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Firehose #172: 💰 Cashing in. 💰
Revisiting Amazon's cash machine. Plus: fraud at Luckin Coffee, the return of Beavis & Butt-Head, hiring crafters, and Quora's "remote first" manifesto.
One Big Thought
I’m conducting an experiment this week and reprinting one of my more popular posts from a few years ago. I’ll also add a bit of commentary to bring it up to date.
My post (see below) “What startups can learn from Amazon’s cash machine” is one of the most cited by long-time readers of this newsletter. It also got some airtime in my appearance on 20 Minute VC back in 2018. The mechanics of cash conversion seemed a bit esoteric for a podcast, but thankfully Harry Stebbings encouraged me to nerd out on air. I had forgotten how mind blowing the distinction between profits and cash flow is the first time you really grok it.
Nearly every successful digital commerce startup I’ve encountered has an interesting spin on the cash flow dynamics of its industry. A few examples include:
Build a product where receipt of cash comes many months before shipment of product (see Zola*).
Build a product with relatively frequent, up-front purchases, but relatively infrequent vendor payments (see Daily Harvest*).
Charge a service fee up-front to offset the cost of tying up inventory with a single customer (see Stitch Fix*).
Balance timing of marketplace payouts and receivables using financial incentives on both sides (see Faire*, thredUP*).
The distinction between positive (bad!) and negative (good!) working capital is often the most striking in comparison to an incumbent. My post below shows how Amazon’s cash conversion cycle (CCC) ran at negative 30 days for years, while Walmart sat around positive 15 days. The comparison also rings true for startups. Macy’s, for example, has a 75 day positive CCC, while Zola’s is negative. The Gap has a nearly 40 day positive CCC, while Stitch Fix is normally less than 10 days.
In fact, nearly all U.S. publicly traded e-commerce or marketplace businesses have a negative CCC, including some with the highest revenue multiples: FVRR (-62 days, 6.2x EV/TTM revenues), ETSY (-12, 15x), FTCH (-62, 6.2x), AAPL (-39, 5.9x), and AMZN (-23, 5.5x). Despite low gross margins of ~23%, W and CHWY trade with ~$20B of enterprise value each, at a premium multiple in e-commerce of 2-3x revenues. That’s partially due to -33 and -21 day CCCs, respectively.
Innovation around working capital cycle is, therefore, a business model feature I pay close attention to. The businesses that get it right see faster compounding growth, and their business models are more resilient. Efficient growth creates fewer dependencies on outside capital, and therefore less dilution to founders. It’s a win-win for all!
What can startups can learn from Amazon’s cash machine (March 2018, link)
Cash is king, but cash flow and profits can often diverge. That’s especially true in e-commerce, marketplace, and subscription businesses. Understanding how to generate more cash flow from the same profit pool can help your company scale faster. In fact, it’s one of the secrets to Amazon’s success since early days.
A Harvard Business Review article from 2014 (an oldie, but a goodie) first turned me onto the fact that so-called “negative working capital” was such a strong driver of Amazon’s growth. At the time, the e-commerce giant had come under increasing pressure from stock analysts for its razor thin profit margins. The article points out that, while Amazon’s GAAP profits were tiny, its operating cash flow and free cash flow were surging:
In the case of Amazon, net income under-reports the cash generating power of the business because it includes massive depreciation and amortization charges. It also doesn’t account for Amazon’s attractive working capital position. A combination of these two factors drives operating cash flow to new heights each year.
Working capital advantages are worth understanding better. The key working capital metric is the company’s Cash Conversion Cycle (CCC), defined as Days Sales Outstanding (DSO) + Days Inventory Outstanding (DIO) — Days Payables Outstanding (DPO). DSO is the number of days required to collect cash payments from customers, so smaller is better. DIO is the number of days it would take to sell through current inventory, so again smaller is better. DPO is the number of days it takes to pay your vendors, so the larger the better. A company is said to have achieved “negative working capital” if CCC is less than zero. At the time of the article’s publication, Amazon’s CCC was negative 30.6 days. It compares quite favorably to Walmart and Costco, two retailers who are notorious for playing hardball with vendors:
Amazon attributes its success to better inventory management (a benefit of investing so heavily in technology for its distribution centers) and the attractive terms it extracts from its vendors. For instance, its DPO at the time was nearly 96 days vs. 30 and 39 for Costco and Walmart, respectively.
How did Amazon get to this enviable position? My understanding is that it created a virtuous cycle. Amazon’s investments in distribution center technology lowered DIO. This allowed it to invest more cash in growth. Its market power with vendors increased with growing scale. That market power translated into better vendor terms, which led to a higher DPO. Higher DPO created more incremental cash flows, which it invested in better distribution center technology. And, so on…
Taking a page out of the Amazon playbook, we’ve seen startups in the apparel (Stitch Fix*), home goods (Zola*), thrift/consignment (thredUP*), and other markets innovate on their working capital model to drive additional scalability. With greater scale, these companies are seeing similar operating cash flow leverage. I fully expect that online commerce entrepreneurs in the next few years will differentiate their businesses not just by focusing on the bottom line, but on the operating cash flow line as well.
Tweet of the Week
Links I Enjoy
Short sellers aren’t well regarded in tech circles, where optimism rightfully rules the day. Elon Musk even went so far as to sell “short shorts” on the Tesla website — an obvious dig at the short sellers that constantly heckle him from the sidelines.
Short sellers can be a heroes sometimes. China’s Luckin Coffee was worth $12B at its peak following a hotly contested IPO. Muddy Waters LLC, a short seller that focuses on Chinese companies with perceived fraudulent behaviors, conducted an investigation of Luckin and found its revenues to be inflated.
Here’s the executive summary of that report, which you can read in full here:
When Luckin Coffee (NASDAQ: LK) (“Luckin” or the “Company”) went public in May 2019, it was a fundamentally broken business that was attempting to instill the culture of drinking coffee into Chinese consumers through cut-throat discounts and free giveaway coffee. Right after its USD 645 million IPO, the Company had evolved into a fraud by fabricating financial and operating numbers starting in 3rd quarter 2019. It delivered a set of results that showcased a dramatic business inflection point and sent its stock price up over 160% in a little over 2 months. Not surprisingly, it wasted no time to successfully raise another USD 1.1 billion (including secondary placement) in January 2020. Luckin knows exactly what investors are looking for, how to position itself as a growth stock with a fantastic story, and what key metrics to manipulate to maximize investor confidence. This report consists of two parts: the fraud and the fundamentally broken business, where we separately demonstrate how Luckin faked its numbers and why its business model is inherently flawed.
Muddy Waters rolled out a workforce of nearly 1,500 full- and part-time employees to record store traffic for 981 store-days. This workforce verified that items sold per day were inflated. It also aggregated over 25,000 customer receipts to demonstrate an inflated net sales figure per item. This boots on the ground, primary research is impressive in its rigor and commitment to uncovering the truth. The stock is down 95% from its peak as a result, with the company admitting to fabricated sales figures.
Chipotle has created a “virtual farmer’s market” for its farm partners, based on the Shopify* platform. It allows customers to shop directly from vendors like Niman Ranch and Petaluma Creamery. Farms traditionally have had trouble reaching end consumers in online venues, so Chipotle likely sees an opportunity to be an aggregator for the customers of its 2,600 fast-casual restaurants and 8 million rewards program members.
Snap* is trying to reinvent QVC for Gen Z with new shoppable shows hosted in the Snapchat app. “The Drop” will focus on exclusive streetwear:
Each episode of “The Drop” will explore the relationship between the designer and celebrity collaborator. Viewers will learn about the item for sale and how it came together as well as what time that day the item will go up for sale. Later that day, at the aforementioned time, the episode will be updated with more content that includes a “swipe up to buy” call to action. The exclusive-to-Snapchat products will have limited quantity, an appeal for viewers to tune in live. (Snap is not announcing partners or celebrity talent slated to appear in “The Drop,” at this point.)
We’ve seen several attempts from startups to build a video-first commerce experience, but the dominant social platforms have yet to make a real attempt to do so. It should be interesting to see if the main barrier to date has been scaled consumer attention, or if the idea is fundamentally flawed in the west (compared to Asia where it works well).
Mike Judge is bringing back the iconic “Beavis and Butt-head”:
“It seemed like the time was right to get stupid again.”
From “Office Space,” to “King of the Hill,” to HBO’s “Silicon Valley,” Mike is consistently one of the best modern anthropologists of popular culture. I’m excited to see what Gen Z looks like through his eyes.
Alex Danco has become one of my favorite business writers of late. His most recent piece on how remote work will affect how companies hire was a gem.
One obvious thing that I suspect will happen everywhere, and which we’re already doing on Shopify Money, is that everyone who practices a craft (which is to say, everyone) has recruitment and hiring as a part of their job. Knowing how to source, do hiring interviews, manage bias and prioritize diversity, and all these other skills are becoming an explicit part of everyone’s job, because it’s inseparable from craft excellence. Another essential part of our jobs, which I bet will be made explicit before too long, is knowing where the highest-quality pockets of craft practitioners are. “I know you from this message board; you’re someone who cares a lot about our craft” will beat any resume line or work credential. Forums will unbundle LinkedIn, for any job where craft matters.
Simply put, remote work tools and easy internet distribution create the opportunity for anyone to practice their craft at scale. That means that the best practitioners will become known in online communities. If you want to recruit these individuals, your company must authentically embrace “craft” and recruit through the practice of your own craft. In short:
“I know you from this message board; you’re someone who cares a lot about our craft” will beat any resume line or work credential.
Mask on! →
Everyone should be wearing a mask right now in public.
If you’re looking for evidence, an analysis by the Philadelphia Inquirer found that states with mandatory in public masking (CA, NM, IL, MI, etc) saw a 25% decline in new cases from the week of June 1 to the week of June 15, while those where masking was only recommended saw an increase of 84%.
Adam D’Angelo of Quora wrote a what may become the defining document on “remote first” employment. It’s a long read that I recommend reading fully.
Remote work isn’t a panacea. It comes with a host of challenges. Some workers will never be able to adapt to fully remote work, but setting up a company as “remote first” will likely become the norm in the tech industry from here forward. The benefits of zero commute, fewer distractions, ability to move to a city with a lower cost of living, and avoidance of visa/immigration issues are simply too powerful to ignore.
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Disclaimer: * indicates a Lightspeed portfolio company, or other company in which I have economic interest. I also have economic interest in AAPL, ADBE, AMT, AMZN, BABA, BRK, BLK, CCI, CRM, GOOG/GOOGL, FB, HD, LMT, MA, MCD, MSFT, NSRGY, NEE, PYPL, SHOP, SNAP, SPOT, SQ, TMO, VEEV, and V.
Header image credit: https://www.thebluediamondgallery.com/wooden-tile/c/cash-flow.html