Negative Gross Margins

http://avc.com/2015/10/negative-gross-margins/

by subnaught • 11 years ago

79 47 11 years ago

avc.com

ameyamk• 11 years ago

I wonder if companies like door dash/ instacart are operating at negative margins?

Uber tinkering with price too much has not gone down well with uber drivers in bay area either.

sokoloff2• 11 years ago

Uber is [edit: almost] certainly not operating at negative gross margin.

kasey_junk2• 11 years ago

My hunch is the same, but why do you say "certainly"?

prostoalex• 11 years ago

They prefer to open an office and hire support staff within each location they operate. In some markets (LA, SF) the revenue from rides quickly outpaces the cost of supporting those offices, in others (Spokane, Halifax) it remains to be seen.

kansface• 11 years ago

Uber makes a nice profit in mature markets, but that does not mean their current margins are sustainable. Its hard to imagine a future where they don't pay drivers more.

7Figures2Commas• 11 years ago

The even bigger question is what their margins will look like if they're forced to reclassify all or most of their contract workers as employees. Both DoorDash[1] and Instacart[2] are facing class action lawsuits over this.

[1] http://www.latimes.com/business/technology/la-fi-tn-grubhub-...

[2] http://www.xconomy.com/san-francisco/2015/08/06/instacart-ex...

evtothedev• 11 years ago

It'll be a sad (and pricey) day in San Francisco when everything starts costing the right price. (I'm looking at you, Lyft Line and Caviar and Square.)

enahs-sf2• 11 years ago

The prices of Caviar fastbite have been slowly creeping up.

gohrt• 11 years ago

If we could just get a VC-backend housing startup, SF would be utopia, until the music stops.

enahs-sf2• 11 years ago

We're losing money, but we're doing it at scale.

anjc• 11 years ago

Well, yeah. That's what the current bubble is based upon, private equity speculation.

It should be pointed out, though, that you can't really analyse many of these startups by looking at their income statements in this fashion, because even their future monetisation strategies are being speculated about. That is, they aren't expected to have healthy bottom lines yet. They're doing this on purpose.

Ultimately, private and public investors will analyse the bottom lines of these companies, but when that happens, there'll be bigger problems to face than a few orgs with unhealthy gross profits struggling, i.e. the bubble will burst.

Incidentally, I'm not sure why the article is specifically talking about gross margin. Especially since most of these company's costs relate to human resources and servicing debt and so on, and not inventory and production. It seems like operating profit or net profit would be a better single figure to focus on.

cs702• 11 years ago

Reading this, an old joke and something Hemingway wrote come to mind.

The old joke is about a retailer whose margins were very thin but wanted to attract more customers, so the retailer decided to have a big sale. After looking at the proposed discounts, an assistant questioned the strategy, noting that they would lose money on each transaction. The retailer said, "That's okay -- we'll make it up on volume!"

The Hemingway bit is this gem from The Sun Also Rises: "'How did you go bankrupt?' Bill asked. 'Two ways, Mike said. 'Gradually and then suddenly.'"

It's understandable for startups who don't yet have a business model not to make any money. In fact, that's what one expects of them. But unicorns are NOT startups; they're fairly sizable businesses that already have a business model, with large organizations, lots of overhead, repeatable processes, etc. It is very risky for companies at such a late stage in their life cycle to still be losing money on every incremental dollar of revenue!

Someone should start a Unicorn Death Watch ;-)

jameshart2• 11 years ago

Paging @pud.... he still owns fuckedcompany.com, maybe it's time to bring it out of retirement?

toomuchtodo• 11 years ago

I got in touch a few weeks ago and it seemed like he wasn't interested in reviving it for the next onslaught of failures. I'd be game to run fuckedunicorns.com if anyone wanted to contribute with me.

jlarocco• 11 years ago

It's understandable for startups who don't yet have a business model not to make any money.

I don't understand how anybody can value a company without a business plan and some idea of how to make money at anything higher than zero dollars. Do they even meet the qualifications for the traditional definition of "company" if they have no plans to make money?

It seems to me as long as venture capitalists are okay investing shit tons of money into silly "startups" that don't know how to make money we're just going to see bubble after bubble after bubble.

It's tempting to speculate that the people inflating this bubble are the ones who managed to cash out of the first dot com bubble before the crash came. Most "real" investors learned their lessons the first time around, and want nothing to do with it. It would explain why so many "unicorns" get such a tepid response when they finally IPO.

GFischer• 11 years ago

I like Steve Blank's definition of startup:

"A startup is an organization formed to search for a repeatable and scalable business model."

So, by definition, you don't know how much it's worth using traditional valuation methods you'd use for "normal" companies, so investors use other indicators like growth, number of users, etc. (which can be gamed).

As the grandparent post states, "unicorns" are companies that already have a repeatable business model, so they should start to be looked at differently.

It's in the "unicorn's" best interests to be valued as a startup for as long as possible, that's one reason they cling to the title far after it's not applicable. It's also a status symbol :) , but it sounds silly when people talk about their "10 year old startup".

thaumaturgy2• 11 years ago

This reads like another iteration of a bubble alarm, which has been going off since 2007 at least (https://news.ycombinator.com/item?id=9860603). I like the sound of what Fred's saying, it gives my sensibilities about business a soothing caress, but the reality is that people have been expecting these businesses to start failing en masse for almost 10 years now and so far most of them are still around.

As long as there's no better vehicles for investment, these companies will probably be able to keep doing what they're doing.

the_watcher2• 11 years ago

There are plenty of businesses with net gross margins that have failed. The difference this time is that there are more companies with net gross margins reaching "unicorn" status.

aidenn0• 11 years ago

Most of the businesses with negative gross margins from 2007 aren't around, a few managed to become profitable, some failed, and many were acqui-hired.

I think we are just starting to hit the point in the last year or so in which you can really say "bubble" but it could pop tomorrow or in 5 years... there's a famous quote about trying to invest by betting against a bubble that is roughly "The market can stay irrational longer than you can stay solvent"

idlewords2• 11 years ago

It (sincerely) baffles me that Fred has to make this point, and that it's not treated as obvious.

People who are deeper into startup world than me, what is the thought process that makes you think you can scale up a money-losing venture and have the math work out? Is it based on the hope of raising prices, or being acquired before funding runs out, or pivoting?

There are a lot of smart people in this game, so there has to be some intermediate mental leap that I'm not understanding.

the_watcher2• 11 years ago

Because it has worked. That's the main reason. A related reason is the volume strategy Wilson mentioned. If you are in a business where you know that you can get discounts with bigger volume, there is a coherent business case to acquire customers at a loss until your per-unit costs fall sufficiently. The problem is that, like Fred writes, this is much harder in practice than in theory.

x0x02• 11 years ago

A guess: take Instacart.

Plan A: They know that people spend $x billion on groceries per annum in sf. They also know that a big chunk of that has to be very expensive real estate and relatively expensive employees who have to be able to afford to live relatively close to sf.

If you can build a warehouse an hour out of sf on dirt cheap land and recover the cost of grocery stores in sf, plus shave some off employee wages, maybe you can make a profitable business out of grocery delivery. This business will need a lot of volume to cover fixed costs. Why will they succeed when Webvan failed? More comfort with online shopping and delivery, cheap labor via exploiting underemployed people, including dumping infrastructure costs off onto employees by making them use their own cars.

Plan B: Google is in a death match with amazon. To first approximation, G's business is taxing ecommerce by owning discovery. If people start on amazon not google, google loses. So google is building out google express because if they don't, amazon ends their business. Therefore maybe instacart is strategic to google.

I don't think I believe A or B, really, but VC is a gamble. If someone can make it work, it's a $1.4T/year market [1]

Oh, and people don't earn billions by taking safe bets.

[1] http://www.ers.usda.gov/data-products/ag-and-food-statistics...

idlewords2• 11 years ago

Thanks for writing this out. It's food for thought.

I will say that every bet is a safe bet when it's not your money.

interesting_att• 11 years ago

There are two ways VCs can make money from investing in companies like this:

1) Hopefully by increasing prices + slashing their own expenses (i.e. Uber reducing the driver's share), some of these cash burning companies can be instantly profitable. Idealistic for sure, but not out of the question.

2) Using the startup as a vehicle to raise more funds from investors- Remember that the VC is mainly just concerned with getting the company to the next funding round. Take this hypothetical: VC firm invest in company X at a 50m valuation. In 1 year that company raises at a 100m valuation. Even if it's an overpriced valuation and the company eventually has a huge chance of dying, the original VC firm can say that their fund already has a 2x annual return before that happens. They use that as marketing material to raise the next round. Remember that VCs get around 2% of whatever they raise for operating expenses, regardless of how the funds perform.

If you are a VC in a bubble, it is in your financial interest to raise as many funds as possible in the shortest amount of time as possible. That in turn means you have to invest big and invest quick.

adventured• 11 years ago

The example of this I've been benefiting from lately, is Jet.com. They keep handing out $x or 20% type discounts, to go with free shipping on items already priced for low margins.

I can't imagine how much money they must be burning right now. With Jet recently abandoning their business model, they're either somehow making enough on what they're selling as is, or they're in bad shape and desperate to bring in customers.

pixelparts• 11 years ago

It took Facebook quite a while before they became profitable. The issue is with the lack of lock in. The "on demand" and service type startups are easier to substitute. It's just another challenge though. I could see Uber reach a point where they raise prices by 25% and I'd still pick them over another service with fewer drivers available.

azylman• 11 years ago

Comparing to Facebook seems like comparing apples to oranges. The article is about selling physical goods and services for less than it costs to produce them, which is different than allowing people to access a service that you don't yet know how you're going to pay for.

A better analogy might be companies that manufacture video game consoles, where they almost always sell at a loss when a new console is first released, with the hope to make profit in the long term - but there you're locked in to some extent, as you pointed out.

jakobegger• 11 years ago

The bigger problem I see is that all the service oriented startups are getting into a market that can't work. Yes, there obviously is demand for cheap services. But there is no way to provide cheap services at scale and turn a profit. The costs of providing a service don't go down as you get bigger. At some point you just can't drop wages anymore. At the same time, you can't just increase prices, since that would immediately kill demand. There is demand for cheap services. There is no demand for reasonably priced services. The problem is not that raising prices would allow the competition to undercut them. If they raise prices, people would just clean their homes themselves etc.

tedmiston• 11 years ago

But there is no way to provide cheap services at scale and turn a profit. The costs of providing a service don't go down as you get bigger.

Unless you automate it.

Maybe Uber's plan at scale is to replace all humans with self-driving cars (http://www.theverge.com/2014/5/28/5758734/uber-will-eventual...).

Maybe SpoonRocket's plan at scale is to effectively be mobile vending machines for hot food.

Obviously I'm speculating, but the general principle applies to a lot of what startups do already as they grow.

Negative Gross Margins

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