Mark Odendahl
Welcome to the Industries in Motion podcast from RBC Capital Markets, where we'll be exploring what's new and what's next in today's fast moving markets and industries, to help you stay ahead of the curve. Please listen to the end of this podcast for important disclaimers.
My name is Mark Odendahl and I am the Head of US Capital Markets research. Let's get into today's episode.
I'm joined today by Brad Erickson. Brad is our new Internet Analyst. He's been here for a few months now and is off to a great start. Brad joined us from Needham, after three years at Needham, and eight years at Pac Crest, Brad, thanks so much for joining us. We're excited to have you and congrats on the great started at RBC.
Brad Erickson
Thanks, Mark, very pleased to be here.
Mark Odendahl
This is a great opportunity to get you on a podcast and talk about some of the things that you've launched on recently. You had an industry launch recently, as well as you hosted several private companies, at our Private Tech Conference. From those events, you've written some thematic work that's really interesting. That thematic work touched on several themes, first of which is internet marketplaces. You've been discussing that internet marketplaces are going everywhere far beyond traditional categories. Could you go into that a little bit more?
Brad Erickson
Yeah, sure. So, you know, I think historically, as the internet kind of got started 15,20 years ago, the obvious places where it sort of got its beginning was, of course with things like Amazon, where they were selling books and CDs and consumer electronics, right? Horizontal ecommerce where the products were small and commoditized, and fragmented, and people could easily see a natural path to vending that stuff and fulfilling it over the internet.
As we've moved forward over the last five or 10 years, obviously, the usage of the internet has become more broad. And as such, every vertical end-market with things like, you know, travel, car, retail, home dervices, transportation, food delivery, even online dating – all of those categories are getting built out by new companies. And so the ability to have a digital marketplace in and around each of those verticals is springing up. And I think one of the things that we found is super interesting now looking forward from 2021, is that you're starting to get even more nichey in terms of the markets. Just at the private company conference you just referenced, we had companies doing really cool things in and around things like farming and the food supply chain, reinventing how people buy car insurance and transact there. So lots of interesting new vertical opportunities that, I think, digital marketplaces are able to capture value in going forward.
Mark Odendahl
So where does this leave smaller companies today? Are they all going to get swept away by mega tech swooping in to every marketplace?
Brad Erickson
In some cases, yes. But in a lot of cases, I don't think so. I think one of the factors that sort of determine success is on the supply side. And what I mean by that is, when a company has a unique ability to capture information on the supply side, that gives it the insulation. Car retail is an example I would reference here. If one of the large ecommerce players, think of the largest ecommerce players, were to come in, and, and go to car dealers and say, “Hey, we want to sell your cars for you”. Guess what? Those car dealers don't want to work with a platform that's so big that they can gouge them on price.
And so what you have is you have companies like Carvana, and some of the car shopping sites that have come out and said, “Hey, we can get unique access to that supply”. And that's going to create a differentiated customer experience and choice, which is obviously what the internet brings. And so there's a lot of verticals like that, where a player that's vertically focused, is able to capture that inventory in a unique way and in a way that the mega tech companies cannot. And that's what we think kind of insulates these guys going forward.
Mark Odendahl
You've also touched in your recent research that some of these marketplaces have been established in travel and real estate. And you've started to talk about potential consolidation of these marketplaces as they come together. Could you expand on that point?
Brad Erickson
Sure, there's kind of two aspects to this. One is the sort of broad platform thesis, which is that, you know, every marketplace starts out in sort of one core market, right, and they have supply for that core market, say it's travel or even in the case of advertising. And so they're able to bring together the two sides of the marketplace supply and demand for that core business. And theoretically, because of network effects, often it's a winner-take-most type of situation.
At a certain point, what ends up happening is that for those players to effectively grow their equity value beyond the core – what's ascribed to them through the core marketplace – they have to try and use that platform to expand into other spending categories. An example of this would be Uber, right? You've got kind of two core basic businesses there. And certainly the principal one is ride-hailing, right? We all have the Uber app on our phone. What happens if they could get you to start ordering from restaurants for food delivery? What happens if they could start to get you to look at grocery delivery, or any other type of same-day delivery, and they looped it all in under one subscription? They're capturing that incremental spend with zero marginal customer acquisition costs. That's the holy grail of platform expansion in the internet.
The second thing there, which I think is pretty interesting, is there are certain verticals that I think just have naturally synergistic sort of usage characteristics that could lend towards this kind of convergence we've talked about. And I guess the big example that I've been sort of focused on lately is in and around real estate, home services, and then also to some degree, travel. And so the common characteristic there is we don't do any of those things very often. So in the US, we get a couple, or three weeks’, vacation, so we don't travel but a few times a year. In home services, COVID notwithstanding, I don't know how often we fix stuff in our house, it's not that often. And then obviously, from a real estate perspective, of course, we all know, we tend to not buy and sell homes all that often either.
Well, my thought was, gosh, there's a lot of interesting companies in and around those three spaces in the internet marketplace landscape. What if one or two or a few of them got together and sort of compressed all of those buyer characteristics to be able to leverage a better customer acquisition costs and sell across multiple end-markets? Essentially, I think there's some really unique combinations both in our current coverage, as well as a lot of private companies out there, where things could make sense over time.
Mark Odendahl
When you think about the combination of some marketplaces, are there regulatory issues to think about?
Brad Erickson
Absolutely, absolutely. Certainly a hot topic. And I think, you know, with the Federal Trade Commission, having made a fairly noteworthy hire for someone who's well-known to have some pretty stated views on some certain large platforms, I think it's going to become an increased issue. I think, what's interesting is, is for the small and mid-cap players, simply because of both the size of their market caps, as well as the size of the end-markets, the relatively smaller size of the markets that they occupy, I don't see there being a lot of necessarily, you know, Department of Justice, or regulatory antitrust interest in those markets. And so I do actually think there are nice opportunities to converge. And we've obviously talked about the one between travel, real estate and home services.
I think what gets really interesting as you move up the value chain, and you start to look at the mega cap tech companies, the four or five or six that people generally think about in that category. Absolutely, I think significant M&A is probably off the table for the foreseeable future. And if anything, I think the direction that, you know, the FTC and Washington DC in general are looking to head is that they would like to break up certain parts of those companies. What's even more interesting about that is just the precedent that that would create. I simplify it to the point of something like every business in the world, not every business, but a lot of businesses in the world, have profit-generating pieces of their business and parts of their business that already that are less profitable, or in some cases loss-making, right? And so often, it's up to the business owner to decide to potentially reallocate some of those profits from the profit center to subsidize another part of the business. Essentially what the view is from the policies and regulators’ standpoint seems to be is that they want to remove that capability for some of the largest companies in the world and effectively, in my opinion, sort of turn capitalism on its nose a bit. So I think they're going down a path that maybe they don't fully or haven't quite thought about all of the potential byproducts of that. But it's going to be, I think, it's gonna make things very challenging on those large cap companies.
Mark Odendahl
And one of the other themes that you were talking about out of your initiation and our private event was customer and equity value insecurity, which is driving funnel migration. Can you explain that theme?
Brad Erickson
Yeah, sure. So we all know that, in particular, mega tech market cap companies, have just reached extraordinary levels, levels probably none of us could have imagined five or even 10 years ago. And so with that, well, that's been a terrific boon for investors of those companies. Again, you reach a point with that core business, where it just runs out of a runway to really grow the equity value.
And so these companies, well, the reason I call it market cap insecurity is, if you're one of those large companies, and I think you can imagine the ones that I'm talking about, the only way to grow is essentially to find other places in that wallet, kind of like that the platform thesis that I was talking about earlier.
And so where funnel migration comes into this is that it basically means if you are at the bottom of the funnel, you're selling books, and CDs, and toilet paper and all kinds of stuff to customers, you're getting a ton of customer signal because of where you reside. Well guess what, if you have customer signal, you can go up the funnel and sell incredibly valuable targeted performance advertising to those brands that are trying to sell at the bottom of your funnel.
Conversely, if you're at the top of the funnel, let's say you're in advertising and you’ve got a ton of traffic, you have the best data, you have a huge funnel. Well guess what? At a certain point, you want to move down the funnel, you want to participate in more of that commerce again, because there's greater value that's down there that you haven't yet tapped. And so when you think about these large companies that have a certain amount of equity value attributable to their core business, that's why they're looking to move up and down the funnel is to create incremental equity value.
Mark Odendahl
So why is the funnel so important to internet companies of today?
Brad Erickson
Yeah, so. And the reason we sort of spend so much time talking about the funnel, there's two drivers that I think have led to this idea I mentioned earlier about equity value and security. One is that every basically every person in the developed markets has a smartphone. And historically, equity value creation occurred, largely or to some degree, because of just growing users. And effectively, we've reached maturity there, certainly there are markets that remain, we'll call it under-penetrated. But we're essentially mature from a smartphone penetration standpoint.
The second thing is that with the cost of capital and the success, frankly, of the venture capital community and private equity, particularly over the last decade, companies, new companies with disruptive models, or really strong value prop, basically have virtually unlimited access to capital, which means they can come out and hit on your customer, right. And that's why we get back to that whole idea of, you have to dominate customer engagement, you have to dominate the relationship you have with your customer and own that relationship super strongly. Because otherwise, the next startup that comes into your space, is going to have capital necessary to go out and try and grab that customer away from you.
Mark Odendahl
So which types of companies are going to be the winners in this funnel migration?
Brad Erickson
Couple characteristics I think I look for. One is in terms of the top of funnel in particular, you have to dominate the customer engagement, meaning when you don't transact with your customer, naturally, you have a less close relationship with your user base with the traffic that's on your site for whatever reason. Zillow would be an example here which is a particularly good one, I think, an attractive one in that you don't have to be terribly engaged to go to Zillow, and look at some houses every now and then. And yet Zillow magically has built this platform where four out of five US adults over the age of 18 go to Zillow once a month without fail. Why is that? No one can quite explain that other than to say their customer base for being top of funnel is incredibly well engaged. They're looking to go down funnel, obviously and close the loop from a transaction perspective, to deepen that relationship. So that's, I think when you think about top of funnel type players, customer engagement matters more than anything.
When you think about the bottom of funnel, obviously, it comes down to size. And what I mean by that is, if you're looking for that signal, right, you start with customer again. But you also need just a size of an audience where you get enough signal where you could potentially translate that back into an advertising business as well. So those are kind of the two characteristics I think about most, whether you're at the top or the bottom of the funnel.
Mark Odendahl
Thanks a lot, Brad. It was great to hear all these themes today. Your work, your expertise and your team is very focused on the disruption in a lot of these marketplaces and we've enjoyed hearing about it. Thanks for your insights today.
Brad Erickson
Yeah, it was great to chat. And thanks for having me.
Mark Odendahl
We look forward to hearing more about some of these themes at our November TIMT Conference.
What else lies ahead in today's ever evolving markets and industries. We'll be keeping track right here on Industries in Motion. Until then, thank you for joining us on today's episode. Make sure you subscribe to Industries in Motion, wherever you listen to your podcasts. If you'd like to continue this conversation or are interested in more information, please contact your RBC representative directly or visit our website, which is www.rbccm.com/industriesinmotion for more insights, thank you.
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