Instacart: analysis of a startup

InstacartInstacart is a seed-stage startup that delivers groceries and other basic items in a very short timeframe. They are the “Amazon.com with a 1 hour delivery.” At the moment their current market is only San Francisco and the Silicon Valley area. Customers can place either a 3-hour order ($3.99) or a 1-hour order ($14.99).  Orders are routed to shoppers who work for Instacart, who then pick up the items at a local store and deliver them within the timeframe.

In October they raised $2.3 million from Canaan Partners and Khosla Ventures. Below is a  a very brief analysis if I were considering a potential investment in Instacart.

Quick analysis

So basically Instacart uses software (algorithms & data analysis on the back-end, with good UI design on the front-end) to connect “deliverers” in need of cash with “buyers” who need quick delivery of basic items.

Opportunity: arbitraging the demand for instant satisfaction and convenience, using software + crowdsourcing. This will be disrupting convenience stores on the low-end, and potentially grocery stores in the future. It is taking advantage of the trends in mobile computing, data analysis, and e-commerce (willingness to trust online vendors).

Potential moatsbrand habit developed through repeated purchases. Learning curve — should remain ahead of competition on the learning curve because of technology (software) advantage. This is a business where it pays to have lots of data on: customer habits, traffic, prices, store traffic, etc. It is a virtuous circle: the learning curve reinforces customer experience, which improves the brand. These advantages are all geographically local, so it will be best to roll out to new cities as quickly as possible once the kinks are worked out.

Management: with only doing minimal due diligence with public information on the founders, I didn’t see any red flags. Apoorva Mehta has worked on the Amazon supply chain, so he has some experience in the business. All founders on the surface seem to be very talented. What am I looking for? Amar Bhide found that the most important traits for the founders of a typical startup are the dichotomies of: (1) seeking uncertainty while being risk averse; and (2) persevering while being adaptable.

What could go wrong: (1) other cities are not as receptive to the concept; (2) Amazon or other grocery company catches on and preempts their growth in new cities.

Investment edge: structural (not very many participants at this early stage) and psychological (grocery delivery has failed many times in the past, sometimes spectacularly — Webvan — investors are turned off by the concept because of these past failures).

Final note

This seems like a company with a good future ahead of it. That usually makes it a good investment, especially at this stage. I’m not sure what the valuation of the company is at the moment. But for a startup at this stage, the precise valuation you invest at isn’t usually as important as how well the company does (within limits, of course — refer to the internet bubble).

Disclosure: I have no ownership in Instacart.

References:

Crunchbase: Instacart
Mobile first, desktop second…
I Trusted a Total Stranger to Buy My Groceries…
Instacart Bags $2.3M To Become Amazon of Groceries
How Instacart Hacked YC

Why big moats can be bad

Large competitive moats play an important roll in determining the current and future success of a business. Moats are barriers to entry that protect the economic castle—from both new entrants, or expansion by current competitors. So the bigger the moat, the better the business, right? For the current and very near future, yes. But huge competitive advantages can become disadvantages when they lead companies to become complacent about their customers and potential alternatives to their product.

On the one hand, you have Wal-Mart and Coca-Cola—companies where consumer preference plays a large role. Wal-Mart has economies of scale that result in lower costs—probably the biggest competitive advantage in all of retail. But as the old saying goes, “retail is detail” and they still have to work hard to get the customer experience right (at least for their price point). If they don’t, competitors like Target and the dollar stores are more than willing to pick up new business.

Coca-Cola also has seemingly large advantages: a powerful brand name due to strong consumer habit and share of mind, plus large economies of scale in global marketing and distribution. Coca-Cola-owned brands account for 3% of every beverage consumed in the world today. But consumer preference still drives this market share, and a single slip-up (like this) can drive customers to the also-dominate #2 in the market, Pepsi.

On the other hand, you have companies with extremely wide moats like Microsoft and Ebay. They essentially have a lock on most of their customers because of high switching costs or strong network effects. Ten years ago, if you used their products and wanted to switch, it would be very difficult. Among other reasons, I think that led them to skimp on product quality and customer experience. There were product updates and improvements, but little innovation compared to alternatives. Why upset the apple cart when people are essentially forced to use your product?

The details matter!

Having a powerful lock on customers can lull companies into complacency. By the time they realize customers  have a good alternative or their business model is being disrupted, it may be too late. For companies who have big competitors or have to constantly cater to customers, it’s easier not to fall into that trap. So if you have the luxury of running or investing in a business with a strong lock on its customer base, remember to sweat the details. Customers will always eventually have an alternative.

Generalists vs. Specialists (And the Specialist’s Dilemma)

In December of last year, I gave a presentation to a group of investors on the mental models of robustness and generalist/specialist species. Below are some of my findings, along with how these models can be applied to business and investing.

Animal species reside on a scale with “generalist” on one end and “specialist” on the other. Specialists can live only in a narrow range of conditions: diet, climate, camouflage, etc. Generalists are able to survive a wide variety of conditions and changes in the environment: food, climate, predators, etc.

Specialists thrive when conditions are just right. They fulfill a niche and are very effective at competing with other organisms. They have good mechanisms for coping with “known” risks. But when the specific conditions change, they are much more likely to go extinct. Generalists respond much better to changes/uncertainty. These species usually survive for very long periods because they deal with unanticipated risks better. They have very coarse behavior: eat any food available, survive in many climates, use a simple mechanism to defend a wide range of predators, etc. But unlike specialists they don’t maximize their current environment, because they don’t fill a niche where they could be more successful. It’s tough being a generalist—there’s more competition.

An environment with more competition breeds more specialists. Rainforests have huge diversity and competition, and therefore many specialist species.

Continue reading “Generalists vs. Specialists (And the Specialist’s Dilemma)”

On Wal-Mart Stores Inc.

The following is a writeup I did for Wal-Mart on Sum Zero, included in its entirety below. Also at the end of the post are some charts that show how Wal-Mart has evolved over time. There is no doubt that Sam Walton and Wal-Mart are one of the, if not the greatest success story over the past 50 years. So it’s a great case study to take a look at. (I believe Warren Buffett once said that his greatest error of omission was not investing in Wal-Mart, a business he could understand very well, in its early days–which is clearly seen in the charts below.)


WalmartWal-Mart is often listed as a cheap large-cap, but is owned by surprisingly few value investors. One reason is that it’s big and well scrutinized and hence its price is more “efficient.”  This is partly true, and you won’t get stellar returns investing in Wal-Mart. But it is a cheap, well-managed company that returns cash to shareholders and should fare well under a number of different macro scenarios.

Competitive Advantages

The U.S. stores division of Wal-Mart (about 3/4 of pre-tax profit) has significant competitive advantages. To consumers, Wal-Mart’s brand represents one thing: low prices. Customers in the vicinity of a Wal-Mart remain loyal because they can be certain that they will have the lowest prices. And as long as Wal-Mart doesn’t slack off in the service and facility departments, there will be no good reason for customers to switch.

Wal-Mart can have the lowest prices because of their (1) efficient operations and (2) economies of scale. Operationally, expenses are lower because of their non-unionized workforce and other shrewd cost management (shrinkage, inbound logistics, etc.). This penny-pinching mentality has been ingrained in the company since it was founded by Sam Walton. The biggest cost advantages are from Wal-Mart’s economies of scale. The most obvious consequence is purchasing power—Wal-Mart can buy products at lower prices because they can purchase in such enormous quantities. But the biggest and most un-replicable scale advantage is geographic concentration. Wal-Mart has a “hub and spoke” system of a distribution centers with 100-150 stores around them, all within about a day’s drive. Because of this concentration, costs can be distributed over a larger base of potential customers: distribution, advertising, regional management, etc. Wal-Mart also has some of the most technologically advanced merchandise and logistics systems in the world. This is something that smaller or more spread-out retailers can’t match. Continue reading “On Wal-Mart Stores Inc.”

Pyramids vs. Skyscrapers

Insight: When looking at a company, what type of building is it?

Large companies (with competitive advantages) can be pyramids or skyscrapers. Both are large and have commanding presences. Both have high returns.

Pyramids are strong — you can’t knock them over. Skyscrapers are tall and strong, but they can be knocked over much easier. For a pyramid to be destroyed, it must start at the top, and slowly erode over time. After a while, only the foundation will be left. With a skyscraper, the foundation can be destroyed first, and the rest of the company will go with it.

Wal-Mart is a pyramid. Google is a skyscraper (for now — it seems that Larry & Sergey are in the process of building the foundation up). Berkshire Hathaway is a pyramid. Newspapers were pyramids — however, over the last two decades, they have been slowly chipped away starting from the top. Now, the foundation is about all that’s left.

Skyscrapers can be turned into pyramids over time.  But that requires great management and somewhat favorable circumstances. The time it took to build a company doesn’t necessarily tell you what type of building it is.

You can combine this analogy with Buffett’s moat analogy. Moats are barriers to entry — the wider the moat, the harder it is for competitors and disruptive technology to affect the company. But if the moat can be crossed, you’d much rather have a pyramid than a skyscraper.

Buffett on Franchises

Warren Buffett talks a lot about competitive moats and franchises. However, I think he most succinctly describes his entire philosophy in this short passage:

An economic franchise arises from a product or service that: (1) is needed or desired; (2) is thought by its customers to have no close substitute and; (3) is not subject to price regulation. The existence of all three conditions will be demonstrated by a company’s ability to regularly price its product or service aggressively and thereby to earn high rates of return on capital. Moreover, franchises can tolerate mis-management. Inept managers may diminish a franchise’s profitability, but they cannot inflict mortal damage.

In contrast, “a business” earns exceptional profits only if it is the low-cost operator or if supply of its product or service is tight. Tightness in supply usually does not last long. With superior management, a company may maintain its status as a low-cost operator for a much longer time, but even then unceasingly faces the possibility of competitive attack. And a business, unlike a franchise, can be killed by poor management. [From the 1991 Berkshire annual report]

The first sentence basically lays out—in only a few words—the definition of a competitive advantage. So a company can be either a franchise or a business. But the separation between the two doesn’t have to be that clear cut.

Some franchises can be much more lucrative and powerful than others. Both Coca-Cola and Pepsi have moats, but Coke has the upper hand when it comes to customer mindshare. Because of this, Coke has always maintained higher worldwide and domestic market share than Pepsi.

Some companies can have both qualities: they are in extremely competitive industries (where lowest-cost wins), but also share some of the benefits of a franchise. The sit-down restaurant business is extremely difficult to operate in—but chains like In-N-Out and Steak ‘n Shake have created a brand that holds a special place in the minds of customers.

One more thing: I think when Buffett talks about mis-management, he really means short-term mis-management. A long period of poor management can have significant impact on any franchise—even one like Coca-Cola. And even with a strong economic franchise, every investment needs to be monitored just in case the moat starts to shrink (like newspapers over the last few decades).