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Living here in Silicon Valley and working with as many venture capitalists as I do, I can’t escape discussions of “The On Demand Economy”. If you aren’t familiar with this, it is an investment thesis of many investors and includes companies like Uber, Shyp, Luxe, Instacart, and many more. The premise of these companies and this investment thesis is, “anything on demand”. With a request from a mobile device, you can have almost any product or service delivered to you, any time, anywhere. Basically, pizza delivery service for practically anything.
In case you haven’t been following this space closely, the trend started in China with what the locals call O2O or online to offline. It is by far the biggest mobile internet trend in China. You can request to have food, a car wash, a massage, your house cleaned, a vast array of gadgets and household items, fresh groceries, practically anything. The kicker and the key to know about this trend in China is the speed of O2O services. In nearly every case, you can have said goods or services delivered within an hour and often times within 30 minutes.
This Wall St. Journal article tells the tale of Car8, an on-demand car wash service, which ran out of cash. This is not the first tale of such a failure and it won’t be the last from China, the US or abroad. At a fundamental level, the business model requirement for many of these companies is scale. Many companies are operating at razor-thin margins, even at a loss, in order to make up for the low profits or negative customer acquisition cost in scale. These startups pour in millions of dollars to acquire customers, make nearly nothing on them but hope they get enough of them to grow and be profitable some day. Sounds familiar to an era past and lessons learned. But there are several interesting points and observations to make when thinking about this incredibly hot category.
First, US-based on demand services lack two critical things which make many of these O2O services in China successful. They lack scale and they lack low wage workers. The reason these services have a chance in China is because, in a city like Beijing, there are over 19 million people living in relatively close proximity. In Shanghai, there are over 22 million people. Several large tier 1 (meaning more developed and wealthier) cities have populations between 8-11 million people. China has an estimated 700+ million people in cities. Many of them living in developed cities and are considered part of the rising middle class, with higher disposable income. Contrast this with the United States where only 10 cities have populations of over 1 million people. Number one is New York with over 8 million, Los Angeles with over 3 million, and Chicago with just short of 3 million people. I make these points because on demand startups like the ones I mentioned will require scale of close proximity urban living and this is something China has at much greater numbers than the US.
Secondly, China has low wage workers. This is probably the most salient point about the contrast of the two on demand economy markets. In China, you can not only have goods or services delivered in an hour or less but at costs only slightly above what it would be for you to go out and acquire the goods or services on your own. The economics work for not just the wealthy. Contrast this with the US where I know of a CEO of a large startup in San Francisco who pays $25 for a burrito once a week to have it delivered to his office from his favorite burrito joint. He could have walked down the street and paid $8 but instead wanted to stay in his office and work.
Another example I’m fond of is Luxe. Mostly because I use this service all the time when I go to San Francisco. Luxe is a company where, with the touch of a button, I set my location and someone will come to me and park my car. Luxe’s average hourly rate is $5 which by contrast, parking in most places in San Francisco is $2-3 dollars every 15 min. Luxe is a great deal and very convenient. The secret is they are parking the car in the same lot where I would have to pay much higher fees than $5 an hour. While it is likely Luxe has struck a deal with some parking lot establishments, it is the low-working wage part that has me worried about their model. Luxe’s Valets ride around on skateboards or scooters and most of whom I encountered look like college kids. They are likely making a decent enough wage but none of these kids are going to be full-time valets as a career. So churn will be high and the economics of cost between parking, wages, and other logistics means Luxe likely has barely any to negative margins. Scale is their answer. Yet knowing there is a much lower total addressable market in the entire US than China, the question is what number do they need to hit to be profitable and how big is the ceiling? Now parking may not be Luxe’s only model. They can offer to have your car washed, serviced, and maybe have the driver run errands for you. The bottom line is the dynamics many on demand startups are using in the US is totally different than China and thus will operate differently. The lack of low-wage workers in cities where these startups need scale is a huge challenge.
The China angle is important because, even with the scale of many hundreds of millions of potential customers and low-wage workers, these O2O startups are already struggling. I’ve spoken with many who describe the startup scene in China to me and I observe a great many patterns happening which bear similarities to the dotcom bubble in the late 90s in the US. While I know many investors have learned from the first dotcom era, it is all new to China and will likely see many public crash and burns. Investors in the US are already guiding these startups to have more sustainable business models. But we will also see many case studies of on demand startups where failure is an important lesson.
Lastly about Uber. Uber seems to be one of the companies many investors don’t seem to criticize too heavily when they are sending warning signs to the on demand economy. Part of this is because many are investors in Uber but also because Uber seems like they can get global scale and don’t necessarily depend on low wage workers. While I’m not saying Uber is immune to dynamics impacting many other startups in the on demand economy, they seem to be more sheltered from them. They are absolutely burning cash and their customer acquisition cost is high, but their business model scales quite well. As I pointed out here, being a taxi service is not their only way to employ people who are happy to drive around all day for a job.