e-commerce roll-ups are the next wave of disruption in consumer packaged goods

The Rise of Roll-Up Acquisitions

The current business landscape is significantly shaped by roll-ups. These aren't the confectionery treats of childhood, but rather the consolidation of smaller businesses into larger entities, presenting a potentially lucrative avenue for increasing equity value.

Key Players in the Roll-Up Space

Currently, considerable attention is focused on Thrasio, the company that achieved unicorn status at an unprecedented rate. A number of competitors, including Heyday, Branded, and Perch, are also actively competing to establish themselves as the leading model for contemporary consumer packaged goods (CPG) businesses.

Adding to the dynamic, prominent investor and operator Keith Rabois has recently unveiled OpenStore, a roll-up venture developed in collaboration with Jack Abraham, co-founder of Atomic.

Catalysts for Growth

Thrasio has capitalized on the substantial growth of the e-commerce sector in 2020, a period that saw over $1 billion in investment directed towards companies focused on acquiring independent Amazon sellers and brands.

Several factors contributed to this surge. The pandemic notably accelerated consumer spending on Amazon and e-commerce platforms in general. Furthermore, favorable interest rates and readily available capital facilitated the raising of both equity and debt financing.

Validation of the Model

The emergence of demonstrable successes has also played a crucial role. Thrasio, alongside others, has secured substantial funding, and Anker, a brand initially built on the Amazon marketplace, successfully completed an initial public offering (IPO).

These achievements have reinforced the idea that substantial brand value can be cultivated within Amazon’s ecosystem.

A Shift in Investor Sentiment

The renewed interest in building value through e-commerce brands is particularly noteworthy. Just twelve months prior, digitally native brands had experienced a decline in favor with venture capitalists, following numerous instances of failing to deliver venture-scale returns. What, then, is driving the current enthusiasm for roll-ups?

• The pandemic accelerated online shopping.
• Low interest rates made capital more accessible.
• Successful examples like Thrasio and Anker have proven the viability of the model.

Roll-ups: An Investment Strategy Explained

The concept of roll-ups isn't novel; it has been utilized in the investment landscape for some time. In traditional business, roll-ups frequently result in significantly higher exit valuations, a phenomenon referred to as "multiple arbitrage." Consequently, it’s logical that this strategy is gaining traction within the digital sphere.

However, past performance indicates that roll-ups haven’t consistently delivered success. Harvard Business Review reports that over 66% of roll-up strategies ultimately fail to generate value for investors. While effective at scaling businesses, they don't invariably lead to improved profitability or enhanced cash flow from operations.

Key to Success: Increasing Equity Value

For roll-up strategies to succeed, acquiring entities must identify and implement innovative operational methods within their newly acquired businesses. The fundamental principle is that increased equity value is directly tied to improvements in operating cash flow.

There are four primary avenues for achieving this: decreasing overhead expenses, lowering operational costs without impacting pricing or sales volume, raising prices without diminishing sales volume, or boosting sales volume without increasing per-unit costs.

E-commerce and the New Wave of Roll-ups

The e-commerce sector is now being viewed as a potentially fertile ground for roll-up strategies, or so investors and experienced capital allocators believe. Let's examine how this current generation of roll-ups is focusing on both expansion and value generation.

• Cost Optimization: Streamlining expenses across acquired businesses.
• Operational Efficiency: Improving processes without affecting customer pricing or demand.
• Strategic Pricing: Adjusting prices to maximize revenue while maintaining sales levels.
• Scalable Growth: Increasing sales volume while controlling production costs.

Successfully navigating these areas will be crucial for the next wave of roll-ups to achieve positive outcomes for investors.

The Importance of a Core Strategy for Roll-Up Businesses

To achieve success, much like any investment firm, a roll-up business requires a well-defined thesis or set of theses to guide its strategic decisions across all portfolio companies. Several key strategies are currently gaining prominence within this trend.

A primary focus for many roll-ups is the dominant distribution channel utilized by the companies they acquire. Identifying businesses that share a common distribution method can facilitate economies of scale and allow for concentrated marketing and growth efforts, rather than spreading resources thinly.

However, this approach also introduces a potential vulnerability: over-reliance on a single distribution strategy. Any significant changes within that channel could negatively impact the entire portfolio. Let's examine how two companies are navigating this challenge with differing strategies.

Thrasio concentrates exclusively on the Amazon marketplace, heavily depending on it for product distribution. This singular focus has allowed Thrasio to develop deep expertise within the Amazon ecosystem, fostering a positive feedback loop. Their extensive experience enables them to identify promising products and determine how to enhance their value. The inherent risk, naturally, is a strong dependence on Amazon, where alterations to the platform’s algorithm could jeopardize performance. Furthermore, the increasing presence of counterfeit products on Amazon poses a potential threat, though Thrasio currently prioritizes branded products.

In contrast, Moonshot Brands is a newer entrant, concentrating on omnichannel brands that maintain both an Amazon presence and direct-to-consumer (DTC) sales channels. This diversified approach reduces susceptibility to changes or vulnerabilities within any single channel. However, scaling can be more complex, requiring a broader range of customer acquisition skills. DTC sales frequently necessitate utilizing platforms like Google and Facebook for customer acquisition.

A significant challenge in iOS-dominated markets is adapting to system updates – such as the forthcoming iOS 14 – that impact targeting and analytics capabilities. Notably, Moonshot focuses on building brands internally rather than solely acquiring existing ones.

Another crucial consideration is the target customer audience or product category. While the previously mentioned aggregators diversify across customer segments and categories, others adopt a more focused strategy.

Grove Collaborative initially specialized in household goods before expanding into related verticals that align with its brand values and customer profiles. Though not a traditional roll-up, Grove Collaborative sells products from brands it doesn't own, develops its own brands internally, and occasionally acquires brands to integrate into its portfolio. Grove Collaborative’s focus on natural, eco-friendly products enables scalable and replicable processes across various categories.

This concept isn’t novel; established CPG retailers have employed similar strategies for decades. Some traditional CPGs pursue a horizontal approach, acquiring brands that appeal to a common customer base, like LVMH (luxury consumers) or Unilever (middle-income households). Others concentrate on a specific category, as exemplified by L’Oreal, which owns mass-market brands like Maybelline and Garnier, luxury brands like Lancôme and Yves Saint Laurent, and professional brands like Kerastase. It’s important to note that each of these categories is substantial enough to support multiple companies with valuations exceeding several billion dollars.

The Question of Optimal Strategy Remains Open

Despite diverse investment strategies and portfolio construction approaches employed by various companies, a definitive path to success remains elusive. Significant risks are inherent in this landscape.

The influx of investment capital leads to a commoditization of cash and inflated valuations for acquisitions. As competition intensifies, viable exit and liquidity options become crucial for these roll-up strategies. Dealmakers may encounter businesses whose worth doesn't exceed their current cash flow. While initial gains may appear substantial for e-commerce entrepreneurs, these benefits are unlikely to be sustained indefinitely.

Achieving initial brand growth within these categories may seem straightforward, but maintaining that momentum presents challenges. Expanding beyond the first few tens of thousands of customers to reach millions can prove difficult. This expansion might necessitate utilizing channels that deviate from the roll-up’s core strategy – will these companies initially focused on Amazon develop expertise in direct-to-consumer acquisition?

These risks are inherently difficult to mitigate due to the long-term nature of these investments and the unpredictable nature of market trends. Accurate forecasting is a significant hurdle.

To differentiate themselves in an increasingly competitive market, aggregators must demonstrably enhance value through improvements in marketing, supply chain and logistics, and/or research and development. This will attract both consumers and potential acquisition targets, improve unit economics, and foster ongoing innovation.

However, even when roll-ups successfully add value to their portfolio companies, the method of realizing that value remains a question. Will these companies be sold at a specific juncture? OpenStore, for example, currently states it doesn’t intend to quickly resell acquired businesses, yet clear exit strategies are still undefined.

The sector is experiencing rapid growth, fueled by substantial market opportunities and the potential for numerous multibillion-dollar companies to emerge. Currently, a race is underway to establish a firm with the appropriate portfolio construction and management techniques in a novel manner.

Traditional private equity firms are being replaced by a new breed of investor – a combination of finance professionals and e-commerce operators proficient in digital growth strategies.

The e-commerce surge, as initially demonstrated by Thrasio, has spurred technological innovation in these areas. However, we are still in the early stages of this evolution, and critical risks remain unresolved. The mere accumulation of hundreds of millions of dollars in capital does not guarantee success.

Ultimately, success hinges on effective execution, as many ventures will inevitably fail. This is a capital-intensive undertaking, and rising capital costs will intensify the pressure to generate returns.

Achieving victory in this arena requires the creation of meaningful value in ways that have not yet been realized. The victor will fundamentally reshape the e-commerce landscape for years to come.