The problem with profitless startups
nymag.com
nymag.com
I never understood the working models of growing at the sole expense of investors money. Because I don't know but last time I checked capitalism and free market still is king, and they always have a history of major market correction. When something's not efficient or something's offplace, market has a tendency to correct itself, in a big, unexpected, ruthless sort of way and we've seen this again and again, but history seems to teach people nothing.
The new excuse is that even if there is a bubble it will be contained. It does seem an entire bubble economy has been created in SV where bogus companies provide bogus products and services for other bogus companies. Maybe in this case any collapse would be contained, but I guess we'll have to wait and see.
As the expression goes: Anything that can't go on will stop.
My guess is it continues. Hedge funds as a whole also perform below market but see continued investment because of the promise that they will have tremendous returns when a firm succeeds. Startups get money from the same sort of investors. People who are only investing a portion of their portfolio, chasing big returns and mostly unconcerned about losing some money along the way.
Let's take a reasonable definition of a bubble: when the price of an asset has risen much higher than what is justified by the market. By that definition I don't think we're in a bubble, I believe investors are logical and they know they are taking risks chasing a large return. I also believe investors will continue to chase big returns from tech companies and that there is precedent for this behavior in other types of investments.
The new paradigm is far more interesting, since it's almost all the investment comes from VC and Angel Investors. I think these entities can leverage risk far better, since they may lose a few million here and there, but when they hit a whale they really hit big.
I think there might be 'micro bubbles' within the industry that may implode under their own weight (F2P mobile games companies come to mind), but I think that's largely separating the wheat from the chaff.
I know some will disagree with me on this analysis, but I don't really subscribe to the sky is falling theory. The tech industry is now big business, that's not going to change.
Stock bubble? Economic stability and the wonderful controls the Fed has on monetary policy. No more economic cycles.
First tech bubble? The internet is a wonderful thing we haven't had before - new opportunities, etc.
Everything is different until it isn't.
First, the VC money isn't going to cost-cutting - it's going to growth. In theory, virtualizing the business processes should lead to higher efficiency and naturally lower costs. This model has been proven out in other fields - it's the Big Box model of retail that created giants like Wal-Mart (although a better comparison would be specialist big box retail like Guitar Center). So the VC money is going to building out the business model infrastructure, not selling a sandwich cheaper than the local shops.
Second, these businesses on the edge don't have enough market share to make a massive dent in the local market - and it's ludicrous to think that they could do so by losing money on transactions at scale. By the time they pose a real threat to local business, they will be profitable. They must be, because the markets are too large to be subsidized by VC forever.
Third, a lot of the businesses that are threatened are not "mom and pop" at all. Taxis? That's a local oligarchy protected by politics. Food delivery? Ever heard of Domino's Pizza or Jimmy John's?
Fourth, these can create new opportunities for local business. I can now get food delivered to my door by one of these startups, but the food comes from excellent local restaurants (the mom and pop ideal) that otherwise could not possibly get a delivery service working profitably. They've outsourced the business model, not the food prep.
And then there's the handwringing about how the long-term professional institutional investors who run pension funds and the like might go broke on venture capital, not realizing what a tiny sliver of that market VC is - it's a diversification strategy, not a core. The biggest concern would be if a VC collapse led to a broader stock market collapse, a la the dotcom era. Not likely.
Yeah, dumb article.
The lunch that guy described is impossible to deliver for $8 in the US, and especially in SF. That business makes no sense, ever. Losing money while making a unit profit on that lunch, ok, let's see where that goes. Getting my business by selling to me below cost? I'll do business with you all day but as soon as you raise the price, I'll switch to the next startup offering me a subsidized lunch. There's nothing 'long view' about that. No vision there.
This trend, if it's as big as the article makes it seem, is way more worrying to me in a 'bubble' sense than the color.com thing.
"it’s just raised $10 million in venture capital expressly so it can keep its prices low". The linked article said nothing of the sort. It said Series A, yes, but not that it was to subsidize pricing. Second, that Series A just happened on April 9 - this week. They haven't had time to even cash the checks yet! (they had a $2.5M seed in 2013, per Crunchbase. If VC thought that money was wasted on cost-cutting, they wouldn't be paying Series A)
Second, SpoonRocket differs in a couple of ways. First, they're a food+delivery service. They don't drive for other restaurants, and they don't have a restaurant space (and associated costs for service and location-driven rent). They only do two meal choices a day, and those are driven by ingredient availability. They're much more like a wholesale bakery than a restaurant.
Their technical edge isn't just communication, either. They have heating systems built into the cars. So I'm assuming they simply fill the cars with meals and send them out, using software to track closest car to the customers, in a high-density urban area. When a car runs out of meals, just come back for a refill.
This is an extremely efficient model, for both food production and delivery, outstripping the benefits of restaurants that have to offer a diverse choice-driven menu, and delivery services that have to do one-off deliveries to support that consumer customization of their food.
So I think it is absolutely reasonable that they could profitably deliver $8 meals.
Still sounds more like 100k bank-loan material than 10M VC material to me. The only way that 10M makes sense is if they're running a per-unit loss. Doesn't cost 10M to build that app.
It is impossible to scale that $8 delivery lunch large enough to provide any significant threat to local business. There simply isn't enough VC money for the hundreds of millions that would take. The scruffy little startup trying that model will either raise prices long before profitability, or will run out of money and disappear.
But a standardized delivery model that is a straightforward service charge, made possible by modern tech? Hell yeah, that's a good business model - and it's good for the mom and pop restaurants too.
Now, if you can point me to the mom and pop food delivery service...
This phenomenon literally breaks capitalism, by routing money from those who can create a product for that price to those who are subsidized, because they're 'innovative' enough to make a cookie cutter mobile app and wear skinny jeans with fashionable glasses.
Now, a standardized delivery model, with a straightforward service charge, and all that? Yeah, great business model. Seamless web is around. They're doing great, and add value to the economy. What value do these clowns add?
You don't seem to disagree with any of this.. your position is that since they'll be out of business soon, the damage is limited? It's still damage, and still stupid.
Again, a: they cannot sell at a loss at scale, and b: venture capital is invested with the expectation of building business model infrastructure, not being a fly trying to beat whales on cost. If they're actually blowing VC money on underpricing commodities like food rather than hiring programmers and marketing, their VCs should be ripping them a new one.
Like I said, if they were making a unit profit and an overall loss due to building out their infrastructure, that would be fine and normal capitalism. They're not.
I agree that their VCs should be ripping them a new one, or should not have invested in this plan in the first place. It's one thing for a 22yo to think you can make easy money in food service, the VCs should know better. What's next, the VCs investing in kids starting a bar with their friends?
Limiting to two meal choices a day isn't an option for most restaurants. This is a significant efficiency optimization in manufacturing that also drives significant optimization in delivery. This doesn't strike me as a dumb hack at all. Quite the contrary, I'm very impressed. I wouldn't be surprised at all if they're actually profitable from a production/delivery standpoint, and the losses are just software and market development.
(I have many years of restaurant experience in addition to software experience. I see the optimizations. Wow!)
It turns out selling at below-cost prices is a fantastic (though ultimately futile) "growth hack".
But I find it hard to believe VCs are that stupid.
I don't.
cough Salesforce cough
also, it takes nothing to start one of these businesses and compete therefore profits can't get too big. The business doesn't really scale.
Sure, in the long run it all works out, but in the short term there's quite a lot of turmoil.
That said, most of the named business lines are those particularly easily replaced even if the threat of other VC-backed businesses coming into the market still exists: those inclined to open sandwich shops or market themselves as handymen aren't likely to be too worried about more online threats emerging in future, and the savvier ones are instead figuring out how to get profitless startups to provide them with low cost marketing.
I don't see how that's a controversial point, but it's a distinction that a lot of people who aren't in tech, or around startups don't get.
A VC once told me that he thinks most venture funds don't really stand a chance of making money at all. The reason they have money to invest is because there's such a surplus of cash from institutional investors who need the "venture capital" checkbox. The lower-end VCs don't get the best deals and have to settle for leftovers, so their chances of getting lucky in a get-lucky business are that much lower.
At any rate, no honestly run pension fund is actually putting its capital at significant risk by tossing a few tenths of a percent at a collection of VC funds.
As for the startups, I think your comparison of Amazon and Pets.com is astute. For each of these companies, are we looking at an unprofitable early stage of a company that will eventually become profitable (e.g. Amazon, probably Uber) or are we looking at a company that can probably never become profitable? The former seems fine even if it causes some temporary disruption, but the latter is just waste.
In general startups that lose money on the margin do not last very long.
Anyway, if the theory is that this food delivery service is selling under cost in order to get rid of the competition, well, then they are going to be displeased to discover that the barriers to entry for a food-delivery service are not particularly high.
I have a feeling that the profit margins are very low, but I do not think they're in the negative.
An $8 meal, they make it at $4. With one avg engineer on salary at 125K, (~10K a month), you'd have to sell 2500 lunches with a $4 profit to cover just his salary.
I'd bet they're losing money.
I find it hard to believe that UberX isn't profitable alone - Uber just takes 20% of fare.
The biggest difference between (say) Amazon and the startups discussed in the article is that the startups in the article are aggressively local. "We deliver lunch in the Bay Area" doesn't scale to other communities as easily as "We ship books to anywhere from a giant warehouse in the middle of nowhere" does, since the former requires building up local infrastructure (meal prep, delivery, legal/regulatory compliance, etc.) for each expansion.