Bershidsky: Disruptors need sound business models too

Leonid Bershidsky

Blue Apron is a company that claims to have “reimagined the traditional grocery business model.” Thursday’s disappointing initial public offering makes you wonder if investors are losing faith in such “reimaginings.” Perhaps not, but it’s time to ask ourselves whether even some of Silicon Valley’s most vaunted attempts to rethink traditional business processes are sound, and what kind of future awaits them.

Marc Andreessen, the outspoken and successful venture capitalist, says there are “no bad ideas, only early ones.” The example he gives is Pets.com – the startup that dared to sell pet supplies online and flopped famously in the dot-com era. But earlier this year, as Andreessen points out, PetSmart paid $3.35 billion for Chewy.com, which does exactly what Pets.com did; it’s now a major competitor to Amazon in pet food and litter sales.

From an investor’s perspective, Andreessen is right: Money can be made on many of these disruptive ideas, especially if there’s a good narrative to sell. But consumers do not care how much money an idea can make for those who invest in it, so much as whether the service can be relied on over time. Many “disruptive” ideas can’t be. Chewy.com, which commissions oil portraits of its customers’ pets to retain their business, was unprofitable by the time it was acquired.

Blue Apron, which placed its shares at $10 each rather than the expected range of $15 to $17, sends people ingredients and recipes so they can cook at home without worrying about grocery lists or figuring out what to make. But the IPO prospectus also says this: “We may not be able to achieve or maintain profitability, and we may incur significant losses for the foreseeable future.” That was a softer version of this line in Snapchat’s parent IPO filing: “We have incurred operating losses in the past, expect to incur operating losses in the future, and may never achieve or maintain profitability.” Snapchat, of course, bills itself as a company that’s reimagining how we use the camera (as a communication tool).

After years of relentless hype, the disruptors and reimaginers of transportation, such as Uber and Lyft, are still highly unprofitable, and it’s not quite clear how that can change. Aswath Damodaran, a finance professor at New York University’s Stern business school who specializes in business valuation, wrote in a recent blog post about Uber’s latest culture and management troubles:

“Prior to these news stories, Uber was a rule-breaking company with a business model that delivered revenue growth but offered a very narrow path to profitability. After these news stories, the story remains the same but Uber has just made its narrow path even narrower and much rests on who will head the company on this path.”

Spotify, Deezer and their peers – audio streaming companies, which have disrupted the music business – lose money. LendingClub, the banking innovator, reports steady losses after a brief period in the black. Tesla eats through cash faster than Elon Musk talks. Disruptive media companies like BuzzFeed and Vice may be highly valued, but their revenues depend on a shaky advertising market that is being eaten by Google and Facebook.

But aren’t Google and Facebook themselves huge, disruptive success stories? Isn’t Airbnb, which turned a profit for the first time in the second half of 2016?

I would not rush on those, either. Facebook is beginning to commit crimes against user experience with sound-on, self-launching videos because it’s running out of non-intrusive ways to increase its revenues. Google has just run into dangerous obstacles in Europe, where the $2.7 billion antitrust fine it has received is only the beginning of a series of challenges to its use of dominance in “free” products such as search and mobile operating systems to push various ad formats. Google and Facebook have been successful with their promise of personalized advertising, but regulators and fickle advertisers themselves will inevitably dig deeper into how the companies deliver on this promise.

Airbnb faces the same fundamental problems as Uber: It was built without regard for the regulatory and physical infrastructure of the cities on which it depends. That (and not cultural issues, which have come to the fore in Uber’s case) is the greatest threat to expansion and market leadership, where they have achieved it.

Amazon is on a more solid footing than these companies since its business is diversified and most of its parts are profitable. It is a truly successful reimaginer, one could say, though it’s nearing a stage of dominance in retail markets where regulators are bound to get interested, as they are in Google today.

Consumers who aren’t also investors may care little about inflated valuations or this week’s market price fluctuations. But if they continue to defy traditional, discounted cash flow valuation methods, despite changing the world, the brave upstarts may go the way of Chewy.com.

A consortium of German carmakers controlling Uber or Lyft? Music companies, thought to be on the ropes just a few years ago, teaming up to acquire Spotify? A major hotel group buying Airbnb and taking care of its regulatory worries? Media startups folded into Disney or a U.S. television network, the way Business Insider became part of Germany’s Axel Springer? None of it is impossible. And it’s likely that these changes would mean we will have to pay more for the services or face cutbacks to their reach to ensure profitability. “Legacy” businesses don’t have much tolerance for losses stretching into the indefinite future.

Even when a company’s big idea looks like a winner because we happily use its product or because “it’s the future,” the soundness of the underlying business model, its ability to turn the idea consistently into profits, is the measure of its staying power. That principle can be temporarily disrupted, but not permanently reimagined.

Leonid Bershidsky is a Bloomberg View columnist. He was the founding editor of the Russian business daily Vedomosti and founded the opinion website Slon.ru. © 2017, Bloomberg View

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