Local Heroes: The Public Companies of Tomorrow
A big investor mantra over the past few of years has been “SoMoLo,” an acronym for three megatrends — social, mobile and local. How have these trends been performing for investors?
Social clearly has been delivering huge, as evidenced by the very strong performance of the Facebook, LinkedIn and Twitter IPOs.
Mobile has arrived with a vengeance, with smartphones and tablets already generating more traffic for many consumer online businesses than PCs.
But at this time last year, the bloom looked to be off of the “local” rose, due at least in part to the very poor performance of Groupon as a public stock. It got so bad that a company that I know in the local space, which was looking to raise a round, was told by multiple venture firms to look elsewhere for capital, as they “don’t do local.”
But I’d argue that in the past year, local has flourished as an investment category. A good chunk of the consumer Internet businesses that have gone public of late focus on local, and these businesses have traded strongly as public companies. OpenTable probably opened the door here in 2009, but other high-quality local companies quickly followed suit, including Yelp, Zillow, Trulia, and Angie’s List.
Even Groupon, just last year the poster child of the demise of local, has enjoyed a resurgence, and now sports a market capitalization of $6 billion — a valuation that rivals the price of its oft-ridiculed non-sale to Google a few years back.
When I talk about local here, I’m focusing primarily on technology businesses that power online-to-offline commerce. Typically, they are two-sided marketplaces, with offline local businesses on one side and consumers on the other. They usually roll out on a city-by-city basis, and require a sales effort to sign up small businesses to populate and/or monetize the marketplace.
It’s clear that mobile is helping these local businesses dramatically. The geolocation capability of the smartphone means that the computers all of us are carrying around in our pockets are location-aware. The resulting killer application is “show me information on businesses that are close by to where I am now.” Using OpenTable as an example, “show me which restaurants around me have open tables that I can reserve right now.”
Building a local technology business is not all easy, due to three related features:
- The need to expand by executing a city-by-city rollout. It can be hard enough to make a business work in one market. But once a local tech company has proven out its concept in one market, it then needs to roll it out to multiple cities very rapidly, or risk losing them to competitors or clones. And as the world has gotten flatter, this has become even more challenging, as fledging startups in many international markets scan the globe for businesses to clone in their home region.
The local food-delivery space is an example where no one company has taken their market, at least initially. Multiple businesses have been competing in the U.S., with different companies winning different markets. GrubHub is in the process of rolling up their U.S. competition, having acquired Campusfood and Seamless. And there is an entirely different competitive set of companies in Europe battling it out among each other for market supremacy.
- The need to build up both sides of the two-sided marketplace in each market, aggregating local offline businesses on one side and consumers on the other. And the skills required to build the two sides of the market are typically different, one with a sales motion and the other with a consumer marketing motion.
- A high level of operational complexity that requires armies of people, largely due to the need to sell and service tens or hundreds of thousands of local businesses. For example, Groupon has more than 11,000 employees, and Yelp has almost 2,000, resulting in annual revenue per employee of just above $.2 million and $.1 million, respectively.
As a result of these challenges, building out a national or even a global footprint tends to take a long time, and require a lot of capital:
While building local-focused tech companies can be very challenging, it can also be highly rewarding. Successful businesses in this space tend to have strong “winner-take-all” characteristics that can lead to very strong market positions that tend to endure:
- Winning companies often sport strong (and largely local) network effects. I’ve had the privilege of being involved in a number of network-effects businesses, and none had a stronger network than OpenTable. The more restaurants OpenTable has in a city, the more useful it is to diners. And the more diners in that city use it to make reservations, the more valuable it is to restaurants. In our IPO road show, we made the statement that we believed it was financially irrational for a restaurant to use a different reservation service, even if it was free, as they’d lose access to incremental diners and thus dollars from the OpenTable dining community. This has subsequently been borne out, as a number of aspiring competitors, many giving their service away for free, have come and quickly gone.
- These winning companies also typically achieve scale advantages that are very difficult for aspirants to match. Critical to every two-sided network is signing up local businesses to use your service. The market leader quickly has the largest team recruiting these businesses. Their team is typically the most productive, because of accrued learning as well as the fact that it’s easier to sell the service that boasts the most consumers in its network. New entrants typically suffer both scale and productivity disadvantages, which in turn often result in investor skepticism that creates capital disadvantages.
The chart below, generated by my colleague Sebastian Cua, shows how the market has been valuing these local companies. Public market investors (a lot like venture investors) are paying very strong premiums for growth.
There is a growing pipeline of late-stage private companies that will become the public companies of tomorrow, including Uber, GrubHub, Seamless, MindBody and ZocDoc. And a newer generation of local-focused companies is showing rapid growth, including Homejoy, DogVacay, Lyft, and Belly (the latter two are a16z venture investments). We strongly believe that opportunities in local will continue to spawn great technology companies.
I would argue that the winner-take-all characteristics of local businesses create what investors crave in companies: Strong competitive moats.” Public market investors clearly have developed an appreciation for the moats that surround the public, local-focused tech companies above given their recent stock market performance. And these public market investors are valuing growth above all else.
Jeff Jordan is a partner at Andreessen Horowitz and is on the boards of Airbnb, Belly, Fab, Circle, Crowdtilt, Lookout and Pinterest, as well as Wealthfront and Zoosk. Prior to a16z, Jeff was president and CEO of OpenTable, which he took public in 2009. Before OpenTable, Jeff was president of PayPal, and he was previously the SVP and general manager of eBay North America. Follow him on his blog and on Twitter @jeff_jordan.