Sharing Economy Shakeout Forces Startups to Face Fundamentals

Businessman touching virtual social network

The headlines are everywhere. Homejoy flopped after it failed to reconcile its own definition of “employee” with that of the tax code. Instacart and Postmates, which have achieved the popularity of becoming household names, have also come to find they cannot make subsidized transactions translate to profit.

It turns out that being the ‘Uber of [insert business here]’ is generally not a good idea. Many sharing-economy startups are finding out the hard way that physical, real-world logistics get in the way of margins. Companies that pull their heads out of the unicorn-infested clouds and examine the hard facts of their business—what people are willing to pay for, how they want to receive it and how to deliver it cost-effectively—will either pivot into a successful business model or find a reason to exit. Everyone else is simply drawing out the pain.

Internet economics vs. real-world business
Just as characterized the first dotcom bubble, another yet-to-be-determined failure will characterize the modern slain unicorn.

Much VC money has been funneled into startups that approached their respective business models using ‘Internet economics’—a language that VCs can understand, but doesn’t translate to the real-world economics of sustainable business models. They are approaching real-world problems with rose-colored glasses: Land and expand and monetize later! Anything will work as a service! They pass off iron-clad logistics laws as trivial issues to be sorted out later.

Shipping and delivery, for example, is an industry that adheres strictly to the laws of physics, geography and time. Newly minted startups and VCs have largely ignored or simply don’t understand the economic complexities involved in moving physical objects from A to B and that’s why many startups are in the position they face today. A quick look at the past year for Instacart shows all the signs of a startup wrestling with reconciling its initial practices with reality—the company most recently cut pay to its contractors by more than 40 percent in some cases, and in preceding months raised customer delivery prices and subscription costs by more than 50 percent.

Even Amazon, a company that has invested heavily in the supply chain, has troubles matching delivery revenue with delivery costs. According to one article, Amazon’s outbound shipping costs rose 374 percent from 2011 to 2015, while its revenue failed to keep pace, rising just 320 percent. Unlike small sharing economy startups trying to compete in this realm, however, Amazon can do things like invest hundreds of millions of dollars in transportation aircraft to ensure those percentages grow near and eventually overlap in its favor. Even legacy companies like UPS and FedEx have had to raise prices recently to deal with the changing landscape of shipping, which has come to include larger than parcel items, with both nearly doubling the extra fee to deal with such items.

How to save a sharing economy startup
Without the basic fundamentals figured out and critical mass to support the economic model, venture dollars will only last so long. And that’s really what we’re seeing now: mostly on-demand, same-day delivery and sharing economy startups facing the challenge of severe burn rates.

So, what can a sharing economy startup do to bring its business model back to fundamentals and stay afloat as funding continues to dry up for the foreseeable future?

With delivery still being a crowded space, companies need to look at driving rapid growth through digital and offline marketing and enhancing their supply side. For example in delivery, find ways to reduce friction and create just as compelling a value proposition for the transporters providing the service as for the people doing the shipping.

As we watch things shake out, the companies that are going to make it will pay attention to the ins and outs of real-world logistics, while offering true innovation in terms of process, both for providers and consumers. In other words, those businesses will return to fundamentals, which can be broken down into three critical steps:

  1.  Have a value prop consisting of products and services that a large number of people want and are willing to pay for.

In the case of Amazon, for example, the breadth of products offered combined with a fast delivery time ensured by an Amazon Prime membership (which also offers streaming online media, among other perks), provides a strong value proposition. Uber, meanwhile, found an industry where latent demand far outpaced supply, and prices may have been artificially high, making it ripe for disruption.

To survive the shakeout, sharing economy startups need to take a similar approach and really focus on finding a product that the broader market is willing to pay for. You can’t scale a startup with a product that only a small segment of the population is willing to buy.

  1. Identify and execute the best way to get your product to the customer in a cost-effective manner.

While Amazon and Uber may use economies of scale to provide nearly instantaneous delivery, when given the choice, consumers prefer slower, free delivery over paying for instant delivery – hands down. According to a recent survey by Forrester Research, 29 percent of respondents said they were interested in guaranteed same-day delivery, but analyst Brendan Witcher noted to the Chicago Tribune that “interested doesn’t mean they’re going to pay for it.” According to a separate poll from Deloitte LLP, 87 percent say free shipping is more important than fast shipping. What it all means is that it makes more sense to be efficient so free shipping is possible than delivering in 1-2 hours.

While Uber can rely on its fleet of more than 300,000 drivers to offer auxiliary services like parcel delivery, the average startup has to offer delivery at a loss in order to keep pace. In other words, don’t kowtow to the idea that you need to subsidize same-day, on-demand delivery with venture capital – recognize that consumers will gladly accept free delivery on a delay and create a business model that is sustainable and scalable over the long run.

  1. Make money – at least at the gross profit level and prove to yourself that the business is scalable.

With funding drying up in 2016, VCs will be looking for a number of key indicators when considering further investments – among them will be monthly recurring revenue and a minimal churn. In order to remain attractive during the lean times ahead, and not become sharing economy road kill, companies will need to focus on having a clear path for revenue growth, operational excellence, customer satisfaction and cost control. If delivery is involved, every entrepreneur must be able to answer to themselves and their investors: ‘How are you going to deliver cost-effectively?’

The reality is that the sharing economy is experiencing a collective shakeout. In the long run, this is healthy for both entrepreneurs and VCs. As an entrepreneur seeking to break into this competitive realm, you can’t be afraid to shoot a bad idea with a silver bullet— and start over.