PS#088: 10 Ways to Build an Investment Thesis – Incumbents (Part 2)
Today, we’re going to discuss a few thesis building strategies focused on incumbents.
First, if you’re just joining us, check out the previous issue that kicked off this series. It will provide some context around the goals, criteria, etc.
As a reminder, the strategies for today will include…
What are the old, outdated solutions?
What are the best businesses in 10Qs and 10ks?
What can be bundled or unbundled?
OK, let’s dive in.
What is an incumbent?
A pretty important question, especially if we want to understand the thesis building strategies in this category.
For our purposes, an incumbent is a company that is already established in a certain market or industry.
The incumbents are the companies that are the (or one of the) entrenched leaders in their space. They have established brands, expansive customer bases, proven business models, economies of scale, etc.
To make it a bit easier, you might think about Microsoft, Apple, Salesforce, Coca-Cola, Walmart, Amazon, etc. However, it’s not just large, public companies. There are many private companies that are leaders in their spaces, such as HEB Grocery Company, Cox Enterprises, etc.
At the end of the day, these are the companies we hope our startups will become.
Why do we care?
The beauty of incumbents is that they’ve already proven the possibility of everything on our basic criteria list (assuming they fit within our fund’s mandate).
They’ve clearly identified a “need-to-have” problem, provided a valuable solution, built a proven business model, and tapped into a significant market. With all of those items crossed off, it’s about finding opportunities to build a business that can capture some of this market.
This is exactly where our previously defined strategies come into play.
Let’s go through these in more detail…
(1) What are the old, outdated solutions?
This is one of my favorite strategies.
What are the old, outdated solutions in this market? Early in my career, this question drove a lot of my investment theses. So much so, that I really reshaped my career to look for these opportunities, picking boring, forgotten spaces as my primary focus.
So, how does it work?
It’s actually pretty simple…
Identify the main incumbents in the space.
Outline the solutions they provide to their customers.
Demo and test these solutions to find the old, outdated ones.
Rinse and repeat.
You would be shocked to see how many enterprise solutions are now 10, 20, or 30 years old.
The functionality, feature set, UX/UI, etc. just haven’t been updated. The solution has been put into maintenance mode because there aren’t any better alternatives (!) and customers aren’t willing to switch. Well, therein lies the opportunity.
Just consider how quickly technology (and our world) has evolved over the past few decades, it’s been moving at an incredible pace. There’s bound to be at least a few of those solutions that could use a few upgrades (at the very least).
(2) What are the best businesses in 10Qs and 10ks?
VCs invest in startups that they hope will one day become big, successful businesses. Essentially, the hope is we are investing in the next incumbent.
In order to become a big, successful business (i.e., the next incumbent), you need to have a profitable business model that drives lots and lots of revenue.
Where do we find these businesses?
The financials.
If we look into a company’s financials, we will find the truth. We will see the parts of the business that are the most profitable, drive the most revenue, have the highest growth rates, etc. We are able to learn what aspects of the business are really succeeding at scale.
This can be a gold mine of information.
To explore this path, go to the SEC’s EDGAR database. In this database, you’ll find the financial filings for most of those big, successful businesses. These are long, complex documents that provide a great overview of the company’s financial performance.
A couple pieces of advice as you explore this path…
Take your time, these are complicated documents.
Read a few of them, get a sense for how they’re structured.
And, a quick tip, 10Ks are annual filings, 10Qs are quarterly filings.
(3) What can be bundled or unbundled?
Former CEO of Netscape, Jim Barksdale, has said, “Only two ways to make money in business: one is to bundle; the other is unbundle.”
There’s no better example of this than the current cycle of cable, then streaming platforms, and now the rebundling of some combination of the two. Through a pretty straightforward process of bundling and unbundling, we’ve created new mammoth companies (i.e., Netflix, Hulu, etc.).
It’s proven to be successful time and time again.
The good news?
Those types of opportunities exist across markets.
Similar to the first strategy in this category, some solutions have been bundled together or unbundled in ways that no longer make sense for their current market. When we look at these incumbents, we may be able to identify opportunities that could be separated out into their own solution or should be bundled together to make a new product.
In my own experience, I’ve seen both work very successfully. I’ve been able to parse out several investment opportunities by unbundling a larger company's offering, and had other investments create incredibly successful solutions by offering a “one-stop-shop” with multiple solutions combined into one.
Incumbents have shown us that it can be done, a big business can be built. If we take the time to look at those businesses from different angles, we’ll end up finding some interesting, potentially venture-backable opportunities.
In the next issue, we’ll discuss customers & users and how I leverage those relationships to think through new, venture-backable opportunities.
