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The Naked Truth About Subscription Start-Ups: The Good, The Bad & The Scams

The Naked Truth About Subscription Start-Ups: The Good, The Bad & The Scams

[Opinions held by the contributor do not necessarily reflect the opinions of OS Fashion and its members.]

Is there a fundamental flaw in the application of the subscription model to consumer commerce start-ups with physical goods like fashion and CPG (consumer packaged goods) companies? There are some terrific consumer companies like Netflix and Spotify that have proved the viability of subscription models. They have innovative ideas. They create something that people want like streaming movies and music. They disrupt old-fashioned ways of doing things like having to physically go into Blockbuster to rent movies. They created markets and trends, instead of chasing the trend. But when start-ups apply this model without innovative products and branding, they sometimes rely on scams to lure customers and smoke and mirrors style PR to lead people to believe that their company is successful. In fact, you can even argue that most (with a few exceptions) consumer subscription models with physical products are flawed and unnecessary.

Initially subscriptions became popular among VCs because a subscription implied predictable, recurring revenue. Recurring revenue software businesses tend to have better valuation multiples. However, consumer commerce subscriptions with physical products generally should not. The problem is that many of these well funded subscription start-ups engage in deceptive customer acquisition, lack focus on retention and branding, and partake in poor business practices.

 

Just last week, the Science incubator in Los Angeles launched yet another subscription start-up, a company called ELLIE. It offers workout clothes for women with a monthly subscription service. Seriously, who buys workout clothes every month?  I wonder what the people at Science do with their clothes every month. Throw them away? Don’t they do laundry like the rest of us?

Science start-ups have one thing in common: an aggressive emphasis on paid and socially-driven customer acquisition. To build a customer base quickly, ELLIE reportedly engaged in deceptive bait and switch tactics that are downright shocking and unprofessional. Prior to launching ELLIE, the founders launched a company called PvBody which offered customers two pieces of designer fitness apparel from brands like Lululemon, Nike and Under Armour for $39.99 a month. PvBody even offered a 40% promotion via popular fitness blogs like SarahFit.com to lure customers. Over 70 of Sarah Fit’s readers who signed up for the promotion complained about their less than stellar experience: everyone got a notification that PvBody was not going to be sending out the designer brands they promised , but their own brand named ELLIE.

Now, PvBody has been rebranded as ELLIE. ELLIE used the clout of leading brands like Lululemon and Nike to deceptively acquire subscribers while promising those brands instead of its own. These alleged bait and switch tactics – sometimes known as  fraudulent conveyance — were used to create “traction” for ELLIE prior to the brand’s launch. Ironically, ELLIE’s scam was rewarded with $2M from three venture capital  funds. (For more information about ELLIE’s bait and switch scam, read posts at: Complaint ListThe Purple Giraffe and Marathon Lar.)

According to a recent Venture Beat article, “the lack of highly sophisticated tech is becoming part of the Science blueprint.”  Well, Science start-ups don’t have sophisticated branding or product either. Their strategy has been to focus on unnecessary subscription start-ups with vanity customer acquisition proof points. This does not work since a subscription model isn’t a guarantee for long-term recurring revenue or customer retention.  In the case of the Science portfolio company Dollar Shave Club, which raised $9.8M on an exceptionally healthy $30M pre-money valuation in their most recent round, it experienced impressive but very fleeting traction after their extensive paid customer acquisition efforts. Paid customer acquisition is useless if your brand and products cannot retain the customer. Customers will not engage or purchase after being acquired. Good brands and products are capable of organic growth with monthly churn under 4%. Good content and branding make a brand sticky. Retargeting makes a brand stickier. When you have exceptional branding, product and content, customers will discover you.  Then the focus shifts to customer retention.

 

Just as Science’s Dollar Shave Club and Wittlebee don’t solve any problems or offer anything new, Ellie does not either. If someone is merely looking for Lululemon- style activewear at a lower price point, there are plenty of online retailers that offer lower priced workout-wear such as H&M, Gap, Athleta, even Target. Unless new start-ups are offering great products, prices and experiences, they shouldn’t even bother to try to compete with established big brands or e-tailers. What problem are they solving? What is their point of difference? Are they making the process easier? Plenty of online retailers are offering lower prices.

Subscriptions only work when the price, product, quality and user experience are great. If there is a product mix, it must be personalized or expertly curated, not random. Beauty subscription companies have a hard time satisfying customers with their one-size-fits all (non-personalized) boxes of sample products due to different skin types, customer preferences in color cosmetics and fragrance. Following the success of New Beauty & Beautylish, companies like Birchbox are now focused on content and eCommerce. New Beauty’s Test Tube,  the original beauty sample subscription company which launched in 2005 (well before Birchbox’s launch in 2010), works because of its targeted focus on high performance and efficacious luxury skincare and haircare products; every month you get some of the hottest new products coupled with the latest issue of New Beauty magazine, an industry authority. Since they aren’t offering random color cosmetics or fragrances, color and scent preferences aren’t an issue and there’s a higher probability of satisfying the customer.

Birchbox’s beauty and greatest vice is that they don’t pay for products from brands. Although Birchbox, which received $11.9M in venture funding, clearly has the cash to pay for the products, it engages in dangerous business practices which jeopardize the long-term viability of their core business model.  I recently interviewed Suk Chan the founder and CEO of Soukenberi, an eco-friendly home fragrance and bodycare brand.  Ms. Chan said, “Birchbox requested 300,000 units of a product for free; in return, they said that could offer a conservative purchase order of 400 units for that product if it was received well by their sampling audience.” Birchbox also requested a special sample size, which Ms. Chan would need to create, that would yield at least 3 uses of the product. After Ms. Chan negotiated with them, they lowered the amount of requested free product to 75,000 and then to 50,000 units (for a more targeted customer base). Birchbox only wanted to pay for a purchase order of 400 units after receiving 50,000 units for free. Ms. Chan decided not to do business with them since it was clear she wouldn’t get even a 1% return. Beyond a very conservative purchase order, Birchbox cannot quantify a significant return to brands despite their huge subscriber base. This is a flawed, inequitable method of doing business with brands since it puts many brands in financial jeopardy. Having a large subscriber base doesn’t necessarily yield a successful business. A successful business invests in its supplier ecosystem, it doesn’t destroy it.

 

The sad truth is most subscription companies are NOT doing anything special and are just adding unnecessary clutter to the ecosystem and our mailboxes.  That’s not to say that I don’t like any subscription models.  Three fabulous consumer commerce companies with subscriptions that make sense are Barkbox, NatureBox and Lacquerous whose visions go far beyond their initial consumer-facing product.

Lacquerous is the Netflix for luxury nail polish. It offers a 3 nail luxury polishes that are on trend for $18/month which is less than the cost of 1 bottle of luxury nail polish. It’s an affordable option for women who want to experience trendy new colors from luxury brands while spending a fraction of the cost. There is no other way to do this; Lacquerous is definitely innovative and disruptive. Although they just launched a month and a half ago, they are overwhelmed with customers; at the moment, there are 5,000 people on their waiting list to become new Lacquerous members. Why does it work? Nail polish is one of the hottest consumer commerce categories right now. Customers want to discover the trendiest luxury nail polishes at a discount. Lacquerous offers nail polishes from the most premium brands like Tom Ford, Chanel and NARS.  The products are on trend (focused curation), and, more importantly, its customers can choose the colors they want (personalization). It’s a business model that is a WIN for the Lacquerous team, the brands that they work with and its customers.

It’s trickier to apply the subscription model to fashion and consumer packaged goods start-ups. While many tech start-ups end up sacrificing their EBITDA to pursue future growth, future growth is often less obvious with some consumer commerce start-ups.  Where can you go next if you’re Dollar Shave? For a consumer commerce subscription to work: 1) the business model must be viable, and 2) the brand, product and price must be really compelling and perhaps even addictive. It should make life easier, solve a problem or create a new market. In the case of superstar subscription companies like Spotify, they initially earned their subscribers via freemium offerings and then turned many of them into paid subscribers. They succeed because they keep evolving and creating new markets and trends. That should be the goal of every start-up!

NOTE: All l the information in this article was compiled from public information and articles online which are hyperlinked except for one interview I had with Suk Chan, Founder of Soukenberi.

Previously by Sindhya:
My Break Up Letter to (Some) VCs
VCs Think My Boobs Need An Algorithm

Original header image provided by Lacquerous.

Posted in: Vision & Opinion

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My Breakup Letter To (Some) VCs

My Breakup Letter To (Some) VCs

[Opinions held by the contributor do not necessarily reflect the opinions of OS Fashion and its members.]

“The game taught me the game. And it didn’t spare the rod while teaching.”  - Jesse Livermore

There’s a new bully in town. And I guess that’s me at least according to a VC who emailed me last week to complain about my blog post. He wrote that it was unfair of me to write such an article. He even told me that I should delete it and all the tweets related to it. I can’t do that. There are just way too many tweets about it that aren’t even mine. The post trended on Hacker News, got over 50,000 uniques and blew away the peak of the domain. A few publications even asked if they could republish it or do a story on me. When I wrote it, I wasn’t worried about it creating polarity because the article wasn’t about VCs in an absolute context. Not all VCs engage in cronyism, invest in stupid startups or perform shallow assessments of start-ups. Moreover, I doubt that smart VCs with balls – the ones I want to partner with – would be even mildly bothered by my last blog post; they are smart enough to use this as an opportunity to really stand out during this Series A Crunch while most other VCs are running away from consumer investments.

At the risk of sounding like a bitchy girlfriend during a breakup, I’d like to tell you that the problem is you, not me. It really is you. In fact, I’d like to propose my issues and solutions for you VCs who are screwing up the start-up ecosystem. There are five primary issues:

  1. Your treatment of non-crony founders
  2. Your obvious lack of guidance
  3. Your herd mentality
  4. Your lack of domain expertise (and)
  5. Your flawed method of assessing consumer start-ups.

VCs who rely on old school-hustle and instinct cannot deliver sufficient returns anymore. Today’s VCs need to grow a pair, gain vision, get domain expertise and adapt their methodologies.

Treatment of Non-Crony Founders
Often non-crony founders are treated like desperate street beggars. Not all non-crony founders are crazy for seeking a Seed or Series A investment from VCs. Founders with compelling business models and domain expertise should be treated with respect and viewed as potential partnership opportunities to build a business and make money. Often VCs pass on these founders without even seeing or hearing a pitch. Check to see if there is a link between the founder’s start-up and his or her background and education. Is the founder an industry superstar? Does the founder have domain expertise relevant to her start-up? If so, it is probably worthwhile to explore the opportunity. Even if you don’t end up investing in his or her start-up, you can connect with an industry superstar or someone with a lot of domain expertise.

Lack of Guidance
Start-up funding shouldn’t be a charitable donation for cronies. It should be about making an investment with returns. When I asked some of the VCs who invested in the start-ups mentioned in my last post, they immediately mentioned that the founders were friends of theirs – no other reason. When a business model isn’t compelling, should friendship be a safety net? Being a crony and having a compelling business model are not mutually exclusive. Can’t VCs find real charities to donate to? How can you let start-ups with flawed business models launch? It’s like letting a friend drive drunk. At least sober him up. At least VCs could help these crony founders come up with a proper business model or help them create a better team. If they are real friends with the founder, they should properly guide him or her and give honest, constructive feedback. At least that way they wouldn’t be wasting their LP’s money.

Isn’t the professional relationship between two co-founders important too? In my last post, one of the start-ups that I mentioned is suffering because the founders broke up after working together less than 6 months. I’m not surprised since they barely knew each other when their company launched.

Herd Mentality
The start-up ecosystem is like junior high. There are a few cool cliques that everyone wants to follow, trends are created by them, and the net effect is a herd mentality. A few VC funds are deemed cool and when they lead a first round of funding, they attract a herd of others. Meanwhile, some VCs will follow and fund any start-up that already that has a committed VC. Often it’s a case of the blind leading the blind, particularly when the leading VC doesn’t go over the business model. Regardless, other VCs follow like flies buzzing around curdled milk in a bowl of Series A Crunch Cereal. Except they are VCs, and there’s no upside to investing in a crappy start-up. If they want to give to a charity, try Charity Water.

A lot of VCs don’t have balls. Just as big balls are an absolute must for a successful entrepreneur, they are absolutely necessary for VCs. Having balls is more than aggression and risk taking, it is the ability to dare to “THINK DIFFERENT,” the desire to build something from scratch, not listen to the peanut gallery and develop independent thoughts. It takes effort and vision, let’s face it-– it’s hard. Maybe the reason why many VCs don’t bother is because they are lazy and blind.

Lack of Domain Expertise
VCs often act like bouncers. Their assessment time of whom to allow “in” is about the same (and as shallow) and lacks domain expertise. Domain expertise can take the form of some or all of the following: deep understanding of the industry, a track record of success in that industry, a history of building superstar products and creating innovations within the sector, and constant self-education. The acquisition of domain expertise is important for (business) survival and definitely for domination. It involves constant evolution and adaptation. Our greatest tool for survival is our ability to think, learn, connect dots and evolve – whether you’re a founder or VC, you have a responsibility to continue to do so. Domain expertise is what separates weak start-ups like Dollar Shave Club and True & Co. from great companies like Nasty Gal, Spanx, and Zappos.

Flawed Method of Assessment
I’ve noticed during my fundraising journey that I prefer VCs who were former bankers or former entrepreneurs. These VCs tend to have vision, balls and domain expertise. The VCs who were former entrepreneurs tend to be more sincere. What I like about bankers is that before making a move, they do research and perform comprehensive competitive analysis in addition to studying industry trends. If they are not experts in the industry, they source the most up-to-date data and research from analysts, pundits and expert networks. VC firms should take a cue from bankers. By contrast, VCs often barely skim a 15-page deck with the least amount of text and most pictures as possible. Heck, Cliff Notes summaries have more meat than the decks VCs like to look at. As a founder of a consumer start-up, I have 2 decks: one for people who understand my industry and one for the VCs who do not.

A new trend in the VC world is that firms are hiring PR firms. Instead of focusing on closing the best deals and making the most money, these VC funds are more preoccupied with their own image while most barely understand “brand” in the consumer world — even though some market themselves as VCs who invest in consumer. Ironic. Instead of worrying about creating their own brand, they should focus on what they are supposed to excel at. Or at least do both, and learn consumer better.

I don’t understand why many VCs hate bankers. Unlike bankers, too many VCs run around town with arrogance and attitude disproportionate to their success. Moreover, VCs often take credit for deals at their firm that they have nothing to do with. Many VCs are clowns, ahem… characters, in the Series A Crunch Clown Show that’s currently playing in Silicon Alley and Silicon Valley. Usually when bankers act arrogant, it’s backed up by a successful record since they are results driven. On the other hand, as Matt Oguz, a venture capitalist and Founding Partner of Palo Alto Venture Science, said, “Traditional VC takes way too much credit for successes, and doesn’t accept its failures.”  It’s time for VCs to grow some balls and take a cue from bankers (several of whom are now launching their own VC funds). If VCs don’t evolve on their own, the game will teach them without sparing the rod. Life is about kicking ass, not kissing ass.

xoxo

Previously by Sindhya:
VCs Think My Boobs Need An Algorithm
Next:
The Naked Truth about Subscription Startups

Original image created by fractured-fairytales.

Posted in: Vision & Opinion

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