How does Grubhub make money?
Tragic Letters from the Outskirts of the New Economy
Dear Techconomist,
A friend of mine says Grubhub sells his father’s pizzas below the price his father gets. Does that even make sense? How does the Sharing Economy Make Money? Shouldn’t Grubhub be broke?
Sincerely,
Confused by low prices.
Dear Confused,
Grubhub, Uber, Uber Eats, Airbnb, We (Wework) Doordash…only one of these actually makes money and has a record of turning a profit. The fact that these massive companies with shockingly large user bases make no money while being worth billions of dollars seems almost irrational. The point of a company in classical economics is to make a profit. That’s what we are all taught, so how can a company lower its prices below inputs and still exist? It doesn’t seem to even make sense? Well, two things are going on here. One is purely financial. The other has to do with market structure.
Let’s talk about finance first. We live in weird times for a lot of reasons. As I write this, Corona continues to allow me to avoid social contact and provides ample opportunity for me to work and go to school from home. The weirdness that enables the sharing economy, though, has to do with the Federal Reserve and the current conditions in interest rate markets. Right now, interest rates are set at historic lows thanks to the purchases of bonds by the Federal Reserve. This creates a low cost of borrowing and investment and high returns.
Because of this low cost of investment, lots of companies that don’t make profits can survive by taking venture capitalist money. It’s a story as old as time: Venture capitalist invests and pumps company value up, company goes public, venture capitalist gets out. Private equity has lots of money, and a lot of it goes into tech startups, some of which are not really viable long term and many of which spend dramatically on customer acquisition. This is not natural. It comes because companies take advantage of perverse incentives. The low interest rate climate makes companies make decisions that under normal conditions would not make economic sense.
Companies like Amazon sometimes make profits in all but name. They make money, but they reinvest the money for future returns in an effort to boost stock price and avoid taxes while creating shareholder value. That’s not what happens in the sharing economy. These companies have made the conscious decision to forgo profits for the short term and focus on acquiring massive user bases to hopefully monetize down the road. Why would any company that isn’t profitable now think more users will help?
Welcome to the economics of networks! Traditionally, producer economics focuses on costs and revenue. Marginal cost, the cost of making an additional unit of product, is supposed to go up after a certain point for most products, while marginal revenue should decrease as more users join. Network economics works a little differently. Many network services benefit from insanely low marginal costs and increased benefit to users with each additional user. For example, one person using Facebook makes Facebook unusable, but more people on Facebook means more content means more enjoyment for each user.
Uber and all the major sharing platforms are two-sided networks that provide the service of matching up the two sides: Passengers to drivers, owners of homes to renters, restaurateurs to foodies. This creates a nice world in which one side of the network can help pay for the other and allows an amount of subsidization of one side of the network. In Grubhub, both the restaurant and the consumer partially pay for Grubhub’s network. Similarly, credit card companies provide customers to stores, and stores pay a small fee for those customers. Customers might even get benefits for using the cards because more people using one card promotes a greater network effect. Network effect businesses like these tend to be winner-take-all. This often leads to buyouts and mergers as well as aggressive spending on customer acquisition in hopes of market domination and profitability long term.
I know the fact that companies like these get to squeeze established small businesses makes you upset and angry, but it’s also a financial problem. It’s not how economies are supposed to work. It’s a product of hyper-low interest rates and massive incentives for low investment costs. Thankfully with the failure of some recent unicorn IPOs — thank you Adam Neumann — we are finally starting to see the decline of investment in BS startups and a little bit of return to sanity in the sharing economy. It seems wrong that companies like Grubhub can hose employees and vendors while making no profit and turning into massive cash cows for creators. That’s because it is wrong, but economics is hopefully going to work it out, so those businesses will get rich and profitable or die trying.
If you’re angry, keep reading these articles.
Techconomist
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