[code4tee]

There’s another often unwritten element here around companies basing their valuation on false markets. For example, if I sell $2 for $1 that’s a false market. Of course I can grow like crazy and gobble up lots of customers. I could even “disrupt” existing players like those stodgy old companies (banks) that sell $2 for $2.15 (a loan).

The VC subsidies for some of these companies are so high that they are basically selling $2 for $1 in some cases (WeWork was basically losing nearly $1 for every $1 of revenue!)

Ride share companies grew fast when they sold VC subsidized rides but have struggled to maintain that market share dominance without subsidies (lots of other players quickly move in). MoviePass sold lots of subsidized movie tickets until the money ran out.

Thus the fallacy of the whole “it’s ok that we’re unprofitable because look at how fast we’re growing” is that in many cases these companies were only growing BECAUSE they were grossly unprofitable in the form of their investors massively subsidizing purchases.

[TheSpiceIsLife]

The whole point of fast growing startups with ever-increasing valuations is to enable early investors to cash out at huge multiples.

Everything else is a side show.

[enkid]

Sounds like a Ponzi scheme

[barry-cotter]

Yeah, Amazon and Google are totally Ponzi schemes.

[Thorrez]

How do they generally cash out? Sell to other investors? IPO?

[tolmasky]

If you just thought about the "false market" like advertising, it wouldn't seem so perverse.

Coca-Cola "wastes" millions on advertising, something that doesn't directly generate profits. From a cash flow perspective, it's giving money away to advertising agencies. The theory is that you have an indirect return through building mindshare. Same goes for "good will" deeds like charitable actions by corporations or taking a hit on a product to use a more environmentally friendly component. From a completely superficial perspective, this is a deliberately inefficient action that makes the market "more false".

You could imagine a scenario where you take in a lot of VC money to jump-start the initial production of a more environmentally friendly product while still selling it at a competitive price that really isn't justified by its production costs. Is this a false market? Perhaps, but it may serve to build out the necessary pipeline enough such that the unit economics eventually work to be self-sustaining and also build a lot of brand loyalty along the way.

These are bets. Advertising is a bet on brand recognition, one that can similarly take years to materialize (see the mattress industry). Facebook was a bet that paid off. Everyone laughed at how much they took in originally too.

Of course, like all bets, there can be bad bets, and even good bets that just don't pay off. In some sense, the WeWork story should be considered a great success: the public market did exactly what it was supposed to do, shine a light at the appropriate time on a bet that had been going on too long. The real danger is when these initial stages are funded incorrectly: if a VC Fund makes a stupid bet, well, that's the game, but if a pension fund had invested in this, then it would be dangerous.

[chii]

> Coca-Cola "wastes" millions on advertising

but they don't overspend on advertising, unlike those VC funded companies. Each can makes a profit for coke, and therein lies the difference.

[marcusverus]

The poster isn't saying that companies should never buy growth by selling $2 for $1. He's saying that VC seems to be bad at avoiding companies that only grow because of this. Consider PayPal. Early on, they would pay a $20 referral fee to anyone if they could get a friend to join and use PayPal. That's insane at first glance, but it worked because those new users kept on using the product; because the product itself was viable without the subsidy. Coca-Cola is the same way. They advertise, but they turn a profit after baking that into the price of the product. MoviePass was never going to work. The subsidy was the product. That's the concern.

[tolmasky]

Are they bad at avoiding that though? Or are we greatly extrapolating from one VC in one high profile case: because that is the actual hilarious part of WeWork, it was basically entirely funded by just one VC that kept doing more rounds.

Additionally, the nature of VC is that it is high risk: you're supposed to have 9 failures for every success. So just from an "amount" of companies perspective, they're always going to seem "bad" at this I guess. That's why I used Facebook as an example. It's unfortunate that it takes very little time for everyone to forget, but the valuation of Facebook seemed ridiculous at the time. That's the nature of the beast: it's really hard to tell the winners from the losers, and thus VC is a necessarily risky enterprise. PG talks about this here: http://www.paulgraham.com/swan.html

That's why my point is that the true problem is if the capital comes from the wrong place, namely non-traditional sources of capital funding these funds due to loss of any other viable more conservative investments.

[jonas21]

And even WeWork isn't that bad. Each new location they open has large startup costs: they have to lease a large space, build it out, hire staff, do a lot of marketing -- only then can they start collecting rent from members, and it takes time to fill the space to capacity.

There's no reason to believe that they wouldn't be profitable if they stopped growing so quickly (they opened 200 locations in 2018 alone).

[TheOtherHobbes]

WeWork was profitable - for Adam Neumann.

Using WeWork funding to buy property that he could then lease to WeWork was brilliant. So was selling the branding and IP back to the company. So was borrowing money against his share ahead of the IPO - although it's not obvious how that's going to work out long term.

Was WeWork ever a serious business? Was there ever a plausible path to consistent profitability? Or was it just a cover story?

[rubicon33]

That's not an uncommon nor unheard of tactic in business. Fuel growth, and capture the market for your brand, by selling at a loss.

The trick is always the transition to profitability. Generally, this comes through layoffs and maybe price increases.

[Waterluvian]

I think the problem is that a lot of these companies are trying this strategy with Juicero-like products. The moment they pivot to profitability, anyone else can just start squeezing at a lower cost.

Is Uber or We really making something that can't quickly be copied, even at a local level, once prices are doubled or tripled?

[tempsy]

If you look at the scooter companies they are now charging $.29/minute (vs I think $.15/min a year ago).

If you rent it for an hour, that now costs more than $20 with tax. Not exactly cheap anymore.

[cannonedhamster]

That sounds like it's probably cheaper in the loan long run to buy a bicycle plus you don't look like an adult using a child's toy.

[p1necone]

Imo this should be illegal. Taking a loss undercutting smaller competitors in a way that's only possible because you have piles of money unrelated to your actual business is going to distort the market in a way that's really bad for consumers in the long run.

Anecdotally I noticed this with Pita Pit in New Zealand. There used to be lots of independent pita places that had decent pricing, then pita pit started buying them out and replacing them with pita pit chains, while still competing on price relatively well. But as soon as they'd bought out all the competitors in the area they immediately almost doubled their prices.

[hammock]

What you describe is illegal in certain manifestations. It's called predatory pricing.

[barry-cotter]

So during the expansion phase they are subsidizing consumers and as soon as the expansion phase ends they open up a space for competition again? Sounds pretty great for everyone except the owners of the independent pita places that go out of business.

[K0SM0S]

I know retail stores in France cannot legally sell anything at a loss, except during government-decided 'sales' periods (twice a year, usually in January then June) which are mostly aimed at emptying stocks for the new 'season' (as if that mattered in the 21st century when most stores are a on a bi-monthly product cycle, but hey, that's the inertia of law/gov).

Not sure about businesses in general but I seem to recall it's a general law for commerce.

The problem is that retail is thus basically unable to compete on price beyond a certain (very mild) degree, notably forbidden to say "I'll sell item X at a loss to attract customers, and then make up for it on other items they buy". It's just illegal to do it in France.

A little bit too reminescent of a planned (communist) economy if you ask me, because it applies to each and every item taken individually, not the store overall or over a certain period of time. Needless to say this doesn't help thwart the collapse of retail versus online shops, especially in the way of services — and consider that foreign online businesses don't even have to follow such regulation, obviously, so...

It's a very, very grey area to regulate, and government being just awful at understanding how business works makes it ill-suited (often misguided) to regulate such things. I think branch negociations (within a given sector) is a much better approach: let actors (businesses) decide how they will compete, and only regulate if there's anti-consumer (cartel) behavior, not prior to any wrongdoing! — it reeks of a view that 'capitalism is bad' yadi-yada (typical French view) and hurts consumers' purchasing power in the end.

[esotericn]

Wow.

So if a merchant buys in too much stock and can't offload it - they're literally banned from selling it below cost?

I assume they can still sell it on a secondary market (just not direct to customers)? Or do they actually have to eat it entirely and just like, burn the stock or something?

[K0SM0S]

Edit after the fact: called my ex-boss, she kindly reminded me that as a company we would store goods for months and sell them during "les Soldes", so yeah you get twice a year a 6-weeks period to offload your stock.

Sorry for the confusion. Note that this only applies to non-perishable goods, food for instance is treated differently. Each sector in France falls under different regulation, it's a mess, very hard to navigate.

[K0SM0S]

I'm not an expert in accounting but I assume there's a legit way to write it off as some exceptional loss and offload it, maybe even to customers; what's however certain is that if you get audited by fiscal authorities, you better be able to prove it's not fraud. (and yes, it'll be subjective, ultimately a judge's ruling I guess)

But don't quote me on that part, it's been a long time since I've worked in retail (10 years). I just know that as a brand store (Esprit de Corp) we would simply send unsold items back to the mother ship and they'd deal with it. I think the maximum allowed sale discount is around 20% outside of the bi-yearly governement-decided national sales (called "les Soldes" in French, and a high time for shopping amateurs, mostly women historically).

This all feels so 19th century / communist, I'm appalled just sharing it. But it was true as of 2008.

But hey, we get e.g. Black Friday online like everyone else, and Amazon does their Prime Days too, so... dunno what's up with that. I just know street retail is dying big time here, more than in most comparable European cities in my anecdotal experience.

[fgonzag]

That's the thing about these non tech companies though. They have fixed costs per transaction, something pure tech companies don't. So tech companies can grow at a loss because their marginal cost for each customer is zero or close to zero. As long as you are selling more, you are getting closer to profitability.

This does not apply to all these "unicorns" that have a non negligible marginal cost on their services.

[ethbro]

The South Park gnome episode comes to mind. For values of:

1 - Demonstrate growth

2 - ?

3 - Profit

https://en.m.wikipedia.org/wiki/Gnomes_(South_Park)#/media/F...

Who knew it was a billion dollar business model?

[treis]

>The VC subsidies for some of these companies are so high that they are basically selling $2 for $1 in some cases (WeWork was basically losing nearly $1 for every $1 of revenue!)

Effectively none of these companies lose money on a marginal basis. In other words, an additional customer making an additional transaction helps their bottom line. There's always two major questions. (1) Can the company grow to where their overhead is covered in that marginal revenue and (2) can they acquire the customers cheap enough.

Your statement that WeWork loses $1 for every $1 illustrates a common misinterpretation. Those two numbers have basically no relationship with each other and don't tell us anything. Imagine that WeWork wasn't a total fraud. They set up their first 10 locations for $500,000, have annual revenues of 1 million and profit of 500,000. A VC comes along and says "Shit dawg, here's 50 million set up 100 more locations". So WeWork takes that money, spends 50 million and a year setting up new locations. \

What's their financial statement going to say? That they lost 49.5 million dollars on revenue of 1 million. Obviously that's an eye popping loss, but assuming they can replicate their success it's a smashing investment. The latter part of that last sentence is the important thing. Whether or not the money these companies is investing is going to see returns or if they're wildly optimistic in their long term projections.

[ahartmetz]

Reportedly Uber did use money on a marginal basis and maybe still does. That's a big and important one.

[GhettoMaestro]

I never understood the "grow fast at any cost" mentality.

If you can't make your shit break-even or near-profitable at small scale, there is a big chance you will not be able to make it work at large scale.

[ChuckMcM]

An interesting brick and mortar example in the Bay Area was Fry's electronics. When they started, they grossly undercut all of the electronics brick and mortar stores and priced more like the distributors did rather than the stores.

As a result their business grew quickly and the other stores were unable to compete and went out of business. Then with the market to themselves they raised their prices to increase their margins. They also used access to adjacent markets (TVs, PCs, Radios, Appliances, Office Supplies) to supplement their margin which specialty retailers like Quement or Jade did not.

Their strategy was essentially to lose money on something that brought in customers, and to make extra money on other things once the customer had been acquired and was in the store.

The "grow fast at any cost" mentality is predicated on the understanding that the most difficult step of any new business is to change consumer behavior such that they go to the new business first. Once they have established that pattern they can then manipulate the pricing of their offerings in order to achieve the highest sustainable level of margin before they lose customers.

[irq11]

Agreed, but phrasing it in the “here’s what changed that most people don’t understand” language that VCs love:

“in the age of cheap money, scale is not a defensive moat”

When Fry’s was founded, it was so prohibitively difficult to get the funding to scale to their size, that competition was thwarted by lack of investment. Now? The trick is public knowledge; the funds are cheaply available to anyone able to scale a competitor. So the critical step two —- raise prices —- is impossible. Your margin is my opportunity, as they say.

What worked in 1985 when interest rates were ~8% doesn’t work when the great global pool of money is sloshing around, desperately seeking returns.

I think the actual investment dynamics are more nuanced (i.e. investors aren’t completely naive), but it’s still true that this get-a-monopoly-and-raise-prices approach is a business strategy from a very different era.

[nostrademons]

The trick still works (and is quite common), because investors apply that reasoning to the upstart, not the established business. If you go to a bunch of VCs and pitch them "Comcast is making a ton of money because they own a monopoly and steadily raise prices. Their margin is our opportunity. Give us $20B so we can build out a national 1G fiber network and take all their customers", their response will be "What's to stop Comcast from dropping their prices and increasing their bandwidth once you've spent all this money building your competing market?"

Knowing that you're the attacker and they're the defender and that most consumer markets favor the incumbent, the investor won't hand over their capital unless you can show that you've already started to take their market. And then once you have shown that you're taking a fat incumbent's market, they're happy to fork over tons because they know that every other investor's reasoning will be the same, and nobody will want to attack an incumbent that can just drop prices to fend off a challenger.

BTW, Google decided to buck the outside investors in exactly this example, funding GFiber internally. It played out basically exactly as the scenario above - the incumbents rolled out gigabit cable/fiber at competitive prices in precisely those markets GFiber was threatening, preventing them from making serious inroads. There were a bunch of other factors (like regulatory issues and the difficulty of scaling last-mile telecom), but after recent examples like that investors would rather find virgin territory rather than fight price wars in large existing markets.

(IMHO, this is one thing wrong with American capitalism today, as our system relies on cutthroat competition and aggressive risk-taking behavior by investors to get good deals to consumers.)

[megaremote]

Like Youtube, which lost money every year until it was bought by Google. Or Instagram? Or a variety of others.

You don't understand why people want to copy those models of growths and get those big payouts? Which part confuses you?

[SpicyLemonZest]

Everyone agrees with that statement. The hard question is what "can't" means. Companies with a grow fast mentality always insist they could break even, and often present financial metrics indicating they do break even with the proper adjustments for purely growth-related costs. There's no obvious rule for how much you should trust a company's adjustments.

[carapace]

“We lose money on every sale, but make it up on volume”

A bit of history of that joke: https://www.barrypopik.com/index.php/new_york_city/entry/we_...

> 6 February 1833, New York (NY) Evening Post, pg. 2, col. 2:

> Among the business anomalies which meet the eye of a stranger visiting New-York, are the placards exhibited in the windows of the retail shops, informing passers by that the stock in trade within is selling off at prime cost, or according to the more alluring announcement which some have adopted, at fifty per cent. less than cost. A person attracted by this lure to become a purchaser, must soon come to the conclusion that either the veracity of the dealer is not of the most scrupulous description, or else that he laid in his goods at enormous prices. One in the habit of passing these shops, must at least smile to perceive that notwithstanding their owners have been selling off their goods “at less than cost” for so long a time, their shelves continue to be as well filled as ever. We have heard of one individual, who “wishing to retire in consequence of declining health,” was five years disposing of his merchandise, “at prime cost,” and at the end of this time he found his capital so much augmented that he removed into a more busy part of the city, and entered into trade on a much larger scale than before. How is it that trades-people can sell their goods at less than they paid for them, and yet realize a handsome profit, is one of those mysteries of commerce which we never could penetrate. Perhaps they are like the Irish mercer, who, having assured a lady customer that the silk he desired to dispose of to her actually cost him more per yard than he charged for it, was asked how he then could afford to sell it so low. “Ah, madam, he replied, we depend for our profit on selling a large quantity.”

[goatinaboat]

present financial metrics indicating they do break even with the proper adjustments for purely growth-related costs

Such as “community-adjusted EBITDA”

[Spooky23]

It works out often enough that it’s worth investing in. The WeWork thing is a great example — if they could dominate commercial real estate, that would be nearly unlimited upside.

[mindvirus]

For a lot of these companies, they are profitable on a per customer basis, they're paying to acquire more customers.

For example, if it costs you $10 in marketing, promotions, etc. to acquire a customer, but on average those customers will pay you $20 over their lifetime, what should you do? Raise money and spend as much as you can to acquire more customers, if you think it scales!

[ropable]

I think that we call this sort of thing a "loss leader" in retail. Unfortunately, it seems like some of these companies' entire market is a loss leader.

[krzyzanowskim]

> old companies (banks) that sell $2 for $2.15 (a loan).

banks sell $0.15 for $2.15, nobody can beat this business model. Bank only need $0.15 to give you a $2 loan and ask for $2.15 in return.

[hammock]

> if I sell $2 for $1 that’s a false market

You're assuming that there is some objective value of a dollar, and that all dollars are worth that same. These assumptions are not necessarily true. Rather, they are myths that are propping up the current system.

[hammock]

Can't believe I got downvoted for this. Would be worth a whole blog post. Start with the fact that only approved banks have access to the "cheap money" that the Fed loans or are targets of the Fed's open market operations.

Or, start with the phrase "bad money chases out good."