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VC’s investing knowledge and operating experience is considered as valuable as their capital. In addition to their operating savvy, VCs now need to develop a strong brand-building experience.
Here is why.
In the past decade, there has been an economic reorientation towards social, cultural, and environmental value of goods. A product like cookware or a plant is never just a cookware or a plant: it’s a conduit for creativity, community, aesthetic pleasure, or a way to minimize environmental impact. When they buy a plate or a dress, consumers signal a lifestyle. When they sell a plate or a dress, sellers signal their worldview. Both sides are looking to impart value signaling into the exchange of goods. A two-track consumption pattern emerged: a) mass consumption of standardized products, and b) considered consumption of signaling products.
A lot of VC funds invest in the latter. Their portfolios are increasingly dominated by innovative consumer goods, travel and hospitality, beauty and care, banking services, and apparel. Despite being differentiated versus mass produced goods, these new products and services are often mutually replaceable. Almost 60 percent of consumers in 90 percent of categories switch when considering a new purchase. To survive and grow, a company needs to make sure that they are part of consumers’ initial consideration set (the set of brands that first come to mind when they are looking to buy something). If it makes it into initial consideration, a company is two times more likely to be purchased than a company that is considered later in the decision journey. This trend only gets amplified with the market share growth.
To become part of the initial consideration set, a company needs to be able to command awareness, but also convey what it stands for: its purpose and promise and values. For example, Nike and Apple offer product innovation and differentiated consumer experience. To evoke a specific meaning through its products, services, and experiences, a company needs to become a brand.
By default, a startup has no brand at launch. VC money comes at the moment when a company commercializes its innovation. When they invest in a company, VCs treat it and manage it as an asset. They seek to maximize growth in the shortest period of time and reduce cost. They rely on customer acquisition versus organic growth. Marketing spend is an operating expense instead of an investment (percentage of sales). Venture money also flows to companies in high-growth industries. This kind of rapid-growth operating model makes any company look good in the short-term, and reflects compressed time horizons that venture capital operates on (8-10 years). During the period of accelerated growth, capital is invested in a company’s balance sheet and infrastructure required to grow the business until it reaches a certain size so it can be sold or filed for IPO.
Beyond tech, this model doesn’t work.
Non-tech assets are easily commodified. The US Department of Labor estimates that only half of small businesses survive after five years. With each additional year, it further decreases to 20 percent. The situation is even more dire when it comes to startup investment by venture capital funds. The high failure rate and mediocre median returns of the VC industry ask for a new approach. At the moment, the majority of a fund’s return is generated by a few superstar companies in their portfolio. At the same time, fund managers spend most of their time on average performers.
Turning startups from assets into brands can improve odds of a portfolio success. Research shows that strong brands outperform the market. The world’s 40 strongest brands give almost double return to shareholders of an investment over the course of 20 years ending in 2019. Companies that invested in their brands marked 67 percent above-average organic revenue growth and 70 percent above average total return to shareholders.
Turning a company into a brand increases its value through:
Expanding the Size of Addressable Market. Brand builds awareness for a company beyond its target audience, hopefully propelling it in the domain of culture and increasing its chances to be part of the consumers’ initial consideration set. Through its brand promise and brand values, a company can reach customers who ordinarily wouldn’t consider its products.
De-Risking the Business. Brand de-risks the business in two ways. It builds customer proximity through qualitative and quantitative data and insights and keeps the company laser-focused on its audience. This laser-focus on the customer increases the chances that brand actions, new products, and services will be a success. Second, having a shared purpose and values creates alignment between an internal culture and the brand. Without this alignment, a company doesn’t have a brand, it has a custom font. Further, having an internal culture that prioritizes diversity, equality, creativity, and innovation is at least risk to spectacularly implode and become a PR disaster fodder than the one that prioritizes relentless and fast-paced growth (ask The Wing and Away).
Long-Term Differentiation. A brand increases the product value by adding the emotional resonance and the symbolic dimension to it. Consumers are not buying products, they are buying stories. Once they buy into a point of view, a set of values, and a lifestyle, consumers are less likely to treat a product as an interchangeable commodity, and more likely to be loyal to the brand.
Strategic Growth. Brand clarifies decision-making criteria. It guides new growth opportunities, product development, operations, and communication. A company that can evaluate whether a specific business action or investment moves it closer to its vision, whether it is true to who it is as a brand, and whether it reflects its values can go faster and more confidently than its peers.
Price and Market Share Protection. Brand is directly correlated with financial performance. Companies that have a clear brand purpose achieve double brand-value growth than companies that are focused purely on profit generation. Brand equity protects product price, as customers are not waiting for discounts and sales in order to buy a product. It also protects market share by creating a clear differentiation versus the competition.
Building and managing a brand requires the same disciplined management practices as operational excellence. To build this new capability, a fund can expand its operational savvy beyond its focus on rapid scaling and responding to market demand to include brand management. It can also pair operational and marketing excellence.
VC funds that combine operational and brand-building capability will outperform their peers. Once they start to manage their portfolio of companies as brands, they will allocate resources and make decisions differently. Brands are managed in a way that maximizes their value and relevance over time. This will expand a fund’s usual VC ROI timeline, but it will be rewarded by higher overall ROI, higher profitability of its brands, and lower chances of PR disasters and failed IPOs.
The chart is from McKinsey’s report, “The Future of Brand Strategy: It’s Time to Go Electric.”
We should all be cancelled. In a mad rush last week to cancel seemingly everyone, well-deserved and less well-deserved, we seem to have forgotten that the reasons behind these cancellations are hardly new or surprising. We all knew about inequality or mistreatment or rotten company cultures for months - even years - and we did nothing. Our past collective silence makes us all complicit, and the fact that we are now outdoing each other in virtue signaling and “who is more woke” race is not going to change that. A few high-profile “sacrifices” should not be a pass for all of us to go back to “normal.” Rather than feverishly cancelling others, we should look at our own misses when it comes to enforcing equality and diversity, cancel ourselves, and course-correct in a long-term and brutally honest way.