Negative Gross Margins
avc.com
avc.com
The old joke is about a retailer whose margins were very thin but wanted to attract more customers, so the retailer decided to have a big sale. After looking at the proposed discounts, an assistant questioned the strategy, noting that they would lose money on each transaction. The retailer said, "That's okay -- we'll make it up on volume!"
The Hemingway bit is this gem from The Sun Also Rises: "'How did you go bankrupt?' Bill asked. 'Two ways, Mike said. 'Gradually and then suddenly.'"
It's understandable for startups who don't yet have a business model not to make any money. In fact, that's what one expects of them. But unicorns are NOT startups; they're fairly sizable businesses that already have a business model, with large organizations, lots of overhead, repeatable processes, etc. It is very risky for companies at such a late stage in their life cycle to still be losing money on every incremental dollar of revenue!
Someone should start a Unicorn Death Watch ;-)
I don't understand how anybody can value a company without a business plan and some idea of how to make money at anything higher than zero dollars. Do they even meet the qualifications for the traditional definition of "company" if they have no plans to make money?
It seems to me as long as venture capitalists are okay investing shit tons of money into silly "startups" that don't know how to make money we're just going to see bubble after bubble after bubble.
It's tempting to speculate that the people inflating this bubble are the ones who managed to cash out of the first dot com bubble before the crash came. Most "real" investors learned their lessons the first time around, and want nothing to do with it. It would explain why so many "unicorns" get such a tepid response when they finally IPO.
"A startup is an organization formed to search for a repeatable and scalable business model."
So, by definition, you don't know how much it's worth using traditional valuation methods you'd use for "normal" companies, so investors use other indicators like growth, number of users, etc. (which can be gamed).
As the grandparent post states, "unicorns" are companies that already have a repeatable business model, so they should start to be looked at differently.
It's in the "unicorn's" best interests to be valued as a startup for as long as possible, that's one reason they cling to the title far after it's not applicable. It's also a status symbol :) , but it sounds silly when people talk about their "10 year old startup".
People who are deeper into startup world than me, what is the thought process that makes you think you can scale up a money-losing venture and have the math work out? Is it based on the hope of raising prices, or being acquired before funding runs out, or pivoting?
There are a lot of smart people in this game, so there has to be some intermediate mental leap that I'm not understanding.
Plan A: They know that people spend $x billion on groceries per annum in sf. They also know that a big chunk of that has to be very expensive real estate and relatively expensive employees who have to be able to afford to live relatively close to sf.
If you can build a warehouse an hour out of sf on dirt cheap land and recover the cost of grocery stores in sf, plus shave some off employee wages, maybe you can make a profitable business out of grocery delivery. This business will need a lot of volume to cover fixed costs. Why will they succeed when Webvan failed? More comfort with online shopping and delivery, cheap labor via exploiting underemployed people, including dumping infrastructure costs off onto employees by making them use their own cars.
Plan B: Google is in a death match with amazon. To first approximation, G's business is taxing ecommerce by owning discovery. If people start on amazon not google, google loses. So google is building out google express because if they don't, amazon ends their business. Therefore maybe instacart is strategic to google.
I don't think I believe A or B, really, but VC is a gamble. If someone can make it work, it's a $1.4T/year market [1]
Oh, and people don't earn billions by taking safe bets.
[1] http://www.ers.usda.gov/data-products/ag-and-food-statistics...
I will say that every bet is a safe bet when it's not your money.
1) Hopefully by increasing prices + slashing their own expenses (i.e. Uber reducing the driver's share), some of these cash burning companies can be instantly profitable. Idealistic for sure, but not out of the question.
2) Using the startup as a vehicle to raise more funds from investors- Remember that the VC is mainly just concerned with getting the company to the next funding round. Take this hypothetical: VC firm invest in company X at a 50m valuation. In 1 year that company raises at a 100m valuation. Even if it's an overpriced valuation and the company eventually has a huge chance of dying, the original VC firm can say that their fund already has a 2x annual return before that happens. They use that as marketing material to raise the next round. Remember that VCs get around 2% of whatever they raise for operating expenses, regardless of how the funds perform.
If you are a VC in a bubble, it is in your financial interest to raise as many funds as possible in the shortest amount of time as possible. That in turn means you have to invest big and invest quick.
As long as there's no better vehicles for investment, these companies will probably be able to keep doing what they're doing.
I think we are just starting to hit the point in the last year or so in which you can really say "bubble" but it could pop tomorrow or in 5 years... there's a famous quote about trying to invest by betting against a bubble that is roughly "The market can stay irrational longer than you can stay solvent"
Uber tinkering with price too much has not gone down well with uber drivers in bay area either.
The number of full-fare (no subsidy to either rider or driver) Uber trips surely absorbs these incentives, leaving a positive gross margin. (There's also a miniscule computing, bandwidth, and payment processing cost to a marginal ride, marginal being defined as the nominal X+1th ride after all the costs for X rides are already paid for.)
Perhaps absolute certainty is a slight overstatement, but here's one where I'd bet eating my hat on it. I edited to insert an "almost".
Example: a few weeks ago, I paid ~3USD for a 13km ride that took 90 minutes (due to Beijing traffic). The driver was definitely paid more than that for the ride.
> People tend to underestimate the true ownership cost of their cars, and Uber uses that to make them believe they're making a lot more per hour than they actually are.
That isn't an argument about its efficiency though.
Maybe the marginal value of a car self-driving itself somewhere is $1 and the marginal cost of that driving is $0.99—it's still more efficient for that car to drive than not. Whether the owner thinks their profit is $1 or 1 cent doesn't really matter.
[1] http://www.latimes.com/business/technology/la-fi-tn-grubhub-...
[2] http://www.xconomy.com/san-francisco/2015/08/06/instacart-ex...
It should be pointed out, though, that you can't really analyse many of these startups by looking at their income statements in this fashion, because even their future monetisation strategies are being speculated about. That is, they aren't expected to have healthy bottom lines yet. They're doing this on purpose.
Ultimately, private and public investors will analyse the bottom lines of these companies, but when that happens, there'll be bigger problems to face than a few orgs with unhealthy gross profits struggling, i.e. the bubble will burst.
Incidentally, I'm not sure why the article is specifically talking about gross margin. Especially since most of these company's costs relate to human resources and servicing debt and so on, and not inventory and production. It seems like operating profit or net profit would be a better single figure to focus on.
Unless you automate it.
Maybe Uber's plan at scale is to replace all humans with self-driving cars (http://www.theverge.com/2014/5/28/5758734/uber-will-eventual...).
Maybe SpoonRocket's plan at scale is to effectively be mobile vending machines for hot food.
Obviously I'm speculating, but the general principle applies to a lot of what startups do already as they grow.
I can't imagine how much money they must be burning right now. With Jet recently abandoning their business model, they're either somehow making enough on what they're selling as is, or they're in bad shape and desperate to bring in customers.
A better analogy might be companies that manufacture video game consoles, where they almost always sell at a loss when a new console is first released, with the hope to make profit in the long term - but there you're locked in to some extent, as you pointed out.