Creating new Consumer brands digitally
In today’s episode, we talk about DINVIBs i.e. Digitally Native Vertically Integrated Consumer Brands and our thesis behind investing deep into this sector. Joining us to discuss this is, Sanjot Malhi(VP & Consumer Sector Lead at Matrix Partners India), Avnish Bajaj(Founder and Managing Director at Matrix Partners India )and Rajinder Balaraman(Director, Matrix Partners India). Tune in to know more.
Rajinder: Hi and welcome to Matrix Moments. My name is Rajinder. And I am joined today by Avnish, Founder and Managing Director at Matrix; and Sanjot Malhi, Consumer Sector Lead at Matrix. Thanks guys for doing this.
Today’s podcast is on consumer brands and why India is ready for a new set of VC-backed companies targeting this opportunity. As Matrix, we have been investing in the consumer sector for a while now, Avnish. I think I can remember investments in W which went on scaled up and successfully exited. Now, it’s a public company. I remember Chumbak. There were many healthcare investments as well that we made. And over the last year, Sanjot, we have made six investments in the consumer brand sector. Why the sudden interest in consumer brands by the broader market? I know we have been doing this for a while. What’s changed in the market, what’s new in the market? And, what’s our thesis on this sector?
Avnish: So let me first welcome Sanjot given it’s his first Matrix Moments videocast. And we hopefully we will do a lot more. He actually got us started. So, I will let him talk about – I have not heard of this terms DINVIB until I think two of you had some thesis document. So, I will let him comment on that. But consumer as a sector for Matrix has been important from the start. Even our internet investments and I think we will contrast that in this podcast at some stage. But why don’t Sanjot, you talk about the whole DINVIB and thesis.
Sanjot: Yes. Thanks guys. So, let answer your question, Rajinder first. You mentioned why consumer brands make sense for India at all, not just from a Matrix perspective. Then you really have to zoom out and think about where India is in its economic journey today. We are at the beginning of what’s called the middle income journey. We have just kind of hit the $2000 of GDP per capita mark. This is where a lot of the emerging markets around the world kind of accelerate their economic growth. Hopefully, we will see the same path. But what’s really unique about India is that India is the first major economy where internet has penetration has preceded economic growth.
So while we are relatively still emerging in our income - so relatively poor as a country, we do have access to the internet. And people in small town India and villages are seeing content from around the world the same day a person from New York or San Francisco will. What that means is that aspirations are global for Indians, but access remains an issue both in terms of affordability and distribution. And I think that’s where homegrown consumer brands make a lot of sense for India because you can create very very high quality aspirational products at affordable prices and give to this new aspiring sort of middle class of India. And I think that’s what I am very very excited by.
Avnish: I don’t know if you layer in, so there is this aspirations, Maslow’s hierarchy. I mean we talk about the fact that we look at different markets and we say, hey, people are different. People are not different. I may sound too much of a capitalist, but their economic levels are different. At similar economic levels in aggregate people behave in a similar fashion. And that’s the classic Maslow’s hierarchy.
So, to his point, there is lack of access yet aspiration and the fact that there is some level of leapfrogging because it’s internet first. But you can also layer in one more thing, at least it seems on the surface that this set call it millennials which you are bumping against, he is, I have in my mind, the existing brands may not be an asset. It may be a liability.
I know in a lot of service brands even things like banking, the brands that our parent’s generation would consider this is a solid brand, my generation is neutral. And you are probably negative. And the younger ones are even more negative. So, there is this gap also saying, what existing brand? I am open to – and this experimental nature. So I think it all kind of…
Sanjot: Sorry to interrupt you, Rajinder. But to that point, I think a lot of the new age brands what we call DINIVB, digitally native vertically integrated brands, are actually focusing on a specific TG as opposed to just a product to that point because there are certain TGs. They could be millennials. They could be the Gen Z. Generally, the younger more connected population that incumbent brands find harder to target and acquire, which new age brands both through new distribution and better branding and marketing and packaging can target and acquire and really retain. I think that’s where the real value lies.
Rajinder: So maybe for listeners actually this DINVIB thesis that we have coined and maybe speak a little bit more about that. What’s the digital consumer I think everyone understands, but what’s the rest?
Sanjot: Yes. That’s a very good question. And I think especially from a venture funding perspective, I think it’s a question we have really debated while the consumer in itself makes a lot of sense. Yes, there will be lots of India brands, but are they investible as a venture opportunity. And I think that’s where the digitally native vertically integrated brands become very interesting.
Traditionally, I think there are three things sort of the holy trinity one looks for as a venture investor. You want deep markets. You want high returns on capital. And, you want nonlinearity in scaling. So, fast scaling businesses. Traditionally, consumer businesses have been deep market because people spend a lot on that, but they haven’t been high return on capital or nonlinear. And I think that’s what the internet has changed today. And, that’s the DINVIB thesis. Because you can target customers directly through the internet, both acquire them in terms of digital marketing and deliver to them directly, you can scale much much more quicker. And because now India and China both large outsourced manufacturing bases, you don’t have to have that much CapEx to produce high quality products. So you can literally control the most important things in-house, which is the quality but produce outside which affects your returns on capital. So, every dollar invested can you get you far more in market cap creation, and do so much much quicker.
And, finally, the most important thing, the mots in this business arguably are higher than most internet businesses because they are vertically integrated. For a lot of internet businesses, they are thin stacked just top of the stack businesses. And so, arguably they can be disrupted. These ones while harder to get off the ground are arguably much much more defensible businesses in the long run.
Avnish: But I struggle with that, Sanjot. Isn’t the flipside of that that because you don’t need manufacturing, anybody can start a brand and sell on Amazon or Myntra or Flipkart, and therefore the mots are harder.
Sanjot: The mots might be harder than a completely traditional brand, but when you compare it to pure tech businesses where there is no ownership per se of your customer. So what in my mind creates a consumer brand in DINVIB, I think it’s ownership of the customer. That comes through distribution, that comes through marketing and speaking to that customer. It comes through packaging and branding. It comes through customer service, post customer service. Getting feedback and creating those feedback loops to improve products.
Avnish: I think therein lies the answer. I think the tricky piece is - and we haven’t fully come up with a viewpoint here, but I think the key is are you fully digitally native? Digital marketing is not digitally native. So, our view is brand should be what 60 to 90% onsite sales?
Sanjot: Yes, ideally in the steady state.
Avnish: And then have these loops where some brands are – I know your ANE is doing that? They have like these QR codes and very high level of engagement.
Sanjot: Truly omni-channel, right? The transition from offline to online should be truly seamless. When you see a brand in a store versus seeing its website, it should look more or less similar. It shouldn’t be this is online/offline and that creates that sort of echo chamber if you for that brand wherever you go.
Rajinder: So you touched upon product. Maybe to make it real, I don’t know if there examples that you all have. But, how do these brands think about product differently from traditional consumer goods companies? And is the product lifecycle different? Or, the iterations on the product different for a DINVIB versus traditional FMCG?
Avnish: I think what he said and I will let him add, but I think the way they think about the product differently is they don’t think about the product. They think about the customer segment. So, they go after one customer segment and they are trying to surround them with different products. The first product may be the thin edge of the wedge for the market.
Sanjot: No, I think that’s right. I have been very positive so for, but let me give you the flipside. I think product cycles to your point here are slower than tech businesses. But, like I said what brands lack in nonlinearity, I think they make up for in their mots. Let me flip the question what is product market fit in this business? I think there are three levels of product market fit. One is product love, the other is quality of growth, and then the third is actual establishment of brand in that sort of order because love should ideally come.
It’s very difficult to measure love in life in general. It’s very hard especially in consumer brands. But I think it shows in high gross margins. It shows in cohorts. It shows in high repeats. Quality of growth shows in non-discounted sales. It shows in organic growth. And the ultimate mot is really brand. And that shows up in word-of-mouth when people are talking about, when people proud of recommending a brand to their friend that’s when you know a brand really being established. And then you can really...
Avnish: But this is what unpacking a bit more. So, if you ask people who this stuff well, what defines a brand? Or, when do you know you have a brand? Some of the things he said are very very important which is the same line of SKU is the sale growing, is your wallet share within a particular customer growing? That’s number one. Non-discounted sales and I will come back to gross margin and how margins are important here. But non-discounted we are all used to ecommerce sites just discounting stuff. How much do you sell without discounting? Like Damenschin our portfolio, they don’t discount. Most of our brands that we are investing in are actually mass premium. They are not mass. They are premium. They believe that they are offering a value prop where they can charge a premium, typically between 25 and 30%.
So same SKU growing, then there is this thing of brand extensions. If you have real love from customers, you should be able to launch adjacent lines, and they should also track. Just coming back to gross margin for a bit. And one contrast with internet businesses, see, in my view PMF is defined you have early PMF, product market fit. You have scalable PMF. And, you have scalable profitable PMF. In internet type of businesses, typically we take scalable. If scalable PMF is happening, we take scalable profitable PMF risk.
A lot of companies have discounted their way through scalable saying if I have enough customers I will be able to charge. I don’t think that works in consumer. I think in consumer you need to have that gross margin. You need to know that you are going to be value because again nonlinearity. Some of these things that play out never play out in this side of it. Your operating leverage and because technology businesses the incremental cost don’t go up that much, you are just able to build margin in the future. Here, it’s very hard.
So, my advice to entrepreneurs in consumer is to build profit – we will take scalability risk, but let’s not take profitability risk. Let’s grow with EBITD zero or something close such that you know that you are getting paid for what you are doing.
Sanjot: Yes and to that point, I think in most cases consumer brands are disrupting an existing part of the economy unlike the internet where sometimes you are creating – actually in the largest outcomes you are creating markets. In this case, you are actually disrupting existing parts of the economy, which means you have very very large incumbent players with large pools of capital to invest in marketing and branding. So without the gross margin, you really don’t have much money to reinvest. So you need that firepower in terms of gross margin to be able to go up against a lot of incumbents and that actually - the beauty of brands is that scale actually begets scale if you do it well because of the high gross margin.
Rajinder: So, I am hearing two different things. So, one is around risk. And basically, the risk here seems to be more on scalability. And you are saying once you have kind of achieved a certain amount of scale given the gross margin profile of the business, scale begets scale. So what are the risks in investing in consumer brands or building consumer brands in this new DINVIB model?
Sanjot: Yes, sure. So I will give you mine. I think it’s a very attractive market which is what the thesis is all about. So it is easy to have false positive initially in this space because you will see a lot of high quality products targeting the affluent urban Indian scaled to a certain extent very very quickly because it’s high quality, these people have a lot of disposable income, they are easy to get to through the internet, through Instagram and so on. So, you will see a certain amount of scale with truly good quality products.
The issue is how do you go from that 1 to 10 to 100? Like how do you take that to a real IPO-able business? I think that’s where the challenge in consumer brands lies. Because you can charge a little bit of a premium and these guys will pay for it, but once you start going to tier II, III India, the true middle class of India, they may or may not pay for the sort of mass premium products. So, I think the trick really lies in getting balance of quality, pricing, and distribution right for the Indian economy.
Avnish: So, I will put it differently. I see in non-consumer businesses more potential failure rate at 0 to 1. Less at maybe 1 to 10. Ten to unlimited everywhere there is similar issue. I see here the flip. I think a number of people because of the factor that Sanjot articulated wherein lies the opportunity of distribution, market gaps and stuff like that, lot of people are seeing that. And, it’s easier to get off the ground and you don’t need manufacturing. So, I think there is serious copycat risk. And which in tech because of just the nature of tech businesses, you are building with passage of time. So I think if consumer brands don’t scale quickly they may never scale because they may get – let’s say you have a great product, somebody will copy you at some stage. And they have the same factors coming into play. So, I do worry about the 0 to 1 will happen, but will a lot of them get stuck in the 1 to 10?
And by the way, this has happened in other businesses. If you look at content production houses historically, I don’t know maybe a 100 in India between to 20 to 50 crores of scale. So there is the zombie effect. And it’s not like they are not good businesses. They will make money. Are they venture funded? And I believe that product is a mot unlike in tech where with every passing month, there is something happening in the product which is probably building a deeper mot. And I know it’s a generalization.
Here, that’s not the case. Your product is launched in the market. It’s there for everybody to reverse engineer. And it is not going to keep changing or iterating that fast. So then, what are you able to do and how do you build that customer connect with enough scale because ultimately your brand is a mot. That’s a little bit of the worry I have.
Rajinder: So you had mentioned something earlier around building around that customer segment. How should founders think about it? Should they be doing that soon in that journey? Or, should they be doing it after a certain scale maybe after a few rounds of capital?
Avnish: I don’t know about rounds of capital, but they should not be doing it too soon. Ultimately, there has to be - in almost all the consumer companies we have met recently, there has been a hero product. This is a business of – first, find your hero product. If the first product is not a hero product, keep iterating till you find you’re hero product. Then, build around that hero product because that product is becoming a hero because it is resonating with a certain TA. Then, surround that TA as opposed to going after the first product which may not be hero product and trying to surround that TA which you may not like, right?
And I think that’s going to be the case almost all our investments. Even Chumbak started as mobile accessories and stuff like that. And then over a period of time is now like a full apparel and clothing. But, their thing was the edginess. So they looked at the edginess and they said, okay, this customer wants edginess, what else can do that’s edgy for them? And where is their wallet share?
Sanjot: Just to that point, I think the thing to keep to in mind is the best brands are built by selling 10 products to one person and not selling 1 to 10, which means that you need to own your TG. I know I sound like a broken record, but that’s kind of what the beauty of this business is. And it’s not just qualitative. The math actually works that those are businesses where the LTV to CAC works the best because acquiring a new customer will almost always be in that same band of cost for most businesses depending on your product. But if you can maximize the long-term value of each customer, which is essentially owning the TA like you said, I think that’s where the real high quality businesses emerge. And connected to that, I think internet lends itself well to that because subscription models, for example, allow you to do that. So the new age distribution lends itself not just through product but also through distribution model. Harry’s in the US is an example of that. And one of our portfolio companies Country Delight is an excellent example. Perhaps, the first and only true consumer brand that has leveraged subscription 98% month-on-month repeat.
Avnish: And it’s truly DINVIB. I mean you want to quickly talk about the company?
Sanjot: Yes, sure. So Country Delight is a subscription-based fresh foods and beverages company. So, it’s starting with milk. Milk being the hero product. Milk as you is highly adulterated as a product in India. So, they have the highest quality and freshest milk delivered from farm to your home within 36 hours through the convenience of an app. And using that as a wedge, they are expanding into multiple categories of fresh foods: bread, ghee, butter. Anything that’s dairy, non-dairy as well as other fresh foods related. And like I said, it’s growing very quickly. And the beauty is in the repeats of the business and the cohorts.
Rajinder: I think the language being used in this conversation is very different from how traditional consumer brands would think. So for a company for example like Country Delight, traditional incumbents like a Nestlé or a Danone or many others, how are they thinking about the evolution of these new DINVIB brands? And what do you think is likely going to happen when they kind of pick up on this trend?
Sanjot: So it’s hard to predict. But I will tell you what’s interesting about these new age brands to incumbents as far as what I have gathered. I think there are two main points. One is owning the TG point, especially if it’s a target segment that the incumbent cannot or find it difficult to otherwise acquire. In this case, Country Delights case, it is the trust of a mother. The most important switching point for a Country Delight consumer is when they have a child because that’s when you really start worrying about the milk you are feeding your child. And they have been successful in acquiring that TG and retaining that TG.
So, I think a Danone or a Nestlé or whoever if at some point they think about acquiring Indian mothers or urban Indian mothers, Country Delight is a very interesting example either organically or inorganically who knows? But just that proposition is very interesting; that’s one.
And then the second is new age distribution because a lot of the older brands are very very conventional general trade driven because they need scale of a 1000 crores. And the only way you get is through general trade or was conventionally. So they find it very hard to explore these new channels of growth. And like I said Harry’s is an example of an acquisition in the US. And it was primarily not due to the blade. The blade wasn’t the innovation. The innovation was acquiring and subscribing to buying blades online and that was the driver. So I think new age distribution.
Avnish: And I would say, look, you as a new brand will not beat one of the large incumbent in GT, general trade; modern trade, distribution, sales, feet on street. You have to beat them digitally. Country Delight actually I mean not to over promote the company but it’s an easy one because it’s fully digitally native and integrated. But I would say the other brands, that’s how they should think. They have to win digitally which is our earlier point, which is it’s not about digital marketing. It’s not about Instagram. I think companies get it wrong. They think promoting on Insta, that’s not digital marketing. Are you digitally native in owning your customer from the transaction till post transaction and getting them back? And I think that is an edge that is going to be very very hard for the incumbents. The incumbents are watching. We speak to – you have spoken to some of their venture arms and some of their senior execs. And they are very clear that we don’t mind these people getting there. And if we can, we will acquire them. So they are watching closely and they are very clear where their strengths are and where their weaknesses are.
Rajinder: One topic we haven’t spoken of but just thinking about this modern trade, general trade point that you brought up, there is a lot of working capital in this industry that’s in inventory or that’s in receivables from trade. Sounds like the digital brands just have a completely unique approach to building…
Avnish: Country Delight is negative working capital. It’s negative working capital. That’s the beauty of it – and subscription. So, subscription and digitally native. You get the money first. You pay later. It is flipping the model on its head. Like I said, that’s an easy example because it’s fully digitally native. The others have…
Sanjot: Yes, I think there are structural advantages. Obviously, Country Delight is a great example because it’s negative. But, there are structural advantages to DINVIBs that apply across because you have more line of sight into what the customer is buying, therefore you can plan better. And working capital management is nothing but common sense and planning. The reason conventional brands don’t have very good working capital cycle because they don’t have that visibility. There are five layers of middleman before you sell to the end customer. So you have to prepare for 180 days. But if you are selling directly and you have line of sight into which product is your hero product, you can plan better – and which are your new products. So your rotation of capital becomes much much quicker as well as there are much better working capital management tools because it’s all integrated. So, you have much higher visibility through dashboards and so on.
Avnish: Sorry to interrupt. And even if you were not selling – so I am big believer in directly selling on your own website. But even if you were not and you were selling through the marketplace like Amazon, I think to his point which is very key, their forecasting and planning tools are so good that if you are integrated, I think your inventory can be – you can effectively mimic a negative working capital even if you are selling on marketplaces.
Rajinder: So million – I mean not million but 10s of millions. Billions of dollars. Do you think consumer brands are going to generate the kind of outcomes and the kind of return characteristics that we have seen in traditional internet businesses?
Avnish: I think the largest one might. I think the way I see it is that the bell curve will be flatter. So, what that means is maybe you won’t have - Flipkart is valued at 20, Paytm 20. OYO, Ola, they are all in the 6 – 10. Do I see that happening in 4 – 5 years? To be very honest, no. I think it will be flatter. But, we will have a lot more hit rate. Number of companies will do reasonably well. And so, the way I think of it is more unicorns, lesser decacorns, and megacorns or whatever you want to call them.
Sanjot: But hopefully more predictable, right?
Avnish: Yes. So that’s what I am saying, it’s flatter.
Sanjot: Yes, exactly it’s flatter. So, more predictable. Hopefully more defensible, but maybe not as scalable. But, definitely highly scaled in the long run.
Rajinder: Aap ka muv ghee shakar, is that what they say?
Sanjot: That’s what Country Delight sells now by the way. They sell ghee.
Avnish: As long it’s a DINVIB ghee because we don’t do ghee…
Rajinder: On that note, thank you, Sanjot. Thank you, Avi. Enjoyed this one. And for founders out there sounds like a lot of exciting stories over the next few years.
Avnish: Thank you, Rajinder.
Sanjot: Thank you.
