Drowning in venture capital, mobile startups are waging unsustainable price wars

By Carmel DeAmicis , written on July 2, 2014

From The News Desk

When millions -- or even hundred of millions -- in venture capital is powering your startup engine, profits are often a distant concern. It’s with this bizarro economic calculus that we stand by and watch an entire sector of on-demand mobile-first startups compete in the kind of price wars that will leave a handful victorious, many bloodied, and more still gasping their last breaths, lucky to be sold at acquihire prices.

In the mean time, though, consumers are getting a free-bags-of-dog-food style golden era of unsustainable discounts and free offers. Soak it up, everyone, because it won't last.

These wars are particularly heating up this summer, following a rash of high-priced, late stage venture capital deal making this past spring. At the top of the economic food chain we have Uber and Lyft, locking horns in a quest for ride-sharing supremacy, each trying to be the customer’s cheapest option while they pay drivers as much as possible. Lyft started the trend back in April, cutting prices twenty percent in all cities. Over the course of the last month, and after raising a whopping $1.2 billion, Uber followed suit, slashing its prices 25 percent at staggered points across its markets.

It's the kind of battle that cheap capital was made for. Unfortunately, it's similar to what we saw with Groupon and LivingSocial's race around the daily deal globe. As that battle showed, wild landgrabs don't always end well. Even the late stage investors in the "market winner" Groupon were lucky to get their capital back. Likewise, look at ecommerce 2.0 companies like Fab and EcoMom who blew millions in capital acquiring customers at unsustainable rates, hoping for some magic lifetime customer value to justify the spending. (It didn't.)

“There’s a tension between growing fast enough and having a disastrous bottom line,” Jeff Clavier, Founder of SoftTech VC, says. Clavier was an early investor in Fab, among others playing this game. “If you don’t have growth you’re stuck, but if you have growth with economics not viable in the long term, [you’re making] a real bet that you’ll be funded nevertheless.”

But while Uber and Lyft get most of the capital -- and attention -- it’s not just the transportation sector that has seen fierce competition among on-demand mobile upstarts. There are no shortage of companies offering services or deliveries via mobile request that are relying on venture capital to subsidize price-war discounts.

Earlier this year, the then $6 meal creation and delivery startup SpoonRocket managed to drive out its non-venture backed competitor Chefler in exactly this way. “SpoonRocket changing the price point made [consumers believe], ‘Hey delivery services ought to cost single digits,’ whereas you can hardly find a restaurant in SF that charges less than $12,” Restom explains. Chefler, which was originally charging $14 for a single meal, just couldn’t compete without an equivalent war chest. Chefler shuttered its operations, fired most of its staff, and is now in the pivot process.

Even SpoonRocket couldn’t sustain its aggressive pricing, and soon after killing off Chefler's original business it raised its prices to $8, drawing the ire of its users. After that, CEO Steven Hsiao told me it will never raise prices again — a bold statement given the ever shifting cost of ingredients.

Fellow food delivery startups like DeliveryHero and Just-Eat are taking a similar approach, each trying to shave just a little more off their costs to attract consumers.

Of course, companies don't always need competitors to play a dangerous game with their margins. As long as there's been venture capital, we've seen that. But the broader mobile landgrab is intensifying it right now. Just as Zappos ruined margins for all of ecommerce by setting the expectation of free shipping, so too have the better funded companies like Lyft and Uber set a precedent of what we should be able to get on our phones.

Consider the on-demand laundry world. YC grad Prim has already gone out of business after trying to subsist while charging just $25 per bag of clothes. That fee included pick up, delivery, laundromat costs, and return delivery. The gross margins were too slim, and Prim didn’t have enough venture — an undisclosed seed pittance — to carry on.

Consider it Silicon Valley’s version of The Hunger Games.

Who can hoard enough resources (venture) from the Cornucopia (Sandhill Road) to weaken your competitors? The resources won’t pour in forever, but in some cases you just need them to go long enough to outlast your enemy. Of course, by relying on these external resources, in most cases said companies aren’t developing a sustainable business model.

We’ve seen this play out before. After all, the Internet has been largely built on free. The reason it keeps happening is that the exceptions -- like Amazon -- frequently frequently provide most of the industry's returns. But as daily deals and ecommerce have shown in recent yeras, the grow at all costs approach can prove particularly painful when companies are delivering a physical good or service, rather than an infinitely scalable software solution.

“When you look back a few years ago, Groupon was the fastest growing company of all time,” says Anand Sanwal, CEO of research firm CB Insights. “Investors were jumping in head first into that market…and then they weren’t. The sentiment can shift very quickly and we’ve seen that happen before.”

Right now there’s an enormous level of interest in on-demand mobile services — the so-called “Uber for X” market. Although such interest will probably remain high for a while, with Uber’s as the rising tide that lifts all boats, the climate can change overnight and it has before.

Sanwal would know from personal experience. He was one of the senior employees at Kozmo, a delivery company that engaged in vicious price wars in the nineties. To take down New York competitor Urbanfetch, Kozmo would even send employees to its enemy’s warehouses bearing fliers promising higher salaries and bonuses to delivery workers who switched companies.

Who does that sound like? Uber of course. The company has been notorious for hopping into Lyft vehicles to recruit Lyft drivers, offering $500 bonuses for switching companies.

“When I read the stories, it has a lot of parallels,” Sanwal says. “Really our business was raising venture capital to subsidize consumers with Krispy Kreme donuts and DVDs and pay delivery guys more than they’ve ever gotten paid.” But he recognizes Uber is in a far different place technologically, and Kozmo made plenty of tactical mistakes. And the market for mobile services today is far bigger than it was for Web services back then.

Still, he spoke about the addictive rush of it all:

For an employee at a company it can be very exhilarating. It actually feels like you’re in a war. It’s us against this enemy. You get motivated, I never worked so hard in my life. At the time we thought we were making the right decision, we saw all these companies IPOing and it was all about growth. It wasn’t about the unit economics.

In the moment it all seemed like the right rational thing to do based on the way the market was rewarding you. Only in retrospective do you realize it’s ridiculous and unsustainable. Silicon Valley has a short-term memory problem -- it has to in order to believe concepts that have been tried before and failed can still succeed. But when you see rampant price wars in a particular sector, it can be a signal that what companies are offering is a commodity. If they have to engage in cutting costs to keep customers away from competitors, it’s likely their product isn’t differentiated enough to keep users around otherwise.

“Are consumers loyal to a particular service or are they going to be promiscuous and go to where the best deal is?” Sanwal says. “Based on what we’ve seen in the past and my own personal experience, people loyal to these services are just loyal to the fact that they’re getting a deal.”

In the case of Uber and Lyft the services have become almost undifferentiated. The same drivers will work on both platforms, so consumers getting the same cars, the same people, and, pink mustaches and fist bumps aside, almost the same experience.

Price wars are a sensitive issue, because admitting to engaging in such practices essentially means admitting your product is a commodity – a dirty word to all who think of their startup as the next unicorn. Many of the founders and investors on-demand startups are unwilling to admit that their business couldn't survive without these steep, and often unsustainable discounts.

For example, a friend who works at Uber categorically denied the company was engaging in price wars, even as the 25 percent off blog posts were being published on a daily basis. Some investors, like Danny Rimer, just refused to comment altogether, considering price wars to be too negative a story.

Sprig founder Gagan Biyani thinks price wars will disappear entirely from the on-demand food sector because the products are too distinct. His company, to its credit, has charged $12 for its dinner meals since launch, avoiding discounting even as the far cheaper SpoonRocket entered its local SF market.

In the meanwhile of course, there is one big winner to all the Silicon Valley Hunger Games, the one group that doesn't go hungry: Consumers. May the discounts be ever in your favor.

[illustration by Brad Jonas for Pando]