How To Fix A Broken Business Model: 3 Case Studies
Almost every business model works on a simple principle: sell a product or service that has a higher value to its buyer than the costs required to provide that product or service. For centuries—millennia, actually— that has been the main requirement for any trade.
But things change: in the past two decades we’ve seen an increasing amount of companies selling their products or services at a loss in order to increase their user base and gain market share over competitors. Many agree that this strategy was made popular by Amazon, which reached its current status of internet giant starting by selling books for less than what they were paying them.
While this has worked out pretty well for Amazon, many other companies across several verticals are trying to pull it off with less success, relying on investors’ money to keep fuelling their growth, offering an under-priced service loved by users but that are not sustainable in the long term.
Three sectors in particular have made this pricing strategy their “new normal”. All three are somehow related to mobility, but we’ll get into that later. We are talking about ride-hailing, delivery and scooter-sharing.
In this blog, we’ll examine relevant examples for all three categories and try to understand if – and how – they will ever be able to adjust their business model economics towards profitability.
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Thanks to the recent IPOs of Uber and Lyft, the ride-hailing sector offers a rare insight into the financial conundrum that these companies are facing. Uber has reported a loss of over $3bn during the 12 months prior to its IPO, Lyft’s loss was $1.8bn. Their revenue growth has also slowed down massively, with the latest quarter-on-quarter figures being 1% and 4% respectively.
Despite the two companies’ apparent financial troubles, both went public at multi-billion dollar valuations – with Uber claiming the title of highest valued start-up in the world for a few years before that. In fact, ride-hailing is ubiquitous in most big cities, in large part due to its low price point.
There is only so much that users will be willing to pay for an Uber ride: that’s the company’s curse and blessing. As much as they tried implementing measures in order to tweak their business model (think surge-pricing, price tiers that go from pooled rides to luxury cars etc) they still cannot manage to turn a profit.
The paradox is Uber is so popular that it provided 5.2 billion rides last year, but even with only 58 cents lost per ride on average, the sum of those losses adds up to a massive amount. And while the average customer would probably pay half a pound more for the same ride, that would give competitors a chance to steal those customers by under-pricing their rides.
However, this competition on price can’t go on forever like an endless game of chicken. Investors’ money will eventually run out and companies will be forced to raise their prices, then we’ll see how much customers are really willing to pay for a ride, but most importantly who they will buy it from.
Scooter sharing has been taking the streets by storm, with several ambitious and well funded companies rapidly crowding what does not seem like a huge market.
The two main players, namely Bird and Lime, raised a total investment of $1bn in just over two years, however they both keep reporting huge losses that are not justified by any substantial revenue growth. In particular, Bird reportedly loss almost $100m in Q1 2019, while its revenue shrank from $40m to about $15m.
Just as ride-hailing companies, scooter-sharing ones also face a business model paradox. Their unit economics are inherently unbalanced: they “forget” about profit in an effort of gaining traction among users, yet these users are young adults and teenagers, the part of the population that hardly earns any money. This makes it seem very unlikely that they will ever be able to raise their prices enough to sustain costs.
Many have responded to such dilemma arguing that once revenues are big enough to cover the upfront cost of purchasing the scooters, the model will work. Others have suggested Uber-style tweaks such as monthly or day passes. Some say that we just need to wait for the technology to catch up, with bigger batteries and higher durability, but others dispute that even arguing that the claim that electric scooters are eco-friendly is just false.
We’ll see about all that. For now all we know is that a lot of cash is burning.
About as “old” as the ride-hailing sector (and somewhat interconnected thanks to Uber Eats), food delivery has also found its ways towards profit. Upfront delivery fees, premium over in-store prices, encouraging tips etc. However, overall, almost all companies in the delivery space are still failing to be profitable, an exception being GrubHub, which enjoyed first mover’s advantage although it is now being outcompeted by other better-funded players.
DoorDash and Instacart, both approaching their respective IPOs, are now rushing to get their finances in order and to follow their competitor’s example, sneaking in those additional prices in order to be in the green.
Of the three sectors in this blog, Delivery’s business model seems the only one with a defined path towards profitability, but it has its limits as customers who don’t want to spend too much for a meal still have plenty of options: go out and buy it from the store, use food they have at home, heat up something frozen etc.
Finding the price point
For now, on-demand start-ups face so much price competition and have so many resources to fund their losses that it’s tough to say what costs the market really will bear.
To what extent are consumers paying because they are getting a good deal? The ability to buy a service for less than the cost of providing said service has its appeal.
When the flush venture funding goes away, will we pay what it really costs? And if we do, will we do so regularly? Transaction volume is essential for these businesses to cover their overheads, so they’ll need to be careful with any price adjustments they’ll choose to make in the future.