
Negative Gross Margins - subnaught
http://avc.com/2015/10/negative-gross-margins/
======
cs702
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 ;-)

~~~
jlarocco
> 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
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".

------
evtothedev
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.)

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

------
idlewords
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.

~~~
x0x0
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...](http://www.ers.usda.gov/data-products/ag-and-food-statistics-
charting-the-essentials/food-prices-and-spending.aspx)

~~~
idlewords
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.

~~~
x0x0
Gambling with OPM is the best. Heads I get rich as fuck, tails you lose.

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

------
thaumaturgy
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](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.

~~~
aidenn0
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"

------
ameyamk
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.

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

~~~
kansface
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.

~~~
jonknee
It's actually hard to imagine a future where they pay drivers at all. Uber is
tailor made for autonomous vehicles.

~~~
jameshart
Then they will pay vehicle owners to lease their cars short term instead.

~~~
username223
Evil... And I'm almost certain it's what they'll do. Owner pays for purchase,
upkeep, parking, and insurance, covering all the capital outlay, depreciation,
and risk, while Uber skims off the profit. It's sort of "insurance in
reverse."

~~~
morgante
What is "evil" about instigating a more efficient use of capital?

~~~
username223
Where do you get efficiency out of their plan? People tend to underestimate
the true ownership cost of their cars, and Uber uses that to make them believe
they're making a lot more per hour than they actually are.

~~~
morgante
Capital sitting idly in driveways is inherently inefficient. How is that hard
to understand?

> People tend to underestimate the true ownership cost of their cars, and Uber
> uses that to make them believe they're making a lot more per hour than they
> actually are.

That isn't an argument about its efficiency though.

Maybe the marginal value of a car self-driving itself somewhere is $1 and the
marginal cost of that driving is $0.99—it's still more efficient for that car
to drive than not. Whether the owner thinks their profit is $1 or 1 cent
doesn't really matter.

------
anjc
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.

------
jakobegger
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
> 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...](http://www.theverge.com/2014/5/28/5758734/uber-will-eventually-
replace-all-its-drivers-with-self-driving-cars)).

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.

------
adventured
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
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
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.

