The Art and Science of Investing in Consumer Businesses
Interviewing Turner Novak, Founder of Banana Capital, and Purveyor of Dank Memes
Of the billions of humans on social media, few have wielded the powers of audience building to their advantage as uniquely as Turner Novak. The God Father of “VCs being helpful” parlayed his twitter explosion into a successful, and ironic, VC career of his own. As founder of Banana Capital, he’s invested in a slew of iconic companies, many in the social media and ecommerce spaces. You’ve probably heard of some of them - like BeReal, Secureframe, Overtime, and Commonstock.
Underneath the dank memes and sophomoric finger pointing is a thoughtful, well-researched approach to investing in businesses that benefit from economies of scale and differentiated distribution channels.
I jumped at the chance to interview Turner, especially since the internet skews heavily towards coverage of Enterprise SaaS investments. This was a refreshing and illuminating look at how he identifies trends in consumer businesses subject to the influences of network effects. Mores specifically, we covered the following:
TL;DR:
Part I: Metrics for evaluating Ecommerce and Social Network investments
Retention, CAC, and the evolution of unit economics
Vanity metrics in social media businesses
Repurchase rate as a sign of product market fit
Part II: Long Term Durability and Customer Retention
Ad revenue’s staying power
Trend spotting, branding, and B2C signaling
Marketplace saving Facebook
Social networks aging alongside their users
Etsy and Ebay identifying underserved markets
Part III: Acquisitions and TAM Expansion
Snap’s sneaky great acquisition of Bitmoji in 2016
Shopify’s logistics misstep
Could Walmart buy TikTok?
Facebook’s ad network leaning on AI
Part IV: Business models and network effects
Network effects vs economies of scale
Substack’s evolution from a platform to a network
Where Clubhouse went wrong
Part V: Lightening Round
Decision making as a solo capitalist
Favorite memes
Career mind shifts
Check out and subscribe to his newsletter if you haven’t already.
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Part I: Metrics for evaluating Ecommerce and Social Network investments
What are some of the non-traditional metrics you look at for the ecommerce businesses you invest in? Is it still all about revenue growth and net retention?
This isn’t specifically a metric, but a simple thing I always try to do is use the product (or at the very least get as extensive of a demo as I can). There are a lot of things that don’t show up in the metrics, specifically the way the founder / team thinks about the user experience + low hanging fruit to improve said metrics.
As an example, one of my portfolio companies improved their 3-month retention from 27%, to 34%, to 43%, to 78% in the span of three years due to a couple of fairly simple product changes that were clearly going to be impactful if you just used it for a while.
I think using the product also helps for digging deeper into the metrics. Looking at the data room, repurchase rates might be high, but if it’s because the company constantly spams me with discounts and retargeting across the internet, that could impact CAC and margins down the road because retention will probably come down once they stop doing so.
I also look for things that have or could have a high word of mouth. This might also be thought of as the K-factor, which is basically just how many new users the average user or customer acquires for you. Some examples of this might be TikTok’s watermarks being all over Instagram and YouTube videos, or BeReal’s “⚠️ it’s time to BeReal ⚠️” scramble every time the world gets the notification.
On the ecommerce side, I have historically skewed towards companies building their own logistics infrastructure. It doesn’t show up in the metrics (it actually usually hurts them in the beginning) and it’s much harder and more capital intensive. But I think it creates the opportunity for a sustainable competitive advantage over time since you actually gain operating leverage if you pull it off.
If I had to pick, above all other things I generally focus on whatever represents customers or users sticking around over time. And if I had to stack rank, it’s typically something like:
Retention
CAC Payback Period
Growth
I’m also perfectly OK with not-that-great unit economics early on, as long as there’s a clear path to improving them significantly + a lot of upside for taking the risk of that never happening.
What’s an example of a vanity metric that ecommerce or social networks cite that you think people should be wary of? Why?
For me, the worst is any sort of cumulative or total number. Cumulative GMV, total registered users, etc. Anything that isn’t intellectually honest about what the company, product, or business model is or how the company is performing.
There are also times that the metrics a company is using don’t make any sense. For example, MAUs (Monthly Active Users) for something that’s supposed to be a daily, habitual product.
Growth can also be a vanity metric. Expanding on the prior example, pretend you show me five months of MAU’s growing 50% each month. There’s typically 30 days in a month; that’s a lot of time to get people to use your product a single time to juice your MAU number. And the real situation is even worse if you’re spending a lot of money on that growth - looking at just the topline number is extremely misleading.
Investing in a lot of ecommerce platforms around the world, everyone reports numbers a little differently. It can be tricky to triangulate as an investor (or an operator!) if you aren’t careful. Things like product costs, logistics (what is classified on a per order basis? and what is considered fixed overhead?), and marketing (are customer discounts negative revenue or are they a marketing cost?), can be bumped up or down a rung in how someone is reporting different types of profitability.
This is extremely rare to find, but I generally look for the ability to be cash flow / contribution margin positive on a customer's first order. So this means if I spend $5 to acquire a customer, I want to have made $6 after all other costs associated with this order before including the $5 in marketing costs.
When you are dropped into a prospective portfolio company’s data room, what’s the first metric you search for (other than revenue / revenue growth)?
I always look for retention first. You can have insane growth, but if no one retains, whether this is a social network, ecommerce, or even SaaS business, it’s just a leaky bucket and growth doesn’t really matter.
This is very rare in the world of consumer products, but if retention is 100% (or more), it’s essentially a bond-like cash flow stream with equity-like upside based on whatever other customers are acquired. I’ve found that can generally happen if you either add more product categories or increase prices over time (but again, it’s very uncommon). I’m not sure if this is true, but I would assume Apple falls in this category.
Is it possible to distill product market fit (PMF) into a metric? What’s your personal definition of Product Market Fit?
I don’t think it’s possible to distill it into one metric. If I had to pick, it would be something like retention or repurchase rate. I think this PMarca quote is the best:
“You’ll know it when you have it. Everything will be flying off the shelves”
-Marc Andreeson, famous investor with cute, but possibly unhelpful, definition
Part II: Long Term Durability and Customer Retention
If you could only invest in one, which do you think is a better business model in the long term - the traditional e-commerce take rate model, or the social media advertising based model?
I think historically the answer to this was ads, because it meant you didn’t have to figure out anything in the physical world. That was the hard part up until even a few years ago (it’s still hard), and you left all of that to the advertisers to figure out. You made way more margin than they did.
But if you look at the success of Amazon, it started with ecommerce, and since it started scaling its ad business five or so years ago, its now one of the largest advertising businesses in the world.
In the future, I think the biggest ones will actually combine both. It’s possible we see even more business models woven in as well - things like Subscriptions (Amazon has this too), tipping and in-product gifts, financial services, etc.
Expanding on points from above, these are generally high margin revenue layered on top of whatever the cost structure is to acquire and support an existing customer.
There’s a power law at play with all venture investments, but is it even more profound for social networks considering how fickle consumers may be?
I think so. But I think it’s less about consumers being fickle and more about products that never truly had product market fit raising obscene amounts of money.
What’s the biggest difference between spotting trends in B2C vs B2B businesses? How do you identify durable revenue growth?
B2C ends up being more of an artform and psychological exercise than B2B. Starting a consumer business producing plant-based milk made no sense 10-20 years ago, but with the rise of veganism, awareness around lactose intolerance on the rise etc., it’s become a sneaky big market over the past decade. And starting it 10-20 years ago was actually probably the best time. In my opinion, this is what makes consumer a really hard category to invest and operate in.
A lot of consumer is about signaling. The car you drive signals something about you. So does the house you live in. You might not care about either of those personally, but you might signal things with the clothes you wear, the music you listen to, or the Substack’s you subscribe to (editor’s note: Turner subscribes to Mostly metrics, lol). And this is generally thought of as “brand”.
And signaling changes. Products that signal you care about your carbon footprint (Tesla) or mental health (Madhappy) are suddenly very real, but were non-existent 10 years ago.
One of the wildest stats I’ve seen recently is that secondhand is expected to be the biggest category in retail by 2030. While I think part of that stat is it's just one of those insane McKinsey stats, it reflects how consumer trends can change over time.
In consumer, I generally look for:
Opportunity to add adjacent products
Potential for marketing costs to come down
Benefits from economies of scale
All these rarely happen, which is why consumer investing is so hard, but also what makes it fun for me personally.
Which ecommerce or social networking site do you feel has had the best second act? What about the worst?
Best: I don’t have any data, but I think Marketplace saved Facebook. Not only for keeping people retained, but for moving it into commerce. I would be very curious to know exactly how big it is today. My guess is it's doing at least 2x more transaction volume than anyone reading this thinks it is.
I also think Etsy’s transformation has been pretty impressive.
Worst: I know the answer to this but can’t share it publicly.
On the secondhand trend we just touched on above, I feel like Poshmark has a lot of low hanging fruit it never took advantage of. And Wish, which went public two years ago but is now practically bankrupt, was basically what Temu is today, which has been #1 in the app store for more or less seven months straight since the month it launched. I don’t know the inside stories, but I wonder what Poshmark and Wish could have done differently.
Which social network has done the best job of aging alongside its initial users? Snap was massive for me in college, but now I feel like it’s fizzled out as I’ve hit 30 (but maybe it’s just that I’m a dad now?). And I feel like only my Aunt Pam uses Facebook at this point. Am I wrong?
I think Facebook is the obvious answer to this question. It’s actually insane how it started with college students at elite US universities, then spread to other colleges, then to high schools, and has taken it all the way to the retirement communities of Florida. (Not part of your question, but Facebook also grew all the way to all the islands of the Philippines and tiny villages in India.)
I think young people still use Facebook for some things, like Marketplace. And we aren’t that valuable from an advertising perspective yet, so I don’t think Facebook is too worried, hah.
Which social network or ecommerce site do you think has done the best job of identifying an underserved market that people originally thought was too niche?
Etsy. It started as a place to sell handmade items and craft supplies, and it’s now an $11 billion publicly traded company. It’s evolved into much more than that today, but always wild to me that it's as big as it is.
Ebay is another good example. One of the first products ever sold on Ebay was a broken laser pointer. And its popular categories early on were Pez dispensers and Beanie Babies. It’s now a $24 billion publicly traded company. It also at one point owned PayPal, a $70 billion public company.
Part III: Acquisitions and TAM Expansion
In your opinion, which social network has made the best acquisition to date? What about the worst?
I think Facebook acquiring Instagram is the only answer to this question. Google acquiring YouTube is another acquisition that’s hard not to include.
One I think is very underrated is Snap’s $64 million acquisition of Bitmoji in 2016. If you’re not familiar, Bitmoji is your digital avatar within the Snapchat app. They’ve since turned it into an SDK with integrations into other social apps, games, media platforms, and even education and enterprise products like Zoom and Teams. It’s ultimately your pre-built AR / VR user profile for whenever the metaverse becomes a thing. Snap recently disclosed that 1.7 billion total unique Bitmoji accounts have been created (Snapchat has 750 million MAUs), which would make it one of the largest social products in history. (I questioned exactly how that 1.7 billion number is being measured, and I asked Snap about it and they confirmed with me its unique accounts.)
If it counts as a social network, the worst I can think of is Yahoo acquiring Geocities.
Was Shopify getting out of the logistics business an admission of a bad ZIRP move? What was the deal with that?
I think it was smart to get into logistics, they just got ahead of themselves on strategy and cost management.
It’s very hard for a customizable ecosystem-based platform like Shopify to be preferential when it comes to logistics. Since Shopify isn’t actually aggregating demand like a marketplace like Amazon, pigeon-holing merchants into specific logistics options restricts growth. I would assume they just didn’t have enough coverage and didn’t have enough money to build it.
Shopify does run the Shop app, which is essentially its marketplace product. I believe it was closing in on 20 million MAUs, but I’m not sure how it’s doing now. My guess is it just didn’t make economic sense to focus on Shop + fulfillment right now.
We see a lot of enterprise software companies buying media companies as an internal lead gen arm. Do you predict any large B2B companies will ever buy a social network to drive down customer acquisition costs?
I think the stars would have to align perfectly, but it’s possible. The “Oracle buying TikTok” memes from a few years ago were funny, but I think the rumors of Walmart acquiring it did make sense.
All that matters on the internet is controlling end-customer demand. TikTok is going to have large ecommerce and advertising businesses, and Walmart’s logistics infrastructure would help accelerate it while also making Walmart much more relevant.
Does AI threaten the traditional ad based search market? Which social networks will suffer the most from AI? Which are primed to benefit the most? Have the Facebook overlords been using AI this whole time to brainwash us, and we just didn’t realize?
Generally speaking, I think generative AI will reduce the friction to create content and unlock more creativity, which are the two main things I look for in a social network. I think it will create new networks. But I also think it will be a net benefit to all the existing social networks, and it’s likely they actually benefit even more than any startup.
I do think AI threatens the traditional ad-based search market, but I think Google will be fine if they react fast enough. I wrote about this a few weeks ago here, but I don’t think it’s much of a stretch to source sponsored links within chat-based results. Google teased an example of this in its recent I/O 2023 event:
I think Facebook will be a huge beneficiary of AI. Its business model is essentially tens of thousands of small agencies running ads for SMBs with credit cards hooked up to auto-buy ad impressions in North America and Europe. What happens when FB’s ad platform auto-generates all the ads? It lowers the cost to create and run ad campaigns, which means FB can increase its ad prices.
I also think Facebook / VR will be a big beneficiary of generative AI. All VR content has to be created by someone, and generative AI could help bring those costs down significantly.
Part IV: Business models and network effects
Are the network effects at play in social networks different from those you find in ecommerce marketplaces? Are there different types of network effects?
I think they’re very different. Social networks (or content networks) are about reducing the friction to create content and/or sourcing content to the right people. It’s about finding new or emerging use cases and media formats that don’t work in the other networks.
In ecommerce, the competitive advantage is generally more related to economies of scale (and specifically within a certain niche or demographic) than network effects.
What do you think of Substack’s business model? In your mind have they made the jump from a platform to a network?
I think so. People who complain about Substack taking 10% of subscription revenue don’t know how hard it is to run a business as a content creator. I don’t have a strong opinion on the valuation, I chose not to invest in the recent crowd funding round, but I do think they have a serious shot at being one of the next big social networks. I wrote about that below:
Where did Clubhouse go wrong? Where did Be Real go right?
I don’t think Clubhouse ever had real retention outside of a small group of tech people. I always assumed they would expand from audio into other content formats like live streaming, games, photo, video, etc, but it never happened. It would have ruined what made the product special, and I understand why they didn’t do it.
I’m a broken record, but BeReal had strong retention from the start. I think it was similar enough to something like Instagram (and specifically Finsta) that made it easy to understand, and they also pioneered an entirely new content format centered around time. Their downloads have come way down from the peak during Summer of 2022, but they still have 20 million Daily Actives and 40 million Monthly Actives. They have their work cut out for them figuring out a business model.
How many last minute grocery apps do we actually need? How many do we deserve?
We deserve at least one, but we need at least nineteen in each metro area.
Part V: Lightning Round
As a solo capitalist is it easier to pull the trigger, or harder to make decisions because you don’t have others to bonce ideas off of (analysis paralysis)?
I think it’s easier to both pull the trigger and get frozen. Deal flow is a firehose. I have a simple system to stay organized, but even then some things fall through the cracks. I also spend about half my time on the media / content side of things (not to mention fundraising, investor relations, actually helping portfolio companies, figuring out how to setup Gusto, etc), so it can be challenging to juggle. But I don’t think it’s unique to being a solo GP.
What’s changed the most in terms of how you think about “what makes a good investment” since you started your career?
When I started, I focused solely on the product, market, competitive landscape, etc. I would end up investing when I thought it was a good idea or based on what I would do if it was my company.
Over time I’ve found it’s much better to just back the best founders, even if I don’t fully buy-in to what they’re doing yet. What this has ended up evolving into over time is investing in exceptional founders but having a “hard no” on certain markets that I don’t like. Historically this has been areas like crypto and real estate tech, but I’m open to changing my mind over time.
What’s the best meme you’ve made of investors being helpful?
People loved this one on VCs adding value to their portfolio companies.
This one was also pretty ridiculous.
If you could put one message on a billboard for startup founders to drive by and read every day, what would it be?
“What’s your retention?
A big thanks to Turner for gracing Mostly metrics. Subscribe to The Split below:
Great interview