The Problem With Profitless Start-ups

From NewYork Magazine:

Yesterday, I ordered lunch from a gourmet meal-delivery start-up called SpoonRocket – a takeout container of sirloin au poivre and roasted cauliflower that was shuttled to my door in exactly 11 minutes, costing me $8. I then took an UberX car to a meeting across town, paying roughly $10 for a 15-minute ride. On my way, I pulled out my phone to see about getting my broken dryer fixed through Handybook, which provides on-demand repairs in the Bay Area for less than a local handyman would charge.

There are dozens more services like these operating in and around San Francisco – Homejoy for cleaning, BloomThat for flowers, Postmates for courier service, and on and on. Most of them provide cheap, convenient amenities at the tap of a smartphone app. Few of them are profitable on a corporate level. And together, they’ve formed the backbone of a strange urban economy: one in which massive venture-capital injections allow money-losing start-ups to flourish, while providing services that no traditional, unsubsidized business can match. It’s an economy built on patience, and the hope that someday, after the land grab is over and the dust has settled, a better business model will emerge.

It’s hard to know which of today’s new start-ups are unprofitable. But in some cases, losing money is kind of the point. I have no inside information on SpoonRocket's financials, for example, but I imagine that the company books a loss of a few cents every time I click the order button. (There’s just no way, short of a supply-chain miracle, that my $8 covers the cost of preparing a gourmet lunch, driving it to my house, and paying all the drivers and cooks and engineers and assorted other costs associated with running their business.) But SpoonRocket doesn’t have to make money, because it’s just raised $10 million in venture capital expressly so it can keep its prices low. The metric its investors care about right now is user growth, not profits. And if, indeed, the company is selling meals for less than they cost to make, those investors are willing to fill the gap.

This business model is great for consumers. As a result of start-ups’ willingness to lose money for months or years at a time, I get cheap, fast services that come with an effective subsidy that can add up to thousands of dollars a year. But they're problematic for the businesses themselves. Unlike Amazon or Google (which have profitable core operations that subsidize the money-losing services elsewhere in their business), or Uber (which uses the profits from its high-margin Uber Black and Uber SUV lines to subsidize its low-margin UberX service), many of today’s start-ups have no profitable parent company pouring in money. They’re simply taking millions of dollars in venture capital with the hope of keeping prices low, pushing rivals out of the market, and eventually finding a way to turn a profit....MORE

HT: Abnormal Returns