The Case for Consolidation
How competitive dynamics in growing on-demand consumer markets are leading to acquisitions
Last Tuesday, Pascal Levy Garboua and Semil Shah hosted the first On-Demand Conference organized by Tradecraft. The speaker panels included a bevy of founders, CEOs and business leaders from some of today’s most high-profile on-demand consumer startups. But Adora Cheung, CEO of house cleaning service Homejoy, was notably absent from a scheduled appearance. Media reports surfaced the next day that competitor Handy was in talks to potentially acquire Homejoy. Coincidence?
The news comes on the tail of the sale last month of fitness class subscription service fitmob to competitor Class Pass. These acquisitions are a positive development in the evolution of consumer startups and in the best interests of the parties involved. Here’s why it’s working for on-demand consumer marketplaces and why verticals practicing other on-demand consumer business models aren’t quite there yet.
Cleaning up the market
Taking a look at the Handy / Homejoy situation, we have a case study for consolidation. Handy is no stranger to buying competitors to quickly expand in new markets. And there’s no doubt that a sale to market leader Handy would be a positive development for Homejoy given its recent spate of troubles. But how would Handy benefit from acquiring a shaken startup with operations in 22 out of 30 U.S. markets that it is already present in?
1) Market leadership
By joining forces with its closest competitor, Handy can capture supply and demand currently owned by Homejoy and expand its user base on both sides of the marketplace. It will be able to increase penetration in existing markets and solidify its leading position in home cleaning services. Handy will need to quickly establish itself as the clear no. 1 to defend against growing competition. Similar home services competitors Taskrabbit, Porch, and Thumbtack are all after a piece of the higher recurring revenue generating home cleaning pie. Rocket Internet backed European competitor Helpling has also been mulling over the very same idea — an acquisition of Homejoy — to enter the U.S. market. And most intimidating of all perhaps is Amazon Home Services’ recent entry into the market. With few differentiating attributes to compete on, size matters for marketplaces.
2) Costs savings and price control
Aside from reducing duplicative operations, Handy can potentially save on growth marketing. In a saturated market with players competing for the same consumer wallet, the spend to grow incrementally can be expensive, more so than an acquisition of a competitor if the deal economics work out right. Most importantly, removing competition gives Handy more control over pricing and prevents price erosion. Instead of subsidizing consumers with lower prices to stay competitive, Handy can price its services for profitability.
3) Scale to profitability and exit
With the increased size post a Homejoy acquisition, Handy will be able to scale much more quickly to achieve additional growth and improved earnings. It will need to accomplish both to secure an exit for investors. At a current run-rate of $52m in annual revenues and having raised over $60m in funding, there’s no turning back for Handy. A sale of the business is unlikely given the lack of potential acquirers, so Handy is faced with the challenge of building the company into an IPO worthy entity — and that means profitability.
Needless to say, such a deal only makes sense if the price is right. Handy must weigh the speed and cost of organic growth against the scale from and cost of acquiring Homejoy. And with signs that things at Homejoy may not be so fresh and so clean, there’s potential for a discount on the price tag.
Like house cleaning services, the subscription-based fitness classes market grew explosively in the last year and competitive dynamics matured so quickly that consolidation was more value-added than continued competition. Class Pass’s acquisition of fitmob expands its consumer user base, reduces competitive marketing costs and gives the company more negotiating leverage with supply side studios and gyms as it continues to scale.
As other marketplace verticals within consumer startups (i.e. laundry, parking and auto maintenance, on-demand medical services) gain traction and become increasingly competitive, industry participants would do well to note when headwinds to growth appear and consolidation is needed.
Here, there and everywhere?
Not every consumer vertical is ready for consolidation yet though. In fact, one of the most competitive markets has yet to see any M&A activity — on-demand food delivery.
There is a distinction between this new crop of food tech and the more tried and true restaurant delivery market where M&A activity is as common as fortune cookies in Chinese food takeout. The newcomers differ from Seamless and Grubhub and even from the newer Caviar and Postmates in that these on-demand food companies operate kitchens and produce their own food in-house. Herein lies the difference — one that has driven the latest food tech trend and produced a number of competitors.
That said, when your smartphone screen is cluttered with 5 different on-demand food delivery services, it begs the question of whether this overcrowded market is ripe for consolidation. Because surely the market isn’t big enough for so many different food delivery companies in one city is it? Well, yes and no.
Room enough
For the time being, the market continues to support the current players for the following reasons:
1) Differentiation
While most on-demand services are built around a marketplace model and a service that is easily commoditized, the new food tech companies resemble a more traditional business. Meals are created and produced in-house, allowing these companies to form niches and differentiate themselves. Sprig is focused on clean cooking and responsible sourcing, Munchery emphasizes its local, chef-made selections and Bento Now highlights Asian cuisine. The unique value propositions of each company make it harder to compete directly with one another. A single user can patronize all competitors unlike house cleaning services for example. There is no unique value to Handy’s cleaners versus Homejoy’s cleaners but hot healthy lunch in under 15 minutes versus chef-prepared reheatable dinner are another story.
2) Daily active use case
Food, like transportation, is a daily necessity. Everyone has to eat at least two to three times a day but they only have to get their homes cleaned once a week. This high daily active use case creates a larger wallet for competitors to share and delays the head-to-head competition that will evolve as the market approaches saturation.
3) Young market with influx of private capital
The on-demand food delivery market is still relatively young with low penetration rates and no shortage of private capital to support growth efforts. In a bid to see who will be the last man standing, VCs are subsidizing these companies’ operations as they try to scale to a market leading position and profitability.
A matter of time
Nothing lasts forever and the current market situation can’t be sustainable long-term. Industry players will grow until they begin to encroach upon each other’s market share. So what would the future competitive landscape of on-demand food delivery look like? Here are a few potential scenarios.
a) Ordering food delivery will become such a part of daily life and so low cost that everyone can afford it. The market will be so big that every food tech startup can get a piece of the pie.
The probability of this outcome is as good winning the Powerball jackpot. Today’s crop of food delivery startups are unlikely to reach a level of scale where costs are low enough to serve anyone other than “the wealthy and young” while still making a margin. For food delivery to be truly affordable and “accessible to everyone, everywhere,” it will require hegemony à la McDonalds and undoubtedly involve an acquisition or two along the way.
b) The proliferation of so many similar companies begins to overwhelm consumers who limit their food delivery services to just one or two.
A likely scenario wherein a no. 1 and no. 2 in the market emerge as industry leaders, continuing to grow and scale while remaining competitors flounder. The resulting market dynamics should resemble consumer marketplaces with consolidation on the horizon.
c) Competition will be neck and neck, growth will slow for all industry participants as the market becomes saturated and margins shrink.
While it’s more probable some participants will fail and exit the market, private market capital and the availability of funding may prolong the life of more than one player. In this case, consolidation will almost definitely be necessary to continue growth, achieve earnings potential and provide an exit opportunity for investors.
Of these possible outcomes, scenario 2 would be the most likely course on-demand food delivery will take. But note that in all cases, consolidation plays a critical part in the maturation of the industry.
We may have to wait awhile yet before a shakeout in on-demand food delivery occurs, but there should plenty of developments in the space to whet our appetite in the meantime.
