Beyond WeWork: On Startups’ Inability to Scale to Profitability
When not every unicorn is the next Amazon
There’s a tech bubble. It’s one of the things that has been whispered about for some time among economists and analysts looking at the wads of cash being thrown by Venture Capital and Wall Street into buzzy but unprofitable startups. They are questioning the end result as the clouds are starting to more resemble billowing waves of smoke over Silicon Valley.
In recent months, much of this attention has been focused on Softbank and WeWork as a $47B valuation that never should have been has since cratered & Masayoshi Son’s Vision fund attempts to bail it out increasingly seem like feeding a bonfire that can’t help but burn out. Even as WeWork’s fortunes continue to plummet at a rate not seen since the Worldcom debacle that became the poster child of the first internet bubble burst, all too many outlets are dismissing WeWork as a solitary occurrence. An outlier. Meanwhile, countless other startups have the same potential to serve as kindling to a market correction that will dwarf that of the first tech bubble.
In the interim, countless other startups have the same potential to serve as kindling to a market correction that will dwarf that of the first tech bubble.
It’s easy to point as WeWork as an anomaly — it never was a proper tech company from the start. However, even within Softbanks’s vision fund there is additional room for pause. Its $6.5B reported loss has been focused on WeWork, but the names spilling red ink include Uber, Slack and Doordash, alongside overseas startup failures like Hong Kong’s Tink Labs, are a sign not just of a single failure but something larger on the horizon with Softbank a large canary in the coal mine suffocating. For a while, the commonly thrown out (and unvalidated) 90% of startups failing statistic could be seen as an invitation to the truly brave only for cracks to reveal in an increasing number of tech unicorns on the precipice of insolvency next to continual smaller losses piling elsewhere. The sustainability of tech’s business model is overdue for a shakeup.
Most tech unicorns and aspiring unicorns aren’t Amazon. They can’t be.
Since going public, Uber has continued to hemorrhage funds to the tune of over 5 billion per year — all with no realistic path to profitability. Doordash has made similar inroads in market share by disrupting the restaurant delivery sector - at great cost, but with questionable long term value. Tech unicorns from Snap to Lyft to Box onward are lauded for high valuations even as the losses pile on with no end in sight. In many cases, IPOs are occurring amid annual losses in the 8, 9 and even 10 figure range on the promise that at the end of the tunnel the profit will come.
Behind all this is the long term view. Many of these folks will point to Amazon as the prime example of a company who overcame years of unprofitability and near collapse to emerge as a juggernaut of corporate enterprise. It’s a long, plodding path to greatness heralded as a model of tech genius without realizing that they are pointing at the anomaly rather than the rule.
Most tech unicorns and aspiring unicorns aren’t Amazon. They can’t be.
Amazon may have started in modest scope exclusively as a book retailer, but the ultimate vision laid out by Jeff Bezos is to be the “Everything Store.” Product divisions were added to the website in increments with varying success, but with the mindset of building a single stop repository for all of the goods and services a household or business could require or desire.
In terms of scale, this means that Amazon’s potential market is — everyone. A bookworm can browse millions of options in their preferred genres with user-friendly search to doorstep logistics that have indeed made them a household name with as many as a hundred million households subscribing to its Prime service. However, Amazon’s genius isn’t just in offering one service to everyone but its ability to shape its service to fit within the lifestyles of every person. Regardless of the specific needs of a household, business or person, Amazon’s experience can be shaped by them to the point where few households or businesses don’t engage with the company in some capacity in their daily lives. Amazon, for better or worse, has infinite potential in a world of finite resources.
In that same vein, Facebook’s profitability became in its near-ubiquitous presence in the social media space. In this case, it’s product becomes less the platform itself, but the revenue that can be generated by companies, brands, and advertisers who want to reach out to various segments of a collected mass of a billion plus users. The customer is not the end user, but rather the user is the product with the bulk of revenues coming from various partnerships with ad agencies, brands all the way down to small businesses and performers who pay to gain visibility to the marketplace of consumers. Facebook, much like Amazon scales by being the “everything store” for connecting brands to consumers.
This is the folly of the recent overvaluation of big tech. For all the disruption happening in areas such as delivery, taxi service or short term office rentals, most big tech exists in segments that have a definitive market value and customer cap. There are only so many customers to go around for each of these services be it delivery, video streaming, ride-shares or tab splitting and there is a limit to the demand from each of these limited customers. Their contribution to modernizing their respective industries has a positive in customer experience and has drawn many people away from their conventional competitors without addressing the problem that the maximum value of each of these markets is finite and revenues remain out of line against costs.
There are only so many customers to go around for each of these services be it delivery, video streaming, ride-shares or tab splitting and there is a limit to the demand from each of these limited customers.
Ridesharing and delivery is a prime example of this phenomenon. These services require dense population hubs in order to flourish, both in terms of driver acquisition as well as the customer user base. For years, companies such as Uber, Lyft, Postmates, and Doordash have spent heavily in promoting their services to extend their market share in major metro areas to great success in terms of market penetration, but without closing the profitability gap. Where for years large losses were dismissed as unimportant in the face of growth, the cracks show as many of these firms have scaled up and expanded into as many local markets as reasonable with few signs of profitability. With most viable markets covered by these unicorns.
The risk here is that in the case of Uber and Lyft, they are approaching if not having reached a wall in growth. Their mass adoption in most major cities means there isn’t the opportunity to hide losses behind rapid user growth and the value add in advertising campaigns for drivers and customers alike will teeter off as growth stalls and we have already seen the beginnings of this growth contraction in recent financial reports. That these services continue to lose money on every single ride even as their expansion is slowing is a sign that the service itself is not scaling to the actual market and volume is not going to close the gap in a $5.2B annual loss — over a billion per quarter.
Other companies struggle with the proper development of revenue streams. Services such as Paypal acquisition, Venmo, promote themselves as free to the consumer as a means of gaining market share. The assumption is the lack of revenue from customer transactions would be offset by fees and charges to business end-users, but this adds in the question of the true value add compared to traditional financial transactions services who similarly rely on diversified service fees to generate revenue. Similar to Uber and Lyft, it is a service that has achieved market penetration without profitability. If moving $26B a year in financial transactions generates less than $400M in revenue with the division operating at a loss, the question stops becoming focused around how these companies intend to be profitable but CAN they be profitable.
When combined with the engineering costs and operation of such services, there is ample reason to question the viability of many of the companies that have undoubtedly made vast improvements in daily lives and a leap in technological progress, but don’t have business models that can carry them in the long term.
Even when the product is a tangible object, there are constant questions regarding the ability of companies to scale. Tesla has wavered back in forth in fortunes, buoyed by the sheer force of personality of Elon Musk — for better and worse — while the company contends with its ability to scale to its own demand. Long wait lists and questions on the sustained procurement of raw materials needed to produce vehicles are being met with challenges in growing it’s charge network to meet peak demand, safety concerns in autonomous driving features while ALSO rolling out new models. Seesawing between funding rounds punctuated by cash on hand crises and with little consistency in earnings much less profit, Tesla has been the talk for years as an example of potentially biting off more than they can chew.
However; disruption in itself is not enough. Disruption doesn’t in itself expand a market or lead to profitability by the nature of being disruptive.
It is for these reasons why WeWork isn’t the anomaly it appears at face value. Runaway valuation and inexplicably careless spending are not limited to WeWork. It’s typical in the tech space. Their challenge is similar to that of its more technical peers where expansion is not generating additional revenue as a means to close the gap in operational losses. Valuations grew to the point of becoming outsized to the point of being unable to turn a profit. As a landlord, there is only so much opportunity, so much demand and so many dollars. Where it may have been able to thrive at more sober funding levels and modest expansion, WeWork is a victim of speculation hype coming before market realities. You can swap in any number of Silicon Valley startups and come to the same conclusion.
In all these cases there is no denial of value and utility existing in each of these companies. Nobody is clamoring for the good old days of smelly yellow taxis that may or may not show up when hailed or called. Few people will deny that the future sustainability of the planet it contingent on developing renewable alternatives to our fossil fuel driven transportation system. However; disruption in itself is not enough. Disruption doesn’t in itself expand a market or lead to profitability by the nature of being disruptive.
But when large investments come rolling in from VC firms, hedge funds, and wall street alike, all too often nobody is thinking in terms of the end game of how money is on the table to begin with. Drunk with cash and a mandate to grow, companies are losing sight of basic fundamentals of what the real profit opportunity amid the finite resources and dollars to go around. Too much growth, too fast is coming at costs that frankly can’t recoup as companies mature — at some point a venture needs to be able to sustain itself without next rounds of funding.
For tech to turn the corner and thrive, they need to be built based on the scale of its market. VCs and other investors need to look at the long term outlook and understand what the end market looks like at mass penetration. If profitability occurs at x customers and/or y transactions, the numbers need to be feasible and obtainable. Valuation and investment need to be scaled not to the emotional hype of the next Amazon, but to the value it presents in the space it exists. It’s okay to build to a 5 year or even 10 year plan, but if we’re to dampen the effects of when this bubble pops and ideally avoid a dotcom 3.0 bubble a generation down the line, we need to go back to the basics of most companies having finite demand and finite dollars available for capture.
Unless you are the next Amazon, it’s best to assume you’re not.
