Building Bulletproof Brands — Part III: How networks and tokens could reshape the economics of physical goods brands

This is Part III of Building Bulletproof Brands, a series that explores how the internet destroyed traditional moats for physical goods brands but created new ones that are stronger than ever before. Read Part I and Part II if you haven't yet.

Part I of this series looked at the changing landscape of brand longevity and how the traditional formulas that used to make brands defensible—(brand + product + distribution) and (brand + product + distribution) x community— are now obsolete. Part II proposed a new formula—(brand + product + distribution) x networkx—that harnesses networks as the only defensible moat for physical goods brands.

Now, Part III looks at how brands can 1) use branded tokens and network-based incentives to grow; 2) how these mechanisms reshape customer acquisition and unit economics, and 3) what these changes mean for companies and investors.

1) Starting and growing a brand

A brand starts when its founder comes up with an idea that she believes needs to exist. From there, she might create and think through the company's branding, product and distribution. Soon enough, she will release the product to the world—on an ecommerce site, in her own store or through wholesale—and hope that a crop of early adopters will flock to the product and spread the word. Soon enough, the brand will take off and prosper for the rest of eternity, making everyone unnecessarily wealthy.

This scenario unfortunately includes an immense amount of wishful thinking. As discussed in Part I, launching a brand today is relatively straightforward and cheaper than it has ever been. Sustainable and defensible growth, however, is much more elusive. The moment a new brand launches is when most things don't go according to plan. Sometimes the brand blows up, other times it makes a small dent, and more often than not it makes a big thud.

Why does this happen? Sometimes it's because of technical issues or deficiencies around product, brand or distribution. Maybe the product is bad and no one wants it. Or the brand is bad, too specific or not specific enough. Maybe the company didn't secure the right distribution.

However, the problem goes deeper. The biggest reason most brands don't grow sustainably is because of a lack of incentives. There's no underlying reason for a shopper to continuously support a brand, let alone in the beginning, especially through all of the trends and cycles that make the physical goods business so challenging. This issue is especially prevalent early on in a brand's lifecycle. Many people are familiar with the chicken/egg problem for networks and marketplaces, which is sometimes called the "bootstrap problem." Brands needs customers and customers need brands. But what comes first? Something must kick-start the interaction.

Up until this point, nothing in the physical goods world incentivizes this early exchange of value. But recent technological developments might be changing this.

Networks, blockchains and tokens

There's a lot of activity in the cryptocurrency space these days. In simple terms, cryptocurrencies are digital currencies backed up by math—specifically encryption—not a central entity such as the Federal Reserve. Many people have heard of Bitcoin, which is the most successful and well-known cryptocurrency. The accounting method behind Bitcoin, which ensures trust without any centralized control, is called the blockchain. It acts as a digital ledger—think of an accounting book or balance sheet—that tracks who owns what. The blockchain serves the same role as the database that stores one's credit card or airline points.

While a traditional database is centralized and closed, the blockchain is decentralized and open. For Mastercard's services to work as intended, people need to trust the company, since (hopefully) no one can look into Mastercard's database and see who has the most credit card points. The blockchain, conversely, functions without any centralized authority that authenticates information—math fills that role. Anyone can look at records on the blockchain and see who holds what, which helps insure that all of the holdings are legitimate. Each participant has a random identifier that masks details such as names and other personally identifying information. Participants can still remain private but everyone's activity is public. This total transparency instills trust in a system with no centralized control.

While Bitcoin has garnered most of the attention in the cryptocurrency space, another development is quickly gaining steam: tokens. Simply put, a token is a digital currency that stores value. Bitcoin itself is a token, but the potential for tokens goes far beyond Bitcoin's use as a currency or store of value.

Tokens, like Bitcoin, are anchored to the blockchain, which accounts for their value. As a result, tokens provide some important differences compared to traditional point systems that brands, credit card companies, and airlines use, which are stored in closed databases: 1) tokens can act as an intra-network currency, facilitating a value exchange from day one; 2) network contributors can be paid for their work in tokens; and 3) tokens can be converted to any other currency since they are on the blockchain, which means they have an exchange rate.

An increasing number of networks have started selling tokens and using their incentives to solve the chicken/egg problem that all companies need for growth. A few examples:

  • Bitcoin: a currency where people are financially incentivized to contribute computing resources that power the network
  • Kin: a currency from the messaging company Kik where users are financially incentivized to develop products on the network
  • Steem: a decentralized version of Reddit where people are financially incentivized to contribute news and content.
  • IPFS: a decentralized file storage system where people are financially incentivized to contribute storage space

Most of these examples are technical networks or protocols, but the power of the system is alluring, specifically for physical goods brands.

Jumpstarting a hive

It's a logical evolution for brands to harness the power of tokens, henceforth called branded tokens. A brand facilitates but does not fully control a branded token, which has the potential to overcome the chicken/egg problem that plagues every physical goods brand. Solving this lies in giving early adopters a financial incentive to launch and sustain the network, which aligns everyone's incentives to ensure prosperity.

Given the laws of supply and demand, the earlier people join the network, the more they earn for their time and money. This is the same idea as investing in a company when it has no revenue (high risk, high reward) versus when it has $100 million in revenue (low risk, low reward). Early on, the risk is high because there is no guarantee the investment will be worth anything. But the potential reward is vast, since early adopters like early investors can acquire assets for pennies on the dollar. In July, 2010, Bitcoin was worth 0.08 cents. As of June, 2017, it's trading at over $2,000. The early adopters took a risk buying Bitcoin for pennies but it has paid off immensely.

Tokens align everyone's incentives, which catalyzes a network's creation and increases the chances of success. This, in turn, increases the physical and emotional degrees of ownership members have in the network. The virtuous cycle compounds and soon enough a nascent network can take flight. This mechanism is exactly what a physical goods brand needs to create a hive and therefore a bulletproof business.

Imagine if Peloton launched by creating its own branded token called PelotonCoin. Early members that bought the company's apparel and bikes, or referred people to buy them, would earn PelotonCoin for their contributions. As bikers climbed the leaderboard and met their own personal goals, they could earn PelotonCoin for their accomplishments. Developers could develop new apps and services to run on the Peloton network that improves the entire experience, which riders could buy with PelotonCoin. After earning PelotonCoin, members could spend it on upgrades, apparel, or their monthly membership.

If a participant wanted to sell all of her PelotonCoin, she could cash it out for dollars or any other currency if PelotonCoin is anchored on the blockchain. She could sell it to someone else in the network or even back to the company. The ability to exit tokens increases the chances someone might take a risk since the investment is entirely liquid.

Early on, PelotonCoin might not be worth much, but participants would earn more PelotonCoin for their contributions to make up for its low value. As more people transact with the branded token and join the network, its value increases, which rewards the earliest members and continues driving liquidity. Additionally, the earliest members are remain incentivized to improve the network because they own a valuable piece of it. All the while, Peloton is building its own mini economy with a thriving hive at the center.

The same approach could work for Supreme, Glossier, and many other network-based brands. Imagine a Supreme-based currency where obsessives could transact and contribute to a dedicated network for the brand. Participants could earn SupremeCoin for authenticating real products or not using bots to scoop up products. Glossier could issue GossierCoin that rewards people for reviewing products, submitting feedback, and getting more members involved in the community.

Branded tokens are fundamentally different from traditional reward systems. For one, integrating branded tokens with a hive is about much more than getting shoppers to spend money. It's about creating value for everyone, not just for the brand. Yet the cycle underpinning branded tokens means that value for everyone is value for the brand. Second, this value creation produces a virtuous cycle that makes the brand, product, distribution, and network increasingly better. Point systems don't incentivize anyone to improve the product or the experience. Branded tokens, conversely, correctly align incentives between participants to encourage interactions and collaboration.

With all of this focus on hives and branded tokens, where does the product fit in? After all, these are physical goods companies. But for network-based brands, the product can exist anywhere it needs to and play whatever role it needs to. Companies can convert branded tokens to product and product to branded tokens. The adoption of one increases the adoption of the other. Interestingly, this cycle makes the bond between the product, the brand and its customers even stronger, while reliving the product itself from being the only defendable part of the company. The opportunities are endless.

2) Network-based customer acquisition and unit economics

Branded tokens could also solve the fundraising and customer acquisition cycle, which is an existential problem for most modern physical goods brands. Marketing is one of the biggest expenditures for most direct to consumer startups. Brands are spending tens to hundreds of millions of dollars individually and billions of dollars collectively to find new customers and scale. This is incredibly capital intensive. Brands have to continuously raise money by issuing debt or selling equity, the former of which is risky and the latter of which is dilutive.

A company's has a finite amount of equity to sell before it becomes worthless and no one wants to work anymore. A company can only take on so much debt before it's no longer creditworthy. Additionally, as more brands are spending on advertising, prices keep rising, since more companies are competing for the same customers. This requires brands to raise more capital, which means selling more equity or issuing more debt, and the process repeats over and over again. Not to mention the increasing expectations from rising valuations.

As a result, many modern physical goods brand are on an unsustainable path. There will likely be a correction as companies were marketed up at valuations that will be impossible to achieve unless they keep spending money. This won't happen because the tap will eventually dry up. These companies won't be able to sell any more equity and reasonable working capital at scale remains an unsolved opportunity. However, the underlying mechanism in branded tokens is a fascinating way to incentivize ownership in a brand without diluting the company's equity.

Branded tokens could fundamentally reshape fundraising and customer acquisition for consumer goods by 1) creating value adjacent to a company's cap table, so it can scale without increasing dilution; and 2) shifting most of the acquisition responsibilities to the network, which participants are heavily incentivized to take on. Instead of brands raising millions of dollars every nine months because they need to keep spending money to acquire customers, they could grow in a much leaner capacity and control their own destiny. This would increase the value for founders, employees and investors, since companies can grow more quickly while selling less equity.

Marginal unit economics

Another existential problem for these brands is how do they sustainably grow beyond their niche of early adopters? Some describe this as the "marginal unit economics" of physical goods companies. The theory is that it's rather straightforward to grow within a niche by selling to early adopters, who present relatively favorable unit economics that allow brands to become profitable, at least on a unit basis. But what happens once a brand captures most of that addressable market? The only option is to keep spending on marketing to reach a wider group of customers, which often drives up costs and makes the company less profitable.

If the company has a massive valuation because it raised tens or hundreds of millions of dollars in venture capital, this becomes a huge problem as the economics of the business that made it seem like such a promising investment slowly unravel. Gilt, Blue Apron, Nasty Gal and many others fell (and will fall) into this trap, as they spent substantial amounts of money on acquiring customers that were less and less profitable as they grew.

Branded tokens have the potential to mitigate many of these problems, shifting acquisition from a cost center to a profit center. Brands have the potential to actually make more money and increase defensibility from their acquisition efforts instead of just spending money and hoping it makes a difference.

Currently, there's a rather high technical barrier to making this theory of branded tokens a reality. To solve it, brands will need to hire more technically-minded people to create and maintain the underpinnings of these networks, in addition to training colleagues on all sides of the company about the mechanics and power of these advancements. Companies will need to understanding the cryptocurrency space and translate the technological possibilities into shopper-friendly language. This takes time and money, but it is entirely worth it. These are the types of investments that brands need to experiment with to become bulletproof.

3) Bringing tech investors back into physical goods

This shift towards network-based brands and branded tokens also changes the landscape for technology investors, who have recently shied away from physical goods and ecommerce businesses. Tristan Walker, the founder of Walker & Company, which owns Bevel and Form Beauty, recently commented on the viability of raising funding for physical goods businesses.

“When I started, I said we’re a tech company. That’s bullshit.... If you go to any kind of venture capital firm on Sand Hill Road and you say you want to build a retail business, you’re not going to raise any money. So to say that you’re a direct-to-consumer e-commerce business focused on subscriptions.... it allows us to really talk about how we kind of focused on tech.... It still is difficult.... No one wants to fund e-commerce companies anymore. There’s been no shortage of e-commerce companies that have just failed recently. No one wants to fund a retail business.”

While Walker has first-hand knowledge of the challenges as a founder in the space, the vast majority of investable opportunities have been in pure physical goods businesses that are integrating (product + brand + distribution) or (product + brand + distribution) x community. While there are always exceptions, this space is very challenging for entrepreneurs and investors because there is little that's defensible over time and physical goods companies are very capital intensive.

However, the shift towards building network-first brands and the introduction of branded tokens should be familiar and promising territory for investors, who can understand and evaluate the opportunities much more clearly. This might be the closest physical goods businesses can come to speaking the same language as tech investors. This is a good thing.

At the same time, branded tokens also exponentially increase the number of people that can help get brands and networks off the ground. Only accredited investors can invest in startups, which is the very small percent of people who have a net worth of $1 million or an annual income of $200,000. But almost anyone can contribute their time or money to a hive by buying some branded tokens. This vastly expands the number of potential shoppers and members who can play an important part sustaining physical goods brands. There is a lot to figure out legally on this front, but that will happen in due time.

The future of durability

Branded tokens present an exciting opportunity to solve the chicken and egg problem that has plagued brands and networks for a long time, while reshaping the economic landscape for building physical goods brands. A hive makes the network the most defensible asset a physical goods company has, relieving brand, product and distribution from trying to fill a role that they can no longer can.

These opportunities apply to all types of physical goods brands. They are not relegated to fashion or luxury or any exclusive part of the industry. Rather, if there is a network that can harness an engaged group of people who will spread their admiration, the possibilities for creating a hives with branded tokens underpinning the network are endless.

While building bulletproof brands in this new framework is not easy, nothing highly defensible ever is. Success doesn't come from taking old strategies from the previous paradigm and moving them into the new paradigm. It comes from building new strategies from the fundamental realities of the new world order. That's the only way to build bulletproof brands in the 21st century.

This is Part III of Building Bulletproof Brands, a series that explores how the internet destroyed traditional moats for physical goods brands but created new ones that are stronger than ever before. Read Part I and Part II if you haven't yet.