platform real estate and compounding moats to become increasingly powerful and large. And thus, more valuable.
We agree with much of the investing world. It’s hard to build conviction in most things, and these tech platforms offer an oasis of certainty. But buying their shares sounds expensive, and it’s a hard way to differentiate. Trying to invest at the atomic level, and understanding the implications of doing so will be a topic we spend much of the next months thinking through.