Newsletter #9: "Perhaps We Have a Quorum Right Now"

Two weeks ago, I attended a dinner in Los Angeles comprised of 25 or 30 venture capitalists.  Much of the conversation that evening revolved around artificial intelligence: given that nearly 40% of all venture capital dollars invested thus far in 2024 have gone to AI companies, and a majority of new venture capital firms formed expressly focused on AI, the buzz that night was unsurprising.  Towards the end of the dinner, the lone other consumer investor in the room came up to me and deadpanned, “I was planning on hosting a meeting for all consumer venture investors in Los Angeles sometime soon, but given there only seems to be four of us remaining, perhaps we have a quorum right now.”

While overall venture investment has dropped 40% since the peak of 2021, consumer venture capital investment fell nearly twice as far over the same time period (Dealroom; Pitchbook).  Looking back a bit further, in 2016 almost 10% of venture capital dollars were spent on consumer goods and services- while in 2023, less than 3% of venture capital dollars were spent on consumer categories.  And yet, consumer goods and services account for 18% of the market cap of the S&P 500, and consumer spending writ large accounts for 70% of US GDP.

Why is there such a disconnect between venture funding for consumer businesses, and the role that consumer businesses play in the broader economy- especially in recent years?  I suspected that Ben Horowitz’ maxim might be at play: “markets weren’t efficient at finding the truth; they were just very efficient at converging on a conclusion- often the wrong conclusion.”

Before I officially launched Ocampo Capital last year, I studied the history of consumer venture investment: historical performance, why some investors aren’t as excited as I am about the space, and expectations for the path forward.  Through that work, I uncovered several explanations as to why consumer investing is less popular within the venture community, and explored them myself.  Below are those statements, along with what my subsequent research taught me:

“Consumer returns aren’t strong enough.”

Data going back over the past 20+ years shows that this is just not true.  In fact, research from Cambridge Associates and the Kauffman Foundation’s Angel Investment Performance Project showed that investors in consumer products realized 3.6 times their investment in an average of 4.4 years- which compares favorably to stated goal returns for top venture funds in the United States.  Moreover, consumer venture capital outperformed total US venture capital returns in over 65% of years over the past quarter-century. 

“Consumer investing is boring.”

While I have heard this from several venture capitalists, I can’t imagine why such a subjective (not to mention, irrelevant) comment should matter.  While it is true that consumer venture capital returns have a standard deviation of returns which is much narrower than tech venture capital returns, I am perfectly fine looking for excitement elsewhere than return volatility.  The often-cited Power Law of venture capital (defined by legendary venture capitalist Peter Theil as “the best investment in a successful fund equals or outperforms the entire rest of the fund”) historically has proven to be less of a requirement in consumer venture investing than it is in tech VC, because of the dispersion of returns for consumer companies.  Said differently, while it is almost unprecedented for consumer businesses to have a 10,000x return, at the fund level that is not necessary for strong performance.

“Tech and biotech have the biggest growth tailwinds.” 

I would respond to this argument with a qualified “yes, but….” 

When you look at the history of sector weightings of the US stock market over the past 200 years, it is interesting to see how it has changed dramatically over time.  Finance made up over 90% of the US stock market before 1830.  From 1830 to 1900, Transports were the largest single sector, with Finance falling to approximately 25% in the latter half of the 19^th century.  Since 1900, the US stock market has become much more diversified across sectors.  Information Technology- as one might expect- has grown the most of any sector, from 0% to now accounting for a 12% weighting within the US stock market.  The next two sectors, tied with the second-most growth since 1900, are Healthcare (0% to 9%) and Communications (5% to 14%), which both have expanded in weighting by 9% over that 124 year period. 

But what comes in right behind those sectors as far as growth since 1900?  Consumer Discretionary, which has expanded to 10% of the US stock market weighting and has grown by 6% over that same period.  A bit further back, but also growing in relative importance, is Consumer Staples- which account for an additional 8% of the US stock market, nearly doubling since 1900.  Moreover, the growth trajectories for Consumer Discretionary and Consumer Staples has been remarkably consistent, decade over decade, since 1900- perhaps due in part to consumer spending as a percentage of GDP has been growing consistently over at least the past 40 years.  Based purely on US stock market sector weightings, it stands to reason that consumer venture capital should probably account for 15%+ of all venture dollars invested- and not 3% as it does now.

A plausible rejoinder to my argument above could be, “what if top consumer companies have so much staying power, as to crowd out any new entrants?  Why would venture capitalists invest in young consumer companies, if older ones are dominant over time?”  The famous Austrian-American economist Joseph Shumpeter, who coined the term “creative destruction,” once said, “stabilized capitalism is a contradiction in terms” and that is true for consumer businesses just as it is for other industries.  To that end, the lifespan of a company in the S&P 500 was 61 years in 1958- in 2020 it was 21 years (McKinsey).  A full half of the S&P500 member companies have been replaced over the past decade- either through creative destruction or acquisition.  Meanwhile, if you look at consumer companies in the S&P 500, while they have slightly more staying power than some other categories, many are also highly acquisitive of new entrants in order to stay on top.  And even amongst the top 50 consumer businesses in the S&P500, two-thirds of the companies from 1950's list have turned over to new entrants.

In total, whether you look at public markets, or consumer spending as a percentage of total US GDP over time, Consumer has a nice tailwind with way fewer venture investors chasing returns than tech or biotech.

“I don’t understand consumer investing.”

According to Forbes, this may be the most honest and true claim of all.  “Structurally, VCs have tended to overlook CPG due to the ecosystem that has evolved around tech innovation….most [venture capitalists] graduated from universities with strong engineering and science programs….what we see is Peter Lynch’s maxim ‘invest in what you know’ in action among venture capital investors.” 

And while it makes complete sense for VCs with tech backgrounds to focus on tech, that does not suggest that consumer VC should be ignored.  It is true that the overlap between consumer operators and consumer venture investors is quite small- but therein lies the opportunity.

Howard Marks’ recently wrote “there simply is no place for certainty in fields that are influenced by psychological fluctuations, irrationality and randomness.”  I couldn’t agree more- but I believe enough in the historical data, and my experience in consumer businesses over the past 20+ years, to have chosen to stake my career on the go-forward opportunity in consumer venture capital.