Entertain a thought experiment: In this day and age, how would you build the world’s biggest lemonade-stand business?
The business of lemonade should be simple: You need the raw goods (lemons, sugar, water) and a sales platform (table, cardboard signs, and coolers). Using this model, you might eke out $0.10 in profit for each $1 cup sold — not bad, but hardly a high-growth, paradigm-shifting business.
Suppose you become more ambitious. You sprinkle some caffeine into your concoction, tout the health benefits of vitamin C, and bill your beverage as the “future of hydration.” You create a mobile app to place orders, contract with drivers to deliver the lemonade, and spend a truckload on marketing. All of this is expensive, so it now costs you $1.75 to sell a $1 cup. Despite these losses, your customer base grows explosively. It’s still roughly the same beverage, but all that progress attracts Silicon Valley funding, which fuels your ascent as the global lemonade leader. Profit? You can figure that out later.
Now consider another question for your newly-minted lemonade unicorn: What happens when investor money runs out?
A whole class of
— Uber, Lyft, DoorDash, Instacart, and the like — have gone through these gymnastics at tremendous scale, building massive operations on the back of money-losing ideas. At their most basic these companies, from taxi-cabs to food delivery, are comparable to my proverbial lemonade stand: a simple business that allows its operators to eke out a profit.
But in pursuit of grand ideals — from the “future of transportation” to the “future of grocery” — and grander funding, these businesses hemorrhage money as they’ve relentlessly chased growth: burning cash, customers, and vendors along the way. Now, as tech valuations crumble and investors ditch their stakes in unprofitable startups, these companies face a reckoning of their own making.
Burning cash and bridges
While Uber wasn’t the first gig economy platform, its rise in 2009 emboldened a generation of entrepreneurs to try their hand at founding companies reliant on contract work and mobile apps. These companies got cheap financing as investors, forced by a decade of near-zero interest rates, searched for yield in ever riskier propositions. Tech financiers piled into these unprofitable but buzzy startups, hoping that the temporary sacrifice of cash flow and huge losses in the present would lead to explosive growth and, eventually, superior returns. The boom continued for over a decade, culminating in a dizzying array of “instant grocery” startups — Gorillas, Zapp, Getir, Weezy, Jiffy, Gopuff, Yango Deli, Buyk, Fridge No More, Jokr, Voly, Market Kurly, and Instacart — that seized on the disruption of the pandemic to raise a combined $14 billion.
Although they provide a wide array of services, these gig economy companies generally share a dubious connection to profitability. For example, between 2018 and the first quarter of 2022, Uber’s users have spent $53 billion on the platform while Uber has burned roughly $73 billion on costs – including erecting offices with a boatload of perks. In order to stem the tide of quarterly losses, Uber relies on frequent sales of stock, debt, and convertible notes to outside investors. Put simply, gig and delivery companies like Uber require regular infusions of cash from the public in order to remain in business. There are so many unprofitable companies staying afloat through investor cash that Goldman Sachs even created a separate index to track the performance of the “unprofitable tech” sector.
Another glaring similarity of many of these companies is that they continue to rack up staggering losses while barely investing in the equipment or labor of their underlying services. Delivery fees eat into already thin restaurant margins and cause chaos for food workers. Uber and its gig-economy brethren hire their frontline workers on a contract basis, meaning they have few obligations to their drivers and delivery people: no health insurance, retirement-savings plans, or consistent pay.
These companies don’t mind squeezing their customers as well. The cost of fuel, previously borne entirely by the driver, is now shared with the passenger. Customers pay increasingly hefty prices for rides; an analysis last year found that fares were up almost 80% from prepandemic levels in some cities. In a world where restaurants can increasingly deliver directly to their consumers, DoorDash’s model of surcharging both the restaurant and the diner is bad for all parties involved — except, of course, DoorDash. And yet the company somehow lost almost half a billion dollars last year.
Gig companies built their businesses on unstable ground, fighting for market share instead of building sustainable businesses. Now their priorities are coming back to bite them.
Time has run out
Given the steep rise of tech stocks over the past few years and their sharp fall over the past five months, it’s hard to resist comparisons to the tech bubble of the late 1990s. Webvan, a 1999 dot-com company, promised to deliver groceries to customers in a 30-minute window of their choosing. In the 18 months before Webvan filed to go public in mid-1999, the company sold $395,000 worth of groceries. To do so, it had to spend more than $48 million. It went bankrupt two years later.
While the technology powering many delivery and gig apps has come a long way since Webvan, the economics of delivery and rideshare have not. And much like the sudden reversal of fortunes that led the tech bubble to burst in the early 2000s, the tide is turning against today’s high-flying startup darlings.
For one thing, the macroeconomic tailwinds that helped fuel the rise of gig companies have begun to dissipate. Inflation and a tight labor market are squeezing companies’ input costs. Higher interest rates and volatile share prices will make it harder for companies to find new financing when they need it.
Investors are also turning against these once-loved companies. Since its initial public offering, Uber has shed almost half of its value, and it’s is down 60% from its record high in 2021. Lyft reported worse-than-expected earnings in early May, and its stock has collapsed more than 70% from its IPO price. After meeting with investors in New York and Boston, Uber CEO Dara Khosrowshahi sent a letter to employees stating that “we have to make sure our unit economics work before we go big.” Uber is a global company, they are already big. It defies belief that they are only now considering the validity of the basic premise of their business. Tiger Global Management and D1 Capital, two investing titans, have signaled a retreat from financing technology companies. Having been stung by the market downturn in these technology companies, hedge funds and private equity companies appear increasingly unwilling to finance the money-losing operations of the gig economy.
The most recent batch of gig companies and uber-fast delivery startups are facing the same struggles. Fridge No More shut down its operations after failing to sell itself to DoorDash. In a statement that makes one question why such a business would have ever been started, Fridge No More’s CEO told employees that “investors were concerned” that “each order brings losses to the company.” Jokr reportedly held talks to sell its New York operations, which make up the bulk of its US business. Gorillas has started layoffs and announced its exit from several European markets. Instacart slashed its valuation by 40% after growth slowed on its platform.
Even the basic labor model that powers these companies is under scrutiny. Drivers are taking advantage of the strong labor market to opt out of the exploitative model; Uber and Lyft have both struggled with driver shortages over the past two years. Lawmakers and regulators are questioning whether gig companies should be required to treat their drivers and frontline workers as full employees, a move that would exponentially increase their labor costs. These efforts are already causing an issue for their bottom lines, as a consortium of ridehailing and delivery companies spent over $200 million in 2020 to try to lobby themselves out of a California law that would reclassify gig workers as full employees. And the Biden administration has suggested it will take up this fight nationwide.
For years economic growth and low interest rates allowed gig economy companies to balloon into household names, stock market behemoths, and major employers without ever becoming viable businesses. Now that the economy, market, and regulatory tides have turned against them, gig economy companies are being forced to wage — and likely lose — existential war in defense of their clearly unsustainable business models.
Kartik Menon is a former Goldman Sachs securities trader who wrote quantitative strategies to trade equities and US-listed derivatives.