20VC: Lightspeed's Alex Taussig on VC Risk Mentality, The Current State of Retail & The Mechanics of Cash Flow

Alex Taussig is a Partner @ Lightspeed Venture Partners, one of the leading firms of the last decade with a portfolio including the likes of Snapchat, Mulesoft, Max Levchin’s Affirm, The Honest Company and many more incredible companies. As for Alex, at Lightspeed, he has made investments in Zola, Daily Harvest, Vector & Poncho. Before moving to the West Coast, Alex spent 7 years at Highland Capital Partners, where, as a Partner, he made investments in thredUp, JauntVR and RentJuice (acq by Zillow) and was involved in several IPOs. Alex is also the writer of a fantastic newsletter: Drinking From The Firehose. In Today’s Episode You Will Learn: 1.) How Alex was inspired by being at Harvard at the time of Facebook to make the move into tech and how that landed a role in VC with Highland Capital Partners? 2.) Why is Alex optimistic about the current state of the retail environment, despite media skepticism? What are the value propositions that physical retail provides online retailers (Warby Parker, Real Real etc)? How does Alex believe we will see the re-platforming of retail in the future? 3.) In today's incumbent world, how can consumer apps demonstrate breakout growth? What does Alex mean when he discusses the importance of product channel fit? Once found, should fuel be poured on the fire to exploit the fit? What would suggest sustainable vs non-sustainable product channel fit to Alex? Who has done this particularly well? 4.) Why does Alex believe that Amazon's cash flow is one of the main reasons for it's success? What is the key working capital metric? How does this unpack into 3 core elements? What is "negative working capital"? What are the core benefits of this? How can startups use these mechanics to use cash flow as their prime advantage? Items Mentioned In Today’s Show: Alex’s Fave Book: The Divine Comedy Alex’s Most Recent Investment: The Daily Harvest As always you can follow Harry, The Twenty Minute VC and Alex on Twitter here! Likewise, you can follow Harry on Snapchat here for mojito madness and all things 20VC. Leesa is the Warby Parker or TOMS shoes of the mattress industry. Leesa have done away with the terrible mattress showroom buying experience by creating a luxury premium foam mattress that is ordered completely online and ships for free to your doorstep. The 10-inch mattress comes in all sizes and is engineered with 3 unique foam layers for a universal, adaptive feel, including 2 inches of memory foam and 2 inches of a really cool latex foam called Avena, design to keep you cool. All Leesa mattresses are 100% US or UK made and for every 10 mattresses they sell, they donate one to a shelter. Go to Leesa.com to start the New Year with better nights sleep! Zoom, fastest growing video and web conferencing service, providing one consistent enterprise experience that allows you to engage in an array of activities including video meetings and webinars, collaboration-enabled conference rooms, and persistent chat all in one easy platform. Plus, it is the easiest solution to manage, scale, and use, and has the most straightforward, affordable pricing. Don’t take our word for it. Zoom is the top rated conferencing app across various user review sites including G2Crowd and Trust Radius. And you can sign up for a free account (not a trial!). Just visit Zoom.us.

Speaker names marked ? are inferred from speaking time and the show’s known hosts — they are not voice-verified.

• 0:00Harry Stebbings?

  We are back on the 20 minute VC and I'd love to see you behind the scenes here on Instagram at H Stebbings 1996 with two Bs. It's mostly health, fitness and mojitos these days, but it would be great to see you there. Now for the show and the 20 minute VC has brought a huge amount to my life and one element is the ability to build great relationships with some very, very special people and that is the case today with a friend and one of Silicon Valley's most exciting younger partners, joining us in the hot seat today, Alex Taussig. So Alex is a partner at Lightspeed Venture Partners, one of the leading firms of the last decade with a portfolio including the likes of Snapchat, Mulesoft, Mattis Levchin's Affirm, The Honest Company and many more incredible companies. As for Alex, at Lightspeed, he's made investments in the likes of Zola, Daily Harvest, Vector and Poncho and before

• 0:43Harry Stebbings?

  moving to the West Coast, Alex spent seven years at Highland Capital Partners, where as a partner, he made investments in Threadup, Jaunt VR and Rent Juice acquired by Zillow and was also involved in several IPOs. You know me, I never plug guests' blogs or newsletters, but I do have to say Alex's is always a must read for me and you can find it in the show notes or by searching for Drinking From The Firehose. That really is a must, it's my favourite. I do also have to say a big thank you to both Jeremy Liu and Nicole Quinn at Lightspeed for the intro to Alex today. I really do so appreciate that. But before we dive into the show today, what are we without a great night's sleep and that's where Lisa comes in. Lisa is the Warby Parker or Tom Shoes of the mattress industry. They've done away with the terrible mattress showroom buying experience by creating this luxury premium foam mattress

• 1:28Harry Stebbings?

  that's ordered completely online and shipped for free to your doorstep. The 10 inch mattress comes in all sizes and is engineered with three unique foam layers for a universal adaptive feel, including two inches of memory foam and two inches of a really cool latex foam called Avena, designed to keep you cool. All Leesa mattresses are 100% US or UK made and for every 10 mattresses they sell, they donate one to a shelter. So go to leesa.com for your perfect night's sleep and if you're like me and lose sleep worrying about the quality of conference calls and communicating remotely, then check out Zoom, the fastest growing video and web conferencing service, providing one consistent enterprise experience that allows you to engage in an array of activities including video meetings and webinars, collaboration enabled. Conference rooms and persistent chat all in one easy platform.

• 2:13Harry Stebbings?

  Plus, it's the easiest solution to manage, scale and use and has the most straightforward, affordable pricing. Don't take our word for it, though. Zoom is the top rated conferencing app across various user review sites, including G2 Crowd and TrustRadius. And you can sign up for a free account, not a trial, just visit zoom.us. But enough from me, so I'm now very thrilled to hand over to Alex Taussig, partner at Lightspeed Venture Partners.

• 2:42Speaker 01

  You have now arrived at your destination.

• 2:45Harry Stebbings?

  Alex, it's such a pleasure to have you on the show today. Obviously, I've heard so many great things from Nicole and Jeremy, and I love your newsletter. So thank you so much for joining me today.

• 2:53Speaker 02

  Oh, thanks, Harry. I'm happy to be here. I've been a listener for a long time, so this is quite exciting.

• 2:57Harry Stebbings?

  Well, you're far too kind, but I'd love to get started today with a little bit about you and how you made your way into what I call the wonderful world of venture.

• 3:05Speaker 02

  Sure, happy to do that. So I think I first heard the term venture capital at a bar at MIT where I was doing my PhD at the time. I think people were drinking some university subsidized beer. And a friend had described to me the process of raising venture capital for a company he was starting, which he was spinning out of a lab. And I just immediately fell in love with the concept. I was just fascinated by these people that helped match capital with groundbreaking ideas and people. But to be totally honest, at that time, I was still a student. I didn't really know much about venture capital. I just had this hunch that it was something I'd enjoy doing. So my education in venture capital really started when I joined a firm in Boston called Highland Capital Partners in 2009. I was hired by one of the firm's founders as his apprentice, effectively. My job was to help with about a dozen portfolio companies and also source new ones.

• 3:48Speaker 02

  And so I was there for about seven years. You know, fast forward to the end of that time, I had moved to the West Coast from the original office in Boston. I'd become a partner at the firm and I was leading investments out here in Silicon Valley. You know, I always think back to my old boss's mentorship and guidance because I think it played a pivotal role for me in learning how to be a venture capitalist. I still very much believe that VC is an apprenticeship business. So I joined Lightspeed about two years ago, and I generally focus on the future of commerce and media. I'm very interested in how retail is getting disintermediated by the internet, as well as how the behaviors encoded in television will evolve. The advent of TV on social platforms and through the App Store. But the most exciting part of this job is often when you see something you don't expect. So you always have to keep your eye open. And so I try to be a quick study of new markets and new opportunities.

• 4:31Harry Stebbings?

  Now, this is very harsh of me because it is off schedule. But you mentioned that the incredible learning under your Highland partner who hired you as his apprentice. I'm intrigued, having luckily been the receiver of many incredible learnings from VCs. What was your biggest learning from that seven years working with him and really gaining your chops in the industry, so to speak?

• 4:48Speaker 02

  I think one of those learnings is just how you approach analyzing companies. There's a lot of different lenses you can take. And he and I had similar paths in our careers. You know, he had started off as an engineer and had come into venture in his twenties and had basically been in the industry his entire career. Which is now, I think, about thirty years. And so his approach is deductive and he really tries to pick apart the market forces and the changes in the market and try and understand the particular moment in time a company is starting and why a particular company has an advantage in a market. And then there's just this ethos of a work ethic that I think is independent of how successful someone is. That someone who could have been doing this for as long as he has and as well as he has, still be interested in learning new things and really working hard for entrepreneurs.

• 5:33Speaker 02

  It's not the specific things I learned, but it was more just watching someone go through the process of intellectually analyzing companies. And then, once we'd made the investment, you know, the tireless work ethic. I think a combination of those two things is really what I took away in terms of how to be a good venture capitalist.

• 5:46Harry Stebbings?

  No, I absolutely love that kind of analytical rigor that was instilled. But I do want to touch on kind of both of the firms that you've worked at. And a question from Jeremy Liu, who asks, having been a partner at two different firms, how would you maybe compare the two firms in terms of culture and focus area?

• 6:01Speaker 02

  Well, I think the cultural elements are always descended from the founders of the firms. It's similar to startups. You can walk into a startup and you can almost feel the personality of the founders often with a lot of the employees. I think scaling that culture is one of the biggest challenges a company faces. And similarly, it's a challenge that venture capital firms face. But I think in both firms, we do have that deductive analytical bent that's instilled in both cultures. I think the other thing is that in both firms, both at Highland and Lightspeed, there's no superstar. Our culture, neither are firms where we really like to go in front and be the star of the show. We prefer to think of venture capital as a service business and that it's our job to remain behind the curtain, out of the spotlight and help the entrepreneurs succeed. And I think those things were in common.

• 6:44Speaker 02

  I think the biggest difference is probably the geographic focus. Highland started in the late eighties in Boston and still today has a very strong focus on Boston and now New York City ecosystems. Lightspeed is really a Silicon Valley firm, founded in Silicon Valley, but we invest globally. But everywhere we invest, we bring that Silicon Valley mentality and technological optimism. And what I mean by that is we're definitely willing to take risk, perhaps losing the vast majority of our capital. But we do that if we believe there's a small chance of unbounded upside. So I sort of characterize it as you're always asking the question of what could go right, instead of asking what could go wrong. And I think that the Silicon Valley culture is a really distinctive factor that I think of in the difference.

• 7:25Harry Stebbings?

  And it's so funny you say that. I always get asked, what's the difference in US and UK VCs? And I say exactly that divergence in what could go right versus what could go wrong. Because subsequent question, how do you balance kind of that incredible vision with a sense of realism? Is it a tough balance to master?

• 7:40Speaker 02

  Well, the realism piece comes into play when you just realize that stuff's going to go wrong. And you just have to get into these companies knowing that. And you can't be surprised when things don't go the way you think they're going to go. You can set up plans, you can set up contingencies. But at the end of the day, once you make that investment, you're in the trenches with the entrepreneur and it's your job to figure it out. And that's what I, when I think of realism, I tell founders, I say, that's your expectation is that we all believe this is going to go up and to the right. We all believe everything is going to work, but we also have to know that things are never going to go according to plan and we have to go figure it out together. So the optimism piece is all around the fact that we can figure it out. It's that smart people that are highly motivated and incentivized to work together can go solve these big problems.

• 8:18Harry Stebbings?

  Absolutely, but kind of staying on that pessimistic versus optimistic stance. There's a lot of doom and gloom around the retail apocalypse, so to speak. But you've presented a maybe more optimistic view than the media suggests. So I'd love to start with that. And is the doom and gloom warranted? And maybe why you're more optimistic, the more macro picture presented?

• 8:37Speaker 02

  Well, yeah, the media kind of likes the gloss of. What's happening in retail right now, I think in the retail sector, a lot of very visible changes are happening and it's causing a lot of people a lot of angst. It's interesting to me to contrast today in the United States in retail with 10 years ago during the recession. Because during the recession, you also had a lot of bankruptcies, a lot of store closures. But the economy was going through a really horrible correction. Now, we're having a lot of bankruptcies. I think there were about 19 or so in 2017. But GDP is on an eight-year growth, we're on the stock market in its longest bull market. Unemployment is low by most measures, consumer confidence is very high. So when you really double click and you and you look at what's going on, it's not that retail is dying. It's that there's a few formats of retail that are no longer working. But those formats are highly visible.

• 9:20Speaker 02

  And I think the the best example of that is department stores. I mean, department stores are in a particularly bad place. You know, once upon a time, there was a theory that you would go to these very large stores that have a lot of variety of inventory. And you shop multiple categories in a single trip. And so that was the value of having them all in one place. But the internet serves that use case much, much better with a much lower transaction cost. So that's caused the decline of foot traffic in these stores, which then causes these guys to discount to get people to come back, which trains the shoppers to expect that discount. And then that means the highest quality brands want to pull out because they're sitting next to discounted stuff, which is not good for their brand. So they pull out, that means the average quality of all the inventory goes down. And that means that you need discount even more to get people to come in. So it's this vicious cycle of discounting and poor redundant inventory.

• 10:05Speaker 02

  And they just can't get out of this cycle. And it's fundamentally because there's really not a good reason to have all those things in one place. But taking that aside, there were actually more store openings than closings across the retail sector in 2017. The offset losses in categories like department store and full price fashion, there were massive gains in categories like fast food, convenience, supermarkets, drugstores, off-price retail. So you kind of think, well, what do these things have in common? There's a few different factors. One is they have a supply chain that doesn't yet work for online very well. Think grocery, for example. They have an advantage in being physically close to the customer. So think convenience store, like it's really hard to buy a single Snickers bar online. You still need to go somewhere because the shipping cost would be astronomical, right? So that's why convenience stores work. Deep value, so customers were retrained.

• 10:50Speaker 02

  During the recession, especially millennials to look for deals and TJ Maxx, Ross Stores, Dollar General, these types of things have done quite well. And then lastly, anything where the experience is an important factor of shopping. So the mall sector, there's a lot of malls that are closing, but there's actually a few high end malls that are doing quite well. And that's because they focus on the shopping experience. So like most things in life, it's not black and white. It's somewhere in the middle. It's gray and it depends on what part of the retail ecosystem you're a part of.

• 11:15Harry Stebbings?

  You mentioned quite a few elements of the retail ecosystem there. I mean, one really interesting element for me is when one sees the likes of The RealReal and Warby Parker opening up physical retail stores. I'm intrigued, why do you think this is? And the online value prop maybe isn't enough to satiate their demands and their hunger for growth?

• 11:31Speaker 02

  Well, again, there's a lot of different reasons why a digitally native brand or digitally native retailer would open up stores. One of the big reasons is you have to remember, e-commerce is still only about 10% of total retail in the United States. So it's still tiny.

• 11:43Harry Stebbings?

  It's crazy.

• 11:44Speaker 02

  Yeah, yeah. As dominant as Amazon, I mean, that's, that's just a statement to how big commerce is. It's just a huge market. And so it's not uncommon for companies to get to a couple hundred million in revenue and see their customer acquisition costs online go up. Now, some businesses can withstand that more than others because some have better lifetime values than others. But you know, we typically start to see, once you breach 100 million, 200 million in revenue, you need to start going and figure out some offline strategy. So what we see actually in the future, looking forward, is a merging of the best to breed online and offline to create a seamless cross-channel experience. Warby Parker's done an exceptional job of this, I think. We have a store here in Hayes Valley in San Francisco where you can go in, you can try on all the different classes, but you don't actually walk out with a pair of glasses.

• 12:27Speaker 02

  You can actually see an optometrist or you can get glasses adjusted, but then you walk out and you go order online. So they fulfill through the online channel. The store is more of a showroom. Bonobos also, which is a portfolio company of ours that recently sold to Walmart, you kind of pioneered this concept with the guide shop. Glossier in New York has, has another innovative model with their retail format. So we're starting to see a change in how online brands view retail. They can, they have the benefit of being able to look at retail with a blank sheet of paper and design what they want to get out of it. For some types of companies, it just means selling more stuff in store. For others, it's a way to reengage. Their customer base and increase their current customers lifetime value. For others, it's about new customer acquisition. So there's a variety of different ways these folks are using retail.

• 13:08Harry Stebbings?

  Can I ask, you've said before about the replatforming of retail. Is that what you mean when you suggest the replatforming?

• 13:13Speaker 02

  Yeah, I mean, what I mean by that is that if retail really served one function in the past, which was get inventory close to customers so they can go buy it. Okay, and and maybe some element of service. Now it has a multitude of use cases. As I said, it's it's about acquiring customers in local areas, but but then sending them to your online site. Or it's about providing a service that you can't provide online as easily to those customers that is that is somehow related to your product. Or it's about over serving your best customers. So there's a startup in New York, for example, that we spoke to a little while ago that has a retail experience that's only for its best customers. And it provides a personal, a more personalized experience for its best customers. So it's invite only. So there's all these different ways people are using the physical experience.

• 13:56Speaker 02

  And it's not purely just holding inventory and people walk in and walk out with it.

• 14:01Harry Stebbings?

  We we spoke there about kind of those killer startups doing incredibly well online. I I'm intrigued, one of them, a portfolio company of yours, Zola, I've read many of your writings about, a startup that clearly has product market fit. But you've said before that the product market fit is now table stakes. So so kind of thinking on that, how do consumer apps demonstrate this breakout growth in today's environment?

• 14:21Speaker 02

  Well, I think what you might be referring to is that the today's environment, I think versus 10 years ago, it feels like the biggest companies are so much more dominant than they used to be. And achieving that breakout growth is not as easy as it used to be. You know, something like 89 or 90% of growth in advertising dollars in the last year or so was inside of Google and Facebook. So those channels are more dominant than they've ever been. And then if you look at the App Store, the average consumer downloads net zero apps each month. So the apps on people's phones don't really change that much. And then the app stores are just dominated by Facebook, Google, Amazon and Apple. So how do you get on there? That's the kind of, I think, the question you're asking. And I I think the answer is, look, the bar is just higher. I think the bar is higher to perform and have a product that really resonates with consumers.

• 15:05Speaker 02

  And nothing beats a product that users want to show off to their friends. I like to think of an example as one of our. Portfolio company is HQ, which I know is at least blowing up in the US. I don't know if it's gone over the pond yet, but we call it screen to screen virality. You know, this is a quiz show and what drives growth is people taking it out at work around the time the show goes live. And everyone else taking out their phones because you need everyone else's knowledge around the table to help you get the question right. So it's a game that necessitates playing with friends and playing with friends in real life because you need to shout out your answers within a few seconds. So that screen to screen virality can drive in real life usage of the product. There's not really that many viral hooks in the product. There's no growth hacking. It's just a great product that people want to share. And I think you need something like that.

• 15:47Harry Stebbings?

  Is screen to screen virality really what you mean when you talk about product channel fit? Or is that a different growth mechanism altogether?

• 15:54Speaker 02

  Well, it's a little tough to use it in that scenario. When I, when I talk about product channel fit, what I'm really talking about is designing your product to resonate within a specific channel to market. It's easiest to understand by example. I, I think I wrote this piece about our portfolio company, Zola, which is the fastest growing company in the wedding category in the US. And what they realized was they start to think about what's a user's mind space when they get engaged? Well, they're about to go spend $30,000 on average in the US. It's much higher if you live in a, in a coastal city. So that's a big amount of money and it's a highly emotional purchase and they wanted to be reflective of them. So they end up doing a lot of research about what other people have done in their weddings. And what that leads them to is a lot of Googling and a lot of searching for data on weddings.

• 16:37Speaker 02

  And what Zola realized was it had a lot of data because it was operating this registry product. So by publishing data about what its customers wanted, it created these articles that naturally fed their way into people's search. And then that created more data and then that data created more users and it created a virtuous cycle. And so earned media for Zola was really a, a channel in which they had an unfair advantage by nature of their product. And they leaned into that and that created a lot of organic growth in the early days. And so that, that, that for me is a good example of product channel fit.

• 17:06Harry Stebbings?

  I'm thrilled you said about leaning into it there. Once found in terms of product channel fit, is it a case of pouring fuel on the fire? And really raising that war chest to dominate that channel? Or is there a more conservative style recommended?

• 17:17Speaker 02

  You know, it's interesting. It depends on the channel. The Zola example, that's not a channel that costs a lot of money to get right, but it requires a lot of insight and a lot of design of the product. Similarly, if you look at a company like Glossier, which is a cosmetics company in New York, they get a lot of users through their Instagram community. It doesn't cost them a lot of money, but they have to be very thoughtful about how they build the products to be photographed. On the other hand, you might look at a company like Masterclass, which creates these celebrity-led educational lessons. They're somewhere between entertainment and education. And for them, you know, they do some paid acquisition on Facebook, but that paid acquisition is assisted by the fact that these celebrities already have followings on Facebook. So they have resonance in that channel. So in that case, raising more money to do more paid acquisitions probably a lot of benefits to that.

• 18:00Speaker 02

  So, but what I will tell you is that even if you find that product channel fit, it's not going to last forever. And it's often the first thing you get right, and then you have to get a lot of other things right. So it's almost always the case that when you hit product channel fit and you're scaling very quickly, you need to start thinking about what your second, third and fourth channels are going to be. And for that, you often need the money. So the answer ultimately is yes, but not for the reasons you would think.

• 18:22Harry Stebbings?

  Can I ask, is there a length of time that you can kind of sustainably enjoy that peaceful period of enjoying that channel fit? Or should it continuously be an upgrading of the next distribution channel?

• 18:31Speaker 02

  I would say that if you're lucky enough to find a channel where you have proprietary advantage, that you can outperform your competition, I would pour as much gas on it as you can, but I'd always still have an experimental marketing budget that you're using to figure out what the next one's going to be. It's a little bit like managing a portfolio of investments. We often say when we talk about marketing, you have your things you're weighting heavily that are already working, and then you have your newer things you're experimenting with, things that have higher beta. But if they hit, then you're going to make them one of your dominant things. So yes, you need to really lean into what's working because you only have a certain amount of resources. But you always also need to be testing. So it's somewhere in the middle. It's maybe something like an 80/20 split early on.

• 19:10Harry Stebbings?

  Okay, question for you. And keeping on this venture analogy, if they hit one of those beta ones, one of those early seed investments, is it not quite likely that the big boys, I guess, like Spid would be one of those big boys? But in the traditional kind of app space, it would be your Facebooks, Googles, Amazons can nudge you out of the way customer acquisitions costs go up. Is it an incumbent advantage?

• 19:30Speaker 02

  Increasingly, the incumbents are more powerful than they've ever been. I think that's something that is a big theme in technology in this latter part of the 2010s. But they can't do everything and they can't focus on everything. My partner Jeremy is often fond of saying that if you're not in one of the three top priorities of the competitor, then you're probably okay for a little while. The key is what advantage can you build while you're still under the radar such that when the incumbents do wake up and want to crush you, you actually have an advantage that they don't have. One of the things I like to think about is just longitudinal data on your customers. If Facebook wants to enter a market, but it requires them to, or Amazon wants to enter a market and it requires them to understand how a customer performs over time, they can spend all the money they want to acquire customers, but it can't create more time.

• 20:14Speaker 02

  There's something to be said for watching a certain set of cohort of users and increasingly acquiring more data over them over time that's hard to replicate. I think Stitch Fix has done a good job of this, for example, because they have a long relationship with their customer and can style based on other things that person has already purchased.

• 20:30Harry Stebbings?

  Does that mean you're a big believer in first mover advantage then?

• 20:33Speaker 02

  Like most things, it's maybe necessary but not sufficient. And sometimes it doesn't matter because if it turns out the first mover has the wrong model, if you looked at MySpace and Friendster and compared to Facebook, you would have said that Facebook would have lost because it didn't have first mover advantage. But the Facebook product was fundamentally different and also had a different distribution mechanism, which was colleges. So I don't necessarily believe that's always the case, but if you're referring to the same data set, if you're going after the same data set on users, oftentimes the first one to market is able to win.

• 21:01Harry Stebbings?

  So if we have that product channel fit, like we discussed that, which I absolutely love, by the way, as one of the characteristics that you really look for, another that we've discussed before between me and you is the element of business models not getting enough attention that they deserve in startup land. You told me that Amazon's cash flow is one of the reasons it's so successful. I'd love to unpack this. What's one of the core secrets to Amazon's early success then, Alex?

• 21:24Speaker 02

  Sure. Yeah, I don't think business model gets enough attention and it's really like, the way you define business model is basically how does the company create cash flow? And that cash flow is the thing that ultimately the business survives on once the venture capitalists stop writing checks. So ultimately you need to turn your business into something that Into capitalist subsidize to something that produces cash. And if you can't do that, it's really hard to sustain yourself. The Amazon story is obviously very complex, but what most people don't realize is they benefited a lot from the fact that book distributors, from whom it purchased its inventory in the early days, had so little power in the market. In the publishing industry, there's like a handful of these book publishers and they have a lot of power. But then they employ these local distributors to reach customers. And those distributors were relative to Amazon, actually pretty small.

• 22:06Speaker 02

  And so Amazon had enough centralized power to extract favorable vendor terms from these distributors. To understand why this was beneficial to Amazon, I kind of need to explain something called networking capital. In many businesses, especially those that hold inventory, there's a difference between typical accounting profits and losses, and how much cash your business generates or burns in a given period of time. We all know cash is king, you may have heard that phrase.

• 22:28Harry Stebbings?

  I have, I say it a lot myself.

• 22:30Speaker 02

  But it's actually the timing of cash flows that really matters. It's when that cash hits your balance sheet, because that's when you can use it. Startups need to pay attention to this even more than larger companies, because they have so much less cash. There's three numbers that affect the timing of cash flow. It's actually more than three, really, but there's really three main ones. The first is accounts receivable. That's the balance of payments that your customers owe you. There's accounts payable, which is the balance of payments you owe your vendors. And then there's inventory, which is the value of the product you have waiting to be sold to your customers. And changes in each of these balances either produce or consume cash. So for instance, to give you an example, if you sell through inventory, that produces cash. But increasing your inventory, for example, in advance of the holiday season. So you're building up your inventory, because you know there's going to be a big demand. That consumes cash.

• 23:13Speaker 02

  So the ideal business is one where your customers pay you immediately. Your inventory flies off the shelves, and you don't have to pay your vendors for a long time. Those businesses generate cash from so-called working capital. And if you're careful, you can use that cash flow to fund operations. And this is what Amazon did.

• 23:28Harry Stebbings?

  When does a company achieve negative working capital?

• 23:31Speaker 02

  Yeah, so negative working capital is kind of a funny term, because it's actually a good thing.

• 23:36Harry Stebbings?

  When I first read it, I was going, you know, this is gonna be a bad thing. And then I'm saying about the benefits of negative working capital. So when is that and what are the benefits?

• 23:43Speaker 02

  The benefit, the benefit, well, so I'll tell you what it is first of all, and then I'll tell you what the benefits are. So instead of thinking of dollars in these balances of these accounts, it's often easier to think of the number of days of cash that are tied up in each of these functions. So that's days of accounts receivable, days of inventory, days of payables. And if you take the days of receivables plus the days of inventory and subtract the days of payables, that number is called the cash conversion cycle. And if that's a negative number, we call that negative working capital. And it is a good thing because what it means is that effectively your vendors are floating you cash so that you can buy inventory and fund the operations of the business. So in Amazon's case, if you go back and look at their prospectus from their IPO and then the few public company filings for the following years,

• 24:26Speaker 02

  their days payable was about three to four times their days inventory from 1995 to 1998, about two times in 1999. In 99, they did over a billion in revenues. The effect of this was that when Amazon went public in 1997, up until that time, it had only consumed about $3 million of cash. And that's about half of what it would have burned without the negative working capital effect. Most of this, they raised one round of venture capital from Kleiner Perkins, and most of it was still on the balance sheet when they went public. So Bezos did an amazing job funding a good portion, and not all, but a good portion of those operations with vendor financing. Now, this is not magic, right? Like, you need to actually spend that cash on other things often. So Amazon, and still to this day, will actually invest a lot in CapEx

• 25:07Speaker 02

  to build out distribution centers and invest in technology that are fixed costs, that are long-term lived. So a lot of that operating cash flow just flows into its capital expenditures. But still, it's an important concept to understand because there's so many startups for whom this is an advantage. With Zola, for example, since we already talked about it, the cycle of getting gifts for someone at their wedding is really interesting because people typically register many months before they get married. And couples receive gifts many months before the wedding day. So Zola receives that cash from customers. But at the same time, customers also don't want their gifts immediately because often they're moving after they get married. So Zola receives cash before it has to actually ship. Product. So it's a very interesting dynamic when you look at cash flow and it can actually influence how capital efficient a business can be.

• 25:51Speaker 02

  And as venture capitalists, we love funding businesses that are capital efficient.

• 25:55Harry Stebbings?

  No, absolutely, we do. I am interested, though, you said there about kind of vendor negotiations and ensuring that you do kind of a beneficial term for you as the startup. I'm intrigued, though, does this not mean there's an inherent incumbent advantage as they have more leverage to negotiate with vendors on kind of longer payable term cycles compared to small startups?

• 26:13Speaker 02

  It's a really insightful question. I generally think that the larger and more important you are to your vendors, the better payment terms you'll be able to extract. You also have to balance that, though, with the fact that your vendors need to stay in business, too. They need to be able to survive and actually thrive in partnership with you. So you can't totally give them something that they can't deal with. But I will also say that just because your competitor gets great terms doesn't mean you can't as well. It's not mutually exclusive. It's just a question of what meaningful scale is and how competitive that vendor base is and how badly they want your business. And the more they want your business, the more flexible they'll be. Sometimes you see the opposite effect. If an incumbent is really dominant, the vendor actually may have a greater incentive to give you better terms because they want to eventually diversify their customer base. It's dangerous for them to just have effectively one customer because then they're beholden.

• 26:56Speaker 02

  So you may come into a market and they may say, oh, great, here's someone else that we can work with. And let's make sure that these guys, even though they're smaller, still get great terms. So it's a push and pull and it's very specific. I don't think it's as simple to say that all the incumbents always have an advantage in this regard.

• 27:11Harry Stebbings?

  A horrible last question for me to ask, but I have to ask it. You said it depends how you define meaningful scale. How would you define meaningful scale?

• 27:18Speaker 02

  Meaningful scale is relative to the size of that vendor's business. So are you 1%, 10%, 50% of their scale? Because at some point you become more important to them than they are to you. And at that point, the negotiation flips. Early on, you're convincing these vendors to even work with you, even pick up the phone. And at some point, you become such a sizable portion of their business that they have to really negotiate with you. So I think of a meaningful scale as being relative to the size of the vendor. And then also you have to take into account how many of those vendors are identical in the ecosystem. If you have a product you need to source and there's only three people who can provide you that product, chances are you're not going to be able to get very good terms. If there's thousands of them, and there are even regionally more, you might be able to do better.

• 27:59Harry Stebbings?

  Alex, I've so enjoyed the conversation. I do want to dive into my favorite element, though, being the quickfire round. So I say a short statement, and then you give me your immediate thoughts. Sixty seconds per one. Are you strapped in and ready?

• 28:10Speaker 02

  I am strapped in.

• 28:11Harry Stebbings?

  So, favorite book and why? What's on the next flight for me?

• 28:14Speaker 02

  Oh, boy. I don't know if you'd want to read this on a flight, but you'd have to read through it.

• 28:17Harry Stebbings?

  Air crash investigation.

• 28:19Speaker 02

  But I, you know, I always think back to a course I took in college where we studied The Divine Comedy for an entire semester. And it was a real luxury being able to read a single book in that level of depth. And, you know, it's hard to sum up why it made such an impression for me. I've always been drawn to epic stories. And this is the template for nearly every journey of redemption that has come after it, and feeds into so much of popular culture. But it's also this intellectual tapestry that has incredible breadth of meaning. Everything from political to religious, historical, allegorical, even just gossip. It's an incredible thing. You reread it. Every time you do, you learn something new. But in addition to that, it's not just the intellectual side. It's the stories that he tells, in particular

• 28:59Speaker 02

  in Inferno, really resonate in their beauty and pathos. People like Oogalino, Ulysses, Paulo and Francesca, there's just amazing stuff in there. So maybe if you're flying on one of those sixteen, seventeen hour flights, you might be able to crack one of these things, but.

• 29:13Harry Stebbings?

  I'm coming to SF soon, so I look forward to tweeting you a photo of me reading it. But then a question from Nicole. Why did you decide to start the newsletter that I love so much? What are the benefits?

• 29:25Speaker 02

  Well, thanks for mentioning it. Brief plug, it's Drinking From The Fire Hose. It's on tinyletter.com/atausick. But my newsletter, you know, I started about a year ago, and I just, I was getting frustrated with the state of discussion on social media, I guess is what I was saying. I wanted a place where I could, I could speak in longer sentences, and I could explore issues in greater depth, and frankly, have a chance to own my audience, and talk directly to them and get feedback directly from them. So that was the main thing. But also, as you know, you're creating content multiple times a week. I think the more you do it, the better you get at it. And for me, a goal of mine's always been to become a better writer. They don't teach you to write super well when you study physics. So this has been my excuse to force myself to write better.

• 30:04Harry Stebbings?

  No, and seriously, it is. Absolutely, my favorite. But what about MBAs? Why do MBAs make good hires and investments?

• 30:11Speaker 02

  So I'm not sure. I wrote this post a little while ago. There was sort of a response to something Paul Grant had said on Twitter, which was that effectively MBAs don't start companies. And it's just patently not true. And I'm not sure an MBA really qualifies you for anything specific, but the counterargument that an MBA disqualifies you from participating meaningfully in the startup ecosystem is just not true. And there's actually, just in my class in business school, Harvard Business School, 2009, you had Rent the Runway, Thredup, Cloudflare, and Tough Mudder. Years later, you had Stitch Fix. You had Birchbox Blue Apron in a prior year. You can go down the list. There's many tens of billions of dollars of market capitalization that's been created just in the last 10 years from MBAs. We certainly enjoy working with them, both as investors and back into them as founders.

• 30:56Harry Stebbings?

  God, that'd be a nice index to be in. That's incredible. A question from Barry Eggers. Why do your partners call you Clark Kent?

• 31:04Speaker 02

  That's the first time I've heard that. I guess they don't say it to my face. Maybe because I've told them not to spill the beans on my secret identity.

• 31:13Harry Stebbings?

  Amazon does more to make the market than destroy it. Agree or disagree?

• 31:17Speaker 02

  I agree with that, actually. And I don't think it's because Amazon helps startups. They certainly don't really do much for startups, but they have weakened the traditional retailers. I think they've made it easier for startups to scale faster and take market share away from those legacy players. But still, remember, Amazon's not doing anyone any favors. I just think they're focused on very few startups in reality, despite the fact that people talk about that. Oh, is Amazon going to disrupt you? They're really not focused on startups. They're focused on Kroger and CBS. Like, those are the people they care about because the numbers are just so much bigger.

• 31:46Harry Stebbings?

  No, I couldn't agree more. And then let's finish today on your most recent investment and why you said yes, Alex.

• 31:51Speaker 02

  My most recent investment is a company called Daily Harvest, based in New York. It's a subscription service that delivers superfoods to your freezer. They're fundamentally reinventing a huge category of consumer purchasing, which is frozen food for the millennial consumer, and even expanding what people think about when they think about frozen, reinventing categories of food that can be delivered through frozen. The thing that we loved about it was that it's kind of unintuitive, but frozen has some Inherent advantages over fresh food, namely the operations of manufacturing are more similar to consumer packaged goods than the complex cooking operations you might find inside of a blue apron or a freshly. Moreover, customers who don't consume a meal, they can just stick it back in the freezer and eat it weeks later. So a combination of these two factors means you have higher customer retention, higher margins, and generally a more scalable business.

• 32:36Speaker 02

  The result of that was that when we met the company, it was growing faster than almost any we'd seen, and only a fraction of the capital. So we just knew we had to be involved and help the founder, Rachel George, retake her business to the next level.

• 32:47Harry Stebbings?

  Well, Alex, if you couldn't tell from my extremely excited English voice, I've so enjoyed Stacey's interview. So thank you so much for joining me, Stacey.

• 32:53Speaker 02

  My pleasure. Thank you so much for having me. I always enjoy listening to you. And now it's great to have this conversation.

• 33:01Harry Stebbings?

  I do just want to take a minute to say a huge thank you to Alex for all he's done for me. He really has been so kind, both for me and the show. And you must check out his newsletter, Drinking From The Firehose. And you can also find him on Twitter, at A Towsey. Likewise, the links for the newsletter is in the show notes. We'd also love to see you behind the scenes here at the 20 Minute VC. You can find us on Instagram, at H Stebbings 1996, with two Bs. It'd be great to see you there. But before we leave you today, what are we without a great night's sleep? And that's where Lisa comes in. Lisa is the Warby Parker or Tom Shoes of the mattress industry. They've done away with the terrible mattress showroom buying experience by creating this luxury premium foam mattress that's ordered completely online and shipped for free to your doorstep. The 10-inch mattress comes in all sizes and is engineered with three unique foam layers for a universal

• 33:46Harry Stebbings?

  adaptive feel, including two inches of memory foam and two inches of a really cool latex foam called Avena, designed to keep you cool. All Leesa mattresses are 100% US or UK made, and for every 10 mattresses they sell, they donate one to a shelter. So go to leesa.com for your perfect night's sleep. And if you're like me and lose sleep worrying about the quality of conference calls and communicating remotely, then check out Zoom, the fastest growing video and web conferencing service, providing one consistent enterprise experience that allows you to engage in an array of activities, including video meetings and webinars, collaboration-enabled conference rooms, and persistent chat, all in one easy platform. Plus, it's the easiest solution to manage, scale, and use. And has the most straightforward, affordable pricing. Don't take our word for it though.

• 34:29Harry Stebbings?

  Zoom is the top rated conferencing app across various user review sites, including G2 Crowd and Trust Radius. And you can sign up for a free account, not a trial, just visit zoom.us. As always, a huge thank you for tuning in and we cannot wait to bring you Founders Friday with Mike at Top Hat.