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Investment Thesis

The World is a Supply Chain

October 20, 2019 by Brian Laung Aoaeh

Lisa Morales-Hellebo, and Brian Laung Aoaeh. Kicking off #SCIT2019, June 19, 2019 in NYC. Photo Credit: Ray Neutron.

Originally published at www.refashiond.com on Friday, October 18, 2019.

Note: 3,749 Words, 14 Minutes Reading Time

Authors: Brian Laung Aoaeh, CFA, and Lisa Morales-Hellebo

The world is a supply chain. It’s that simple. 

But what does that really mean?  Whether we like it or not, current economic, political, social, and technology trends will compel more people to think about the implications of that statement more consciously each day.

In this blog post we;

  • Share a definition of supply chain,
  • Put the challenges confronting supply chains in context,
  • Discuss why socio-cultural forces will act as the leading catalyst for the innovations that will define supply chains of the future,
  • Explain why the refashioning of supply chains matters,
  • Explain why the technological transformation of supply chains is an economic issue, as well as one driven by evolving consumer preferences,
  • Describe the role that early stage technology venture capital can play in the transformation of supply chains,
  • Describe how individuals, private sources of capital, and governments can play a role in the transformations that will lead us to the supply chains of the future. 

What Is A Supply Chain?

First, let’s answer the question: What is a supply chain? 

A supply chain is a network of organizations that work collaboratively to move products and services from producers to consumers. At a high level, the business of supply chain can be subdivided into: 

  • Supply chain management;  which is about supply chain network design and management; 
  • Supply chain logistics; which is about the storage, transportation, and movement of physical goods from one place to another;
  • Supply chain finance; which is about ensuring that producers, and other supply chain participants and intermediaries get paid for the value they create and deliver to consumers.

Supply chains play two critical functions: 

  • First, they enable the flow of goods and services from producers to consumers. 
  • Second, they facilitate the transfer of information about the movement of goods and services between every entity that is part of the supply chain network.  

The world we’ve become accustomed to will not exist without supply chains.  And further, the world is a mechanism for providing humanity with the resources we need to survive on Earth.  We know this to be true — “when supply chains function, societies thrive”.

The Challenges Confronting Supply Chains

Today, we face an inflection point as our world confronts some big crises. If current trends hold, between 2015 and 2050 the world’s population is expected to increase by about a third, to roughly 10 billion people. According to Our World in Data, the world’s population stood at about 190 million people in the Year 0, and approximately 4 billion in 1975. In other words, the world’s population will jump by about 6 billion people over the 75 years between 1975 and 2050 after having only climbed to 4 billion people over the previous 1,975 years. This is happening, according to Our World in Data, despite the world’s population growth rate peaking at 2.2% per year in 1962 and 1963, and then declining to its current rate of about 1% per year. 

While this rapid increase in the world’s population is occuring, global supply chains face some big challenges: 

  • An ongoing increase in the frequency of severe weather events that cause large-scale disruptions to local and global supply chains. 
  • Trade disputes threaten to dismember the system of world trade established following the end of World War II. 
  • The growing world population has created a critical need for significantly better dynamic resource allocation throughout supply chain networks in every industry around the world. 
  • Changes in consumer behavior are putting the world’s supply chains under increasing strain and business competitiveness is increasingly tied to supply chain mastery.

Socio-cultural Attitudes Will Be The Catalyst For Supply Chain Innovation

Perhaps counterintuitively, innovation in global trade and supply chains will be driven most immediately by changing social attitudes towards climate change. A recent poll of adults and teenagers in the United States conducted between July 9 and August 5, 2019 by The Washington Post and the Kaiser Family Foundation offers some early evidence of the changes taking place. 

When asked if human activity is causing climate change, 79% of the adults polled responded yes, while 86% of teenagers responded yes. When asked if reducing the negative effects of global warming and climate change would require major sacrifices, more than 30% of adults, and more than 40% of the teenagers surveyed said yes. Also, at least 70% of adults and nearly 80% of teenagers said that technological advances will be able to reduce most of the negative effects of climate change. 

There are more conversations than ever about decarbonizing supply chains. At about the same time this poll was published, Quartz reported that two states in India have said they will not build new coal power plants. Earlier this year, governments in Europe called on the fashion industry to tackle its waste and pollution problems more aggressively and some are looking at passing legislation to that end. In Asia, more governments are moving to address issues around plastic waste imported from abroad. Starting in January 2020, the International Maritime Organization will begin adopting new regulations to curb harmful emissions from the container shipping industry. 

Another example of the rapidly evolving social and cultural attitudes that will drive innovation in supply chains and global trade is the growing movement led by young people such as Greta Thunberg, Jamie Marglois and others like them. Political, business, and technological leadership is shifting into the hands of a generation of men and women who do not want to leave a more inhospitable planet as their legacy to their children and grandchildren.

What does this mean? 

In the next half-decade or so we will see political and business leaders facing increasing pressure to adopt policies and business practices that reflect how voters and consumers feel about climate change. Those who do not risk losing political power and market share, respectively, to their opponents and competitors who do. As this social and cultural movement gains strength, it will accelerate the economic drivers of innovation, which in turn will propel the drivers of technological innovation in global trade and supply chain. 

In his August 2011 article, Why Software is Eating The World, Marc Andreessen said: “Companies in every industry need to assume that a software revolution is coming.” The process he described has only accelerated over the intervening 8 years, and that statement is more true now than it was then. As information technologies that were pioneered in the 1950s have reached maturity, technology startups around the world are developing new innovations to solve some of the supply chain problems that seemed intractable in the recent past.

Why The Refashioning Of Supply Chains Matters

However, before we can understand why the confluence of software and hardware engineering is going to be transformative to the supply chains on which the world runs, we must understand why that matters.

Supply chains exist to connect producers and consumers in an ongoing exchange of value. As a result, innovations in supply chain drives innovations in the rest of the economy. Given that supply chains are about the back-and-forth movement of physical goods, services, and information, it is easy to understand why advances in information technology must necessarily precede cycles of innovation in supply chain.

Because innovation in supply chain acts as an accelerant for increases in production and consumption, supply chain innovation acts as an economic multiplier. Every dollar of innovation in supply chain innovation leads to more than a dollar of total economic output. It is not a coincidence that countries ranked highest on the Worldbank’s Logistics Performance Index tend to have the most developed economies, while those ranked lowest tend to have the least developed economies. 

Supply chains are to human civilization what oxygen is to life; When they work well, no one notices them. It is only when they start to fail that we realize there’s a problem. It is easy to assume that there’s no room for innovation in global supply chains and trade, but this is simply not true. Here are four examples. 

  • As governments and people around the world awaken to the issues posed by climate change, there’s a growing social, regulatory, and economic push for innovations in supply chain logistics that will significantly reduce the amount of pollution created by the transportation industry. Some of these innovations involve the application of machine learning to the analysis of data obtained from connected devices in transportation and supply chain networks in order to make the operation of such networks more efficient and optimized. This needs to be done in a way that ensures that the transportation of people and merchandise does not destroy the environment. 
  • There is an ongoing shift away from linear supply chains in which the materials that remain after consumption has taken place are discarded, and more towards circular and regenerative supply chains that place an emphasis on using post-consumption waste as raw materials for new products. This shift relies on advances in materials science – both in the creation of new materials that did not exist before, and in the processing of materials that we have become accustomed to, but which we now recognize pose a growing threat to the environment as waste accumulates in quantities that the world can no longer sustain. In order to reduce or eliminate waste and pollution, the focus here is on developing supply chains around the repair, renewal, regeneration, and recycling of materials and products.
  • Manufacturing is undergoing a transformation of its own, one which will make the changes happening in transportation and materials that much more impactful. With the recent shift in political attitudes towards global trade, more companies are beginning to consider regionalized and localized manufacturing as a path towards avoiding costly tariffs. Such a transformation will rely on a mix of emerging and mature manufacturing techniques in order to keep costs within a manageable range. These advances in manufacturing will rely heavily on manufacturing goods to fulfill actual demand, rather than manufacturing goods in anticipation of future demand.
  • Invariably, software is being used more than ever to create new methods of collecting, storing, and analyzing data to augment human decision making in every industry. These technologies are being applied in industrial supply chains as distinct as: Pharmaceuticals and industrial chemicals – to simulate new compounds and test them more quickly and inexpensively; They’re also used in agriculture – to manage the production, storage and distribution of food and other agricultural produce in order to minimize food loss and food waste; And in energy – to aid in the production, storage, and distribution of energy from increasingly complex power grids that incorporate renewable and non-renewable sources of electrical power. 

The way we make things, the way we consume things, the way we move things, and the power that is required to make all that possible is changing dramatically thanks to advances in software and hardware technologies. Solving the foundational problems that plague global supply chains is a daunting task. Moreover, global GDP, most recently estimated at about $88 trillion, rests on our ability to solve these problems. 

Technological Transformation of Supply Chains: An Economic Problem, An Economic Opportunity

In our conversations with other people, we are often asked the question; “Wouldn’t this be easier if the transformation of supply chains were driven more by economic forces and consumer needs?”

In The Supply Chain Economy: A New Framework for Understanding Innovation and Services, Mercedes Delgado and Karen Mills state that; “The U.S. supply chain contains 37% of all jobs, employing 44 million people. These jobs have significantly higher than average wages, and account for much of the innovative activity in the economy.” 

Similar conclusions hold true in every other region of the world, and there is ample evidence to support that belief thanks to work by a number of global. Multilateral organizations like the World Economic Forum, The World Bank, The International Monetary Fund, various agencies of the United Nations, and others.

For example;

  • According to Growing Better: Ten Critical Transitions to Transform Food and Land Use, a September 2019 report by the Food and Land Use Coalition;  “The hidden costs of global food and land use systems sum to $12 trillion, compared to a market value of the global food system of $10 trillion.”
  • According to Long-Term Macroeconomic Effects of Climate Change: A Cross-Country Analysis, a July 2019 paper by researchers at the University of Southern California (USA), the University of Cambridge (UK), Trinity College (UK), the International Monetary Fund (Washington DC, USA), and National Tsing Hua University (Taiwan); “Our counterfactual analysis suggests that a persistent increase in average global temperature by 0.04C per year, in the absence of mitigation policies, reduces world real GDP per capita by 7.22 percent by 2100.” Furthermore the authors state; “We also provide supplementary evidence using data on a sample of 48 U.S. states between 1963 and 2016, and show that climate change has a long-lasting adverse impact on real output in various states and economic sectors, and on labour productivity and employment.”
  • According to Impact of the Fourth Industrial Revolution on Supply Chains, an October 2017 report published by the World Economic Forum; “Disruptive technologies are transforming all end-to-end steps in production and business models in most sectors of the economy. The products that consumers demand, factory processes and footprints, and the management of global supply chains are being re-shaped to an unprecedented degree and at unprecedented pace. Industry leaders who were consulted believe that new technological solutions heralded by the Fourth Industrial Revolution – such as advanced robotics, autonomous systems and additive manufacturing – will revolutionize traditional ways of creating value. As the costs of deploying technology continue to fall, international differentials in labour costs will no longer be a decisive factor in choosing the location of production.” 

Other examples are not difficult to find. 

A company’s supply chain is an integral part of that company’s customer experience, and consumers all over the world will continue to become more demanding, not less. The supply chains of the future will become a reality precisely because the refashioning of global and local trade infrastructure is an economic issue that is driven by consumer preferences.

That being said, it is important to recognize why conversations about the transformation of supply chains are less straightforward than one might hope.

In Disaster Mitigation is Cost Effective, a world development background note by Ilan Kelman, he states that it is easier for politicians who tend to seek visibility for themselves to pursue after-the-fact measures rather than pursue prospective and preventative measures related to disaster risk reduction. After-the-fact measures are more visible, while prevention is intangible and difficult to quantify, resulting in less of a boost for the personal ambitions and ego of individual politicians.

We observe a similar pattern of behavior among corporate executives, who tend to pursue highly visible, customer facing, short-term, tactical initiatives at the expense of long-term strategic initiatives that will help their companies develop and gain mastery over their backend supply chain operations. On the other hand, we observe that the companies that have become globally dominant are also those that have developed superior supply chain mastery within their respective markets and industries. We believe that companies with inferior supply chain operations will continue to fall victim to a degraded customer experience. We also believe that companies with inferior supply chains will lose market share to established, and new, competitors with superior supply chain capabilities.

Early-Stage Technology Venture Capital Will Play An Important Role

Surprisingly, the men and women who set out to tackle these problems usually find a lack of sufficient early-stage venture capital to support their efforts at the earliest and riskiest stages of their work – as they take that work out of academic research labs, or small apartments and houses, and start the often arduous process of commercialization. 

That is when there is the greatest need for venture capitalists who understand the nature of the problems, who recognize the potential commercial opportunities, who have a willingness to do the necessary hard work required to help these entrepreneurs succeed, and who have developed relationships with prospective commercial partners willing to investigate new technological innovations for long-standing supply chain problems.

This is changing, but it is not changing fast enough. The world needs much more risk-seeking capital to fund these entrepreneurs – the market opportunity is enormous. As we have already pointed out, global GDP rests on a foundation built entirely on physical and digital supply chains.

For these innovations to succeed, governments and traditional industry must become more open to partnering with venture capitalists and technology startups. Unlike innovations in information technology, the technological innovations that will transform global supply chains and trade interact with the real world. As a result, it is not enough for policies and regulations to lag innovation by years. Instead, regulators and policy makers must work hard to create regulatory frameworks that help to nurture innovation rather than assist in suffocating it. Correspondingly, venture capitalists and entrepreneurs must partner with community organizations, politicians, and regulators to help them keep up with advances in technology and innovation. 

One might ask: “Are there really enough opportunities for early-stage investments in supply chain?” Yet, once one understands what a supply chain is, a few minutes spent thinking about that question illuminates the misconception. 

The recent success of funds like Lux Capital – which announced that it raised a billion dollars distributed across two funds, and DCVC – which announced a $725 million fund, suggests that there are significant financial returns to be harvested by limited partners who have the foresight to invest in the small handful of venture funds that are now choosing to focus on funding early-stage startups solving the sorts of problems we have already described. 

The longevity of Supply Chain Ventures, established in 2001 by Dave Anderson, also suggests that this is a market that is ready for more early-stage venture capital, not less. This is assertion is based on how many advances in computational and information technologies have occurred since 2001, and how much easier it is now for such technologies to be implemented in physical supply chains. That observation is also based on the rising interest, relatively speaking, in issues surrounding supply chains within the general population.

Our conversations with corporate executives responsible for meeting demand from customers suggests that there is a growing appetite for new technology to enable companies to meet the expectations of an ever more impatient and demanding customer base. Also, our conversations with government officials point to a growing desire by public servants to seek new innovations geared at solving the problems that plague large and growing urban communities, and the suburban communities that surround them. 

What Can You Do?

There is a lot that one can do to participate in the coming transformation of supply chains;

  • Individual Consumers: As individual consumers we can all continue to become more active and engaged about understanding how our consumption affects the finite world around us. Social media and information technology makes it easy for attitudes and beliefs about consumption, production, sustainability, the environment, and climate change to spread. In Consumer attitudes towards sustainability and sustainable business: An exploratory study of New Zealand consumers., a 2015 master’s thesis by David Anthony Thompson at Lincoln University in New Zealand, he states; “From a purely pragmatic perspective, this study has indicated that consumers are generally likely to be supportive of not just purchasing sustainably produced goods and services, but that they feel positively towards companies that demonstrate sustainable social and environmental behaviour. This has implications for reputation building for organisations and in turn hints at benefits when it comes to securing supply contracts, recruiting staff and relationships with their physical communities. The study also suggests that understanding and knowledge play a – 56 – contributory role in forming these attitudes, therefore supporting the value in education and information strategies for sustainably run businesses.”
  • Sources of Private Capital: As we have already discussed previously, investing in early-stage innovations in supply chain transformation is an opportunity that remains largely under-resourced in terms of risk-seeking capital relative to the size of the opportunity. It is an area that is ripe for increased allocations of capital within the private equity asset allocation targets of family offices, endowments, foundations, and pension funds.
  • Governments: During #SCIT2019, The Worldwide Supply Chain Federation’s inaugural global summit on supply chain, innovation, and technology held in NYC on June 19 – 20, 2019, Samuel Chan, Regional Vice President, Americas, at the Singapore Economic Development Board provided attendees with a sense of how the Government of Singapore is thinking about the role that supply chain, innovation, and technology can play in Singapore’s economic development. Supply chain occupies a central position in Smart Nation Singapore, and specifically in its Smart Logistics initiative. As we have stated previously; It is not a coincidence that countries ranked highest on the Worldbank’s Logistics Performance Index tend to have the most developed economies, while those ranked lowest tend to have the least developed economies. Increasingly, the countries and regions of the world that will continue to experience the strongest economic growth will be those that are quickest to embrace and deploy the still nascent and emerging engineered systems that reflect a tight integration of computation and physical supply chains, in every area of economic activity.

If by now, the reader is beginning to conclude that the future of supply chains will be driven largely by supply chain enthusiasts, we agree.

We Will All Be Supply Chain Enthusiasts

So who is today’s supply chain enthusiast? A supply chain enthusiast is;

  • Someone who recognizes that the world is a mechanism for providing humanity with the resources it needs to survive. 
  • Someone who recognizes that each of us has a responsibility for ensuring that this supply chain that we are part of is managed in a way that ensures that humans continue to thrive. 
  • Someone who understands that collectively, we must summon the political will to begin the effort of arresting, and then reversing, the harm that we have caused to the environment. 

We will all become supply chain enthusiasts, not because it is the fashionable thing to do, but because with every year that passes it will become an issue of increasing and critical necessity. As more people become aware of, and start to understand that how we produce, store, transport, and consume things has a profound impact on our environment, enthusiasm about supply chain, innovation, and technology will become more socially and culturally mainstream. 

At that point, “The world is a supply chain.” will become a rallying cry everyone innately understands.

Note: “The world is a supply chain.” is a trademark owned by The New York Supply  Chain Meetup.

About The Authors: Brian Laung Aoaeh (@brianlaungaoaeh) and Lisa Morales-Hellebo (@lisahellebo) are co-founders of REFASHIOND Ventures, an early-stage venture capital fund that is being built to invest in startups creating innovations to refashion global supply chain networks. They are also co-founders of The Worldwide Supply Chain Federation, a growing network of grassroots-driven communities focused on supply chain, innovation, and technology.

Filed Under: Entrepreneurship, Innovation, Investing, Investment Analysis, Investment Philosophy, Investment Strategy, Investment Themes, Investment Thesis, REFASHIOND Ventures, Startups, Strategy, Supply Chain, Technology, Venture Capital Tagged With: #InvestmentPhilosophy, Disruptive Innovation, Innovation, Investment Analysis, Investment Strategy, Investment Themes, Investment Thesis, REFASHIOND Ventures, Startups, Supply Chain, Technology, Venture Capital

#UserManual – Send Us All The Early-Stage Supply Chain Technology Startups

October 17, 2019 by Brian Laung Aoaeh

Brian Laung Aoaeh and Lisa Morales-Hellebo, at #SCIT2019, June 19 – 20, Microsoft, Times Square, NYC. Photo Credit: Ray Neutron.

Author’s Note: This blog post is an updated version of User Manual: The Early Stage Startups I Want To Hear About Most in 2016 and 2017 and User Manual: The Early Stage Startups I Want To Hear About Most in 2017 and 2018. Certain portions of this version may be exactly the same as in the prior versions. However, there are significant differences between the prior versions and this one.

About REFASHIOND Ventures

REFASHIOND Ventures is a seed-stage venture fund that Lisa Morales-Hellebo and I are building to: invest in startups developing technology innovations to refashion global supply chains – across different industries. 

We are in the process of raising our first fund. Once we raise the fund, we will be based in New York City. 

While we are raising the fund, we are collaborating with a family office to make some early investments that fit our investment thesis, and the family office’s investment interests.

The three philosophical pillars of our investment thesis are;

  1. The world is a supply chain.TM
  2. Software is eating the world.
  3. Disruption creates opportunity.

Our working definition of a supply chain: “A network of connected and interdependent organisations mutually and cooperatively working together to control, manage and improve the flow of materials and information from suppliers to end users.”

– Martin Christopher, Logistics & Supply Chain Management: Creating Value-Adding Networks, 4th ed, Pearson Education Limited 2011, p4

We believe that a perfect storm of irreversible social, economic, technological, and environmental forces, has created an urgent and critical need to refashion global supply chains. This process presents the biggest investment opportunity of the next half-century. We are building a fund to invest in that opportunity.

We’ll invest in startups in the following areas; Supply Chain Management, Supply Chain Logistics, and Supply Chain Finance – across industries.

Our initial focus is on startups based in the United States, and Canada.

About The Worldwide Supply Chain Federation

The Worldwide Supply Chain Federation, which we founded in August 2017, is the collaborative, and mutually supportive coalition of grassroots communities focused on technology and innovation in the global supply chain industry. Each chapter is a community of practice that connects the builders of technology innovations for supply chain with the buyers of technology innovations for implementation in real world commercial supply chains. The New York Supply Chain Meetup is its founding chapter.

The Worldwide Supply Chain Federation is the world’s first, largest, fastest growing, and most active network of grassroots driven communities focused on supply chain, innovation, and technology. You can learn more here: The Worldwide Supply Chain Federation.

You can check out our Youtube Channel here. Join our community here. Follow @tnyscm on Twitter.

Characteristics We Look for in Teams, and Founders

We look for – we will not learn this until we actually interact with you. But this is what we will be looking for;

  • Teams in which the founders have known one another for a considerable amount of time prior to launching their startup; We look for teams in which the level of trust and respect between the co-founders is high. This reflects our belief that at the earliest stages of a startup’s life, team risk is the greatest risk we must worry about.
  • Teams that will not have difficulty attracting other great people to join the startup; We look for founders who inspire confidence and loyalty from others because they are good at what they do, the kind of people we could picture myself working for. We look for people that others outside the startup can come to look up to as thought leaders in their chosen area of expertise.
  • Founders for whom solving the problem that their startup is solving has become their life’s mission and they will work to solve that problem with or without help from outside investors; We look for founders who have an unconventional opinion about the market opportunity they are pursuing, and can explain their position is with evidence that investors can analyze independently. We look for founders who are focused squarely on solving their customers problems.
  • Teams that can focus on building a simple product that their initial customers love, and who can focus on a niche within which to launch that product. We look for teams that are judicious and frugal in how they deploy the startup’s resources.
  • Founders who value teamwork, and who can become great leaders if they desire to do so; We value transparency, honesty, and openness. We value self-awareness. We like people who are determined and tenacious, who do not give up just because the going gets uncomfortable and things seem bleak.
  • Founders who have a hard time doing something simply because it is what someone else expects them to do; We do not like obedience. We detest arrogance. We admire confidence. We look for founders who are not afraid to be different. We look for founders who have prior demonstrable experience of good decision-making when things are uncertain and information is incomplete. We are not looking for perfection.

Characteristics We Look For in Markets

We look for;

  • Large markets that could ultimately be served by the startup’s product, even though the initial target might be a small portion of the whole. We look for customers capable of and willing to pay for the product, and who are looking for and eager to find a solution to their problem.
  • Markets in which the pain is acute because the problem suppresses customers’ profits significantly, or because the problem makes users far less effective and efficient than they could be.

If currently the addressable market is between $1B and $10B, we want to see evidence that it is growing quickly enough to support the startup’s future goals, and the competition that we assume will quickly follow if the team is successful.

Characteristics We Look For in Business Models

We look for products and business models that:

  • Will benefit from network effects as time progresses,
  • Can scale efficiently and quickly once product-market-fit has been established, and
  • Can eventually benefit from an economic moat as the startup matures into a company, and the business model becomes established.

The Themes We Are Focused On

Notes:

  • These themes cut across different industries and sectors. That is a deliberate choice in the way we are designing REFASHIOND Ventures.
  • The technology sector evolves constantly. Accordingly, our team’s interests might adjust in response. The themes we have described below should serve as a rough guide to how we think about the universe of startups in which REFASHIOND Ventures will invest. It is not comprehensively exhaustive, nor is it mutually exclusive of themes we have not described. If the innovation you are working on fits our definition of supply chain and the descriptions above, please reach out to us.
  • We anticipate that REFASHIOND Ventures first fund will be a pre-seed and seed-stage fund. Our current collaboration will primarily focus on startups raising an institutional seed round, or raising a round between a previous institutional seed round and a series A round.

Our current investment themes;

  • Next Generation Logistics: Platforms or applications that significantly improve how logistics and transportation networks are operated and managed.
  • Advanced Materials: Platforms or products that make it possible to research, invent, and create new types of materials at scale. We are especially interested in the conversion of large quantities of waste of different types into new materials. 
  • Advanced Manufacturing: Platforms or applications that make it possible to integrate advances in software engineering into manufacturing processes. 
  • Data & Analytics: Platforms or applications that help people or other machines to manage, analyze, interpret, make decisions, and take actions based on vast and growing amounts of centralized or decentralized data from disparate sources. Such platforms or products enable large numbers of different types of connected devices, machines, apps, and websites to communicate with one another seamlessly, and with the people managing or using them, within a secure environment. 

Connecting With Us

If you know someone who knows us, an introduction would help. If you do not, never hesitate to communicate with us directly. We are both very easy to reach on the major social networking platforms. 

The best time to start communicating with us is before you are raising a round because we believe it is important to build trust and understanding before entering into the kind of working relationship that exists between startup founders and their early stage investors.

That also gives us sufficient time to understand the problem you are solving, so that if REFASHIOND Ventures invests, we are doing so with conviction. Time enables us to become a more effective advocate on your startup’s behalf when we have discussions about you with other investors we know, and who we feel would be a good match for the round you are raising.

Communicating With Us

If we are not meeting through an introduction, we will respond quickest to founders who get straight to the point, and explain why we should speak with them in 250 – 400 words in their first email to us. We try our best to respond to founders who initiate communication with us. However, depending on what else we have going on, we may not respond if we feel the startup is outside REFASHIOND Ventures’ areas of interest. 

Follow up with us once or twice if you believe we have made a mistake by not responding.

Things We Believe Are Red Flags

  1. Exploding rounds: An exploding round comes with a caveat like “Seed round in ground-breaking tech startup closing in 1 week!” We need time to do our own homework.
  2. Meetings led by an advisor: We prefer our first few interactions with a startup to be with the team of co-founders, not with an advisor or an investment banker. It is okay for an introduction to come from an advisor if that advisor is someone we already know. We do not like to have advisors or mentors micro-manage our interactions with startup founders. That does not inspire confidence.
  3. Lack of control over core technologies: We try to avoid situations in which the startup has a product that has launched to the public, but the startup’s team has no primary responsibility for actually building the core product. If there’s IP we’ll spend some time trying to understand who owns the IP.
  4. Founders who are mainly focused on invention: Some founders are born inventors. In and of itself, that is not a bad thing. However, as investors we have made a choice to invest in founders who want to build potentially big businesses. 

Our Commitment To Startup Founders

Based on Gil Dibner’s VC Code of Conduct;

  • We will be transparent.
  • We will respect your time.
  • We will not ask you for material we do not need.
  • We will not string you along.
  • We will let you know about any competitors in our portfolio.
  • We will be transparent about conflicts of interest.
  • We will not share any of your material without your permission.
  • We will not speak with your customers without your permission.
  • We will educate before we negotiate.
  • We will be honest about what standard terms are.
  • We will not issue a term sheet unless we have made a firm decision to invest.
  • We will reflect the term sheet in the final legal documents.
  • We will not seek an unreasonable equity stake.
  • We will avoid surprises.
  • We will always act in the best interests of the startup.

Without doubt, there will be times when we fail to live up to these ideals. When that happens we hope founders will let us know. That is the only way we can get better.

Filed Under: Investing, Investment Themes, Investment Thesis, REFASHIOND Ventures, Venture Capital Tagged With: #InvestmentPhilosophy, Early Stage Startups, Investment Themes, Investment Thesis, REFASHIOND Ventures, Startup Communities, Strategy, Supply Chain Finance, Supply Chain Logistics, Supply Chain Management, Venture Capital

#MarketVoices | Introducing My Weekly Column at FreightWaves

April 23, 2019 by Brian Laung Aoaeh

Brian + His Pencils

According to the International Monetary Fund, the world’s economy is worth $88 Trillion as of 2019. The Conference Board estimates that the global economy will grow at an annual rate of about 3% between 2019 and 2023, and at about 2.8% between 2024 and 2028. None of this is possible without supply chains; The networks of interdependent organizations that cooperate and collaborate with one another to move goods and information between producers and consumers. In the past this mission-critical activity was relegated to the unsexy confines of the business world – back office operations. That attitude is changing and it is changing fast.

The changes taking place in attitudes about supply chains are due to a combination of factors;

  1. Changes in consumption patterns driven by economic growth in China, India, Brazil, Russia and other markets outside North America and Western Europe.
  2. Changes in the buying behavior and consumption patterns of individuals and businesses around the world, accompanied by increasing awareness about how the production and consumption patterns of the past may be affecting climate change and the future of our planet.
  3. The inexorable forward march of technology, as it evolves to solve the problems that have arisen due to the preceding two factors; Connected devices, artificial intelligence, autonomous vehicles, predictive data and analytics, 3D printing, blockchain, advanced manufacturing, and advanced materials. These technologies, and others, have finally matured to the point where they are being tested in the world’s supply chains – to solve problems that could not be solved in the past, to eke out efficiencies, and in some cases to completely overturn how things have been done in the past.
  4. The politics of tradewars, tariffs, and geo-political groupings and alliances brings the interconnected, interdependent, and fragile nature of today’s global supply chains into stark relief for even the most uninformed citizen.

These concerns are not some theoretical or imaginary distraction; Supply chain is the basis on which corporations win or lose competitive advantage. In the space of a few decades Amazon has become one of the world’s most valuable companies at the expense of Walmart, Toys R US, Barnes & Noble, and other retailers, largely on its superior supply chain management,  and its expertise in technology. In its heyday, the same was said about Walmart. There are many more examples

Well functioning supply chains are also positively correlated with economic development: Regions of the world with well developed infrastructure and supply chains tend to experience superior economic growth in comparison to parts of the world with poorly functioning infrastructure and supply chains.

My column will study, analyze, and highlight the innovations that are being brought to market to solve problems in supply chain management, supply chain logistics, and supply chain finance, with a particular focus on how they are inextricably interdependent on one another. I will examine this topic across industries, and across regions of the world. Where possible we will look to data to help inform the discussion. Often we will highlight the specific individuals and organizations doing interesting work tying supply chain, innovation, and technology together in ways that create value for businesses, for individuals, for countries, and for the world; A 1% efficiency improvement in global supply chains represents aggregate value-creation of roughly $880 Billion.


The column will appear on FreightWaves once a week. If you have ideas you want to see me cover in future articles, send them to me via Twitter @brianlaungaoaeh or via LinkedIn. I believe that the best ideas come from the most unexpected places, so I want to hear from FreightWaves’ readers and anyone else who is obsessively enthusiastic about supply chains, innovation, and technology.

Filed Under: Innovation, Investing, Investment Themes, Investment Thesis, Market Study, MarketVoices at FreightWaves, Startups, Supply Chain, Venture Capital Tagged With: #MarketVoicesAtFreightWaves, Innovation, Investment Analysis, Investment Thesis, Supply Chain, Supply Chain Finance, Supply Chain Logistics, Supply Chain Management, Technology, Venture Capital

#NotesOnStrategy | Seed-stage Venture Capital Portfolio Construction

March 21, 2019 by Brian Laung Aoaeh

Note: Although I have not used quotation marks, much of this blog post quotes the people to whom I have ascribed comments almost verbatim. I made slight stylistic and mechanical edits to account for the fact that presented in this format, I do not have the constraints that Twitter imposes on users. Where meaning is unclear or erroneous, I bear full blame for the mistake.

The man who grasps principles can successfully select his own methods. The man who tries methods, ignoring principles, is sure to have trouble.
– Ralph Waldo Emerson

Background: I joined a single family office in December 2008 as the second employee on the team, and as the first employee on what would become the direct investing team. In January 2011 we started building a venture fund from the ground up, KEC Ventures. It grew to $98M of assets under management distributed across a $35M 2011 fund and a $63M 2014 fund, with 51 investments in aggregate. I left KEC Ventures in September 2018. You can read my reflections on my time at KEC Ventures here: #ProofPoints.

I have now teamed up with Lisa Morales-Hellebo to build an early stage fund to invest in startups building innovations to refashion global supply chains. We’re in the early stages of raising the fund, so I am thinking through the issues that every emerging fund manager grapples with. We are simultaneously building The New York Supply Chain Meetup, and The Worldwide Supply Chain Federation – more about that at the end of this article.

This blog post is a qualitative examination of issues pertaining to portfolio construction and portfolio management, from the perspective of a seed-stage manager who is managing a Fund I portfolio that falls somewhere between $10M and $25M of AUM. It is based on a discussion that occured on Twitter in early February 2019.

Before I go much further, some philosophical housekeeping;

  1. It is my belief that the seed-stage technology venture capitalist’s only goal is to benefit disproportionately from uncertainty. To do this the best seed-stage venture capitalists seek startups that fit an investment thesis, and make investments before other investors would normally invest.
  2. When I think of uncertainty, I am thinking of a state of affairs in which I have limited information and knowledge, and must make a decision whose outcome I can’t predict because the future is unknown and unknowable. I do not think one can measure uncertainty quantitatively.
  3. When I think of risk, I am thinking of undesirable future outcomes some of which I can enumerate quantitatively.

A startup is a temporary organization built to search for the solution to a problem, and in the process to find a repeatable, scalable and profitable business model that is designed for incredibly fast growth. The defining characteristic of a startup is that of experimentation – in order to have a chance of survival every startup has to be good at performing the experiments that are necessary for the discovery of a successful business model.

This is the definition I have in mind when I speak of a startup. Early stage venture capitalists will typically invest before search and discovery is complete. This definition is based on a definition by Steve Blank, to which I have added the characteristic of fast growth based on Paul Graham’s observations.

In the remainder of this post, I try to synthesize and organize the comments that arose from my original question on Twitter. I add some commentary of my own where I feel it will be helpful. I am always thinking about this topic so if there is other material you think I should read please send it to me. The easiest way to do so is via Twitter: @brianlaungaoaeh.

I assume that the reader is already familiar with the basics of VC and how a venture fund is structured. If not, here’s a decent introduction from the Harvard Business Review: How Venture Capital Works.

Note: When I make references to modeling portfolio construction for REFASHIOND Ventures’ first fund – which we are in the early days of raising, I am using a spreadsheet model template developed by Taylor Davidson at Foresight. I have known Taylor since 2013 and I couldn’t recommend his work highly enough.

The data below from Correlation Ventures, and CBInsights is pretty self-explanatory.

Correlation Ventures’ data looks at individual financings rather than at individual companies – one company can have multiple financings. The data from CBInsights looks at individual startups, where, similarly, one startup can have multiple financings.

My conclusion, based on these two pieces of analysis, is that an early stage VC should expect that at least 50% of the startups in any given fund portfolio will lose all the money that the VC invests in them. The data from Correlation Ventures suggests an even more grim outlook – though as you’ll see later it is somewhat less categorically conclusive. However one looks at the data, the conclusion is sobering.

To put the data in context, for a while the rule of thumb was that 33% of the startups in a VC portfolio would go to zero, another 33% would return invested capital, and the remaining 33% would do significantly better – resulting in the 3x net return that limited partners expect.

According to this historical distribution of returns data compiled by Correlation Ventures, 10% of financings provide over 5x return while 65% are partial or complete write-offs.
In this analysis by CBInsights, less than 50% of startups that raised a seed round in the United States between 2008 and 2010 were able to raise a subsequent round of capital.
In this analysis by CBInsights, less than 50% of startups that raised a seed round in the United States between 2008 and 2010 were able to raise a subsequent round of capital.

Given this state of affairs, how do different VCs think about portfolio construction and portfolio management? If you are a family office, an individual, or a corporation getting into venture capital as an asset class for the first time, and if you are investing in a manager who is raising their first fund, what should you be on the lookout for? I hope this helps frame the issues worth considering. Note that the discussion documented below centered around the data from Correlation Ventures only. I have not included every response to my tweet, only those I feel contribute directly to the topic. It is possible I have missed a few replies because the thread started branching off in several directions after a while.

Eliot Durbin (@etdurbin) from Boldstart Ventures: Two nuggets of advice I got on our early funds . . . expect 20% of portfolio to drive 80% of returns. Pay attention to founders that get those 1x – 3x returns on their first rodeo, because the next will be better. Also, third, plan your percentage reserves for follow-on investments because ownership in your winners matters most.

Jerry Neumann (@ganeumann) from Neu Venture Capital: It means you have to make enough investments so that you have a decent shot at being in some of the outliers. The expected value here is at least 1.2x.

Hadley Harris (@Hadley) + Nihal Mehta (@nihalmehta) from ENIAC Ventures: The key is to build out two models. The first is a fund model with number of companies and projections about how broad/deep you follow. The second is a liquidity model to project when money will come back for recycling, and the triggers for investing past initial investable capital. Note: The process of recycling capital allows the fund to gain leverage without exposing limited partners to additional risk beyond their capital commitment.

Albert Wenger (@albertwenger) from Union Square Ventures has blogged about uncertainty for some time, and he discusses this topic in this installment – arguing that because this distribution is now well understood, valuations are being bid up significantly. This puts small funds at a disadvantage, and contributes to the phenomenon whereby VCs raise larger and larger subsequent funds. It’s a brief post. You should read it.

Chris Douvos (@cdouvos) from AHOY Capital: Here’s a thought:

  • VC has always been a power law business, so big hits drive portfolio returns . . . and the big hits are getting bigger, but on the other hand, pricing going up is going to cut returns, not only of the big winners, but also of the middle OK part of the portfolio.
  • Remember: Opportunity = Value – Perception, and the industry is so good at blowing up perception, but true Value is more fleeting – and, if we’re being pedantic, Value is the discounted present value of future (positive) cash flows. [My comment; The dichotomy between Value and Perception that Chris is referring to explains why the data from Correlation Ventures seems so jarring at first glance.]
  • But everyone’s bought into the power law dogma, so unicorns are getting bid up, often with pricing for perfect execution, following winds, and fair seas . . . any hiccup (systematic or idiosyncratic) will lead to a lot of stranded unicorns, or as Bryce (of Indie.VC) calls them, “donkeys in party hats” . . . Speaking of which, I think his efforts over at Indie.VC have been a creative and thoughtful search for Opportunity in the context of Value – remember, Opportunity = Value – Perception.
  • At the end of the day all that matters is Moolah in da Coolah – the distributed to paid-in-capital multiple that a fund ultimately achieves. Here was my effort at thinking about some of these portfolio construction issues in the context of valuation environment: All About the Benjamins.
  • But I remain really nervous about the environment. As Henry McCance at Greylock told me in 2001, VC works well when time is cheap and capital expensive. When that relationship is reversed, trouble ensues.

Dave McClure (@davemcclure), formerly of 500 Startups:

  • This means you should do a LOT more deals, unless you pick better than Sequoia. Of course depends on dealflow, selection, and stage, but if you start investing at seed-stage, most GPs with portfolios with N < 50 companies are playing Russian roulette. If large outliers of > 20x happen only 1% – 2% of the time, basic math would suggest a portfolio size of N > 100 is more rational.
  • [My comment; Yes, The basic math certainly supports that conclusion. Though, I wonder if there are nuances the basic math doesn’t capture. Do you think there are conditions under which one might justify deviating from that prescription?] Well if you’re a subject matter expert and/or have excellent access to dealflow or an established brand, you might choose to build a concentrated portfolio – but again you’d have to convince yourself, hopefully based on data, that you’ll generate a higher percentage of outliers than the average VC.
  • [My comment; Got it . . . Though, one has to wonder if there’s such a thing as a subject matter expert when it comes to predicting how the future will unfold. But, I see why that approach would make sense – in some rare cases. Who would you say does that really well? Anyone? CVCs?] Well for specific IP-related areas, people who are scientists/PhDs/professors might have an advantage. For industry verticals, maybe experienced business or technical folks. Famous people and/or famous VC firms might also have an advantage. Not sure about CVCs, unless specific IP perhaps.
  • [My comment; That reminds me of one of the points Richard Zeckhauser makes in Investing in the Unknown and Unknowable; collaborate with other investors with superior knowledge of specific industry verticals, among other things.]

Josh Wolfe (@wolfejosh) from Lux Capital:

Huge wins are rare / Mostly luck / Claimed as skill / But huge wins beget halos / And halos beget better reputation / And better rep begets better opps / And better opps up the odds / That you get lucky / With a rare huge win [My comment; Josh typed this like a poem. I just couldn’t figure out how to get that layout using this new UI on WordPress. I have spent a lot of time thinking about the skill versus luck dichotomy in early stage VC. So one way to think about this discussion is to ask; In relation to portfolio construction, what can a seed-stage VC do to optimize luck?]

Tren Griffin (@trengriffin), author of 25iq – a blog about markets, tech, and everything else:

At the core of almost everything is probability. The future is a probability distribution. The best processes creates favorable odds of a correct decision. A good process can create a bad result and vice versa. Quoting Warren Buffett:

Warren Buffett, on Diversification and Portfolio Construction
Warren Buffett, on Diversification and Portfolio Construction

Fred Destin (@fdestin) of Stride.VC:

  • In my experience the skew is almost systematically massive. With one fund returner – your fund is likely to be fine, with two – it’s likely to be great, etc. The top 2 to 4 exits will likely more than 2x+ the fund, the next 5 to 8 exits together will return 1x the fund, and the rest might lose some money.
  • Hence I’m always thinking – never invest in anything that can’t return the fund – which is, of course, a function of ownership and upside, with upside uncapped if you want to have a shot at a “glimmer of greatness”.

[My comments; Thanks, Fred. “Never invest in anything that can’t return the fund.” How does one figure this out? In one of his books Nassim Nicolas Taleb talks about two forms of analysis; First – Thinking forward to the future state, and then, Second – Thinking backwards to the current state. But, how does one do that without succumbing to magical thinking? Are there other approaches? I created a grid based on a blog by Bill Gurley – All Revenue is Not Created Equal: The Keys to the 10X Revenue Club. But, I’m always wondering how others approach this question. I have to admit, team decision-making then becomes an issue . . . Doesn’t work if rest of the team doesn’t buy into systematically thinking about that question as a group. I used a similar approach to guide my effort to determine if a startup has the potential to develop moats. This also raises an issue that Dave McClure mentioned in our exchange on this same question; A VCs ability to add value – early customer introductions, engineering outcomes to help avoid or minimize the scenarios where a startup doesn’t return invested capital – makes a big difference – I noticed this while I managed a fund of funds portfolio at KEC Holdings between 2008 and 2012. I’m confident using a template or checklist is helpful – Michael Mauboussin discusses that approach in The Success Equation. A question in my mind is how Lisa and I can codify best-practices into decision-making processes as we get REFASHIOND Ventures off the ground. But perhaps as Hadley and Eliot alluded, it’s a question that requires a multi-step solution with at least 2 layers of analysis; First – a fund level macro analysis, and then, second – an analysis of each investment to see how it fits the fund level macro framework. Though, I think in Zero to One, Peter Thiel discusses how at the early-stage one differentiator is a VCs qualitative analysis of how the future will unfold more so than anything else. That does not negate anything that’s been said so far, but it suggests that there’s a lot of room for interpretation.]

  • Tie decision making to absolute rules (eg I need a moat in every investment) and you’re introducing a systematic bias / hard screening criteria. That may be fine – but don’t confuse a disciplined decision-making process and method with fixed decision-making “rules”. The only rule that should be fixed in my opinion is: the potential for unlimited upside exists within the fund’s duration. [My comment; I agree. It’s less about absolute rules, and more about ensuring I have thought about the issues and have consciously decided one way or the other. I think it’s important to do that when things are uncertain and and failing to think through the issues is costly. As you point out, it’s more about process than hard rules . . . Especially – at the stage at which I’m doing this there are no moats yet, but I need to consider the possibility that they can develop over time, and why that may happen if things work out. But, point taken re systematic bias.]

Never invest in anything that can’t return the fund.

Fred Destin, Stride.VC

Note: At this point I shamelessly plugged my work on Economic Moats: Economic Moats for Early-stage Tech Startups (Half a Dozen Blog Posts & A Presentation. Also, note that there’s a philosophical divide about economic moats and startups among VCs. Some think they matter. Others do not. I think they do, and I think a careful analysis of the issue leads to that conclusion for startups that will go on to return an entire fund, for example. However, I also agree with the observation that at the the earliest stage of a startups existence the thing that matters most is the startup’s ability to make its customers happy as it conducts the search for a scaleable, repeatable, and profitable business model.

An economic moat is a structural feature of a startup’s business model that protects it from competition in the present but enhances its competitive position in the future.

This is the definition of an economic moat I have settled on, based on my work thinking about the topic from my specific vantage point as an early stage VC.

Ed Sim (@etdurbin) from Boldstart Ventures: Great questions but don’t overthink it; First, every investment has to have opportunity to return fund. Second, ownership matters. Third, reserves matter. A related question; What is your return the fund exit (RFE) for each investment assuming dilution? That analysis will show that ownership and reserves matter, and so does capital efficiency. [My comment – I have known Ed and his partner, Eliot since 2012; Ed! I am trying to find the Goldilocks Zone; not too much thinking, but not so little that we get taken by surprise . . . I agree working through these points will cover most, if not all the necessary ground.]

What is your return the fund exit (RFE) for each investment assuming dilution?

Ed Sim, Boldstart Ventures

Sean Glass (@SeanGlass), Founder and CEO – Advantia Health. Founding Partner – Acceleprise; What was the return on that meta portfolio? I think the role of vc as investor is to generate alpha, and you do that by taking an approach that gives your portfolio asymmetric risk. Just like with public equity investing there are a different approaches to doing that.

Sean’s comment raises an observation first made by, Arjun Sethi (@arjunsethi), who is Co-Founder of Tribe Capital, and formerly of Social Capital, Yahoo, and MessageMe, and LoLApps – about the graph from Correlation Ventures; The graph is a poor illustration of what defines a venture round, fund and timeline of investment. [Jerry Neumann’s comment; Agree. The data is fairly useless. If you take the bottom end of each bucket it’s 1.2x, top end (except 50x+) it’s >4x. So, runs the gamut.]

Deepak Gupta (@DeepakG606) from WEH Ventures; The Correlation Ventures data refers to financings and not number of companies. It’s possible a VC made an overall 10x+ in aggregate in one company but would still be hitting 2x or 1x fund in this data. So overall percentage of multibagger companies will be higher than suggested by this analysis. [My comment; This is true, given the modeling I have been working on. There are scenarios in which the fund would fail to meet LP expectation of a 3x+ net distributed to paid-in-capital ratio even though the percentage of big winners is non-zero. It’s quite trivial to see how this might happen if the general partners’ capital allocation decisions do not ultimately work in the fund’s favor.]

  • I wouldn’t go as far as to say the data is completely useless, though I see the argument Arjun and Jerry are making. If one assumes that the two sets of data suggest possible probability distributions, then I think the interpretation should be that; First, any portfolio construction that assumes less than 50% of the portfolio going to zero is almost certainly naively over-optimistic. Second; assumptions about big winners should be scrutinized closely because they are rare – so fund managers should be able to explain how they will attract dealflow that will include more than their fair share of potential fund-returning startups AND the processes they have developed to maximize the chance that they actually select those startups for inclusion in the fund’s portfolio.
  • In my work on modeling portfolio outcome scenarios for REFASHIOND Ventures’ first fund, I have gone as far as assuming 90% of the portfolio goes to zero. I have not modelled 100% of the portfolio going to zero because that’s obviously the trivial case – if that happens we’ll most certainly have bigger problems to worry about. Most of the time spent in discussions between prospective limited partners and the venture fund’s general partners should be in arriving at underlying assumptions that reflect reality and can be justified by how the general partners have said they will run the fund, with enough flexibility to allow the fund to exploit unforeseen and unexpected opportunities as they arise in real-time – remember that optimizing luck is an important aspect of all this.
  • Correlation Ventures has not made public a version of this analysis that presents the results in a manner similar to that done by CBInsights. It is likely that they were unable to get to that level of granularity given the source data, or they may prefer to keep that specific version of the analysis as a trade secret.

Dan Buckstaff (@Buckstaff) shared a link to an article by Morgan Housel (@morganhousel) from Collaborative Fund – Tails, You Win; It’s a short article and you should read it if you want to learn more about how prevalent power laws are around us. I like this quote from Benedict Evans – I have paraphrased it to refer to Early-stage Venture Capital rather than Silicon Valley: Early-stage Venture Capital is a system for running experiments. It’s the nature of experiments that some fail – the key is for the ones that work to really really work. [My comment; Once you read the article you should notice that it echoes themes from the comment Josh Wolfe made earlier.]

Early-stage Venture Capital is a system for running experiments. It’s the nature of experiments that some fail – the key is for the ones that work to really really work.

Paraphrasing, Benedict Evans, Andreessen Horowitz

Baris Guzel (@BarisGSF), of BMWi Ventures, pointed me to a blog post by Seth Levine (@sether) from Foundry Group – Seth’s contribution to the discussion is below;

  • To your specific question; Given skewed outcomes what’s the right strategy for a small fund? in general smaller funds will have less opportunity to consolidate ownership in outperforming companies. Thus I think the right strategy is to seek more exposure – place more bets. [My comment; Thanks, Seth. There seems to be a tension between seeking more exposure AND getting as much ownership % as early as possible, and reserving capital to follow on in later rounds. Especially, in the context of a fund 1 with say $10M – $20M of AUM. Thoughts? If you had to choose?]
  • There’s definitely that tension. In an ideal world you’d have enough capital and enough early, but predictive, data to consolidate into your best companies. Larger “Series A” funds do that regularly, but with a seed fund you have challenges with both capital and information.
  • You have a small fund and by the time you have to make a follow-on decision, or more ideally preempt a round, you don’t really have that much more data about the opportunity. That’s really the argument for placing as many early bets as possible.
  • The ones that run on you drive value and you’ll have plenty of exposure to the potential for upside. It’s easy to say in hindsight that you “knew” something was going to be great, but how often do you have that reliable insight between Pre-seed, Seed, Seed+, and Series A? [My comment; I know that’s a rhetorical question, but there’s so much pressure to seem prescient, all knowing, and fully certain about the future . . . But yes, it’s generally hard to know. So it seems things point back to the decision-making process, and a bit of luck, as others have alluded. I’ve stopped paying attention when people tell me to “sound more confident about what you’re saying” . . . How can one be confident when decisions are being made under extreme uncertainty? I’ll stop bloviating.]
  • Re: Luck, that reminded me of this ancient post of mine (2005 – I was an associate) about what makes a good venture capitalist and David Cowan’s comment, which has always stuck with me. [My comment; I couldn’t find the blog post Seth is referring to, but I found a discussion thread elsewhere in which David Cowan, of Bessemer Venture Partners says the correct answer to the question “What do you think is the most common trait among successful venture capitalists?” is “Luck.” This reminded me of a blog post I wrote about Fab.com around the time I was studying economic moats; Vcs often rail about startups raising too much money at valuations that are too high to sustain, but VCs too sometimes make investments that assume perfect knowledge, perfect execution by the team, perfect market adoption . . . etc, to the point Chris Douvos made earlier. I wonder how the early stage venture funds that invested in Fab.com have fared. I have not looked that up yet.]

This also calls to mind a quote from Andy Rachlef, formerly of Benchmark Capital; Investment can be explained with a 2×2 matrix. On one axis you can be right or wrong. And on the other axis you can be consensus or non-consensus. Now obviously if you’re wrong you don’t make money. The only way as an investor and as an entrepreneur to make outsized returns is by being right and non-consensus.

The 2×2 Matrix of Investing Outcomes

This article by Tren Griffin delves deeper into the topic: Why Investors Must Be Contrarians to Outperform The Market.

Investment can be explained with a 2×2 matrix. On one axis you can be right or wrong. And on the other axis you can be consensus or non-consensus. Now obviously if you’re wrong you don’t make money. The only way as an investor and as an entrepreneur to make outsized returns is by being right and non-consensus.

Andy Rachlef, formerly Benchmark Capital, now at Wealthfront

Note: At a certain point in the discussion on Twitter a side-bar discussion developed about how much help seed-stage venture capitalists should provide to startups in which they have made an investment as those startups search for product-market-fit. I am not including those here as that is a separate topic worth exploring on its own.

Chinedu Enekwe (@Cope84) from Affiniti VC; Very true – risk in the winner and finding ways to coach the laggards into favorable exits. [My comment; He highlighted this blog post by Fred Wilson (@fredwilson). It’s worth reading, if you’re an emerging manager coming to grips with how to manage your portfolio. The primary uptake from Fred’s blog post is that the best early-stage VCs spend more time with startups in the second and third quartile of portfolio returns than with startups in the top quartile. This is keeping with my beliefs on the topic; The very best investments in an early-stage VC portfolio will do fine, those founders are pretty self-directed and resourceful. They will succeed with or without anyone’s help. Also, they are very proactive about letting investors know what assistance will be most beneficial to them, in advance. So where a VC can really move the needle with regard to portfolio returns is with the startups and founders that really need some help to avoid returning 0x the invested capital. I saw this play out in a fair amount of detail when I was also responsible for performance monitoring and reporting on a sizeable fund of funds portfolio between 2008 and 2012 – it included early stage VC funds, growth funds, buyout funds, hedge funds, and some public equity active funds.]

Note: The following discussions were not part of the thread that formed from my question on Twitter, but they are relevant, and so I am including them here.

Samir Kaji (@Samirkaji) from First Republic Bank; Shared an article by Clint Korver of ULU Ventures: Picking winners is a myth, but the Power Law is not. It is worth reading Clint’s article because he introduces some added dimensions to the discussion. Here’s additional advice from Samir, some of which I got over email, and then during a call with him when Lisa and I told him about REFASHIOND Ventures. I have also cherry picked comments from some blog posts he’s written on the topic.

  • To maximize the probability of success, fund GPs raising a first fund should perform the portfolio construction exercise based on their investment thesis, their knowledge of the market in which they plan to operate, and how much capital they need to prove that they can execute the thesis. Although, macro considerations are always a concern for managers raising their very first fund, this exercise should be performed independent of considerations from prospective LPs who make comments such as “You should not raise more than $X for your first fund.” In other words the dog should wag its tail, not the other way around. He discusses that topic here: Is there ideal portfolio construction for seed funds?
  • Although many will pejoratively speak of large portfolios as “spray and pray”, doing so ignores years of probability and statistics, and likely over-weights skill versus luck.
  • That said, larger portfolios do come with some challenges: Scaling value-add to portfolio companies. Requiring larger exits (given smaller initial checks/ownership vs. concentrated portfolios) for definition of outlier (fund returner). Tougher to make follow-on decisions.
  • When pitching LPs, at a minimum expect to discuss
    • Target Fund Size,
    • The stage at which the fund will make its initial investments; Pre-seed, Seed, Series A, Series B . . . or later,
    • Average Initial Check Size,
    • Average Initial Ownership Target – which establishes the valuation bands within which the fund should invest,
    • Total Number of Startups in the Portfolio – a range is the norm,
    • The fund’s Follow on Reserve Percentage, and
    • The Fund’s Investment Period.
  • As conversations progress, more sophisticated LPs may want to discuss the key assumptions driving the sort of scenario analysis I described earlier. Clint performed a simulation to arrive at the conclusions in his article.

Conclusion: The goal of this article was to develop a qualitative understanding of how other VCs think about portfolio construction and portfolio management from the perspective of an emerging early-stage VC raising an initial fund of between $10M and $25M of AUM. Limited Partners in a new manager raising a first fund face the same questions about making an investment that venture capitalists encounter when they seek to first deploy capital into a startup they have just met. For most LPs the easier decision is “wait and see” rather than to take on the uncertainty, risk, and hard work necessary to make a decision to invest in a new VC fund manager. One way to get LPs comfortable making a commitment is to;

  • Demonstrate that the new manager has a unique investment thesis based on knowledge about a market that is under-appreciated by other investors,
  • Demonstrate an ability to source deal-flow in a manner that is both efficient and proprietary – given the rule of thumb that the best VCs see 100 startups for every 1 investment they make,
  • Demonstrate the ability to pick startups that have a high probability of returning the portfolio within the duration of the fund,
  • Demonstrate an ability to manage the portfolio’s losses in a way that maximizes the likelihood that the fund will meet LPs’ expectations, and
  • Demonstrate an ability to execute the fund’s stated portfolio thesis, portfolio construction and portfolio management strategy under real world scenarios.

This is by no means an easy task, and it is only one of the many issues an emerging manager raising a first fund must worry about. As has been reiterated more than once previously, it requires hard work, smarts, keeping one’s wits about oneself, and a fair bit of luck.

Additional Reading:

  • By Hunter Walk from Homebrew VC: Two Portfolio Tips For First Time Seed Funds
  • By Christoph Janz from Point Nine Capital: Good VCs, Bad VCs
  • Jerry Neumann: Power Laws in Venture
  • There’s a lot more here: #BeYourOwnMentor – Independent Study in Early Stage VC

About The Worldwide Supply Chain Federation

The Worldwide Supply Chain Federation is the collaborative, and mutually supportive coalition of open and multidisciplinary grassroots communities focused on technology and innovation in the global supply chain industry. Founded in August, 2017, The New York Supply Chain Meetup is its founding chapter. The New York Supply Chain Meetup is the world’s largest, fastest growing, and most active community on Meetup.com – with well over 1700 members. The Worldwide Supply Chain Federation is the first community of its kind to focus on supply chain, innovation, and technology. It seeks to bring together BUYERS and BUILDERS of the technology innovations that will refashion global supply chains.

About REFASHIOND Ventures

REFASHIOND Ventures is an emerging early stage venture capital firm that is being built to invest in early-stage startups creating innovations to refashion global supply chain networks. REFASHIOND Ventures is based in New York City. The Worldwide Supply Chain Federation and The New York Supply Chain Meetup are initiatives of REFASHIOND Ventures.

Update: March 23, 2019 at 08:32 to fix some mechanical errors, typos, grammar. Also added definition of a startup, and definition of an economic moat, and highlighted some quotes.

Filed Under: Entrepreneurship, Investment Analysis, Investment Themes, Investment Thesis, Portfolio Management, Private Equity, Startups, Technology, Venture Capital

Where Will Technological Disruption in The Fashion Supply Chain Come From?

October 25, 2018 by Brian Laung Aoaeh

If you know how to learn, you know enough.

Originally published at www.refashiond.com on October 25, 2018.

By Brian Laung Aoaeh and Lisa Morales-Hellebo

Authors’ Note: This is the second in a series of six articles about problems and opportunities in global supply chains, with a focus on the fashion industry. In this article we focus on trying to learn how executives at fashion industry incumbents may learn how to predict technological disruption in order to develop appropriate responses to the evolving environment that surrounds their companies. We start by briefly surveying some of the theory about disruption. Then, we delve into a series of brief historical analyses of technological disruptions in a number of industries. We try to understand those episodes by using the theoretical foundations developed earlier. Finally we ask the question that forms the basis for this article, by posing questions about potential sources of disruption in the global fashion industry, the issues that every team of c-level executives in the industry worries about daily. If you have not read the first article in the series you may do so using this link: The Fashion Supply Chain Is Broken. However, reading the first article is not a prerequisite for following this discussion.

Acknowledgement: We are grateful to Tayo Akinyemi for reading and critiquing previous versions of this article.

The fashion supply chain is broken and must be refashioned. This is the conclusion we have come to after studying the issue, starting in 2014.

Background

We each independently became interested in supply chains in 2014. We have collaborated with one another in learning about supply chain since June 2016. In August 2017 we teamed up to start The New York Supply Chain Meetup, and building on that work are on the verge of launching The Worldwide Supply Chain Federation when The Bangalore Supply Chain Meetup hosts its kickoff event in November. In September 2018, we teamed up to start building REFASHIOND: a venture firm that will invest in early-stage startups creating innovations that make global supply chains more efficient. We will initially focus on startups at the intersection of fashion and retail. You can learn more about us by visiting REFASHIOND’s website. We also provide more detail about our background in the first article in this series.

In order to ensure that everyone is on the same page about disruption, we have chosen to conduct a brief survey of the key ideas that underpin the concept. We believe this is necessary to ensure that any dialogue that ensues is on the basis of a shared mental model. In writing this article we took inspiration from the work of Joshua Gans, author of “The Innovation Dilemma.” His work has greatly helped our understanding of innovation and disruption theory.

We do not claim to have a special talent for predicting disruption, however Lisa has a track record of leading disruptive innovations and has been featured in the book, “Disrupters: Success Strategies from Women Who Break the Mold.” This is not an article in which we are going to provide canned answers. Rather, our focus in writing this article is two-pronged: First, we will briefly examine the theory behind disruption, and attempt to connect the dots between various schools of thought on the subject. Second, using the lessons from that exercise, we will then look at some historical examples of disruption and see what insights we might glean from them.[1] We conclude the article by considering where disruption in the fashion industry may come from.

Our goal is to foster and participate actively in industry-wide dialogue about the future of the global fashion industry. We hope the result of such dialogue will be inter-industry collaboration aimed at making the future reality more prosperous and sustainable than the present or the past. We’re excited about participating in such conversations with startup founders and fashion industry executives.

Do not hesitate to email us if you would like to speak with us about our work, and possible collaborations in the future.

We can be reached at:

  • Lisa Morales-Hellebo — lisa@refashiond.com, and
  • Brian Laung Aoaeh — brian@refashiond.com.

What Is Disruption?[2]

Creative Destruction — A Result of Fundamental Market Shifts

Joseph Schumpeter (1883–1950) is the first person to have clearly described the concept on which subsequent work on developing a theory of disruption is based.[3] He describes “Creative Destruction” as:

“The opening up of new markets, foreign or domestic, and the organizational development from the craft shop to such concerns as U.S. Steel illustrate the same process of industrial mutation — if I may use that biological term — that incessantly revolutionizes the economic structure from within, incessantly destroying the old one, incessantly creating a new one. This process of Creative Destruction is the essential fact about capitalism.”

He goes on to say that Creative Destruction is about more than price competition:

“But in capitalist reality as distinguished from its textbook picture, it is not that kind of competition which counts but the competition from the new commodity, the new technology, the new source of supply, the new type of organization (the largest-scale unit of control for instance) — competition which commands a decisive cost or quality advantage and which strikes not at the margins of the profits and the outputs of the existing firms but at their foundations and their very lives. This kind of competition is as much more effective than the other as a bombardment is in comparison with forcing a door, and so much more important that it becomes a matter of comparative indifference whether competition in the ordinary sense functions more or less promptly; the powerful lever that in the long run expands output and brings down prices is in any case made of other stuff.”

Finally, he makes the observation that:

“The fundamental impulse that sets and keeps the capitalist engine in motion comes from the new consumers’ goods, the new methods of production or transportation, the new markets, the new forms of industrial organization that capitalist enterprise creates.”

Disruption — A Result Of Movement Up The Technology S Curve

Richard Foster examined the role that technology plays in disruption, and used technology S curves to advance our understanding of disruption in his 1986 book, “Innovation: The Attacker’s Advantage.” An S curve is a graph of a logistic growth process. In such a process, growth is initially slow, speeds up in the middle period, and then levels off after that, as it approaches some upper maximum limit at the end of the growth period. Foster’s key realization was that technological innovations can result in a change in the underlying process, leading to a fundamentally new S curve with a discontinuity between the original S curve and the new S curve. Using this formulation, disruption happens during the shift in customer demand from the products along the old S curve trajectory to those products along the new S curve trajectory. On a long enough time-horizon, it should be easy to understand that an industry may experience multiple waves of disruption depending on the rate of technological advancement and entrepreneurial innovation within the industry.[4]

Disruptive Innovation — S Curves & Discontinuities in Market Structure

Clayton Christensen pushed our understanding of disruption further with the publication of “The Innovator’s Dilemma: When New technologies Cause Great Firms to Fail.” Below, we highlight and summarize some of the main ideas.[5]

A Sustaining Innovation: leads to product improvements without fundamentally changing the underlying structures of the market to which it applies; it enables the same set of market competitors to serve the same customer base, while typically extracting more value from them. It is important to note that sustaining innovations may lead to a rearrangement of the competitive landscape, but rarely will they lead to the outright failure of a leading incumbent. Sustaining innovations can be radical, revolutionary, or discontinuous if they lead to dramatic and unexpected product improvement. In Foster’s formulation, a sustaining innovation merely advances a technology up the same S curve.

A Disruptive Innovation: starts out with worse product performance relative to the available alternative from market incumbents, and is often not very complex technologically. As a result the new product is attractive to a small niche of the customer base. However, if product performance improves quickly enough, at a certain point the new product provides superior product performance relative to the alternative that is available from market incumbents. This process leads to a significant, dramatic, and fundamental shift in market structure, that is to say, suddenly the new entrants go from serving a niche customer base to gaining a majority of the market while, at best, erstwhile incumbents become mere shells of their former selves or even go out of business entirely. To use Foster’s formulation, a disruptive innovation moves the product to a new S curve.

Clayton Christensen also differentiates a low-end disruption from a new-market disruption. In a low-end disruption, the attacker enters the market with a product that is inferior relative to the needs of mainstream customers. In a new-market disruption the attacker enters the market by serving a customer niche that was previously unserved by the existing incumbents.[6] A low-end disruption results from a low-end innovation while a new-market disruption is the result of a new-market innovation.

Architectural Innovation — A Fundamental Change in Systems

Rebecca Henderson and her co-author, Kim Clark, focus on another important component that adds to our understanding of disruption: Why is it so difficult for incumbent firms to respond even when they possess the technical expertise to do so? In “Architectural Innovation: The Reconfiguration of Existing Product Technologies and the Failure of Established Firms,”[7] they make the distinction between the components that are combined to form a product and the system that makes it possible to combine disparate components into a single product or a unified service offering.

Component Innovation: is innovation in the modular design of a product. Such innovations are easy for incumbents to respond to because they arise from using technical knowledge about each component of a product to make improvements to the overall product, within existing organization structures and business models. Component innovation arises from component knowledge.

Architectural Innovation: is innovation in the end-to-end system that enables the combination of various, disparate components to form a product. Incumbent firms find it difficult to adapt to such innovations because the innovations render the incumbent’s component knowledge useless, given that the innovation is in a new organizational structure or a new business model that reconfigures the end-to-end system leading to the creation of a product using the same core body of component knowledge. Architectural innovation arises from architectural knowledge.

A key observation in Henderson and Clark’s work is that a market disruption — the attacking new entrant quickly supplants the incumbent in terms of market share and market power, leading to financial distress for the incumbent, can occur in a market when a sustaining innovation is married with architectural innovation. This helps explain certain market disruptions that would not qualify as disruptions if we only used the Christensen formulation.

Technology, Innovation, and Disruption — Two Sides To The Story

Joshua Gans helps us connect the dots more fully between Clayton Christensen’s Disruptive Innovation and Rebecca Henderson and Kim Clark’s Architectural Innovation. In “The Disruption Dilemma” he introduces us to the concept of a Demand-Side Disruption and Supply-Side Disruption. Below, we explore those ideas in more depth.[8]

The Demand-Side Theory of Disruption is an outgrowth of the Christensen School, wherein as attackers enter a new market incumbent firms perform a demand-based risk assessment and decide that mainstream customers are highly unlikely to desire the product on offer from the attackers. In fact, in many cases, the appearance of such inferior products is welcome because unprofitable customers move to adopt the products now being offered by the upstart attackers, freeing incumbents to focus all their resources on their most profitable customers. This is all well and good, until, through the process of iterative improvement, the attacker’s product moves rapidly up the new technology S Curve and quickly achieves performance-parity with the incumbents’ product at a significantly more attractive price-point. It is at this stage that customers abandon the incumbent in favor of the attacking firm in cascading waves, causing seemingly sudden failures of once dominant incumbent firms. This is a vast simplification of the discussion by Gans, however the key to understanding demand-side disruption is that it is driven by changing consumer tastes and expectations.[b]

The key to understanding demand-side disruption is that it is driven by changing consumer tastes and expectations.

The Supply-Side Theory of Disruption is an outgrowth of the Henderson-Clark School, wherein as attackers enter the market it becomes extremely difficult for incumbents to respond because the basis on which they have achieved success attaches them to a certain foundation of architectural knowledge from which they cannot detach themselves even if they admit that that their core business is at risk. To respond, incumbents must develop an entirely new system of doing things. This is difficult for incumbents to do since, at the outset, there is no guarantee that the new system will succeed any better than the existing architecture which has been the basis of the incumbent’s historical success. In other words, uncertainty causes incumbents to drag their feet about making the difficult choices they must make in order to adapt, assuming they know what changes need to be made. Remember that the architectural knowledge which forms the basis on which attackers enter the market is invisible to incumbents, and the attendant uncertainty makes an already daunting task even more difficult.[c]

The architectural knowledge which forms the basis on which attackers enter the market is invisible to incumbents, and the attendant uncertainty makes an already daunting task even more difficult.

So What?

Now that we have surveyed some of the key ideas in disruption theory, we’ll explore how disruption has played out in a few industries. Before we do so, it is worthwhile to reconcile the ideas we have encountered in the preceding discussion.

First, if emerging technologies progress quickly enough up the technology S Curve and gain sufficient customer adoption, the probability that a disruptive event will occur in a given industry increases until it becomes practically inevitable. This evolution is accompanied by a high degree of uncertainty about future states of the world. The uncertainty complicates decision-making for the executives who must decide how incumbent firms should react when attackers enter the market with a low-end or new-market offering.

Second, architectural innovation will always lead to a degree of market disruption if it catches a wave of changing and favorable consumer expectations. A sustaining innovation that is combined with architectural innovation will lead to an outcome to which incumbents cannot respond even though they possess the technical knowledge to respond to the component-level innovations. Since architectural knowledge is invisible, there is no way for incumbent’s and other competitors to respond to architectural innovation without assuming risks of an existential nature given that they have no real understanding about how the innovation works, assuming they recognize and admit there’s an innovation before it is too late.

A disruptive innovation married with architectural innovation will lead to potentially more extreme market dislocations because incumbents can only respond to the component-level innovation on the basis of old architectural knowledge. This will cause their offerings to consistently underperform the products introduced by the attacking firms along the dimensions that now matter most to customers. Eventually waves of customers will abandon the incumbent product in favor of the new product offered by attacking new entrant firms. In other words, the new architecture supplants the old.

Third, the forms of innovation we have discussed above are not mutually exclusive. Rather, it is often the case that each form of innovation is present to a certain degree in any case of market disruption that one studies

Fourth, and this bears repeating, it is a mistake to ignore the role that uncertainty plays in complicating the decision-making process that individuals in positions of authority within incumbent firms face.Uncertainty is the factor that causes decision-paralysis, buying attackers time to gain strength and ultimately dislodge once powerful incumbents.

Uncertainty is the factor that causes decision-paralysis, buying attackers time to gain strength and ultimately dislodge once powerful incumbents.

Does this sound frightening? It is. Why? It means that, on average, chief executives, chief technology officers, chief strategists, heads of innovation, and other senior executives, are altogether incapable of protecting leading incumbent firms from failure. Not unless the entire firm adopts a culture whose strategic choices are informed by assessments of demand-side and supply-side innovations. Even then, as Schumpeter observed, it’s just a matter of time before every incumbent is overwhelmed by waves of creative destruction. To a certain extent, this may explain why over the course of the recent past, companies that continue to be led by members of the founding team demonstrate a greater capacity to cause and respond to potential market disruptions than incumbents managed by teams of professional executive managers who did not found the company.[9]

We now turn our attention to some historical examples of disruption. For brevity’s sake, we have intentionally left out many details.

Disruption In Action

Tech Ate Books

Between 1960 and 1970 mall-based chain bookstores started supplanting independent bookstores. This process continued till about 1980, when mall-based chain bookstores suffered a similar fate with the rise of big-box bookstore chains. By 2000 big-box chains like Barnes & Noble, and Borders dominated the market. However, with the advent of the internet and its adoption for online retail; Borders is already out of business, while Barnes & Noble is struggling to reorganize and sustain its business.

We believe this is an example in which architectural innovation is the dominant factor at play. However, one should not underestimate the contribution of changes in consumer behavior. As our teenage and pre-teen children remind us; “Amazon’s supply chain is so awesome! You do not have to go anywhere, they will just bring your stuff to you while you stay home and play video games.” As time has progressed and digital media technology that is delivered over the internet has improved, disruptive innovation has come increasingly to the fore as ebooks and audiobooks began gaining in popularity.[10]

Tech Ate Video

Film projection technology started to become available between 1900 and 1930. As the technology matured, the period between 1930 and 1950 came to represent the Golden Age of Hollywood. Between 1950 and 1960, broadcast TV, small screen, and videotape recording gained a foothold in the market. The three decades between 1960 and 1990 saw the proliferation of color TV, and home video recorders. Notably, Blockbuster was founded in 1985. From 1990 to 2000 flat screen TVs, laser discs, and video CDs appeared as technologies in this market. Netflix was founded in 1997. Between 2000 and 2010, DVDs and mobile viewing become more mainstream. Netflix expanded its DVD rental business by introducing an over-the-top (OTT) streaming option in 2007. Since 2010, Video-Over Internet Protocol (Video-Over IP) and OTT video have gained dominance in terms of consumer consumption of video content. Blockbuster filed for bankruptcy protection in 2010, eventually becoming part of DISH Network which acquired the assets of Blockbuster in a bankruptcy auction in 2011. In 2013, DISH announced that it would close all of Blockbuster’s store and DVD-by-mail operations in early 2014. Meanwhile, Netflix is now available in 190 countries with 130.1 million paid subscribers and 137.1 million subscribers overall. Netflix generated more than $11 billion in global revenues in 2017.[11]

Once again, from the perspective of an incumbent’s chief strategist, or a head of innovation worried about protecting the incumbent from disruption, a more complete explanation of the circumstances that surrounded this episode can only be found by combining the Christensen School’s Theory of Disruptive Innovation with the Henderson-Clark School’s Theory of Architectural Innovation.

At the outset, Netflix entered the market with an architectural innovation: Blockbuster was not designed around a system of mailing videotapes or DVDs to people’s homes. As internet technology matured and broadband connections to people’s homes became ubiquitous, the low-end innovation of streaming video provided the final punch required to send Blockbuster crashing to the proverbial canvas of bankruptcy court. As OTT and Video-Over IP technology travelled up the technology S-Curve, Netflix had the advantage of far less in overhead costs than Blockbuster, allowing it to invest more aggressively in streaming technology, and winning the market.

Tech Ate Music Stores

The Acoustic Era stretched from 1877 to 1925. During this period the phonograph and the theremin resulted from experiments in sound recording and the technology started being applied to recording music. This was followed by The Electrical Era, when electrically recorded LP records supplanted acoustic phonographs. It extended from 1925 to 1945. Between 1945 and 1975, The Magnetic Era, magnetic 8-Track Tapes and cassette tapes supplanted LP records and other electrically recorded media. The Magnetic Era was followed by The Digital Era, between 1975 and 1993. It is during this period that MP3s started supplanting magnetic tapes and LPs. The Streaming Era started around 1993 and extends till today, MP3s lead to an explosion in peer-to-peer (p2P) file-sharing platforms. These platforms have supplanted old ways of packaging and selling music, and physical music stores have now largely been replaced by online streaming services.[12]

Although, it is popular to assume that the music industry was disrupted by MP3 technology, it is not so clear to us that such a sweeping statement captures the nuance of the situation. It is certainly true that music stores as a channel of distribution for the music industry have succumbed to digital formats and channels. It is also true that sales of physical albums have plummeted as the Streaming Era has progressed. However, Warner Music Group, Universal Music Group, and Sony Corporation together control more than 70% of the market. As a result streaming platforms like Spotify, Pandora, and Soundcloud are subject to the pricing power of the big music companies. Apple’s iTunes, Amazon’s Music, and Google’s Play are somewhat protected from the supplier power wielded by the music companies because of the power that is in turn wielded by Apple, Amazon, and Google respectively.[13]

Tech Ate Phones

The history of telephony dates as far back as 1876, when Alexander Graham Bell placed the first phone call. Early advances in telephony were made by the U.S. Army Signal Corps Engineering Laboratories, Motorola, Bell System, and Ericson between 1915 and 1956. By 1956, Bell Labs had begun work on conference calling systems, and in 1964, the first video conference call was made between New York and California using a Bell Labs Picturephone. Phones began to get lighter, but they still weighed 20 pounds or more. The first mobile phone call was made in 1973 using a Motorola DynaTac prototype which weighed 2.5 pounds. The technology continued to mature after 1973, with notable developments in 1989 when Motorola introduced the MicroTac, the world’s first flip phone.

In 1992, Motorola introduced the 3200, a hand-sized digital mobile phone that used GSM technology. That was followed in 1993 by the IBM Simon, arguably the world’s first smartphone, with a pager, a fax machine, a PDA, a calendar, an address book, a calculator, a notepad, email, games, a touchscreen, and a QWERTY keyboard all included in the same mobile phone. In 1997, Nokia kickstarted the smartphone era with the Nokia 9000 Communicator. Nokia continued to improve on its phones with the 8810 in 1998, and the 3210 in 1999 — selling over 160 million units. The Nokia 7110 introduced web access to mobile phones, and GeoSentric brought GPS navigation to mobile phones. Sharp introduced the J-SH04 in 2000 — it was the first camera phone. In 2002, the Sanyo 5300 became the first camera phone to be sold in North America. Also in 2002, RIM introduced the BlackBerry 5810, it was the first device to combine a mobile phone with a data-only device that targeted white-collar professionals. Mobile phone technology kept improving incrementally, with Nokia, RIM, and Motorola featuring as dominant incumbents in the North American Market.

Apple introduced the iPhone in 2007. Google introduced its Android OS for smartphones in 2008.[14] Since then Apple’s iOS and Google’s Android OS have gone on to dominate market share in the mobile phone OS market. Apple, Samsung, Huawei, Xiaomi, and OPPO occupy the top 5 spots in terms of smartphone shipments and market share as of the fourth quarter of 2017, according to IDC Worldwide.[15] Nokia sold its mobile phone business to Microsoft in 2014 and has instead shifted into telecommunications infrastructure and network equipment manufacturing. Motorola was bought by Google in 2012 and then sold to Lenovo in 2014. RIM has ceased manufacturing mobile phones and is now focused on developing software.

Is the iPhone disruptive? Clayton Christensen did not think so in 2006, 2007, or even in 2012. Is Android OS disruptive? From the outside looking in, it appeared that the iPhone + iOS, and Android OS represented sustaining innovations based on the Christensen School, or component innovations only, based on the Henderson-Clark School.

But, what was really happening? First Apple and Google shifted the focus away from being entirely focused on hardware engineering as a source of competitive differentiation and moved the focus more towards software platforms as the source of competitive advantage. Second, this shift coincided with a growing desire from consumers for mobile devices that performed more functions than Nokia, RIM, Motorola, and the other incumbents in the market at the time offered on their mobile devices. It is generally difficult for firms that grew to prominence on the basis of skill in hardware engineering disciplines to adjust to a market where skill in software engineering forms the basis for survival.

Tech Ate Cameras

The history of cameras and photography goes farther back in history than one would ordinarily think. Although the historical details are useful,[16] we will skip the vast majority of them up to the point in 1884 and 1888 when George Eastman patented photographic film, and the Kodak roll-film camera respectively. Edwin Land launched the Polaroid camera in 1948. Eventually Kodak, Agfa-Gevaert, and Fujifilm dominated the market for analog photography and camera equipment.[17] The market for analog cameras and photography was characterized by very complex and advanced manufacturing processes, and high barriers to entry, enabling Kodak and its peers to build highly profitable consumer franchises on the basis of that technology.

Ideas and concepts related to digital photography first appeared in the early 1960s and 1970s. In 1975, an engineer at Kodak invented and built the first digital camera. Digital Single-Lens Reflex (DSLR) cameras appeared on the market in the 1980s and 1990s, and had supplanted analog film cameras by the mid-2000s. In 2000, Sharp introduced the first mobile phone that incorporated a digital camera. Now every smartphone has an integrated digital camera.

Polaroid, Agfa and Kodak filed for bankruptcy in 2001, 2005 and 2012, respectively. Meanwhile, Fujifilm continues to record some of the most profitable years in the company’s history. What gives?

Most analyses about Kodak’s fate focus on explanations based on the Christensen School of Innovation. Others assume that executives at Kodak sought to protect its photographic film and analog camera business, the company’s cash cow. However, in “The Real Lessons From Kodak’s Decline”, Willy Shih points out that such arguments mischaracterize what was really happening within the company.[18] He arrived at Kodak in 1997, and ran a division of the company charged with exploring how Kodak might exploit the opportunity presented by digital photography.[19]

The shift from analog to digital photography posed challenges on many levels. First, there were dramatic shifts in the technology of photography. Second, the nature of the technological shifts lowered barriers to entry and significantly increased the scope of the competitive landscape. Third, as a result of these shifts in the market, Kodak’s legacy business, once the source of its unrivaled dominance, now became an albatross around its neck, imposing a severe handicap from which it could not very easily escape to contend with the horde of attackers. Fourth, these changes introduced a shift in the balance of power between the players in the market, weakening Kodak’s hand while strengthening that of its ecosystem partners and counterparts.

How did Fujifilm navigate this crisis? This is the focus of Shigetaka Komori’s book: “Innovating out of Crisis: How Fujifilm Survived (and Thrived) as Its Core Business Was Vanishing.”[20] Mr. Komori is CEO of Fujifilm. In reading the book, it becomes clear that Fujifilm is alive today because it accomplished the rare feat of adjusting its business to account for both the demand-side (disruptive) and supply-side (architectural) innovations that were taking place in the global camera and photography market. Fujifilm developed three strategies to help it contend with the coming digital era: First, Fujifilm invented original digital technology of its own — it affirmatively chose to adjust and adapt to the unfolding architectural innovation. Second, the company extended the life of its analog photography business by developing innovations to increase the gap between its existing analog products and the attacking wave of early digital alternatives — responding to disruptive innovations by building sustaining innovations to buy itself some time for its efforts in adapting to the new architectural innovations to bear fruit. Third, recognizing that the digital photography business would impose low margins on the market overall, it developed new businesses that were peripheral to its analog and digital photography businesses, but that could command high margins — though, some of these businesses were sold as revenues and profits from the analog business deceptively continued to rise and show strength. Quoting Mr. Komori;

No matter how good business is, you have to foresee and prepare for a coming crisis. Looking directly at reality, you have to recognize what is happening at the moment, as well as what is going to happen in the future. You have to read the situation, understand it, think about it, and decide what needs to be done. This is what management is all about.

Tech Is Eating Tech

In “The Scale of Tech Winners”, Benedict Evans discusses how Google, Apple, Facebook, and Amazon have supplanted the companies that defined the the preceding technology era which was characterized by the partnership between Microsoft and Intel, and IBM to some extent. Here are some quotations from that blog post:[21]

1. “So, the four leading tech companies of the current cycle (outside China), Google, Apple, Facebook and Amazon, or ‘GAFA’, have together over three times the revenue of Microsoft and Intel combined (‘Wintel’, the dominant partnership of the previous cycle), and close to six times that of IBM. They have far more employees, and they invest far more.”

2. “Scale means these companies can do a lot more. They can make smart speakers and watches and VR and glasses, they can commission their own microchips, and they can think about upending the $1.2tr car industry. They can pay more than many established players for content — in the past, tech companies always talked about buying premium TV shows but didn’t actually have the cash, but now it’s part of the marketing budget. Some of these things are a lot cheaper to do than in the past (smart speakers[22], for example, are just commodity smartphone components), but not all of them are, and the ability to do so many large experimental projects, as side-projects, without betting the company, is a consequence of this scale, and headcount.”

3. “Google, Facebook, and Amazon are still controlled by their founders, and they are aggressive street fighters.”

In Essence, Ben is saying that no industry that offers attractive enough margins is immune from the attentions of large tech companies with ambitions of global domination. Or, as Jeff Bezos of Amazon puts it;

Your margin is my opportunity.

What Factors Lead To Market Disruption?

When an attacker emerges with a new design concept, it is rational for incumbents to ignore it, since it is uncertain whether the new design concept will gain overall market acceptance. Moreover, evidence may suggest that mainstream customers do not value the new product that the attacker is introducing to the market. This is true, up until the point at which the new design introduced by the attacker wins the allegiance of customers and other parties in the market — in effect making the new design the dominant design. In the process the design standards on which incumbents built their businesses become obsolete, and incumbents now need to adjust to a fundamentally new and unfamiliar basis of competition. It is at this inflection point that attackers start to pull away from, or catch up with, incumbents with such speed that it is rare for any of the incumbents to recover, or protect, a position of dominance.[23]

As incumbents struggle to adjust to the new paradigm, their efforts fall short of customer expectations because they may have component knowledge, but insufficient architectural knowledge to enable them to build products that meet the entirely new performance thresholds established by the attacking firms. In the examples we have discussed above;

  • Ecommerce has become the dominant distribution channel for book retail.
  • OTT and video-over IP has become the dominant distribution channel for video content.
  • Streaming platforms have become the dominant distribution channel for people who wish to buy and consume music.
  • Mobile phones now function as small computers, with software design being as important, if not more important, than hardware engineering. Moreover, despite the ridicule that mobile phone industry executives first showered on the iPhone after its initial launch, the design it introduced in 2007 now dominates the market.
  • A smartphone that incorporates a digital camera has become the dominant design for the consumer photography market with further differentiation arising from computational photography, building on the strengths both Apple and Google possess in software engineering.
  • Finally, technology companies that embraced the internet as a platform for their business models are supplanting those technology companies that were slow to recognize the internet’s promise.

Conclusion: Will Tech Eat Fashion?

Yes. It is just a matter of time. We believe that the global fashion industry is approaching a tipping point that is similar to one of those we described in the preceding examples. Consumer perceptions and expectations in the major fashion markets of Western Europe and North America are slowly beginning to favor speed, customization or personalization, and environmental sustainability, over lowest price. These are issues we have already touched on in the article preceding this one, and that we will discuss again in a subsequent article, so we will not belabor the point here.

It would seem that the most obvious threat comes from digital native marketplaces like Alibaba, Amazon, Asos, Farfetch, JD.com, and Yoox Net-A-Porter Group. The next most obvious potential source of danger are the vertically integrated digital native brands like Bonobos, Boohoo, Eloqui, eShakti, Everlane, Fame Partners, Forever 21, Lesara, ModCloth, Outdoor Voices, and Reformation. Another obvious potential source of threat is sharing economy and recommerce digital native companies and startups like Ebay, Gwynnie Bee, LePrix, Material World, Rent The Runway, and ThredUp.[24]

Uncertainty stems from sources one least expects. So, we decided to analyse the financial statements of the tech companies, to see what we would find. We have been surprised by how much cash they carry on their books. Leading us to conclude that tech incumbents have the cash, knowhow, appetite for risk, and other resources to initiate experiments in any industry they determine provides attractive opportunities. Along those lines we have been asking ourselves many questions, here are a couple — note we do not know if these are the right questions, but we have to start somewhere:

  • Could the global fashion and accessories market attract the interest of companies whose core competence is building and deploying general-purpose software technology platforms[25]? If it did, how might that play out over time?
  • Are the technologies on which global fashion industry supply chains run at risk of becoming modularized into interchangeable and rapidly evolving components? What impact will that have on the specialized knowledge that current fashion industry incumbents have accumulated? Will it make that knowledge more valuable or less valuable? How will that affect profit margins?
  • How will legacy assets enable or hinder fashion industry incumbents’ ability to respond to demand-side or supply-side disruption?
  • How will the competitive landscape shift if fashion industry incumbents come under increased and sustained attack from digital native competitors? This is already happening and the large incumbents — digital immigrants, are responding by acquiring digital native brands. It remains to be seen if this will enable or hinder the acquired companies’ once they become attached to incumbents. How will these digital native brands be integrated into an existing incumbents’ culture, systems, and marketing strategies?
  • In what ways will concerns and awareness about climate change, and environmentally sustainable supply chains impact how the fashion industry evolves over the next decade or two? Can the industry approach this proactively?
  • Is there anything fashion incumbents can do beyond iterative improvements to their existing supply chains? Circularity, customization, and localization require an entirely new supply chain architecture. How will incumbents adapt? How should they adapt? The MacArthur Foundation is doing a lot of work on this topic through its Make Fashion Circular initiative. We refer to that shortly.

The Role of Leadership

After we published the first article in this series, we received some comments from people who read the article. The following comment comes from Steve Hochman. Steve was chief operating officer at Bolt Threads from April 2017 till September 2018 after serving as an executive at Nike for over nine years. Bolt Threads harnesses proteins found in nature to create fibers and fabrics with both practical and revolutionary uses, starting with spider silk. Here’s Steve’s comment:

“Nice post today. A few thoughts: It seems there’s growing consensus that speed and flexibility is key to brands’ and suppliers’ survival and much more inter-enterprise collaboration is needed to achieve it. Thanks to Zara and others, that’s an increasingly visible insight. The harder question to me is about the leadership required to make it happen. Who will emerge to make it safe to behave this way, ie to drive and choreograph the necessary confidence and trust between historically adversarial members of the same ecosystem, and what are the first moves that will bridge us from old to new? Would love to see us explore that question, because all the technology and process investment in the world is for naught without that other answer first, I think! Thanks again for pushing the dialogue.”[26]

Steve’s comment reflects our beliefs. As Fujifilm demonstrates, proactive leadership makes it more likely that entrenched incumbents can predict and react quickly to impending market disruptions. Indeed, that is the topic of Clayton Christensen’s most recent book, “Competing Against Luck.” To paraphrase his words: Fashion industry incumbents must proactively decide that surviving market disruptions is not something they can afford to approach with a hit-or-miss attitude. Rather, they must proactively choose to predict what demand-side or supply-side innovations have a potential to disrupt their business, and then act to ensure they are among the beneficiaries of these developments. As Andy Grove, former CEO of Intel put it: “Only the paranoid survive.”

Taking control of uncertainty is the fundamental leadership challenge of our time.

– Ram Charan, The Attacker’s Advantage

We are in full agreement with the following statement from The Ellen MacArthur Foundation’s report: “A New Textiles Economy: Redesigning Fashion’s Future.”

“Transforming the industry to usher in a new textiles economy requires system-level change with an unprecedented degree of commitment, collaboration, and innovation. Existing activities focused on sustainability or partial aspects of the circular economy should be complemented by a concerted, global approach that matches the scale of the opportunity. Such an approach would rally key industry players and other stakeholders behind the objective of a new textiles economy, set ambitious joint commitments, kick-start cross-value chain demonstrator projects, and orchestrate and reinforce complementary initiatives. Maximising the potential for success would require establishing a coordinating vehicle that guarantees alignment and the pace of delivery necessary.”[27]

Transforming the industry to usher in a new textiles economy requires system-level change with an unprecedented degree of commitment, collaboration, and innovation.

We believe it is the responsibility of leaders within the global fashion industry to strive to understand the causal mechanisms of disruption, and to ask the questions that lead them towards answers that enable their respective companies to successfully navigate the waves of creative destruction that characterize capitalist economies. This is a dialogue in which we are eager to participate as early stage venture capitalists investing in supply chain startups, and as thought partners working with executives in the global fashion industry.

Next in the series: What Are The Established and Emerging Business Models in The Global Fashion Industry Today?

About REFASHIOND Ventures: REFASHIOND Ventures is an early-stage venture capital investment firm that is being formed to invest in early-stage startups creating innovations that make global supply chains more efficient, starting with startups at the intersection of fashion and retail.

About REFASHIOND CO:LAB: REFASHIOND CO:LAB is the systems design, research, and strategy consulting arm of REFASHIOND Ventures. REFASHIOND CO:LAB helps organizations create competitive advantage through supply chain innovation.

About The Worldwide Supply Chain Federation: The Worldwide Supply Chain Federation is the collaborative, and mutually supportive coalition of grassroots communities focused on technology and innovation in the global supply chain industry. The New York Supply Chain Meetup is its founding chapter.

________________

[1] We realize there’s a great risk of hindsight bias. However, analyses of this sort is one of the best tools in chief executive officers’, chief strategists’, or chief innovation officers’ toolkits and we feel it would be foolish not to use it if it helps us develop a good theoretical framework for correctly predicting, reacting to, and exploiting new innovations that threaten to reorder an industry.

[2] This discussion builds on Aoaeh, Brian Laung. “Notes on Strategy; Where Does Disruption Come From?” Innovation Footprints, 19 July 2015. innovationfootprints.com/notes-on-strategy-where-does-disruption-come-from/.

[3] Schumpeter, Joseph Alois. Capitalism, Socialism and Democracy. Routledge, 1994. Chapter VII

[4] Foster, Richard N. Innovation the Attacker’s Advantage. Summit Books, 1986.

[5] Christensen, Clayton M. Innovator’s Dilemma: When New Technologies Cause Great Firms to Fail (Management of Innovation and Change Series). Harvard Business Review, 1997.

[6] The Innovator’s Solution: Creating and Sustaining Successful Growth, by Clayton M. Christensen and Michael E. Raynor, Harvard Business Review Press, 2013, p. 45.

[7] Henderson, Rebecca M., and Kim B. Clark. “Architectural Innovation: The Reconfiguration of Existing Product Technologies and the Failure of Established Firms.” Administrative Science Quarterly, vol. 35, no. 1, 1990, p. 9., doi:10.2307/2393549.

[8] “Chapter 3.” The Disruption Dilemma, by Joshua Gans, MIT Press, 2016.

[9] For an accessible discussion of the issues see: Kidder, David, and John Geraci. “CEOs Should Think Like Founders, Not Just Managers.” Harvard Business Review, 13 Nov. 2017, hbr.org/2017/11/ceos-should-think-like-founders-not-just-managers. Accessed 25 Oct. 2018.

[10] The Case for E-Commerce Acceleration (Aka, Bye Bye BBY?), by Jeff Jordan, a16z.com/2012/06/29/the-case-for-e-commerce-acceleration-aka-bye-bye-bby/. Adapted. Accessed October 21, 2018.

[11] Boricha, Mehul. “A Brief History of Video Technology [Infographic].” Tech Arrival, 12 May 2018, www.techrrival.com/video-technology-history-infographic/. Accessed 21 October 2018.

[12] Wedding, Nicole. “How Tech Disrupted The Music Industry: A Timeline.” Hybrid World Adelaide, 20 Sept. 2018, hybridworldadelaide.org/2018/03/27/tech-disrupted-music-industry-timeline/. Accessed 21 October 2018.

[13] In this case, generally, the music companies extract profits from the streaming platforms because there are fewer music companies than music streaming platforms. See Porter, Michael E. “The Five Competitive Forces That Shape Strategy.” Harvard Business Review, January 2008.

[14] Meyers, Justin. “From Backpack Transceiver to Smartphone: A Visual History of the Mobile Phone.” Gadget Hacks, Gadget Hacks, 5 May 2011, smartphones.gadgethacks.com/news/from-backpack-transceiver-smartphone-visual-history-mobile-phone-0127134/#ixzz1La40vQTO.

[15] Samsung, Huawei, Xiaomi, and OPPO all ship smartphones using Google’s Android OS.

[16] “Timeline of Photography Technology.” Wikipedia, Wikimedia Foundation, 4 Sept. 2018, en.wikipedia.org/wiki/Timeline_of_photography_technology. Accessed 22 October 2018.

[17] Analog photography relies on a chemical or electronic recording medium, with photographs ultimately printed on paper through chemical processing. In digital photography, arrays of electronic photodetectors capture and store images which are then processed as digital files only. Computational photography refers to the application of algorithmic processing to digital photography.

[18] Shih, Willy. “The Real Lessons From Kodak’s Decline.” MIT Sloan Management Review, 20 May 2016, sloanreview.mit.edu/article/the-real-lessons-from-kodaks-decline/?use_credit=a6ae29dde4b8fea84677452a90228c83. Accessed 22 October 2018.

[19] Kodak is trying to resurrect itself by focusing on new consumer demands and connecting with millennials — see Kodak + Forever21, InstantPrint Cameras, KodakOne and KodakCoin.

[20] Komori, Shigetaka. Innovating out of Crisis: How Fujifilm Survived (and Thrived) as Its Core Business Was Vanishing. Stone Bridge Press, 2015.

[21] Evans, Benedict. “The Scale of Tech Winners.” Benedict Evans, 13 Oct. 2017, www.ben-evans.com/benedictevans/2017/10/12/scale-wetxp.

[22] Amazon Alexa, Google Dot, Apple HomePod, for example.

[23] Gans, Joshua. “The Disruption Dilemma”, MIT Press, 2016. Page 40.

[24] This list is by no means exhaustive.

[25] Such a platform would make it relatively easy for a team of engineers to establish competing fashion companies using modular technology-enabled components which replicate everything large fashion incumbents do well, while simultaneously doing something that is valued by customers but which current incumbents cannot replicate without significant effort.

[26] Comment sent by Steve Hochman, via LinkedIn Messaging to Lisa Morales-Hellebo, on 15 October 2018.

[27] Ellen MacArthur Foundation, A new textiles economy: Redesigning fashion’s future, (2017, http://www.ellenmacarthurfoundation.org/publications). Accessed 23 October 2018.

Filed Under: Entrepreneurship, How and Why, Innovation, Investment Themes, Investment Thesis, Startups, Strategy, Supply Chain, Technology, Venture Capital Tagged With: Early Stage Startups, Entrepreneurship, Fashion, Innovation, REFASHIOND, Supply Chain, Technology, Venture Capital

The Fashion Supply Chain Is Broken

October 15, 2018 by Brian Laung Aoaeh

By Brian Laung Aoaeh and Lisa Morales-Hellebo

Originally published at www.refashiond.com on October 14, 2018.

Authors’ Note: This is the first in a series of six articles about problems and opportunities in global supply chains, with a focus on the fashion industry. This article frames the problem. The next article will delve into a historical analyses of technological disruption, from the perspective of risks and uncertainties for the fashion industry.

Executive Summary: Recent trends present incumbent companies in the global fashion industry with challenges and opportunities related to innovation in supply chain. In this article, we discuss how a historical top-down approach to business is giving way to an emerging bottom-up approach that is driven by consumer preferences. This is placing stresses on fashion supply chains which the industry can only address by adopting a collective, collaborative, ecosystem-driven approach to innovation.

The fashion supply chain is broken and must be refashioned. This is the conclusion we have come to after studying the issue, starting in 2014.

About The Authors

After 19 years in tech, Lisa Morales-Hellebo founded and launched the New York Fashion Tech Lab in 2014 with Springboard Enterprises and the Partnership Fund for NYC while serving as Executive Director for the first year. She then spent a year traveling to Puerto Rico to visit apparel factories, maker labs, cut-and-sew shops, ateliers, and universities in order to learn about the existing apparel supply chain and the challenges it faces.

Brian Laung Aoaeh, CFA spent 10 years in investment research and management, with 2 of those 10 years as the first and only member of the corporate development team at KEC Holdings, a single family office, and 8 of those 10 years as the first member of the small team that built KEC Ventures, an early-stage venture capital investment firm based in New York City. KEC Ventures grew to $98M of AUM across two funds, with 51 investments. Brian was a partner at the fund from its inception till his departure in September 2018.

Our interest in supply chain originated independent of one another. We first met in June 2016, and spent hours talking about supply chain at our first encounter.

After having started thinking about value chains[1] in 2014, by August 2017 Brian had decided to become a specialist early stage investor in supply chain technology after having been a generalist early stage venture capitalist up till that point. So we teamed up and started The New York Supply Chain Meetup: to nurture and grow the world’s foremost open, global, multidisciplinary community of people devoted to building the supply chain networks of the future. Driven by our shared enthusiasm for all things supply chain and our belief in what the future of supply chain will resemble, we are now on the verge of launching sister chapters of The Worldwide Supply Chain Federation: a collaborative, and mutually supportive coalition of grassroots communities focused on technology and innovation in the global supply chain industry.

In September 2018 we decided to team up to build REFASHIOND; an early-stage venture fund that will invest in the startups creating innovations to make global supply chain networks more efficient, starting with those reinventing the fashion supply chain.

Our Goal: To Catalyse Industry-wide Dialogue & Action

In engaging in the work that has gone into this article, and those that will follow, we hope to start an industry-wide conversation about tangible steps that participants in the fashion industry can take to arrive at a common framing of the problems confronting the industry, and then to find ways to work together to address those problems that can only be solved effectively through collective action. We encourage you to reach out to us if you’d like to discuss any aspects of this work, or if you’d like to collaborate with us in some way. Given our conversations with the industry executives in our network with whom we have the closest relationships we know supply chain, technology, and innovation are topics that every executive management team in the fashion industry is discussing and thinking about to some extent. It is time to start taking collective action to tackle the big issues. Please reach out to us by email;

  • Lisa Morales-Hellebo — lisa@refashiond.com, and
  • Brian Aoaeh — brian@refashiond.com.

A Bit of Historical Perspective

It is easy for outsiders to assume that the history of the fashion industry is completely divorced from that of technological innovation. That is wrong. In fact, the history of fashion, apparel, and textiles can be linked directly to some of the most important inventions of the industrial revolution.[2] A few key examples are the Fly Shuttle Wheel to allow one weaver to do the work of two; the Spinning Jenny, which increased wool mills productivity, the Cotton Gin, Power Loom, yarn Spinning Mule, the first factory, and even materials and textile innovations, like those used in the Mackintosh Raincoat.

Having acknowledged the role technological innovation has played in the history of the fashion industry, it is fair to ask: Has the industry’s more recent history lived up to the technological promise of the current era? That depends. We argue that the fashion industry’s incumbents’ collective investments in the industry’s supply chain have failed to keep pace with changing consumer expectations, expectations that change ever more quickly as advances in digital media and telecommunications unfold and shape consumers’ expectations of when and how to shop.

This is creating challenges for the industry as a trend towards shorter, less complex supply chains appears to be in the early stages of supplanting the long, global, and highly complex supply chains that accompanied globalization and large companies’ insatiable quest to outsource their manufacturing to foreign markets with the lowest combination of fixed and variable costs.

A Definition, And A Reiteration Of The Problem

Throughout this discussion, we will rely on the following definition of supply chain. A supply chain is:

A network of connected and interdependent organisations mutually and cooperatively working together to control, manage and improve the flow of materials and information from suppliers to end users.[3]

To reiterate the problem;

  • First: The fashion and apparel supply chain is broken and must be refashioned.
  • Second: Innovation is happening so fast and is so complicated that there isn’t a single company in the fashion and apparel industry that can reinvent itself quickly enough to take full advantage of new technologies and innovations. Instead, the industry needs to consider taking an industry-wide ecosystem approach to adopting technology and innovation.
  • Third: Because fashion and apparel is the world’s second largest polluting industry, the future of our planet depends on the industry adopting technologies that will accelerate the move towards more economically and environmentally sustainable supply chains.

According to FashionUnited, the global fashion industry is valued at $3 trillion in annual sales, with the United States accounting for approximately $400 billion of the global total. According to the New York City Economic Development Corporation’s Fashion.NYC.2020 report, New York City’s fashion and apparel retailers generate about $15 billion in sales, annually. It is inevitable that an industry of this scale will face supply chain challenges. Yet, as a whole, the industry has been slow to adopt digital technologies to aid in solving the supply chain issues it encounters.

The Current Paradigm

Predicting & Dictating Trends: Style and fashion has historically been dictated by a top-down system of influential designers and tastemakers who set the standards for beauty, taste, trend, and style. The rise of social media has created an unprecedented shift from top-down to bottom-up style and trend mandates, where the designers and tastemakers are now looking to street style, emerging brands, and influencers for inspiration and ideas about what consumers want. A team of trend-trackers monitors global social phenomena, hoping to observe the behavior of youth tribes and other emergent youth-driven phenomena that may be transformed into global fashion trends. The trend-trackers job is to record such phenomena and supply the information to industry clients, while also advising on brand strategies, developing marketing tactics, organizing events, and even providing designers and stylists who may design an entire collection for a brand. This process can take anywhere from 6 to 18 months. By the time it is complete the trend may already be out of style, and the result may be unsold inventory.

Sourcing & Materials[4]: Apparel sourcing is becoming more challenging due to; rising labor costs in foreign markets, increasing compliance costs due to alleged and documented labor abuses in far flung apparel manufacturing hubs in developing countries, and increasing consumer preference for sustainable methods of production as the effects of climate change come into stark relief.

Design: Designers work very closely with trend-trackers to anticipate consumer tastes, and to design clothes that they expect consumers to buy. However, by the time new designs find their way into retail showrooms, consumer tastes may have evolved away from the trend that inspired the designs.

Manufacturing: Apparel manufacturing is largely labor-intensive, concentrated in low-wage countries that are far away from most major fashion and apparel consumer markets, and subject to abuses such as the use of child-labor and slave labor. The process is inefficient, slow, and prone to quality control issues.

Distribution: Consumer behavior is forcing a convergence towards omni-channel and multi-channel distribution with increasingly decentralized warehousing, technological complexity arising from multi-platform selling channels, last-mile logistics, and automation all playing parts in making todays apparel supply chain more complex to manage than in the past.

Sales & Marketing: Technology has provided numerous distractions and shortened attention spans, making it more difficult for fashion and apparel brands to cut through the noise long enough to generate sales. Technology is also making it much easier for consumers to engage in comparison-shopping before they make a purchase.

With the proliferation and popularity of on-demand business models, consumers’ shopping behavior is shifting away from norms the global fashion and apparel industry is accustomed to and can control, and towards norms that favor consumers’ preferences. This shift is resulting in the hyper-segmentation of consumers who used to be seen as too “niche” to address because expectations built around sales volume didn’t make sense, or the industry deemed certain consumer segments as not meeting the standards for beauty imposed from the top. Plus-sized clothing is only recently being accepted as the untapped opportunity that it has always been in the United States where the average woman is a size 16, according to Racked.com’s article, “Size by the Numbers.”

Factors Driving Industry Profitability

Below, we highlight a few measures of profitability. There are others, but for brevity we have chosen to focus on a handful. To do analyses of this sort it is most useful to analyze trends over time for a company, and then compare that data on a relative basis to data for the industry as a whole or to data for a designated subset of peers.

Gross Profit Margin: Gross profit is measured by deducting cost of goods sold from revenue, and gross profit margin is calculated by taking the ratio of gross profit to revenue. Gross profit and gross profit margin reflect a company’s pricing power, the power exerted by its suppliers as reflected in its cost of goods sold, as well as the impact of competition.

Operating Profit Margin: This is also often referred to as EBIT Margin. It is calculated as the ratio of operating profit to revenue, with operating profit obtained by subtracting operating expenses from gross profit. Operating profit margin is a measure of how variable costs affect a company’s profit margins, and can be used to assess how much control a company has over the costs associated with running its operations. One-time charges should be excluded from the calculation. In the fashion and apparel industry generally, we expect that IT infrastructure investments that are required to operate in a multi-platform and multi-channel environment, increasing freight and supply chain logistics costs, as well as labor inflation in foreign markets will each have a negative impact on operating profit margins. Moreover, as we have previously stated, the trend towards increasing marketing expenditure in order to hold consumers’ attention long enough to generate sales will also have a negative impact on operating profit margins.

Return on Equity (ROE): A firm’s return on equity is calculated as the ratio of net income to average shareholders’ equity. It is a measure of how effective a company is at converting its assets into earnings growth. For example, if ROE is 15%, a dollar invested generates 15 cents of assets for the business. ROE is affected by revenue, selling and general administration expenses, taxation, operating efficiency, and inventory management. Management may use share buybacks to offset declines in ROE.

Inventory Turnover: The inventory turnover ratio is an efficiency ratio that measures a company’s effectiveness at generating sales from the inventory it holds. It is calculated as the ratio of cost of goods sold to average inventory. Inventory turnover ratio is affected by the rate at which sales occurs, which, in-turn is dependent on consumer sentiment. Companies in the industry often overestimate how much to stock in inventory, leading to steep wholesale and retail discounts. In the worst cases, inventory that cannot be sold is destroyed.

Earnings Per Share (EPS) Growth: Earnings per share is calculated as a company’s net income minus its preferred dividend payments, divided by the weighted average number of shares outstanding. Generally, earnings per share is affected most negatively by factors that reduce net income. As the industry generates increasing proportions of sales from the BRIC nations and other emerging markets, foreign exchange risk imposes negative pressures on revenues and net income. It is important to note that companies can easily manipulate earnings per share growth by instituting share-buyback programs.

Inventory Forecasting & Management Issues

The issues at play here are illustrated best in H&M, a Fashion Giant, Has a Problem: $4.3 Billion in Unsold Clothes a story by Elizabeth Paton that appeared in The New York Times on March 27, 2018. The article highlights a drop in quarterly sales accompanied by an increase in unsold inventory. According to the article, H&M’s customers have either moved to doing more of their shopping online or have gone seeking lower-cost offerings elsewhere. This is ironic since H&M has been a fast fashion stalwart for two decades during which it has experienced massive growth. The article describes some of the supply chain challenges H&M is grappling with, and how the company intends to respond: “H&M has insisted it has a plan, saying it would slash prices to reduce the stockpile and slow its expansion in stores. It said it hoped its online business would expand 25 percent this year.”

Lack of Efficient & Agile Supply Chain

What happens when the information or forecasts at one node in a company’s supply chain is incorrect? Incorrect information at any node in a supply chain creates a phenomena wherein the flow of goods is unexpectedly distorted over time due to differences between actual demand by end-consumers and forecasted demand by suppliers.

The phenomenon is known as the bullwhip effect, and it arises because demand signals are incorrectly amplified as information is transmitted along the supply chain. The bullwhip effect arises due to; poor coordination along the various nodes in a supply chain, and rational decisions that are made by supply chain participants using the best information at their disposal. The distortions are made worse because of the uncertainty that accompanies activities at every point in a company’s supply chain. The general consequence of the bullwhip effect is poor customer service.

How might a fashion company counteract the bullwhip effect? First, some companies are reversing the effects of globalization by creating the cyber-physical infrastructure required to enable networks of small-batch, quick-turn, and localized manufacturing hubs in order to make it possible to manufacture goods for consumers in the key markets of Western Europe and North America in small batches, closer to the ultimate end-consumers. Second, some companies are developing and using more advanced software for predictive analytics. Advances in artificial intelligence make this a much more feasible proposition today than at any time in the past. Third, some companies are improving the real-time flow of predictive information and data between key nodes in the supply chain. This allows every participant in the supply chain to anticipate future demand more accurately, and to stock raw-materials inventory more efficiently. We will discuss the technology trends that are making solutions to this problem possible in the fifth article in this series.

Conclusion: A Race To The Bottom?

Prevailing economic, social, and technological trends point towards a challenging future for the global fashion industry. Incumbent players may choose to operate with a business-as-usual attitude. Alternatively, they may opt to address the industry’s supply chain challenges by adopting an ecosystem-based approach to solving the problems that are too big for a single company to solve on its own. This will require adopting a systems-thinking approach to how companies in the industry are run, and how they view their relationships with one another.

The companies that win will adapt to the changing landscape by building on their historical strengths, while simultaneously developing new supply chain capabilities through partnerships with former sworn rivals or relatively new technology startups.

The companies that lose will remain entrenched in the old ways of doing business, following one extreme round of price-cuts by even more extreme discounts. This race to the bottom will be exacerbated by additional measures like reducing the number of brick-and-mortar locations — measures that do nothing to solve the fundamental problem: The fashion and apparel supply chain is broken and must be refashioned.

Next in the series: Where Will Technological Disruption In Fashion Come From?

About REFASHIOND Ventures: REFASHIOND Ventures is an early-stage venture capital investment firm that is being formed in order to invest in early-stage startups creating innovations that make global supply chains more efficient, starting with startups at the intersection of fashion and retail.

About REFASHIOND CO:LAB: REFASHIOND CO:LAB is the systems design, research, and strategy consulting arm of REFASHIOND Ventures. REFASHIOND CO:LAB helps organizations create competitive advantage through supply chain innovation.

________________

[1] One may think of a value chain as a company’s internal supply chain. The term is used to distinguish internal operations from operations that rely on a network of external parties.

[2] McFadden, Christopher. “27 Industrial Revolution Inventions That Changed the World.” Interesting Engineering, 18 Feb. 2018, interestingengineering.com/27-inventions-of-the-industrial-revolution-that-changed-the-world. Accessed Oct. 12, 2018

[3] Christopher, Martin. Logistics & Supply Chain Management: Creating Value-Adding Networks. 4th ed., Financial Times Prentice Hall, 2011.

[4] Berg, Achim, and Saskia Hedrich. “What’s next in Apparel Sourcing?” McKinsey & Company, May 2014, www.mckinsey.com/industries/retail/our-insights/whats-next-in-apparel-sourcing. Accessed Oct. 8, 2018.


Originally published at www.refashiond.com on October 14, 2018.

Filed Under: Entrepreneurship, Industry Study, Innovation, Investment Themes, Investment Thesis, Long Read, Supply Chain, Technology, Venture Capital Tagged With: Apparel, Entrepreneurship, Fashion, Innovation, Logistics & Supply Chain, Logistics and Supply Chain, Long Read, Luxury Goods, REFASHIOND, Startups, Strategy, Technology, Venture Capital

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