Commerce businesses are notoriously difficult for a number of reasons.  Multiples in this category are usually pretty low, due to low margins, capital intensity, and competitive rivalry.  Also, Amazon has made it such that consumers are accustomed to fast, free shipping, great service, free returns, and other things that are super costly to deliver on (and certainly tough to deliver on better than Amazon).  Some companies may be able to escape this sort of valuation pressure for some time, but most companies end up coming down to earth eventually. And sometimes, coming down to earth happens in dramatic fashion, as was the case with companies like Fab, One Kings Lane, Nastygal, and maybe some others out there right now.

When thinking about commerce businesses, I find it helpful to ask the following question. Is this company sending boxes of stuff, or are they sending a conveyer belt?

Box companies struggle to keep customers engaged and buying from the company over time. Conveyer belts happen when consumers assume they will be getting a box from the company, and so look for more stuff to put in. Companies that send boxes of stuff have retention curves that show customers getting less and less valuable over time. Conveyer belts show customers that maintain value, or might even become more valuable.

This is very different from subscription commerce, by the way. Amazon is the ultimate conveyor belt. I can guarantee that in a given month, we will get several boxes from Amazon. The longer I’ve been a customer, the more I’ve spent with them each quarter. I’m sure this is true for many many prime customers.  And Amazon is not a subscription box business.

Conversely, I know subscription commerce companies that look nothing like this. The subscription piece is more of a novelty, but the vast majority of customers completely churn within half a year. The subscription was a hook, but never helped the company become a conveyor belt.

My observation is that companies that have a shot at becoming conveyor belts are ones that are quickly able to win a high % of a household’s spend in a particular category.  Our portfolio company Grove exhibits this characteristic. Many of their customers buy most of their household and personal care goods from them, and so we see customers that increase in value over time. The thinking goes, “I already buy my X and Y from them, so maybe I should really be buying Z from them too.”  The company is also insanely good at finding these customers too, so they don’t waste customer acquisition dollars on the wrong customers.  This is why I think our portfolio company Dia&Co is particularly special as well, because the plus size market segment is so poorly served by traditional brands and retail that they become THE way their customers shop the apparel category.

Conversely, companies that do not represent a big share of spend in a category are always on the bubble. There ends up being more scrutiny about price, quality, substitutes, or just more experimentation overall. The customer is often in a situation where they run into competing products elsewhere, so it’s tough to keep them loyal and happy for a long time.

One of the best examples of this is the online pet food retailer Chewy (full disclosure, my wife serves as an advisor to the company and we are happy customers). They sell consumables that we pretty much keep ordering again and again for our two cats.  The company has eaten (pun intended) 100% of our household spend on pet food and cat litter, and will likely also represent nearly 100% of any other pet related purchases in the months and years to come. They are our pet conveyor belt.

The beauty of conveyor belts is that the benefits will continue to compound over time. Conveyor belts end up having more opportunities to delight their customers. They are willing and able to invest more in service. They are in a better position to sell private label brands and improve margins. They don’t need to run frequent promotions or offer deep discounts. They can move into adjacent product categories with a huge installed base of customers. It’s a really beautiful thing.

The problem is that most households will only have so many conveyor belts. For a long time, Amazon looked like the only one. But a few others seem to be emerging, with conveyor belts that are specifically tuned to their particular vertical. These companies build long term moats through competition crushing execution.  They may not be the sexiest businesses that grab all the headlines, but they are the ones that will capture most of the value in the commerce category.