15 ms·

The problem with profitless startups

76 points by joshreads 13y ago

PublicEnemy111 13y ago
As someone who recently accepted a job in silicon valley, I've started to become concerned that there is a bubble. I feel there are many parallels between 1999 and today. I would love to be convinced otherwise because I am concerned with job security, but I can't escape the feeling that the "music" will soon stop. At the very least I'd like to hear people's opinions on whether there is a bubble or not
- highace 13y ago
  If it looks like a bubble and acts like a bubble...
- Edmond 13y ago
  It is unlikely that those who stand to profit from a bubble would acknowledge it....up until the housing market came crashing down there was a continuous stream of people on CNBC talking up the market....the same happened in the first dot com bubble, you can expect the same now. The new excuse is that even if there is a bubble it will be contained. It does seem an entire bubble economy has been created in SV where bogus companies provide bogus products and services for other bogus companies. Maybe in this case any collapse would be contained, but I guess we'll have to wait and see. As the expression goes: Anything that can't go on will stop.
  - ritchiea 13y ago
    Isn't the crazy thing that it can go on? There's enough money at the top of the economy that the rich can keep investing in startups as an asset class and not really feel the losses even though they seem huge to those of us who get by on a salary from a job. The real question is: will the investments keep coming? My guess is it continues. Hedge funds as a whole also perform below market but see continued investment because of the promise that they will have tremendous returns when a firm succeeds. Startups get money from the same sort of investors. People who are only investing a portion of their portfolio, chasing big returns and mostly unconcerned about losing some money along the way.
    - waterlesscloud 13y ago
      So it's a new paradigm and it's different this time?
      - ritchiea 13y ago
        I don't think I said anything like that. All I said is there is a culture that embraces the sort of risky investment that VCs make & that hedge funds are comparable investments. Let's take a reasonable definition of a bubble: when the price of an asset has risen much higher than what is justified by the market. By that definition I don't think we're in a bubble, I believe investors are logical and they know they are taking risks chasing a large return. I also believe investors will continue to chase big returns from tech companies and that there is precedent for this behavior in other types of investments.
- LandoCalrissian 13y ago
  So the biggest difference to me is that the 1999 bubble was completely built on the backs of everyday investors. It was a rush to IPO and easy money, and eventually the market got wise and the whole thing fell apart. The new paradigm is far more interesting, since it's almost all the investment comes from VC and Angel Investors. I think these entities can leverage risk far better, since they may lose a few million here and there, but when they hit a whale they really hit big. I think there might be 'micro bubbles' within the industry that may implode under their own weight (F2P mobile games companies come to mind), but I think that's largely separating the wheat from the chaff. I know some will disagree with me on this analysis, but I don't really subscribe to the sky is falling theory. The tech industry is now big business, that's not going to change.
  - ajiang 13y ago
    Regardless of my opinion on whether or not we're in a bubble, the argument of "it's different this time because..." is used in the build up of every bubble we've ever experienced. Stock bubble? Economic stability and the wonderful controls the Fed has on monetary policy. No more economic cycles. First tech bubble? The internet is a wonderful thing we haven't had before - new opportunities, etc. Everything is different until it isn't.
  - GFK_of_xmaspast 13y ago
    Right now there's so much money sloshing around here because (a) there's nowhere else for it to go and (b) everybody's doing it. What happens when there is somewhere else for it to go?
- GFK_of_xmaspast 13y ago
  Of course it's a bubble. Stack that paper now.
dalek2point3 13y ago
tl;dr the author argues that the ultra-cheap venture backed services are a problem because while they're using money from VC firms and being patient, they're driving out local businesses, and they'll ultimately fail, leaving a hole in the local service ecosystem.
- arbuge 13y ago
  If that's the problem, it should eventually autocorrect when the investors give up permanently and local businesses return.
  - wffurr 13y ago
    That word "autocorrect" masks quite a lot of suffering on the part of local business owners who close up and lose their livelihood and investors (including pension funds, retirement accounts, etc.) which lose their money. Sure, in the long run it all works out, but in the short term there's quite a lot of turmoil.
    - smacktoward 13y ago
      As John Maynard Keynes put it, "in the long run we are all dead."
  - notahacker 13y ago
    Even if that invariably happens it's not much consolation to the local business owners bankrupted because their skinny margins couldn't compete with the "disruptive" idea of running at a massive loss for two years. Venture capitalists make a loss inducing formerly marginally profitable businesses to make a loss represents a deadweight loss to society overall even if the service gap gets filled. That said, most of the named business lines are those particularly easily replaced even if the threat of other VC-backed businesses coming into the market still exists: those inclined to open sandwich shops or market themselves as handymen aren't likely to be too worried about more online threats emerging in future, and the savvier ones are instead figuring out how to get profitless startups to provide them with low cost marketing.
bthomas 13y ago
Does Uber Black Car really subsidize UberX? I find it hard to believe that UberX isn't profitable alone - Uber just takes 20% of fare.
- johnrob 13y ago
  If they don't pay the drivers enough, there won't be any drivers. 20% is probably not a hard rule.
rdudek 13y ago
How do we know that some of these businesses are losing money? Looking at the menu of SpoonRocket that the author listed, you could make the same meal for less. I have a feeling that the profit margins are very low, but I do not think they're in the negative.
- aantix 13y ago
  Paying employees, executives, money for the car leases, gas, all while located in SF? An $8 meal, they make it at $4. With one avg engineer on salary at 125K, (~10K a month), you'd have to sell 2500 lunches with a $4 profit to cover just his salary. I'd bet they're losing money.
  - anoncow 13y ago
    Outsource the engineer. At 30-40k salary per annum, they can scrape by on 625 to 833 deliveries a month. 20-28 deliveries a day. You still have to look at paying the delivery guys and managers.
johnrob 13y ago
The article actually missed one angle: increasing cost of living. It's not just that prices are dropping for services like food/trasportation/etc, but that it's happening while rent prices are going up. If anything, local service prices ought to be rising along with rent. It's doubly striking that they are dropping.
sharemywin 13y ago
Their workers aren't independent contractors because they don't offer their services to multiple companies. The IRS will figure this out and get their taxes. Next, eventually when the employee count is big enough they will sue for things like minimum wage, breaks etc. also, it takes nothing to start one of these businesses and compete therefore profits can't get too big. The business doesn't really scale.
pbreit 13y ago
There's possibly some decent arguments in there but they are shrouded by inanity. They aren't "profitless-on-purpose". They understand the simple fact that a dollar is better spent building the business than sitting in a bank account. The author simultaneously degrades startups for not having other business lines to fund them while also degrading the VCs that do. The retirement funds care about returns not portfolio business model nuances. Pretty much every credible "money losing" business I've seen needs to be able to project out profitability at modest scale. Google Shopping Express and Ebay Now are far more perplexing form a cost perspective. If physical businessed can't compete on cost then rents need to come down or they need to figure out how to benefit from their advantages (location, service, etc).
mathattack 13y ago
Remember that Priceline had a history of loss leaders. Amazon was patient in making money too. A couple million here or there is pennies if you're funding the next big thing. This turns into a way for companies to subsidize early adopters. Yes, the interface may not be perfect, and you never know what will appear in the box, but if you'll give us a go, you'll get an $8 lunch that might just be good... Sounds fair.
- smacktoward 13y ago
  Not all startups are created equal. The biggest difference between (say) Amazon and the startups discussed in the article is that the startups in the article are aggressively local. "We deliver lunch in the Bay Area" doesn't scale to other communities as easily as "We ship books to anywhere from a giant warehouse in the middle of nowhere" does, since the former requires building up local infrastructure (meal prep, delivery, legal/regulatory compliance, etc.) for each expansion.
  - mathattack 13y ago
    Fair enough. If a VC wants to toss money at them, why not?
deleted 13y ago
[deleted]
cookerware 13y ago
I remember a coworker telling me in a condescending tone 'this is how a startup runs, you break even and try to expand market share, burning investors cash and growing without profit' when I asked about how it is that our company that has not made any profit in the past 4 years serving enterprise customers is able to still be solvent. What if investors suddenly stop injecting cash? Financials would be negative in the first quarter. I never understood the working models of growing at the sole expense of investors money. Because I don't know but last time I checked capitalism and free market still is king, and they always have a history of major market correction. When something's not efficient or something's offplace, market has a tendency to correct itself, in a big, unexpected, ruthless sort of way and we've seen this again and again, but history seems to teach people nothing.
beat 13y ago
Wow, this article is kind of clueless. First, the VC money isn't going to cost-cutting - it's going to growth. In theory, virtualizing the business processes should lead to higher efficiency and naturally lower costs. This model has been proven out in other fields - it's the Big Box model of retail that created giants like Wal-Mart (although a better comparison would be specialist big box retail like Guitar Center). So the VC money is going to building out the business model infrastructure, not selling a sandwich cheaper than the local shops. Second, these businesses on the edge don't have enough market share to make a massive dent in the local market - and it's ludicrous to think that they could do so by losing money on transactions at scale. By the time they pose a real threat to local business, they will be profitable. They must be, because the markets are too large to be subsidized by VC forever. Third, a lot of the businesses that are threatened are not "mom and pop" at all. Taxis? That's a local oligarchy protected by politics. Food delivery? Ever heard of Domino's Pizza or Jimmy John's? Fourth, these can create new opportunities for local business. I can now get food delivered to my door by one of these startups, but the food comes from excellent local restaurants (the mom and pop ideal) that otherwise could not possibly get a delivery service working profitably. They've outsourced the business model, not the food prep. And then there's the handwringing about how the long-term professional institutional investors who run pension funds and the like might go broke on venture capital, not realizing what a tiny sliver of that market VC is - it's a diversification strategy, not a core. The biggest concern would be if a VC collapse led to a broader stock market collapse, a la the dotcom era. Not likely. Yeah, dumb article.
- jbooth 13y ago
  You totally missed the point of the article. The lunch that guy described is impossible to deliver for $8 in the US, and especially in SF. That business makes no sense, ever. Losing money while making a unit profit on that lunch, ok, let's see where that goes. Getting my business by selling to me below cost? I'll do business with you all day but as soon as you raise the price, I'll switch to the next startup offering me a subsidized lunch. There's nothing 'long view' about that. No vision there. This trend, if it's as big as the article makes it seem, is way more worrying to me in a 'bubble' sense than the color.com thing.
lauradhamilton 13y ago
Interesting argument, but I sort of doubt that local small businesses and bootstrapped startups really need to worry too much about VC-backed startups that truly lose money on the the margin. In general startups that lose money on the margin do not last very long. Anyway, if the theory is that this food delivery service is selling under cost in order to get rid of the competition, well, then they are going to be displeased to discover that the barriers to entry for a food-delivery service are not particularly high.
lazylizard 13y ago
meanwhile, enjoy your consumer surplus.

76 points by joshreads 13y ago

As someone who recently accepted a job in silicon valley, I've started to become concerned that there is a bubble. I feel there are many parallels between 1999 and today. I would love to be convinced otherwise because I am concerned with job security, but I can't escape the feeling that the "music" will soon stop. At the very least I'd like to hear people's opinions on whether there is a bubble or not

highace 13y ago
If it looks like a bubble and acts like a bubble...
Edmond 13y ago
It is unlikely that those who stand to profit from a bubble would acknowledge it....up until the housing market came crashing down there was a continuous stream of people on CNBC talking up the market....the same happened in the first dot com bubble, you can expect the same now. The new excuse is that even if there is a bubble it will be contained. It does seem an entire bubble economy has been created in SV where bogus companies provide bogus products and services for other bogus companies. Maybe in this case any collapse would be contained, but I guess we'll have to wait and see. As the expression goes: Anything that can't go on will stop.
- ritchiea 13y ago
  Isn't the crazy thing that it can go on? There's enough money at the top of the economy that the rich can keep investing in startups as an asset class and not really feel the losses even though they seem huge to those of us who get by on a salary from a job. The real question is: will the investments keep coming? My guess is it continues. Hedge funds as a whole also perform below market but see continued investment because of the promise that they will have tremendous returns when a firm succeeds. Startups get money from the same sort of investors. People who are only investing a portion of their portfolio, chasing big returns and mostly unconcerned about losing some money along the way.
  - waterlesscloud 13y ago
    So it's a new paradigm and it's different this time?
    - ritchiea 13y ago
      I don't think I said anything like that. All I said is there is a culture that embraces the sort of risky investment that VCs make & that hedge funds are comparable investments. Let's take a reasonable definition of a bubble: when the price of an asset has risen much higher than what is justified by the market. By that definition I don't think we're in a bubble, I believe investors are logical and they know they are taking risks chasing a large return. I also believe investors will continue to chase big returns from tech companies and that there is precedent for this behavior in other types of investments.
LandoCalrissian 13y ago
So the biggest difference to me is that the 1999 bubble was completely built on the backs of everyday investors. It was a rush to IPO and easy money, and eventually the market got wise and the whole thing fell apart. The new paradigm is far more interesting, since it's almost all the investment comes from VC and Angel Investors. I think these entities can leverage risk far better, since they may lose a few million here and there, but when they hit a whale they really hit big. I think there might be 'micro bubbles' within the industry that may implode under their own weight (F2P mobile games companies come to mind), but I think that's largely separating the wheat from the chaff. I know some will disagree with me on this analysis, but I don't really subscribe to the sky is falling theory. The tech industry is now big business, that's not going to change.
- ajiang 13y ago
  Regardless of my opinion on whether or not we're in a bubble, the argument of "it's different this time because..." is used in the build up of every bubble we've ever experienced. Stock bubble? Economic stability and the wonderful controls the Fed has on monetary policy. No more economic cycles. First tech bubble? The internet is a wonderful thing we haven't had before - new opportunities, etc. Everything is different until it isn't.
- GFK_of_xmaspast 13y ago
  Right now there's so much money sloshing around here because (a) there's nowhere else for it to go and (b) everybody's doing it. What happens when there is somewhere else for it to go?
GFK_of_xmaspast 13y ago
Of course it's a bubble. Stack that paper now.

dalek2point3 13y ago

tl;dr the author argues that the ultra-cheap venture backed services are a problem because while they're using money from VC firms and being patient, they're driving out local businesses, and they'll ultimately fail, leaving a hole in the local service ecosystem.

arbuge 13y ago
If that's the problem, it should eventually autocorrect when the investors give up permanently and local businesses return.
- wffurr 13y ago
  That word "autocorrect" masks quite a lot of suffering on the part of local business owners who close up and lose their livelihood and investors (including pension funds, retirement accounts, etc.) which lose their money. Sure, in the long run it all works out, but in the short term there's quite a lot of turmoil.
  - smacktoward 13y ago
    As John Maynard Keynes put it, "in the long run we are all dead."
- notahacker 13y ago
  Even if that invariably happens it's not much consolation to the local business owners bankrupted because their skinny margins couldn't compete with the "disruptive" idea of running at a massive loss for two years. Venture capitalists make a loss inducing formerly marginally profitable businesses to make a loss represents a deadweight loss to society overall even if the service gap gets filled. That said, most of the named business lines are those particularly easily replaced even if the threat of other VC-backed businesses coming into the market still exists: those inclined to open sandwich shops or market themselves as handymen aren't likely to be too worried about more online threats emerging in future, and the savvier ones are instead figuring out how to get profitless startups to provide them with low cost marketing.

bthomas 13y ago

Does Uber Black Car really subsidize UberX? I find it hard to believe that UberX isn't profitable alone - Uber just takes 20% of fare.

johnrob 13y ago
If they don't pay the drivers enough, there won't be any drivers. 20% is probably not a hard rule.

rdudek 13y ago

How do we know that some of these businesses are losing money? Looking at the menu of SpoonRocket that the author listed, you could make the same meal for less. I have a feeling that the profit margins are very low, but I do not think they're in the negative.

aantix 13y ago
Paying employees, executives, money for the car leases, gas, all while located in SF? An $8 meal, they make it at $4. With one avg engineer on salary at 125K, (~10K a month), you'd have to sell 2500 lunches with a $4 profit to cover just his salary. I'd bet they're losing money.
- anoncow 13y ago
  Outsource the engineer. At 30-40k salary per annum, they can scrape by on 625 to 833 deliveries a month. 20-28 deliveries a day. You still have to look at paying the delivery guys and managers.

johnrob 13y ago

The article actually missed one angle: increasing cost of living. It's not just that prices are dropping for services like food/trasportation/etc, but that it's happening while rent prices are going up. If anything, local service prices ought to be rising along with rent. It's doubly striking that they are dropping.

sharemywin 13y ago

Their workers aren't independent contractors because they don't offer their services to multiple companies. The IRS will figure this out and get their taxes. Next, eventually when the employee count is big enough they will sue for things like minimum wage, breaks etc. also, it takes nothing to start one of these businesses and compete therefore profits can't get too big. The business doesn't really scale.

pbreit 13y ago

There's possibly some decent arguments in there but they are shrouded by inanity. They aren't "profitless-on-purpose". They understand the simple fact that a dollar is better spent building the business than sitting in a bank account. The author simultaneously degrades startups for not having other business lines to fund them while also degrading the VCs that do. The retirement funds care about returns not portfolio business model nuances. Pretty much every credible "money losing" business I've seen needs to be able to project out profitability at modest scale. Google Shopping Express and Ebay Now are far more perplexing form a cost perspective. If physical businessed can't compete on cost then rents need to come down or they need to figure out how to benefit from their advantages (location, service, etc).

mathattack 13y ago

Remember that Priceline had a history of loss leaders. Amazon was patient in making money too. A couple million here or there is pennies if you're funding the next big thing. This turns into a way for companies to subsidize early adopters. Yes, the interface may not be perfect, and you never know what will appear in the box, but if you'll give us a go, you'll get an $8 lunch that might just be good... Sounds fair.

smacktoward 13y ago
Not all startups are created equal. The biggest difference between (say) Amazon and the startups discussed in the article is that the startups in the article are aggressively local. "We deliver lunch in the Bay Area" doesn't scale to other communities as easily as "We ship books to anywhere from a giant warehouse in the middle of nowhere" does, since the former requires building up local infrastructure (meal prep, delivery, legal/regulatory compliance, etc.) for each expansion.
- mathattack 13y ago
  Fair enough. If a VC wants to toss money at them, why not?

deleted 13y ago

[deleted]

cookerware 13y ago

I remember a coworker telling me in a condescending tone 'this is how a startup runs, you break even and try to expand market share, burning investors cash and growing without profit' when I asked about how it is that our company that has not made any profit in the past 4 years serving enterprise customers is able to still be solvent. What if investors suddenly stop injecting cash? Financials would be negative in the first quarter. I never understood the working models of growing at the sole expense of investors money. Because I don't know but last time I checked capitalism and free market still is king, and they always have a history of major market correction. When something's not efficient or something's offplace, market has a tendency to correct itself, in a big, unexpected, ruthless sort of way and we've seen this again and again, but history seems to teach people nothing.

beat 13y ago

Wow, this article is kind of clueless. First, the VC money isn't going to cost-cutting - it's going to growth. In theory, virtualizing the business processes should lead to higher efficiency and naturally lower costs. This model has been proven out in other fields - it's the Big Box model of retail that created giants like Wal-Mart (although a better comparison would be specialist big box retail like Guitar Center). So the VC money is going to building out the business model infrastructure, not selling a sandwich cheaper than the local shops. Second, these businesses on the edge don't have enough market share to make a massive dent in the local market - and it's ludicrous to think that they could do so by losing money on transactions at scale. By the time they pose a real threat to local business, they will be profitable. They must be, because the markets are too large to be subsidized by VC forever. Third, a lot of the businesses that are threatened are not "mom and pop" at all. Taxis? That's a local oligarchy protected by politics. Food delivery? Ever heard of Domino's Pizza or Jimmy John's? Fourth, these can create new opportunities for local business. I can now get food delivered to my door by one of these startups, but the food comes from excellent local restaurants (the mom and pop ideal) that otherwise could not possibly get a delivery service working profitably. They've outsourced the business model, not the food prep. And then there's the handwringing about how the long-term professional institutional investors who run pension funds and the like might go broke on venture capital, not realizing what a tiny sliver of that market VC is - it's a diversification strategy, not a core. The biggest concern would be if a VC collapse led to a broader stock market collapse, a la the dotcom era. Not likely. Yeah, dumb article.

jbooth 13y ago
You totally missed the point of the article. The lunch that guy described is impossible to deliver for $8 in the US, and especially in SF. That business makes no sense, ever. Losing money while making a unit profit on that lunch, ok, let's see where that goes. Getting my business by selling to me below cost? I'll do business with you all day but as soon as you raise the price, I'll switch to the next startup offering me a subsidized lunch. There's nothing 'long view' about that. No vision there. This trend, if it's as big as the article makes it seem, is way more worrying to me in a 'bubble' sense than the color.com thing.

lauradhamilton 13y ago

Interesting argument, but I sort of doubt that local small businesses and bootstrapped startups really need to worry too much about VC-backed startups that truly lose money on the the margin. In general startups that lose money on the margin do not last very long. Anyway, if the theory is that this food delivery service is selling under cost in order to get rid of the competition, well, then they are going to be displeased to discover that the barriers to entry for a food-delivery service are not particularly high.

lazylizard 13y ago

meanwhile, enjoy your consumer surplus.