While I'm not intending to be heavy-handed and reductionist, I think the (macro) trend(s) we've seen in (domestic) startup investment since 2008-2009 can satisfactorily explain this behavior.
Disinflation & deflation, capital flows and political friction preventing effective (any?) fiscal policy have produced an environment where private capital set on a given rate of return on investment is chasing increasingly risky organizations [1][2].
Large firms have been sitting on enormous sums of cash; e.g., why is it that the most capitalized company on earth isn't investing aggressively. In lieu of investment, many of these firms have been focused on engineering stock buybacks.
So, the thesis: why are so many firms pouring money into startups with increasingly questionable fundamentals? Because hands previously gripping bundles of capital have (nominally) more capital than they did with decreasing options for productive investment and downward pressure on returns.
P.S. I recognize that I'm probably a bit left field for this group as I'm not a libertarian, I support strong regulation and I question the marginal value of lots of Valley products.
I think this is a pretty clear failure of capitalism, since the whole point of having greedy, top-hat-wearing capitalists chasing profits is to have them re-invest that profit in the hopes of making more. In the meantime, they compete with each other and end up magically allocating resources in a socially useful way.
Instead, big companies sit on their profits (like you say), while startups compete for the attention of a small group of investors who behave for all the world like the central planners of old, deciding how to allocate money based on their own tastes, interests, and gut feelings, rather than anything resembling a market test.
A failure of capitalism? I have to question the premise. Capitalism does not have as a goal some social-utilitarian purpose. Capitalism is practiced by individuals for their own self-interest. Sometimes they work together for a shared self-interest (e.g. corporations, investor groups) or they work against each other as needed (competition). But you cannot take self-interest out of the equation and still have capitalism. Every trade (be that stock for cash, or work for cash, etc.) is predicated on each of the parties fulfilling their individual needs and wants to the degree that they can. On it's own terms, capitalism hasn't failed at all.
What you can say is that capitalism has failed to mollify those that seek non-capitalistic goals. This is true of some so-called capitalists who experience guilt in pursuing their self-interest as well. If your view is that capitalists are "greedy, top-hat-wearing" types that fail to meet your social welfare goals, then my bet is your characterization masks a larger purpose. Primarily at bringing them down, probably in favor of the central planners of old (or some degree thereof).
Perhaps the real question should be: why would companies and individuals with captial choose to sit on it, or choose to spend it on relatively worthless start-ups? Why would a capitalist choose to sit on cash or buy-back shares if there are other, more profitable avenues to invest those funds? I think if you take a critical look at it you might find that there's still a fair amount of central planning behind what we'd like to think is a capitalist economy.
I mean, when Adam Smith says "It is not from the benevolence of the butcher, the brewer, or the baker, that we expect our dinner, but from their regard to their own interest," he's not saying that in support of self-interest, he's saying that in support of OUR DINNER. The point of capitalism as economic system is not that self-interest is inherently good but that self-interest can be yoked to "some social-utilitarian purpose."
Of course, Adam Smith's opinion of corporations was "The directors of such [joint-stock] companies, however, being the managers rather of other people’s money than of their own, it cannot well be expected, that they should watch over it with the same anxious vigilance with which the partners in a private copartnery frequently watch over their own," and he thought they'd all die out unless they were propped up like the East India Company, so it's not like the Wealth of Nations is much of a guide to what we call capitalism nowadays. But still.
Adam Smith was wrong with the regard to the moral case for capitalism. He rightfully recognized why people acted, but he failed to recognize any substantive moral basis is such self interested actions; instead he resorted to the precise premise that the post I originally responded to pre-supposed. That argument must fail because one cannot act with self-interest AND altruistic interest consistently. The capitalist must always fail on these terms as there is always someone with a perceived greater need, and perceived greater right, to the capital of the capitalist.
If you consider first and foremost your own happiness and life as a moral value worthy of pursuit, you loose the hang-ups that Adam Smith had with capitalism. There's a whole separate discussion that goes down that path about what constitutes self-interest in the large (and no, defrauding innocents is not your best interests); but that's a bit out of scope to what the original poster stated.
I think the Ayn Rand viewpoint--that self-interest is intrinsically a moral good and that capitalism is justified by this moral good--is not very widely held as a justification for capitalism.
I think modern American political discourse makes this a harder position to take. Which is not to say it's correct, because it's transparently not, but selfishness-as-Godliness is a firm part of the American right wing, self-styled libertarians included.
Greed's been good since the eighties, didn't you get the memo? =(
Well, modern states do "prop up" corporations with all sorts of perks, such as limited liability and tax benefits. So Adam Smith might not have been altogether wrong about that. How many of us would even consider incorporating if the law did not guarantee limited liability?
>Capitalism does not have as a goal some social-utilitarian purpose.
Not intrinsically, no, but it is justified by it in the face of alternatives. When you present people with an economic system that does have a social-utilitarian purpose, those people will select capitalism over it on the basis that capitalism is better at fulfilling that purpose.
And most of the time, the argument is "capitalism self-optimizes for that purpose." Except that it self-optimizes in ways that result in central planning, monopolies, and deception. Capitalism is not convergent on social goals, it is divergent, and we have to keep pushing and prodding, regulating and deregulating in order to get anywhere near our goals.
Capitalism fails every day. And we just roll up our sleeves and get to work fixing it because there is no other option.
One wouldn't ague that a hole in the boat is a good thing because it keeps the crew fit trying to bail the water out. Especially when there's a whole world of other skills we'd rather have a crew be proficient at.
Capitalism requires no further justification than individuals acting to dispose of their time and property in ways that they see fit. I absolutely guarantee you that when I trade my labor and expertise with an employer or client for cash, I have no other objective that maximizing the return I get on that effort. I do not ask if my engaging in such a trade has some greater social good and I need no justification other than the trade being in my self interest. If I go to the store, I don't first ask who needs me to spend money on their products, I first ask, 'What do I need?', 'What do I want?'. I don't consume on anyone else's behave nor do I need some external justification for my own existence. Period.
Capitalism does not converge on monopoly, central planning, or deception any more than any other system, and in fact it does so a lot less. Again the assertion that capitalism is broken is just false; that it doesn't meet your non-capitalist goals is correct. My cable company has monopoly-like powers not because it's run by evil capitalists, but because there's a government agency that gives them a monopoly in my area. That's not capitalism. Microsoft, "a monopoly", wasn't defeated by the government regulators, ultimately, but by better alternatives appearing on the market and their own self-inflicted irrelevance. Same arguably with IBM. That was capitalism dealing with outmoded incumbents. I see a lot of crying in these threads about how VCs or corporations seem like central planners, yet the answer being proposed seems to be engage real central planners with the legal use of force in their tool box. Indeed, the only part that I seem people really dislike about capitalism is that it's voluntary engagement... when they'd really rather force someone to act against their best interests.
Telling me that you make poor, short-sighted decisions isn't an argument that capitalism doesn't require justification. It means you have low standards for an economic system.
You could just as well try to argue that every word out of your mouth doesn't require justification simply because you accept it all as true without it. Well good for you.
>Again the assertion that capitalism is broken is just false; that it doesn't meet your non-capitalist goals is correct
...? Just what the hell do you think I mean by 'broken' if not failing to achieve our collective goals?
Just because it does what it is described to do doesn't mean it's doing what it's supposed to.
> Telling me that you make poor, short-sighted decisions isn't an argument that capitalism doesn't require justification. It means you have low standards for an economic system.
That's pejorative and uncalled for. There's nothing in that post that indicates those choices are either poor or short sighted, just that they are motivated by the exercise of free will. What alternative criteria would you impose on the poster's decisions?
>You could just as well try to argue that every word out of your mouth doesn't require justification simply because you accept it all as true without it. Well good for you.
I'm deeply concerned about your blatant disregard for the freedom of expression of others. Who should the poster be _required_ to justify their words to? You?
Capitalism is only one characteristic of our modern global economy out of many. Typically developed western countries have capitalist corporate structures, regulated markets, centrally planned social welfare systems and the occasional monopoly. Capitalism is justifiable on two premises.
The first is the exercise of freedoms. The freedom to own your own property and invest your own earnings and property as you see fit is a basic right that is widely recognized in the western world. It's hard to see how restricting or curtailing that right can be morally justified. The second premise is that capitalism is overall an efficient way to allocate resources because it engages the creativity and energy of the maximum possible number of people rather than restricting it to a politically selected few. And yes, Capitalism does engage a vast swathe of the population. The local shop owner down the road I buy my milk from is just as much a capitalist as any banker. That doesn't mean capitalism allocates resources perfectly, just that it's more efficient than the other methods that have been tried. As Winston Churchill said of Democracy - it's the worst system, except for all the others.
I think it is more complicated than that. First, the right to invest your own earnings is in fact severely restricted in most countries. It is called taxes and one of the primary justifications for the existence of taxes is moral one. Second, there is vast difference between your milkman and your banker - your banker has so much more power to wreak havoc on your life as compared to milkman.
I called out exactly the sorts of complications you're talking about - those taxes go towards funding the centrally planned welfare state I mentioned (I'm generalizing across western countries here, of course there are exceptions) as well as policing, education, defence, market regulation activities, etc.
Of course there are differences between a milkman and a banker, but fundamentally capitalism is about freedom and individual rights and striking an equitable balance between those and the common good.
My father in law is Chinese. He remembers when his family were cast out on to the street and lost everything, because they owned a few plots of land that they rented out to neighbors in their rural village and were therefore capitalists. So when you start talking about capitalism, let's be clear. We're talking about the basic right to own personal property, and those arguing against capitalism are arguing for taking that away. They've done it before and given the chance will do it again. It's not theory, it's my family history, but is something that is directly relevant to every single one of us.
This kind of argument (taking the definition of capitalism used by Chinese revolutionaries and the fact that they used it as ideological foundation for doing violent and horrible things and inferring that any capitalism critique is evil) is flawed. In fact some would go as far as calling it The Worst Argument In The World :) (this post is excellent: http://lesswrong.com/lw/e95/the_noncentral_fallacy_the_worst...)
I also have to disagree with you on the premise that capitalism is about balance and protecting small property owners. In fact unchecked capitalism leads to just the opposite (think of how many small bookstores can withstand the competition with Amazon). The system becomes workable only in the presence of some essentially anti-capitalistic countermeasures.
There's nothing anti-capitalistic about regulating companies and markets. We regulate everything we do from medical care and certification at birth through education, marriage/civil partnership, employment and death but regulating these things doesn't mean we are against them. There's nothing special about Capitalism or the operation of markets that should make them exempt from operating under the rule of law. Capitalism isn't about regulation any more than marriage is about marriage certificates.
Have a look at the first paragraph of the Wikipedia definition of capitalism (or all of it, it's very good). That definition applies to the owner of a bookstore that buys books and sells them to the public as much it does any shareholder or director of a public company such as Amazon. That's what capitalism is. If you are using it to mean something else - some other different more narrow or specific kind of business activity that your disapprove of - please state it or come up with your own new word for it and what you offer as an alternative.
If you have no problem with the private bookstore owners owning their own businesses, for example, but want to restrict some other types of activity involving earning money from the employment of capital, then what you are advocating is extending the (existing) regulation of capitalism. Not getting rid of capitalism or substituting something else which you have yet to mention. In which case, please feel free to be more specific.
> When you present people with an economic system that does have a social-utilitarian purpose, those people will select capitalism over it on the basis that capitalism is better at fulfilling that purpose.
No one has ever offered people that choice, as far as I know, certainly not in a way that wouldn't in many cases be confounded by rational or irrational attachment to the present mode of social organization. (And in fact plenty of people seem to like social democracies just fine. And, for that matter, plenty of people seem to want socialist or communist modes of social organization.)
> (And in fact plenty of people seem to like social democracies just fine. And, for that matter, plenty of people seem to want socialist or communist modes of social organization.)
Plenty of people seem to want more socialism for the country they live in, but given the choice many move to countries that have less socialism. (Ie richer countries.)
This is a non-sequitur. Most wealthy countries have economies that are extremely well regulated, and their effectiveness is much more conditioned to factors beyond regulation. Scandinavia has very high levels of regulation and is one of the wealthies regions in the world and the one with the highest standard of living.
Well, that's why you have to argue against capitalism. If you don't present any alternatives, you won't know that they're worse than the way things are. There are important things that it doesn't do well, and we have enough information to know that.
> A failure of capitalism? I have to question the premise. Capitalism does not have as a goal some social-utilitarian purpose.
Yes, I think that's the point. Generally, when you evaluate a means of organizing production for a society, you evaluate it on how society will benefit.
Capitalism (i.e. accumulation of resources in private hands with the goal of employing it for generation of profit) should not be conflated with free market (i.e. roughly equal individuals engaging in voluntary transactions). They are in fact antithetical! For capitalism to work some individuals must be entitled for more resources than others so that these individuals can tell others what to do. Of course you can then argue that everybody is still engaging in voluntary transactions. But is it really so when the balance of power is so skewed?
I think you may have misunderstood my point, which we actually agree on: Our so-called venture capitalists right now are behaving a lot like central planners.
I don't understand this. When big companies "sit on their profits," that capital is invested somewhere. It's not like companies have big Scrooge McDuck tanks full of gold coins.
The capital might be invested in fairly generic, low-return assets but it's still invested and doing work somehwere. It doesn't mean it's a failure of capitalism. Capital allocation doesn't need to agree with your (or anyone in particular's) preferences at every point in time, for capitalism to work.
As best I can tell, it's invested in US treasuries and corporate bonds [http://www.theguardian.com/business/2015/feb/02/apple-cash-m...]. It's doing much less work than if Apple paid it out as a dividend, or spent it on Bentleys for all its employees, or invested it in creating some new product category. And we don't see a penny of it paid as taxes.
I think this is a failure of anything that has very few actors making decisions. Central planning (not a political statement) does not work well in economies.
I think the failure is in the tax code. Large corporations able are able hire expensive lobbyists and accountants to pay much lower taxes than smaller upstarts. This gives them an advantage and allows them to crush innovative smaller companies before they can scale. Until we fix the tax code to favor small businesses this problem will continue to grow.
Tax code isn't really a problem for companies that have little to no profit -- which is most "small upstarts". The great fallacy of most political debate on economics is that taxes hurt small business. Extortionate rents hurt small businesses far more than taxes do.
The way the original tax code was written was to give either individuals or the small businesses they work for a break -- up to a certain point [source: https://books.google.com/books?id=ogUNAAAAYAAJ&printsec=fron...]. But to necessarily kick in at some critical point where 1 + 1 = 1. This is a theoretical stage where potential for exploitation deserves a slight downward pressure (partnerships operating as a single business unit, corporations of 1+ people subjected to a single tax bill). Tax higher incomes at higher rates ... makes sense: Try and keep disproportionate wealth all to yourself, pay more in taxes (forced payments to social welfare). Generously reward your workers, and hey -- it's theoretically possible to pay everybody decently, reward external shareholders, and to minimize tax paid to the social welfare system.
But the problem is REITs, especially private ones. And especially when VCs are the landlords; they're making money even when "they're not" making money.
Which is the core of the issue that rgarrett88 got: lobbying - yes. The NAR, especially. But that's another tangent entirely.
Capitalism does not oblige anyone to invest their capital immediately and whenever possible. If the majority of the market chooses to withhold its capital, then withholding capital is likely a rational response to market conditions.
> Hutt goes for the heart of Keynes’s prescription for recovery, which was to get idle resources moving, whether that is money, capital, or labor. If something isn’t being employed right now, it is being wasted.
> Hutt responded at length that there is nothing uneconomic or necessarily inefficient about an idle resource. It is the decision of the owner to hold back when faced with a long-term plan, a judgment call concerning risk, a high reservation wage, or a demand for larger cash balances.
capitalism is capital-ism which is predicated on literally: the more capital you have, the more revenue you get in return (which lets you buy more capital, which lets you sell more things and receive more revenue).
Except, these days, nobody needs to continue buying capital or purchasing labor with their revenue. You can sit back on your unlimited money makers, receive hundreds of billions of dollars in profit, then just hoard it. In a knowledge/skills economy, you can't grow by throwing money at people (since only a chosen few hundred or few thousand are driving things forward anyway). In fact, once you're at virtual peak productivity, investing more would only make things worse due to increased internal coordination costs (meetings! knowledge sharing!) and internal politicking (no—I want to run the new project and I'll turn everybody else against you until it happens!).
If you don't have a use for $100 billion dollars today, why would you turn around and invest it to get $500 billion dollars you also have no use for?
There's a very significant and logical reason why American corporations - particularly tech companies - are accumulating so much cash: repatriation taxes.
The cash is collecting dust abroad, and large tech companies are waiting for a tax holiday, for which there is precedent [0].
There are a number of fascinating reasons why companies may hold cash (e.g., it's been suggested that companies with CEOs that grew up during the Great Depression hold (held) more cash than those that didn't). [1]
That said, it does appear that taxes seem to be one of the more significant (if not the most significant) reason in our current economic climate.
>There's a very significant and logical reason why American corporations - particularly tech companies - are accumulating so much cash: repatriation taxes.
Absolutely.
I'll claim no authority to speak on corporate tax policy (at least from the perspective of firms); on the face of it, I can imagine that it might be reasonable to suggest that tax policy is the major contributor to the dynamics of firm investment behavior.
I wasn't, however, really sincerely questioning why, e.g., AAPL is accumulating cash or necessarily correlating that fact with domestic investments. It was sloppy writing on my part, but my intent was only to give an obvious example of capital accumulation.
Surely, cash is not the only means of firms funding investments. Firm investment behavior will be guided by a variety of factors; my thought was to point to macroeconomic factors like insufficient aggregate demand, capital flight from EM and persistent deflationary pressure to provide simpler explanation to the conclusions of the OP.
"But why does the cash keep piling up? Why doesn't Apple spend it?
One issue is that Apple is holding most of that cash overseas to avoid paying the steep 35% U.S. corporate tax. As of Q3, almost 90% ($181 billion) remains offshore."
There is great video and article about it on Bloomberg[2]. A lot of companies are on the same boat not just Apple.
Yes and I believe even emerging markets have dried down a little recently. None of the BRICs is looking like a great opportunity (considering risks), interest rates have been very low both in EU and US. As much as the sums seem enormous, software startups are comparably cheap, which mitigates their high risk -- e.g. look at industries like oil, mining, real estate, chemical.
> Large firms have been sitting on enormous sums of cash; e.g., why is it that the most capitalized company on earth isn't investing aggressively. In lieu of investment, many of these firms have been focused on engineering stock buybacks.
Ie they have essentially been paying dividends. Working as intended.
What is it that's working as intended? The process of buying back shares of your own company?
If you read what I wrote carefully, you should notice something that I didn't say:
AAPL has a bunch of cash and is using it to fund its stock buyback program. Thus, capitalism has failed.
In fact, I was attempting to elucidate the OP's topic. I believe a reasonable interpretation to be: why are so many startups with weak fundamentals and/or specious business models receiving so much funding via private equity?
My response to this question was to observe macro-level phenomena and speculate that the _emergence_ of this dynamic was due to a broad-based failure in matching capital with desired investment risk and return. I mentioned Apple to demonstrate what a capital hoarder has done (which is to reinvest in its own equity) in relief against private equity firms. In a global environment where demand for safe assets exceeds supply, less risk-averse firms are chasing further risk to maintain their desired level of return.
None of these points, I thought, required a race to defend attacks against capitalism; however, in the interest of demonstrating my sincerity, I'll share a couple of my own positions I believe are loosely-relevant to the broader discussion:
* Capitalism maximizes human capital: no
* Efficient markets hypothesis: wrong-headed, at best
* Moralizing capital: one of the most socially and politically toxic behaviors
It is my view that capitalism is a set of prescriptions which seek to define and regulate economic behavior. Further, it seems misguided to say simply that capitalism has succeeded or that it failed. A better alternative might be to say: given a set of expectations, a capitalist environment produced correct or incorrect results. Or, a more politically-charged example: capitalism has succeeded (or failed) in maximizing, e.g., environmental capital, human capital, social welfare or aggregate happiness.
In any case, I now regret side-tracking myself and I don't find it particularly relevant to be debating the merits of capitalism in this context.
Kept waiting for him to drop the phrases "network effect" and "economies of scale" but it never happened. AKA burn to acquire users until you're so big that you can throw your weight around to reduce costs ala Amazon. The holy grail of software startups.
Given this post, I think it makes sense that YC is pivoting to include more hardware startups in its portfolio. Software is so saturated that people are starting to regard the majority of it as free. The people who do pay for services like Twitter & Facebook are the advertisers and business owners who have probably observed questionable ROI on average for the past few years.
I don't expect a bottle of coke to be free, and I don't expect a condom [1] to be free. So the "unit economics" make more sense in hardware (tangible/consumable product) land. Network effects are still important, but shipping a product and collecting revenue from each sale even if you still have negative margins lengthens your ability to stay in business, giving you valuable time during which you might hit critical user mass or achieve economies of scale.
> Software is so saturated that people are starting to regard the majority of it as free.
This doesn't match my experience at all. To me it seemed that throughout the 00s both consumers and small businesses were unwilling to pay anything for the cloud software, but tide has definitely turned. Now, all smart small companies I know don't blink an eye to spend hundreds of dollars per month for various cloud subscriptions and consumers are starting to pay for software both on mobile devices and cloud SaaS.
I get the sense that small-business SaaS companies can usually charge (after a short free-trial period), but consumers are still very reticent to pay for software. There are some services that are the exception (eg. Spotify/Netflix), but generally those are industries that were very large before software came along, and they replace incumbents (eg. RIAA/cable) that people used to pay for as well.
Yes, consumers are much more willing to pay for content-driven services - after all they are mostly consuming, not creating. But if you observe niches and prosumers (who are creators), they are already paying for software. And niches can be huge on global scale: think about running, cycling, gym training. Or pets, dogs, horses. Investing. Knitting. Photography.
You are totally right that they are currently much more reticent to pay for software than businesses but based on my anecdotal observations, I think that the trend line is growing and accelerating. I also think that for consumer businesses, you have to be a bit more creative with your monetization models. Cost/benefit calculation of subscription model is an easy task for small businesses, but consumer spending has always been much more erratic in the physical world also, thus subscription models are not necessarily the best fit for consumer space.
Consumers pay for software all the time - games, outlook/office, dropbox, phone apps. (And if you put netflix on the list, then tons of content such as ebooks, music, paywalls and such are bought all the time)
We tend to dismiss these because they aren't bigshot modern startups.
Consumers don't buy alot of services, since frankly most have good free alternatives, but they buy software that sits on their hardware and they buy content.
If you have negative contribution margins, scale only accelerates your demise. Driving toward scale with those economics is exactly what it means to "lose money on every sale, but make it up in volume".
Is selling something at a unit loss better than shipping something for free? Maybe, but in the case of software the marginal cost per unit is near zero, so scale can be achieved without huge amounts of capital. Hardware doesn't quite enjoy quite the same leverage.
> If you have negative contribution margin, scale without an appropriate reduction in total cost only accelerates your demise. Which is the hallmark of a non-viable business.
I agree that it's easier to scale software, but I'd be interested to hear whether or not you think software is a saturated space that has engendered a sense of entitlement in many would-be customers. If you can't convert/monetize your userbase, nothing else really matters.
Economies of scale exist but they aren't a given. You can't just grow your sales and automatically have a lower cost structure. Amazon actually learned this the hard way, and they've had to relearn the same lesson multiple times. It is extremely common for people to overestimate how much they can lower their cost structures at scale, and to be caught off guard when they actually achieve that scale. Amazon Fresh tried the "scale your way to cash neutrality" approach, but ultimately it was price increases that made it sustainable enough to roll out to other cities.
> The people who do pay for services like Twitter & Facebook are the advertisers and business owners who have probably observed questionable ROI on average for the past few years.
Demonstrating ROI on Twitter/Facebook advertising is one of the hardest things to do for clients that don't sell their products online (e.g. breakfast cereals). It leads to backwards behaviour: because you can't prove that advertising lifted sales, you start thinking, "What promotions result in trackable performance metrics?" and do them because they're trackable, not because they're good ideas.
The number of companies that have bad unit economics is, I agree, substantially higher than it should be. But I'm not sure this explains the bubblegum expansion of valuations and rounds we're seeing today. There are many thoughtful comments on the perceived bubble from people all over the industry. I'm not qualified to say one way or the other, but I did enjoy Mark Cuban's recent post on the matter. [1]
My company, Thumbtack, got a lot of this right early on. Years ago we doubled down on getting the unit economics right. So right that we were (IIRC) profitable for a month or two before taking a big VC round. Not sure how many other companies can say that. But at the end of the day, if the bubble is a bubble and it pops, knowing that we would survive and be able to make a profit is hugely satisfying.
My advice to any young startup is figure out how to make money early on. It's the rare Google/Facebook that can blow up and use the platform to sell ads. Most startups will not do this, but many can still make good money doing important things that people will pay for.
I've gotta think one category he's talking about are the delivery services. I still have not seen a decent articulation of the end-to-end economics. But they can't be terrific.
I know, for example, that Sidecar pays drivers up to $20 for a single delivery and just can't see how this is viable outside of rare exceptions. At least Instacart prices the item being delivered (and I suspect never gives you the yellow ticket price which pretty much every Safeway item gets nowadays).
I agree; delivery services will only make sense with autonomous delivery (which I suspect is the long-term plan for all of them - Uber included). But realistically, the R&D required there is crazy if you're trying to be first to market - Amazon and Uber are investing billions in this, and they're the competition.
Once drones or autonomous cars become widespread, this business becomes a commodity and anyone without a legacy business they have to migrate will be at an advantage. So I have no idea why these companies are getting funded other than it's a problem that's simple enough for a really smart university student to tackle.
Uber is profitable in many of its mature markets. This is while charging less than half what you would pay a legacy taxi service, while paying drivers more than they would make at the same.
This is the direct byproduct of strong network effects on both the supply/demand side, paired with operational excellence on their part.
Self driving cars would bring the marginal cost down even further, but they have built a stunningly good business with or without a quantum leap in automation.
The same probably isn't true for many other Uber-for-X companies, particularly those with underwater unit economics.
Uber's success has nothing to do with their technology and everything to do with the fact that they straight-up ignored the regulations on their industry by claiming to operate in a different one.
The taxi-industry is overregulated and corrupt, so Uber created a "car service" that works exactly like a taxicab.
Yeah; Uber had a unique opportunity because the taxi business was stuck in the 20th century and had a bad case of regulatory capture as a result. That said, in Uber's more "mature" markets you're starting to see a lot of the problems that caused the taxi business to regulate in the first place: too many drivers, no way to guarantee steady revenue as a driver, etc.
The purpose of the industry isn't to provide steady revenue to drivers. That's a non issue that will be solved by drivers quitting when the price gets too low.
Regulation is marketed by nice sounding goals like that, while it is actually motivated by protecting the established players and keeping competition out.
There isn't really any correlation between smoothness of booms and busts and regulation. Quite frequently regulation causes massive swings because it prevents the market from pricing risk correctly (e.g. The affordable housing act leading to banks not needing to care about mortgage payback risk).
Uber is profitable in many of its mature markets. This is
while charging less than half what you would pay a legacy
taxi service, while paying drivers more than they would
make at the same.
What? Seriously? Are you saying that say the cost of a "medallion" is more than twice the cost of all other costs in a taxi service? Can you give any examples?
The average NYC taxi driver does not own a medallion. A couple years ago they traded hands for $1,000,000.00. Most of them are owned by companies which have many hundreds if not thousands of them.
These companies rent the medallion for 12 hour blocks to drivers and would charge them between $175-250 per block. Before Uber there were many more drivers than medallions and drivers would bid the price of renting the medallion for 12 hours up!
Drivers who worked full time and took a few weeks off would spend around $40,000.00/year on renting the medallion. A cab that was rented for 24 hours/day all year would easily generate $90,000.00/year for the owner of the medallion.
With Uber the companies that own the medallions (and more so those that took massive loans to acquire them) are the ones hurting. The drivers are just fine, if not better. And even taxi drivers I've spoken with like Uber because medallion owners are desperate for drivers now and are charging $100-$150/12 hours. They just want to get the cars out of the garage.
Uber drivers expenses that are different from cab drivers include a car mainly. Something that costs far less than the money they gave medallion owners and something they can write off big parts of on their taxes. And they can use it on their free time.
> Uber drivers expenses that are different from cab drivers include a car mainly. Something that costs far less than the money they gave medallion owners and something they can write off big parts of on their taxes.
License cost is 154 GBP (200 bucks) annually in London. Not a million. I maybe misunderstanding a lot of the cost issues in taxi services but it seems the medallion cost is a huge racket - but that's hardly a global issue?
That's not a "Black Cab" which would be the equivalent of NYC yellow taxis. A private taxi cannot be hailed on the street, I assume much like yellow taxis. This was once a major advantage, but uber (and equivalent apps) make it almost irrelevant.
Becoming a Black Cab driver is much harder than renting a medallion, though. You have to pass "The Knowledge" which is considered at least as hard as passing a university degree. You have to have an encyclopaedic knowledge of London roads, and generally spend at least a couple of years (often longer) driving around those roads on a scooter so you can demonstrate that knowledge in a series of tests.
I'm not sure if the problem is similar in other major cities, but I expect there is some form of cartel in force in most of the major cities.
However, even if there isn't, there is still a real advantage to profitability from something like uber: if there are enough customers using a passenger exchange, then the likelihood of having passengers near to you is significantly higher. So less of your time is spent in unbillable transit to your next customer. In London there are hundreds of taxi firms; each of them gets some share of the passengers calling them up, so they have to take what they can get. With a central exchange, they get the passengers most suitably located for them from all possible passengers.
In Vancouver (Canada), until recently the market price for a "medallion" was $800,000-$1,400,000. Taxis are often unavailable when you want one. A significant portion of the taxi fare does not got to the driver - it goes to the person they are renting the taxi/medallion from.
Uber briefly entered the market using licensed limousine drivers. They were pushed out because we have a crazy rule that limousine rides can't cost less than $80-90 - the only reason for that rule is so that limousines don't compete with taxis.
Wouldn't the statement also be consistent with an increased percentage of car time with a passenger? That is, if all other costs were equal, and occupied time per driver-hour doubled despite per-ride profit halving?
This doesn't seem that unreasonable - weren't/aren't medallions over $1M in NYC, which is a factor more expensive than labor, fuel, or maintenance of a vehicle...
Yep, and they were all effectively owned by banks who leased them to cab drivers on a per-shift basis. Your cab driver has to pay ~$150 (I don't know the actual number) per day to drive a cab, so until he makes that $150 back he is losing money. If you had to do this every day, knowing there is a chance you might lose money by going to work, well, you'd be a pretty miserable human being -- just like most NYC taxi drivers.
The logistics industry has actually done a pretty good job of getting deliveries in the 2-4 day range (depending on warehouse locations) across the continental US to the few $$ range whether paid for explicitly or bundled.
But routine same-day delivery even in relatively dense urban areas is still pretty clearly a premium service (and pretty much unavailable if you go 15 miles out of the urban core). Grocery delivery for $10 isn't that interesting to most people if they're in a position to hop in a car or walk 5 blocks. And single items like something from the hardware store don't work at all.
I'm in Mumbai, and can day-deliver pretty much everything from everywhere.
I can order 5 eggs, 1L milk, or a hammer.
Not sure how this system works though.
I'm sure the basic answer is very low labor costs. There are lots of personal services available in countries with low labor costs that aren't nearly as affordable in the US.
I think there are a few aspects to making delivery service economics work, marginal costs go down the more you can group deliveries and route better in areas. In other words, network effects.
1. Do I need it right this minute ( example pizza)
2. Is it purchased in advance or planned? Like weekly groceries
3. Are you just doing delivery, and that is your only revenue?
4. Will your earn a commission, transaction fee or add a markup? (i.e Instacart)
4. Are you going to follow an uber type model or integrated by hiring staff?
5. Can you group customers orders together and do delivery runs using optimization algorithms (tsp, vrp). Lowering your cost?
Here is an example (Using ZAR values / 10 for approx USD values):
Say you start a diaper delivery business. On average a parents will need it once a month. To make it simple we will assume 1 customer initially, and then scale up to 10. We will compare 2 scenerios.
Cost of diaper pack: $30
Avg cost of delivery per KM: $ 0.40
Distance to Deliver: 20 KM
Time to deliver & return to Hub: 1 Hour
Cost Per Hour for Driver (South Africa): $5
Delivery Fee: $3
Retail of Diaper with Margin: $35
The one product that I use and pay for that is so good that I recommend to all of my friends is Spotify. I'm so surprised how few of my friends actually pay for it though. They're willing to put up with ads and reduced quality for just $10 a month.
Other services I found so good that I recommend to all of my friends but do not pay for because my data needs are very small are dropbox and evernote. I bet some of my friends wonder why I wouldn't spend such a small amount of cash for their usefulness.
Getting people to pay for digital services is hard.
> They're willing to put up with ads and reduced quality for just $10 a month.
I see two reasons for this:
1) Free is huge. Most people are willing to put up with a lot of bullshit for free.
2) Netflix. We pay $7.99/mo for essentially infinite TV on multiple devices, but $9.99 only gets me audio on one device at a time. It seems like a worse deal, so why would I pay?
Also: never underestimate laziness. Typing in a credit card takes work.
Re: Netflix/Spotify price differences. The relative size of the libraries (vs all content in the domain) is something to keep in mind. Netflix gives users access to some videos, but Spotify gives users access to almost all songs [1].
[1] Can't find precise estimates for sizes of libraries, so apologies for the argument from anecdotal evidence.
OTOH, $120/yr for music is, depending on your assumptions and how you measure, actually pretty high compared to what people have historically spent on recorded music. [1] I know I've been on the fence about paying for a subscription given that I already have a big library of most of the music I care about. It's not so much that I'm too lazy to subscribe but I'm very slow to sign up for services that are going to hit my credit card every month.
Netflix video streaming is close to worthless for movies. But combined with DVDs it's pretty good.
I guess it's because I value music much more than TV and movies. I listen to music all day at work, but I may watch a movie or show once every couple of weeks.
I am one of those people. I usually use Spotify only to listen to a few popular songs – I am not one of those people who has 2657 carefully curated playlists and 22693 files in their music library.
So, to me, Spotify is really more like a convenient desktop client to the local radio station. And, just like I don't mind the ads from the local station, I don't mind the ads from Spotify. I'm certainly not paying them more than I pay Netflix per month.
What's driving a lot of the idiotic investment is FOMO (fear of missing out). It is a powerful thing and can override a rational assessment of a businesses chances for success.
This combined with a lack of historical perspective is dangerous. Nearly _every_ smartphone app you see had a voice/phone counterpart a few years ago (remember 777-FILM or #TAXI?), most of them are long dead, and were killed off by the same market forces that will release their latest mimics from their mortal coil.
This is why there's a dearth of reasonable funding these days. VCs, the bad ones (which most of them are), are flock-driven creatures. Nobody wants to step out of line, and that's a problem when something new, novel, or actually different walks in your door. The flip side of FOMO is "if nobody else is doing X, I won't do X either."
Startups can get $100k in seed money by yelling on the street in soma.
Startups can get $100 million by tickling andreessen in the right spot and chanting forbidden words from the before time.
Nobody can seem to get $5 million to bridge the gap between living-in-coder-poverty and being able to hire a real team for more than two months.
1) A business with good fundamentals doesn't need a VC.
If I've got cash flow, I can probably get a loan with a bank on much better terms than any VC will give me.
If I don't have cash flow, well, okay, I need a VC. But then, tautologically, my business doesn't have good fundamentals.
2) VC's only care about unicorns.
Since VC's make up their whole portfolio based around the 100X+ returns on a single company wiping out the losses from the rest, fundamentals are irrelevant. Being in the hot buzz which enables you to flip to somebody else for 100X is far more valuable.
A business with good fundamentals sells for about 10X which is nowhere close enough to offset the rest of the losers.
Re (1), I just tried to get a loan from Wells Fargo last week for a consulting business with a few hundred K in annual revenue, and it was an incredible pain in the ass (multiple years of balance sheets/income statements, tax returns, trips to the bank, and all for, like, 25% of one year's profit-sized loan) -- there's truly an opportunity to disrupt small business lending, but the hard part there is capital aggregation.
Low margin businesses are all the rage because all the large, high-margin opportunities are either gone or have such huge barriers to entry that startups have to raise a half billion dollars before making an honest attempt.
At least that's what I see. Not that we shouldn't chase the expensive ones, but I don't know that VC is the right framework for that.
This is currently the model that most big consulting companies use: find a thousand niches and fill them all with people. I have a feeling that if you enter these markets as a startup, you'll find they're not really as high margin as they look, and that the margin will get eaten up by integrators anyway (integration work doesn't scale exponentially and causes your costs/outputs to lag your pipeline).
Anyway it's not a bad idea; just not one I feel is especially well suited to the VC investment model.
I think the idea is to pick niches that are small now but will become big in the future. Build the only programming language available for the Altair and you have a high-margin monopoly on a market of a few thousand machines. Build the only operating system for every IBM PC and clone, and you have a high-margin monopoly on a market of hundreds of millions of machines.
That's behind the common SV wisdom of "catch a wave", "ride a trend that's larger than yourself", "find markets, don't try to create them", etc.
The pitfall is that it requires some degree of future-prediction, and predicting the future is left as an exercise to the entrepreneur. The guy who built the first programming language for the Altair is the richest man in the world; the guy who built the first programming language for the Alto [1] has largely been forgotten by history.
It's also the model for a lot of business software that caters to some specialist requirement, industry vertical, etc. Just look at the huge partner ecosystem of Salesforce for example. Something like 160,000 people attended Dreamforce. Some of that is large software firms and in-house end-user development of course, but a lot of it is small ISVs with niche add-ons.
On the one hand: who cares? It's private, non-leveraged private money. It isn't a debt bubble like the mortgage crisis and hasn't infected the public markets like the 90's. Caveate Emptor and all that.
On the other hand: the suckers at this table are pension funds and other LPs that are terrible at picking managers. A few good years of returns and money will flood from underfunded pension plans into VC .... just in time for a nice healthy correction. If I was relying on a pension to retire in the next decade or two, then I'd be worried.
"It isn't a debt bubble like the mortgage crisis and hasn't infected the public markets like the 90's. Caveate Emptor and all that."
I've heard that a lot, but I wonder if it's as harmless as people say? If/when this bubble pops, won't that have a pretty tough spiral effect? Granted it might not be as deep as the late-90's bubble, but I'd have to think that this will be pretty grim when it happens too.
Along with sky-high valuations come sky-high salaries, which breed high rent & purchase prices for homes. Along with that comes high tax revenue and such.
If suddenly a young engineer's expected income drops from $150-$200k/year to $60k, that could be pretty rough. Granted it probably will affect the coasts a lot harder than the central US, but I'd think it'd have national effects regardless. Salaries drop, suddenly people can't afford their houses, so they either have to sell at a loss or try to hold on to it. What if a sizable chunk of the population is no longer able to afford college loans?
You also mentioned the pension problem; if tax revenue starts to dry up because housing prices goes down, that could exacerbate a problem that's already popping up around the US.
You know, I've long wondered this for the Bay Area.
The question in my mind is...how much of the housing crisis, rents, and raw population are coming from people employed by startups that are most at risk of this?
Google, FB, Apple, Adobe, etc. have strong revenue (perhaps other issues, but there is no argument that there is money to be made and that they are making it). They also employ massive numbers of people. If a so-called funding bubble bursts, is it really going to make a dent in the other areas like you suggest? Or is the bulk of the "tech industry" comprised of the larger tech companies?
If it is the larger tech companies, and a bubble bursts, it might provide less flexibility for leaving to start your own thing, and there may be overall less competition, but they still compete against each other for top talent, and need way more resources than a startup does.
All this dumb money is tying up perfectly good engineers that could otherwise be working on useful stuff. So in that sense the process is harmful even if you don't care about whose pockets get emptied.
Business 101 doesn't apply to Rapid Startup Knowledge 101.
Rapid Startup Knowledge only involves things like LTV, CPM, MAU, DAU, DAU/MAU, and (monthly employee cost / corporate bank balance).
After all, the entire YC thesis is: take technical, non-business people and convince VCs they can run companies. It's okay if the actual business knowledge is just smoke and mirrors for a few years until you hire someone to understand it for you or you study enough on your own to be less of a "business outsider/imposter."
No it's not. Things like Tesla & SpaceX have lousy unit economics for long periods of time and it's almost a leap of faith that they eventually can work out. Thank goodness you were not in charge of them.
@sama: right on with this. SV $ metrics are always measured in revenue growth, not free cashflow, margin, etc. Measuring revenue works fine for high-margin businesses, which software has been for a long time.
Now that we're using VC to finance resource-intensive SaaS companies (e.g. analytics) and even cleaning/home care/service companies, there's a need for collectively higher financial sophistication.
Revenue growth is a good proxy when you're selling zero-marginal cost products; not so when you're selling 95 cents of cost for $1.
It seems like VCs ought to be more sophisticated than to naively apply the model for SaaS to low margin consumer facing products, but I don't know enough - this really could be the case.
Similarly, I have no understanding of all the money that flows into the space (from the outside). The margins are low (to non-existent) and the space is brutally punishing. Screw up a persons laundry, food order, or plain just take too long and you have to give away a year's worth of margins to keep the customer. Delivery as a service is a commodity - who cares who delivers your food or does your laundry? At the same time, the cost of switching between providers is as close to zero as it gets (they are doing home delivery after all!). In the parallel universe that is SF, VCs subsidized (thanks!) the industry to the tune of making it comparable (or actually cheaper) in price for me to pay someone to pick up my laundry, wash and fold it, and return it, to doing it myself at a coin operated laundromat. Whenever the service I used raised prices to stop hemorrhaging money, I simply switched to their latest VC funded competitor.
The idea behind 'only revenue growth matters' is that if you have an exponential growth curve then the actual numbers don't matter as long as they are positive.
If you're making tiny margins on every $1 of revenue then you'll still be a billion dollar profit business quite quickly if you grow that revenue by 100% every week. $100 sales and $1 profit this week? No problem, wait awhile and soon it's $1 billion profit off of $100 billion revenue.
Whether this model is realistic is obviously very much up for debate. Just because you grow 100% for the last 50 weeks says nothing about what will happen on week 51 when the easy source of growth is gone but your burn rate has to increase further to keep afloat... Of course, with scale you might be now making $2 off every $100 and your profit is now growing enough anyway?
Either way, using any single number as a proxy (or even complex finance without understanding the operating market) is never going to give you a perfect picture of anything.
Well, a "per-user" cost growth-model might work. That is, your business follows the Uber model of geeks on top and "contractors" at the bottom. You can ignore everything other than the contractors with the assumption that you'll outgrow them or optimize them into negligible levels, but you accept he contractor cost in your big "growth curve" pitch.
Does anyone else think that these unoriginal, doomed-from-the-start startups are a direct result of funding institutions looking for founders that appear really good "on paper"? You know, experience with this BigCo, a degree at that IvySchool, etc. Even YC may be becoming guilty of this, as it seems like a top school brand is a prerequisite.
Or the more sinister metric, do you have growth? PG wrote that startup=growth, and that growth is the all-encompasing metric. Might this incentivize some prestige-seeking 'entrepreneurs' to do things that don't scale like pumping money into convincing users to join their website, or making fake accounts?
Not that growth and a founder's unsustainable touch early on aren't excellent things for which to strive. But in any system in which there is prestige to be gained, there will be those who will match patterns and fool the heuristics of the gatekeepers.
The worst part of it is that companies with bad unit economics are not just shooting themselves in the foot for the sake of "growth" or simply faking hotness, but that in acquiring users for more than they are worth they effectively drive acquisition costs up for everyone else in the industry.
As a side note, unless you have a secret sauce (something unique to your company, like better proprietary data, lower operating costs, etc.) all acquisition channels will decline in effectiveness over time, making it harder to make unit costs work. This is generally known as audience fatigue.
You have to admit, though, that there is nothing quite like the feeling of paying $7 for an Uber pool to go all the way across San Francisco, especially when it's surging 3.9x.
I was nodding my head in agreement until I got to this line
> where you make more than you spend on each user, and it gets better not worse as you get bigger, you may not look like some of hottest companies of today, but you’ll look a lot like Google and Facebook.
Wouldn't Facebook be an example of a company with bad unit economics?
You're accounting for Facebook's and Google's business model all wrong. The end users aren't the customer. Advertisers are the customers. Think of Facebook and Google more like giant hydro-generation plants that have to continually work to divert the flow of attention of its users to its customers.
Like any hydro-generation plant, you want to capture a monopoly from this recurring source of income so you can dictate premium prices from your customers.
They also have basically zero user-acquisition costs, on both the user and advertiser side. CAC (customer acquisition cost) is usually the largest variable cost for most businesses. Things like server costs, electricity, etc. are tiny in comparison. Cut CAC and your margins skyrocket.
Indeed, the reason why Google & Facebook are profitable is because they're a very effective way of cutting CAC for other businesses. Their revenue is another businesses's marketing spending, and yet they're still better than the alternatives for driving customer conversions.
To see these systems like massive hydro-generation plants, you first have to assume that human attention for advertising is an infinitely-renewable resource.
Considering Facebook is a website with zero marginal costs and zero acquisition costs, no. It makes way more $$ than it spends, especially marginally/per-unit.
Yea, and why not just look at the actual history of FB where they were quite easily able to pay for server costs at an early point with ads. It's possible they hit a point where they were losing money, but 100% at any point past the very beginning if they wanted they could've invested less and been a profitable business. Possibly not a business that would've existed for the long run and it might have opened the door for a competitor, but they could have drawn down money out of the business they had built. Many of the companies people complain about actually couldn't do that because they don't have any ability to raise their prices without losing all of their customers.
Unlike the others replying to you, I tend to agree. At least, I am dubious that they will "keep customers forever", which seems to be a key part of good unit economics. Things change, sometimes very fast.
First they talked about valuations being too high. Then they talked about valuations not really meaning anything. Then they talked about companies staying private too long. Then they talked about burn rates.
The first 3 are essentially the same thing and the 4th is related.
I don't get why we always cite Google, Facebook, WhatsApp, Instagram as an example of companies that have shown the way. While, those companies are great in their work and business, they didn't really start with an aim of providing value but as just-another-side-project. Why do we ignore the thousands of online businesses that might not be raking in billions but are successful by every measure? A reason why I look forward to products like Bare-metrics, and AeroFS.
The problem I see with seeing these companies as an example is that most people think around the ideas that they feel good about. It is disappointing that so many people are just driving towards building another photo sharing app or a low margin business.
Google and Facebook are cited because they generate an ungodly amount of cashflow/profit and have manage to do it in a smaller timeline than their equally financially regarded counterparts (Google took 15 years to reach that of the revenue that took Coca Cola took 100+ years to reach).
I'm curious as to why you consider Baremetrics a success and by what measures? No offense to the guys at Baremetrics (they're product is well executed and I reference their SaaS metrics constantly), but their financial performance is not great [0] given their funding raise and valuation [1]. They're losing more customers than they gain, they're presumably cashflow negative (for a team of 6 engineers at competitive salaries, you're looking at $750k/year cost) and their ARPU/LTV numbers are really low (in relation to their low number of customers). Right now they're getting 10x on revenues, which is crazy high.
Exactly. It is silly to aim for billions. Aim for making a living by providing a service that some people will pay for. Small percentage of people paying a small fee multiplied by the Internet. The maths works.
As more and more people realise that "free" means "costs are hidden" more and more people will start paying small fees for what once was free. It will never be a high percentage, but high enough
> Games like Candy Crush Saga and Game of War spend absurd amounts of money in acquisition.
Yes, because they know on average every person that starts using the app makes them $1.50. So they spend a lot of money acquiring users at $1 each. That's not a failure of unit economics.
I strongly doubt the average user spends $3, given that the current freemium environment is hedging by offering freemium perks for free periodically to get user retention. Which makes them less likely to actually spend money.
Candy Crush brought in $1.5 Billion dollars in revenue in 2013[0]. In 2014 it had 93 million users[1]. That means Candy Crush brings in at least $16 / user / year. I'm guessing they don't really care what the cost per acquisition is when they are making that much per user.
Are you suggesting that CCS and GoW have negative unit profit? That seems surprising to me. They probably have somewhat slim profit margins per user, but that's because they have a large market and great scalability.
I don't think the original essay means "hey, your gross unit margin is only 10%, but your market size is 500,000 units at $5 per month." I think it means, "Hey, your gross unit margin is -20% and with a lot of luck you might increase it to -5%."
I remember this from the very early days of Facebook apps. I worked for a company in 2007 that made one, and we bought users by advertising with other facebook apps. The problem was this was the ONLY revenue model for facebook apps; getting other facebook apps to advertise with you. There was no actual external revenue source.
> Games like Candy Crush Saga and Game of War spend absurd amounts of money in acquisition.
I think this is wrong. These games have strong invite-friend mechanisms and have high retention. That's why they are popular in the first place. No source at hand though.
That's how it used to be years ago. The economics have changed; due to the increased competition in that marketplace and the extreme aversion of users to paying for things, freemium games must use social engineering to survive.
"A service launching this week will tell you that Machine Zone is currently spending somewhere around $12 per user with AdColony, InMobi, and Unity Ads, up to $20 per user with Vungle, and between $2 and $30 per user with Chartboost."
GoW has very low retention. Users who stick around in GoW are the kind of people who like to spend a lot of money to feel empowered. But, finding and keeping those people is very expensive because it involves churning through a whole lot of users who aren't like that.
Previous companies made a loss, but in the end started to make a stonking profit (google, airbnb)
However they seem to be the exception not the rule. Currently in london there is an explosion of highly integrated iphone ebay apps. Quite why they (the investors) think its a great idea to fund so many clones is beyond me.
But then the economics of startups are odd. like broadcasting seeds, you expect infant mortality. However this acceptance of utter failure has creeped up from the seed funding stages into series a,b,c and even d (twitter still cant make money.)
Its fine if you manage to sell your shares onto the next sucker. But the problem is that each round bring a bigger price of failure.
If you can achieve profitability, then you could presumably wait for your competitors' business models to fail and then rake it in when all their customers have to migrate. They pay all the costs to build up your customer base then go away.
>then you could presumably wait for your competitors' business models to fail
Isn't that essentially playing the market? You might be waiting until the bubble bursts - which puts you in the same position as everyone else trying to short this bubble thats supposed to pop any day now.
And even if you are profitable now, the effects of a bubble doesn't mean you will be profitable afterwards.
If you're playing anyone, it's your competitors. Understanding your competitors is much easier than understanding the market. Actually running a business in the space makes you much more familiar with the unit economics of it. If the market fails, that is, if people decide they no longer wants the service you're both offering, then you're both hosed.
If you feel there's a bubble, that is, if you feel that demand for a product / service is going to eventually collapse, then the rational response is to get out of that market, assuming your position is liquid enough to do that, and invest in asset classes that will do well if and when the market collapses. You don't start taking short positions unless you have specific reason to believe a specific company isn't looking good. Otherwise volatility could cause you to lose a lot of money in a very short period of time. Also, you can't short a whole market, you can only bet against it.
What I don't get is this: the freemium pricing model is often used, but what few people seem to know is that selling below cost is also called "predatory pricing" [1] and it is illegal. And there are good reasons for that. So... why are we letting the market get ruined by this phenomenon?
Not exactly, and I'm not even sure 'freemium' falls into these categories anyway. Selling in a way that is deliberately designed to drive off competition is illegal, assuming you can prove it. Selling below cost is just called 'making a loss' and is perfectly legal, if generally unsustainable ;)
Here are two scenarios:
1. I sell product A at a loss, intending to attract customers who will then buy product B at much higher margin, making me a large profit - legal.
2. I sell A at a loss to attract company X's customers and drive them out of business, then raise the price of A once they go bust - illegal and predatory pricing.
Yes, but what is happening right now is that start-ups are taking funding, build a brand on VC money, hence drive everybody else practically out of business (and blocking potential newcomers), while making losses year after year.
To me that sounds pretty much like predatory pricing (and anti-competitive behavior in general).
Only in the particular industries they operate in. And the whole point of this essay (and the reason this is a problem) is because these are bad industries, known to have bad economics, and companies are using VC money to paper over the bad economics.
Just ignore the herd and look for overlooked industries which don't have bad economics. That's what you have to do to survive as a startup founder anyway.
It's pretty analogous to the family next door who goes and buys a yacht on credit cards even though their income can't support the payments. Yes, it's annoying to watch people have nice things they didn't earn, and yes, they do marginally prop up the price of yachts. However, were you really planning on buying a yacht anyway? They will get their come-uppance when the bills come due, and it's not worth worrying too much about what other people are doing in the meantime.
The exception may be for companies that have clearly recognized network effects.
In this case, your product may not be valuable without a lot of users, customers or cars .. You need to spend to get to critical mass, but I'm sure it's important to articulate a plan on why your business becomes profitable from that point onwards.
Too often, there isn't a tipping point or that tipping point is very hard to reach and companies never become profitable
Moving matter rather than information is inherently expensive. A lot of the current darlings are about moving matter around. Their best bet is to achieve monopolistic dominance by being radically more cost-efficient than the old-school industries they disrupt, but it's still expensive.
Advise for game developers: that's why you should not do clones or games which looked different but are actually clones - like not-so-innovative 2d platformers. If you think about an innovation for your next game, think about it twice, will it drive sells, really?
The reason this is complicated is that the burn rate of the business is determined its net margin (NM) and the viability of the business is determined by its contribution margin (CM) (NB I didn't say gross margin - they are slightly different).
CM is extremely hard to calculate because "fixed" costs - in practice - do scale with the number of customers. But on the other hand, if you have a positive CM, it may make sense to invest heavily in capacity, leading to negative NM.
Those two certainly apply IMO, they both have The Next Zynga written all over them. Any investment where you have to spend the money buying every ad on TV has a red-flag that the valuation isn't nearly what people claim it is.
Actually, Zynga itself is another one (though it's a public company). I don't see any evidence Zynga will ever be a profitable company, and it has no valuable assets, so I think it's fair value is pretty close to $0.
TV ads can be quite price-effective if you have the right strategy, are catering to a broad enough market, and have a good pro. Fantasy football has such broad market appeal that pretty much any ad buy is going to reach a significant number of people that play it.
Disinflation & deflation, capital flows and political friction preventing effective (any?) fiscal policy have produced an environment where private capital set on a given rate of return on investment is chasing increasingly risky organizations [1][2].
Large firms have been sitting on enormous sums of cash; e.g., why is it that the most capitalized company on earth isn't investing aggressively. In lieu of investment, many of these firms have been focused on engineering stock buybacks.
So, the thesis: why are so many firms pouring money into startups with increasingly questionable fundamentals? Because hands previously gripping bundles of capital have (nominally) more capital than they did with decreasing options for productive investment and downward pressure on returns.
1. http://www.economist.com/blogs/freeexchange/2015/04/puzzles
2. http://krugman.blogs.nytimes.com/?s=low+inflation+return+inv...
P.S. I recognize that I'm probably a bit left field for this group as I'm not a libertarian, I support strong regulation and I question the marginal value of lots of Valley products.