
Unit Economics - _sentient
http://blog.samaltman.com/unit-economics
======
yorkedork
While I'm not intending to be heavy-handed and reductionist, I think the
(macro) trend(s) we've seen in (domestic) startup investment since 2008-2009
can satisfactorily explain this behavior.

Disinflation & deflation, capital flows and political friction preventing
effective (any?) fiscal policy have produced an environment where private
capital set on a given rate of return on investment is chasing increasingly
risky organizations [1][2].

Large firms have been sitting on enormous sums of cash; e.g., why is it that
the most capitalized company on earth isn't investing aggressively. In lieu of
investment, many of these firms have been focused on engineering stock
buybacks.

So, the thesis: why are so many firms pouring money into startups with
increasingly questionable fundamentals? Because hands previously gripping
bundles of capital have (nominally) more capital than they did with decreasing
options for productive investment and downward pressure on returns.

1\.
[http://www.economist.com/blogs/freeexchange/2015/04/puzzles](http://www.economist.com/blogs/freeexchange/2015/04/puzzles)

2\.
[http://krugman.blogs.nytimes.com/?s=low+inflation+return+inv...](http://krugman.blogs.nytimes.com/?s=low+inflation+return+investment)

P.S. I recognize that I'm probably a bit left field for this group as I'm not
a libertarian, I support strong regulation and I question the marginal value
of lots of Valley products.

~~~
idlewords
I think this is a pretty clear failure of capitalism, since the whole point of
having greedy, top-hat-wearing capitalists chasing profits is to have them re-
invest that profit in the hopes of making more. In the meantime, they compete
with each other and end up magically allocating resources in a socially useful
way.

Instead, big companies sit on their profits (like you say), while startups
compete for the attention of a small group of investors who behave for all the
world like the central planners of old, deciding how to allocate money based
on their own tastes, interests, and gut feelings, rather than anything
resembling a market test.

 _Goes off to have red flag dry-cleaned_

~~~
sbuttgereit
A failure of capitalism? I have to question the premise. Capitalism does not
have as a goal some social-utilitarian purpose. Capitalism is practiced by
individuals for their own self-interest. Sometimes they work together for a
shared self-interest (e.g. corporations, investor groups) or they work against
each other as needed (competition). But you cannot take self-interest out of
the equation and still have capitalism. Every trade (be that stock for cash,
or work for cash, etc.) is predicated on each of the parties fulfilling their
individual needs and wants to the degree that they can. On it's own terms,
capitalism hasn't failed at all.

What you can say is that capitalism has failed to mollify those that seek non-
capitalistic goals. This is true of some so-called capitalists who experience
guilt in pursuing their self-interest as well. If your view is that
capitalists are "greedy, top-hat-wearing" types that fail to meet your social
welfare goals, then my bet is your characterization masks a larger purpose.
Primarily at bringing them down, probably in favor of the central planners of
old (or some degree thereof).

Perhaps the real question should be: why would companies and individuals with
captial choose to sit on it, or choose to spend it on relatively worthless
start-ups? Why would a capitalist choose to sit on cash or buy-back shares if
there are other, more profitable avenues to invest those funds? I think if you
take a critical look at it you might find that there's still a fair amount of
central planning behind what we'd like to think is a capitalist economy.

~~~
cwyers
I mean, when Adam Smith says "It is not from the benevolence of the butcher,
the brewer, or the baker, that we expect our dinner, but from their regard to
their own interest," he's not saying that in support of self-interest, he's
saying that in support of OUR DINNER. The point of capitalism as economic
system is not that self-interest is inherently good but that self-interest can
be yoked to "some social-utilitarian purpose."

Of course, Adam Smith's opinion of corporations was "The directors of such
[joint-stock] companies, however, being the managers rather of other people’s
money than of their own, it cannot well be expected, that they should watch
over it with the same anxious vigilance with which the partners in a private
copartnery frequently watch over their own," and he thought they'd all die out
unless they were propped up like the East India Company, so it's not like the
Wealth of Nations is much of a guide to what we call capitalism nowadays. But
still.

~~~
sbuttgereit
Adam Smith was wrong with the regard to the moral case for capitalism. He
rightfully recognized why people acted, but he failed to recognize any
substantive moral basis is such self interested actions; instead he resorted
to the precise premise that the post I originally responded to pre-supposed.
That argument must fail because one cannot act with self-interest AND
altruistic interest consistently. The capitalist must always fail on these
terms as there is always someone with a perceived greater need, and perceived
greater right, to the capital of the capitalist.

If you consider first and foremost your own happiness and life as a moral
value worthy of pursuit, you loose the hang-ups that Adam Smith had with
capitalism. There's a whole separate discussion that goes down that path about
what constitutes self-interest in the large (and no, defrauding innocents is
not your best interests); but that's a bit out of scope to what the original
poster stated.

~~~
philwelch
I think the Ayn Rand viewpoint--that self-interest is intrinsically a moral
good and that capitalism is justified by this moral good--is not very widely
held as a justification for capitalism.

~~~
eropple
I think modern American political discourse makes this a harder position to
take. Which is not to say it's correct, because it's transparently not, but
selfishness-as-Godliness is a firm part of the American right wing, self-
styled libertarians included.

Greed's been good since the eighties, didn't you get the memo? =(

------
roymurdock
Kept waiting for him to drop the phrases "network effect" and "economies of
scale" but it never happened. AKA burn to acquire users until you're so big
that you can throw your weight around to reduce costs ala Amazon. The holy
grail of software startups.

Given this post, I think it makes sense that YC is pivoting to include more
hardware startups in its portfolio. Software is so saturated that people are
starting to regard the majority of it as free. The people who do pay for
services like Twitter & Facebook are the advertisers and business owners who
have probably observed questionable ROI on average for the past few years.

I don't expect a bottle of coke to be free, and I don't expect a condom [1] to
be free. So the "unit economics" make more sense in hardware
(tangible/consumable product) land. Network effects are still important, but
shipping a product and _collecting revenue from each sale_ even if you still
have negative margins lengthens your ability to stay in business, giving you
valuable time during which you might hit critical user mass or achieve
economies of scale.

[1] [http://techcrunch.com/2015/08/09/y-combinators-l-condoms-
pro...](http://techcrunch.com/2015/08/09/y-combinators-l-condoms-provides-
safe-sex-on-demand/)

~~~
dirtyaura
> Software is so saturated that people are starting to regard the majority of
> it as free.

This doesn't match my experience at all. To me it seemed that throughout the
00s both consumers and small businesses were unwilling to pay anything for the
cloud software, but tide has definitely turned. Now, all smart small companies
I know don't blink an eye to spend hundreds of dollars per month for various
cloud subscriptions and consumers are starting to pay for software both on
mobile devices and cloud SaaS.

~~~
nostrademons
I get the sense that small-business SaaS companies can usually charge (after a
short free-trial period), but consumers are still very reticent to pay for
software. There are some services that are the exception (eg.
Spotify/Netflix), but generally those are industries that were very large
_before_ software came along, and they replace incumbents (eg. RIAA/cable)
that people used to pay for as well.

~~~
dirtyaura
Yes, consumers are much more willing to pay for content-driven services -
after all they are mostly consuming, not creating. But if you observe niches
and prosumers (who are creators), they are already paying for software. And
niches can be huge on global scale: think about running, cycling, gym
training. Or pets, dogs, horses. Investing. Knitting. Photography.

You are totally right that they are currently much more reticent to pay for
software than businesses but based on my anecdotal observations, I think that
the trend line is growing and accelerating. I also think that for consumer
businesses, you have to be a bit more creative with your monetization models.
Cost/benefit calculation of subscription model is an easy task for small
businesses, but consumer spending has always been much more erratic in the
physical world also, thus subscription models are not necessarily the best fit
for consumer space.

------
martian
The number of companies that have bad unit economics is, I agree,
substantially higher than it should be. But I'm not sure this explains the
bubblegum expansion of valuations and rounds we're seeing today. There are
many thoughtful comments on the perceived bubble from people all over the
industry. I'm not qualified to say one way or the other, but I did enjoy Mark
Cuban's recent post on the matter. [1]

My company, Thumbtack, got a lot of this right early on. Years ago we doubled
down on getting the unit economics right. So right that we were (IIRC)
profitable for a month or two before taking a big VC round. Not sure how many
other companies can say that. But at the end of the day, if the bubble is a
bubble and it pops, knowing that we would survive and be able to make a profit
is hugely satisfying.

My advice to any young startup is figure out how to make money early on. It's
the rare Google/Facebook that can blow up and use the platform to sell ads.
Most startups will not do this, but many can still make good money doing
important things that people will pay for.

[1] [http://qz.com/356620/mark-cuban-is-absolutely-convinced-
we-a...](http://qz.com/356620/mark-cuban-is-absolutely-convinced-we-are-in-
tech-bubble-and-its-worse-than-the-last-one/)

------
pbreit
I've gotta think one category he's talking about are the delivery services. I
still have not seen a decent articulation of the end-to-end economics. But
they can't be terrific.

I know, for example, that Sidecar pays drivers up to $20 for a single delivery
and just can't see how this is viable outside of rare exceptions. At least
Instacart prices the item being delivered (and I suspect never gives you the
yellow ticket price which pretty much every Safeway item gets nowadays).

~~~
exelius
I agree; delivery services will only make sense with autonomous delivery
(which I suspect is the long-term plan for all of them - Uber included). But
realistically, the R&D required there is crazy if you're trying to be first to
market - Amazon and Uber are investing billions in this, and they're the
competition.

Once drones or autonomous cars become widespread, this business becomes a
commodity and anyone without a legacy business they have to migrate will be at
an advantage. So I have no idea why these companies are getting funded other
than it's a problem that's simple enough for a really smart university student
to tackle.

~~~
_sentient
Uber is profitable in many of its mature markets. This is while charging less
than half what you would pay a legacy taxi service, while paying drivers more
than they would make at the same.

This is the direct byproduct of strong network effects on both the
supply/demand side, paired with operational excellence on their part.

Self driving cars would bring the marginal cost down even further, but they
have built a stunningly good business with or without a quantum leap in
automation.

The same probably isn't true for many other Uber-for-X companies, particularly
those with underwater unit economics.

~~~
lifeisstillgood

      Uber is profitable in many of its mature markets. This is 
      while charging less than half what you would pay a legacy  
      taxi service, while paying drivers more than they would 
      make at the same.
    

What? Seriously? Are you saying that say the cost of a "medallion" is more
than twice the cost of all other costs in a taxi service? Can you give any
examples?

~~~
nemo44x
The average NYC taxi driver does not own a medallion. A couple years ago they
traded hands for $1,000,000.00. Most of them are owned by companies which have
many hundreds if not thousands of them.

These companies rent the medallion for 12 hour blocks to drivers and would
charge them between $175-250 per block. Before Uber there were many more
drivers than medallions and drivers would bid the price of renting the
medallion for 12 hours up!

Drivers who worked full time and took a few weeks off would spend around
$40,000.00/year on renting the medallion. A cab that was rented for 24
hours/day all year would easily generate $90,000.00/year for the owner of the
medallion.

With Uber the companies that own the medallions (and more so those that took
massive loans to acquire them) are the ones hurting. The drivers are just
fine, if not better. And even taxi drivers I've spoken with like Uber because
medallion owners are desperate for drivers now and are charging $100-$150/12
hours. They just want to get the cars out of the garage.

Uber drivers expenses that are different from cab drivers include a car
mainly. Something that costs far less than the money they gave medallion
owners and something they can write off big parts of on their taxes. And they
can use it on their free time.

~~~
lifeisstillgood
But ... [https://www.gov.uk/vehicle-licences-private-hire-taxis-
londo...](https://www.gov.uk/vehicle-licences-private-hire-taxis-london)

License cost is 154 GBP (200 bucks) annually in London. Not a million. I maybe
misunderstanding a lot of the cost issues in taxi services but it seems the
medallion cost is a huge racket - but that's hardly a global issue?

~~~
_benedict
That's not a "Black Cab" which would be the equivalent of NYC yellow taxis. A
private taxi cannot be hailed on the street, I assume much like yellow taxis.
This was once a major advantage, but uber (and equivalent apps) make it almost
irrelevant.

Becoming a Black Cab driver is much harder than renting a medallion, though.
You have to pass "The Knowledge" which is considered at least as hard as
passing a university degree. You have to have an encyclopaedic knowledge of
London roads, and generally spend at least a couple of years (often longer)
driving around those roads on a scooter so you can demonstrate that knowledge
in a series of tests.

I'm not sure if the problem is similar in other major cities, but I expect
there is _some_ form of cartel in force in most of the major cities.

However, even if there isn't, there is still a real advantage to profitability
from something like uber: if there are enough customers using a passenger
exchange, then the likelihood of having passengers near to you is
significantly higher. So less of your time is spent in unbillable transit to
your next customer. In London there are hundreds of taxi firms; each of them
gets some share of the passengers calling them up, so they have to take what
they can get. With a central exchange, they get the passengers most suitably
located for them from all possible passengers.

------
ececconi
The one product that I use and pay for that is so good that I recommend to all
of my friends is Spotify. I'm so surprised how few of my friends actually pay
for it though. They're willing to put up with ads and reduced quality for just
$10 a month.

Other services I found so good that I recommend to all of my friends but do
not pay for because my data needs are very small are dropbox and evernote. I
bet some of my friends wonder why I wouldn't spend such a small amount of cash
for their usefulness.

Getting people to pay for digital services is hard.

~~~
jobu
> They're willing to put up with ads and reduced quality for just $10 a month.

I see two reasons for this:

1) Free is huge. Most people are willing to put up with a lot of bullshit for
free.

2) Netflix. We pay $7.99/mo for essentially infinite TV on multiple devices,
but $9.99 only gets me audio on one device at a time. It seems like a worse
deal, so why would I pay?

~~~
martian
Also: never underestimate laziness. Typing in a credit card takes work.

Re: Netflix/Spotify price differences. The relative size of the libraries (vs
all content in the domain) is something to keep in mind. Netflix gives users
access to some videos, but Spotify gives users access to almost all songs [1].

[1] Can't find precise estimates for sizes of libraries, so apologies for the
argument from anecdotal evidence.

~~~
ghaff
OTOH, $120/yr for music is, depending on your assumptions and how you measure,
actually pretty high compared to what people have historically spent on
recorded music. [1] I know I've been on the fence about paying for a
subscription given that I already have a big library of most of the music I
care about. It's not so much that I'm too lazy to subscribe but I'm very slow
to sign up for services that are going to hit my credit card every month.

Netflix video streaming is close to worthless for movies. But combined with
DVDs it's pretty good.

[1] [http://recode.net/2014/03/18/the-price-of-
music/](http://recode.net/2014/03/18/the-price-of-music/)

------
brianmcconnell
What's driving a lot of the idiotic investment is FOMO (fear of missing out).
It is a powerful thing and can override a rational assessment of a businesses
chances for success.

This combined with a lack of historical perspective is dangerous. Nearly
_every_ smartphone app you see had a voice/phone counterpart a few years ago
(remember 777-FILM or #TAXI?), most of them are long dead, and were killed off
by the same market forces that will release their latest mimics from their
mortal coil.

~~~
seiji
This is why there's a dearth of reasonable funding these days. VCs, the bad
ones (which most of them are), are flock-driven creatures. Nobody wants to
step out of line, and that's a problem when something new, novel, or actually
different walks in your door. The flip side of FOMO is "if nobody else is
doing X, I won't do X either."

Startups can get $100k in seed money by yelling on the street in soma.

Startups can get $100 million by tickling andreessen in the right spot and
chanting forbidden words from the before time.

Nobody can seem to get $5 million to bridge the gap between living-in-coder-
poverty and being able to hire a real team for more than two months.

------
bsder
There are two sides to this:

1) A business with good fundamentals doesn't need a VC.

If I've got cash flow, I can probably get a loan with a bank on much better
terms than any VC will give me.

If I don't have cash flow, well, okay, I need a VC. But then, tautologically,
my business doesn't have good fundamentals.

2) VC's _only care about unicorns_.

Since VC's make up their whole portfolio based around the 100X+ returns on a
single company wiping out the losses from the rest, fundamentals are
irrelevant. Being in the hot buzz which enables you to flip to somebody else
for 100X is far more valuable.

A business with good fundamentals sells for about 10X which is nowhere close
enough to offset the rest of the losers.

~~~
eldavido
Re (1), I just tried to get a loan from Wells Fargo last week for a consulting
business with a few hundred K in annual revenue, and it was an _incredible_
pain in the ass (multiple years of balance sheets/income statements, tax
returns, trips to the bank, and all for, like, 25% of one year's profit-sized
loan) -- there's truly an opportunity to disrupt small business lending, but
the hard part there is capital aggregation.

------
exelius
Low margin businesses are all the rage because all the large, high-margin
opportunities are either gone or have such huge barriers to entry that
startups have to raise a half billion dollars before making an honest attempt.

At least that's what I see. Not that we shouldn't chase the expensive ones,
but I don't know that VC is the right framework for that.

~~~
nostrademons
Maybe the solution to that is to go after small, high-margin opportunities,
ideally growing ones.

[http://paulgraham.com/startupideas.html](http://paulgraham.com/startupideas.html)

~~~
exelius
This is currently the model that most big consulting companies use: find a
thousand niches and fill them all with people. I have a feeling that if you
enter these markets as a startup, you'll find they're not really as high
margin as they look, and that the margin will get eaten up by integrators
anyway (integration work doesn't scale exponentially and causes your
costs/outputs to lag your pipeline).

Anyway it's not a bad idea; just not one I feel is especially well suited to
the VC investment model.

~~~
nostrademons
I think the idea is to pick niches that are small now but will become big in
the future. Build the only programming language available for the Altair and
you have a high-margin monopoly on a market of a few thousand machines. Build
the only operating system for every IBM PC and clone, and you have a high-
margin monopoly on a market of hundreds of millions of machines.

That's behind the common SV wisdom of "catch a wave", "ride a trend that's
larger than yourself", "find markets, don't try to create them", etc.

The pitfall is that it requires some degree of future-prediction, and
predicting the future is left as an exercise to the entrepreneur. The guy who
built the first programming language for the Altair is the richest man in the
world; the guy who built the first programming language for the Alto [1] has
largely been forgotten by history.

[1]
[https://en.wikipedia.org/wiki/Xerox_Alto](https://en.wikipedia.org/wiki/Xerox_Alto)

------
LordHumungous
It's pretty funny that this even needs to be said, but for some reason it
does. This stuff is business 101. Irrational exuberance anyone?

~~~
spinlock
On the one hand: who cares? It's private, non-leveraged private money. It
isn't a debt bubble like the mortgage crisis and hasn't infected the public
markets like the 90's. Caveate Emptor and all that.

On the other hand: the suckers at this table are pension funds and other LPs
that are terrible at picking managers. A few good years of returns and money
will flood from underfunded pension plans into VC .... just in time for a nice
healthy correction. If I was relying on a pension to retire in the next decade
or two, then I'd be worried.

~~~
JonFish85
"It isn't a debt bubble like the mortgage crisis and hasn't infected the
public markets like the 90's. Caveate Emptor and all that."

I've heard that a lot, but I wonder if it's as harmless as people say? If/when
this bubble pops, won't that have a pretty tough spiral effect? Granted it
might not be as deep as the late-90's bubble, but I'd have to think that this
will be pretty grim when it happens too.

Along with sky-high valuations come sky-high salaries, which breed high rent &
purchase prices for homes. Along with that comes high tax revenue and such.

If suddenly a young engineer's expected income drops from $150-$200k/year to
$60k, that could be pretty rough. Granted it probably will affect the coasts a
lot harder than the central US, but I'd think it'd have national effects
regardless. Salaries drop, suddenly people can't afford their houses, so they
either have to sell at a loss or try to hold on to it. What if a sizable chunk
of the population is no longer able to afford college loans?

You also mentioned the pension problem; if tax revenue starts to dry up
because housing prices goes down, that could exacerbate a problem that's
already popping up around the US.

~~~
shostack
You know, I've long wondered this for the Bay Area.

The question in my mind is...how much of the housing crisis, rents, and raw
population are coming from people employed by startups that are most at risk
of this?

Google, FB, Apple, Adobe, etc. have strong revenue (perhaps other issues, but
there is no argument that there is money to be made and that they are making
it). They also employ massive numbers of people. If a so-called funding bubble
bursts, is it really going to make a dent in the other areas like you suggest?
Or is the bulk of the "tech industry" comprised of the larger tech companies?

If it is the larger tech companies, and a bubble bursts, it might provide less
flexibility for leaving to start your own thing, and there may be overall less
competition, but they still compete against each other for top talent, and
need way more resources than a startup does.

------
eldavido
@sama: right on with this. SV $ metrics are always measured in revenue growth,
not free cashflow, margin, etc. Measuring revenue works fine for high-margin
businesses, which software has been for a long time.

Now that we're using VC to finance resource-intensive SaaS companies (e.g.
analytics) and even cleaning/home care/service companies, there's a need for
collectively higher financial sophistication.

Revenue growth is a good proxy when you're selling zero-marginal cost
products; not so when you're selling 95 cents of cost for $1.

~~~
kansface
It seems like VCs ought to be more sophisticated than to naively apply the
model for SaaS to low margin consumer facing products, but I don't know enough
- this really could be the case.

Similarly, I have no understanding of all the money that flows into the space
(from the outside). The margins are low (to non-existent) and the space is
brutally punishing. Screw up a persons laundry, food order, or plain just take
too long and you have to give away a year's worth of margins to keep the
customer. Delivery as a service is a commodity - who cares who delivers your
food or does your laundry? At the same time, the cost of switching between
providers is as close to zero as it gets (they are doing home delivery after
all!). In the parallel universe that is SF, VCs subsidized (thanks!) the
industry to the tune of making it comparable (or actually cheaper) in price
for me to pay someone to pick up my laundry, wash and fold it, and return it,
to doing it myself at a coin operated laundromat. Whenever the service I used
raised prices to stop hemorrhaging money, I simply switched to their latest VC
funded competitor.

~~~
S4M
I think you explained very well why HomeJoy failed this summer.

------
zxcvvcxz
Does anyone else think that these unoriginal, doomed-from-the-start startups
are a direct result of funding institutions looking for founders that appear
really good "on paper"? You know, experience with this BigCo, a degree at that
IvySchool, etc. Even YC may be becoming guilty of this, as it seems like a top
school brand is a prerequisite.

Or the more sinister metric, _do you have growth?_ PG wrote that
startup=growth, and that growth is the all-encompasing metric. Might this
incentivize some prestige-seeking 'entrepreneurs' to _do things that don 't
scale_ like pumping money into convincing users to join their website, or
making fake accounts?

Not that growth and a founder's unsustainable touch early on aren't excellent
things for which to strive. But in any system in which there is prestige to be
gained, there will be those who will match patterns and fool the heuristics of
the gatekeepers.

------
Mahn
The worst part of it is that companies with bad unit economics are not just
shooting themselves in the foot for the sake of "growth" or simply faking
hotness, but that in acquiring users for more than they are worth they
effectively drive acquisition costs up for everyone else in the industry.

------
cm2012
As a side note, unless you have a secret sauce (something unique to your
company, like better proprietary data, lower operating costs, etc.) all
acquisition channels will decline in effectiveness over time, making it harder
to make unit costs work. This is generally known as audience fatigue.

------
the_economist
You have to admit, though, that there is nothing quite like the feeling of
paying $7 for an Uber pool to go all the way across San Francisco, especially
when it's surging 3.9x.

------
moistgorilla
I was nodding my head in agreement until I got to this line

> where you make more than you spend on each user, and it gets better not
> worse as you get bigger, you may not look like some of hottest companies of
> today, but you’ll look a lot like Google and Facebook.

Wouldn't Facebook be an example of a company with bad unit economics?

~~~
steego
You're accounting for Facebook's and Google's business model all wrong. The
end users aren't the customer. Advertisers are the customers. Think of
Facebook and Google more like giant hydro-generation plants that have to
continually work to divert the flow of attention of its users to its
customers.

Like any hydro-generation plant, you want to capture a monopoly from this
recurring source of income so you can dictate premium prices from your
customers.

~~~
nostrademons
They also have basically zero user-acquisition costs, on both the user and
advertiser side. CAC (customer acquisition cost) is usually the largest
variable cost for most businesses. Things like server costs, electricity, etc.
are tiny in comparison. Cut CAC and your margins skyrocket.

Indeed, the reason why Google & Facebook are profitable is because they're a
very effective way of cutting CAC for other businesses. Their revenue is
another businesses's marketing spending, and yet they're _still_ better than
the alternatives for driving customer conversions.

------
aliston
_First they talked about valuations being too high. Then they talked about
valuations not really meaning anything. Then they talked about companies
staying private too long. Then they talked about burn rates._

The first 3 are essentially the same thing and the 4th is related.

------
shubhamjain
I don't get why we always cite Google, Facebook, WhatsApp, Instagram as an
example of companies that have shown the way. While, those companies are great
in their work and business, they didn't really start with an aim of providing
value but as just-another-side-project. Why do we ignore the thousands of
online businesses that might not be raking in billions but are successful by
every measure? A reason why I look forward to products like Bare-metrics, and
AeroFS.

The problem I see with seeing these companies as an example is that most
people think around the ideas that they feel good about. It is disappointing
that so many people are just driving towards building another photo sharing
app or a low margin business.

~~~
mbesto
Google and Facebook are cited because they generate an ungodly amount of
cashflow/profit and have manage to do it in a smaller timeline than their
equally financially regarded counterparts (Google took 15 years to reach that
of the revenue that took Coca Cola took 100+ years to reach).

I'm curious as to why you consider Baremetrics a success and by what measures?
No offense to the guys at Baremetrics (they're product is well executed and I
reference their SaaS metrics constantly), but their financial performance is
not great [0] given their funding raise and valuation [1]. They're losing more
customers than they gain, they're presumably cashflow negative (for a team of
6 engineers at competitive salaries, you're looking at $750k/year cost) and
their ARPU/LTV numbers are really low (in relation to their low number of
customers). Right now they're getting 10x on revenues, which is crazy high.

[0] -
[https://demo.baremetrics.com/?start_date=2013-11-13&end_date...](https://demo.baremetrics.com/?start_date=2013-11-13&end_date=2015-09-20)

[1] - [https://angel.co/baremetrics](https://angel.co/baremetrics)

------
minimaxir
Let's extrapolate the argument to the second order.

Mobile gaming, for example, has bad Unit Economics. Games like Candy Crush
Saga and Game of War spend absurd amounts of money in acquisition.

...which is Facebook and Twitter's primary revenue stream.

There is a possibility of a domino effect.

~~~
austenallred
> Games like Candy Crush Saga and Game of War spend absurd amounts of money in
> acquisition.

Yes, because they know on average every person that starts using the app makes
them $1.50. So they spend a lot of money acquiring users at $1 each. That's
not a failure of unit economics.

~~~
minimaxir
If those numbers were the case, then that definitely would be correct.

But cost to obtain the average user is $3, nearly double from what it was last
year. [http://venturebeat.com/2015/04/30/it-costs-more-than-3-to-
ac...](http://venturebeat.com/2015/04/30/it-costs-more-than-3-to-acquire-a-
mobile-user-now-fiksu-finds/)

I strongly doubt the average user spends $3, given that the current freemium
environment is hedging by offering freemium perks for free periodically to get
user retention. Which makes them less likely to actually spend money.

~~~
malisper
Candy Crush brought in $1.5 Billion dollars in revenue in 2013[0]. In 2014 it
had 93 million users[1]. That means Candy Crush brings in at least $16 / user
/ year. I'm guessing they don't really care what the cost per acquisition is
when they are making that much per user.

[0] [http://bgr.com/2014/02/18/how-much-money-does-candy-crush-
ma...](http://bgr.com/2014/02/18/how-much-money-does-candy-crush-make/)

[1] [http://www.gamespot.com/articles/93-million-people-play-
cand...](http://www.gamespot.com/articles/93-million-people-play-candy-crush-
saga-daily-do-you/1100-6417819/)

~~~
minimaxir
Huh, I thought CCS revenue was an order of magnitude lower. My mistake.

In that case, the numbers make more sense.

------
KaiserPro
Its the classic suspension of disbelief.

Previous companies made a loss, but in the end started to make a stonking
profit (google, airbnb)

However they seem to be the exception not the rule. Currently in london there
is an explosion of highly integrated iphone ebay apps. Quite why they (the
investors) think its a great idea to fund so many clones is beyond me.

But then the economics of startups are odd. like broadcasting seeds, you
expect infant mortality. However this acceptance of utter failure has creeped
up from the seed funding stages into series a,b,c and even d (twitter still
cant make money.)

Its fine if you manage to sell your shares onto the next sucker. But the
problem is that each round bring a bigger price of failure.

------
applecore
In today's environment, it's better to be one of the "hot" companies with
presumably poor unit economics.

Otherwise, your competition will out-market and out-sell you every month
simply by spending more money.

~~~
vinceguidry
If you can achieve profitability, then you could presumably wait for your
competitors' business models to fail and then rake it in when all their
customers have to migrate. They pay all the costs to build up your customer
base then go away.

~~~
nemothekid
> _then you could presumably wait for your competitors ' business models to
> fail_

Isn't that essentially playing the market? You might be waiting until the
bubble bursts - which puts you in the same position as everyone else trying to
short this bubble thats supposed to pop any day now.

And even if you are profitable now, the effects of a bubble doesn't mean you
will be profitable afterwards.

~~~
vinceguidry
The market is not a company.

If you're playing anyone, it's your competitors. Understanding your
competitors is much easier than understanding the market. Actually running a
business in the space makes you much more familiar with the unit economics of
it. If the market fails, that is, if people decide they no longer wants the
service you're both offering, then you're both hosed.

If you feel there's a bubble, that is, if you feel that demand for a product /
service is going to eventually collapse, then the rational response is to get
out of that market, assuming your position is liquid enough to do that, and
invest in asset classes that will do well if and when the market collapses.
You don't start taking short positions unless you have specific reason to
believe a specific company isn't looking good. Otherwise volatility could
cause you to lose a lot of money in a very short period of time. Also, you
can't short a whole market, you can only bet against it.

------
amelius
What I don't get is this: the freemium pricing model is often used, but what
few people seem to know is that selling below cost is also called "predatory
pricing" [1] and it is illegal. And there are good reasons for that. So... why
are we letting the market get ruined by this phenomenon?

[1]
[https://en.wikipedia.org/wiki/Predatory_pricing](https://en.wikipedia.org/wiki/Predatory_pricing)

~~~
grkvlt
Not exactly, and I'm not even sure 'freemium' falls into these categories
anyway. Selling in a way that is deliberately designed to drive off
competition is illegal, assuming you can prove it. Selling below cost is just
called 'making a loss' and is perfectly legal, if generally unsustainable ;)

Here are two scenarios:

1\. I sell product A at a loss, intending to attract customers who will then
buy product B at much higher margin, making me a large profit - legal.

2\. I sell A at a loss to attract company X's customers and drive them out of
business, then raise the price of A once they go bust - illegal and predatory
pricing.

~~~
amelius
Yes, but what is happening right now is that start-ups are taking funding,
build a brand on VC money, hence drive everybody else practically out of
business (and blocking potential newcomers), while making losses year after
year.

To me that sounds pretty much like predatory pricing (and anti-competitive
behavior in general).

~~~
nostrademons
Only in the particular industries they operate in. And the whole point of this
essay (and the reason this is a problem) is because _these are bad industries_
, known to have bad economics, and companies are using VC money to paper over
the bad economics.

Just ignore the herd and look for overlooked industries which _don 't_ have
bad economics. That's what you have to do to survive as a startup founder
anyway.

It's pretty analogous to the family next door who goes and buys a yacht on
credit cards even though their income can't support the payments. Yes, it's
annoying to watch people have nice things they didn't earn, and yes, they do
marginally prop up the price of yachts. However, were you really planning on
buying a yacht anyway? They will get their come-uppance when the bills come
due, and it's not worth worrying too much about what other people are doing in
the meantime.

------
ykumar6
The exception may be for companies that have clearly recognized network
effects.

In this case, your product may not be valuable without a lot of users,
customers or cars .. You need to spend to get to critical mass, but I'm sure
it's important to articulate a plan on why your business becomes profitable
from that point onwards.

Too often, there isn't a tipping point or that tipping point is very hard to
reach and companies never become profitable

------
beat
Moving matter rather than information is inherently expensive. A lot of the
current darlings are about moving matter around. Their best bet is to achieve
monopolistic dominance by being radically more cost-efficient than the old-
school industries they disrupt, but it's still expensive.

------
highCs
Advise for game developers: that's why you should not do clones or games which
looked different but are actually clones - like not-so-innovative 2d
platformers. If you think about an innovation for your next game, think about
it twice, will it drive sells, really?

------
satjot
Homejoy seems to be the most recent example of non-sensical unit economics.

------
tvladeck
The reason this is complicated is that the burn rate of the business is
determined its net margin (NM) and the viability of the business is determined
by its contribution margin (CM) (NB I didn't say gross margin - they are
slightly different).

CM is _extremely_ hard to calculate because "fixed" costs - in practice - do
scale with the number of customers. But on the other hand, if you have a
positive CM, it may make sense to invest heavily in capacity, leading to
negative NM.

------
LAMike
Is Sam talking about Fanduel and DraftKings?

~~~
powera
Those two certainly apply IMO, they both have The Next Zynga written all over
them. Any investment where you have to spend the money buying every ad on TV
has a red-flag that the valuation isn't nearly what people claim it is.

Actually, Zynga itself is another one (though it's a public company). I don't
see any evidence Zynga will ever be a profitable company, and it has no
valuable assets, so I think it's fair value is pretty close to $0.

~~~
vinceguidry
TV ads can be quite price-effective if you have the right strategy, are
catering to a broad enough market, and have a good pro. Fantasy football has
such broad market appeal that pretty much any ad buy is going to reach a
significant number of people that play it.

