Jan 05

Negative Gross Margin Of Startups

profit1Fred Wilson, a Venture Capitalist from US which talk about negative gross margin of startups in Silicon Valley.

Recently in silicon valley there is talk about a company that is growing fast with high valuations will face problems in the next few years.

Bill Gurley, a well-known silicon valley investor, saying “I think we’ll see some jednoro┼╝ce whether to die this year.

Mike Moritz of Sequoia capital and a former board director of google says “there will be a few Unicorns are extinct”

But how quickly will this happen?

The most likely scenario is for the company to print growth and valuation was incredible with a negative gross margin (the price of capital is greater than the sale price aka selling loss).

We see a number of companies with a high growth and gross margin – negative – get funding, which means they sell cheaper than the cost of making their products/services.

Can be either “on-demand” service provider which subsidizes the cost of the workers inside the trains so the service that he looks more expensive than it looks. Why on demand startup doing this approach? Of course build demand for its service. The idea is to make the user’s “locked” with service, house cleaning services, ride sharing service, food delivery service, and other services by throwing them into the market with a price that is very attractive, and at the moment the user already “addiction”, they can increase the price of its service.

Another example, the startup could also provide service for startups, such as feature grind through the API, service payment processing via an API, a service that lets companies pay a specific benefit to employees. Examples of this service have real costs (e.g. Programmers) to build their products, but they do not charge at the customer and decided to subsidize its service to gain market share. The result was rapid growth, but the negative gross margin. Once again, companies that do this are hoping when they successfully download the scale of user and user has been “addicted”, they can raise prices.

There are again some examples of companies with negative gross margins, but the two above categories very often we see (on demand service provider and service for startups)

The problem is, this strategy could be a problem, if when want to raise prices, or use volume to lower costs, to generate positive gross margins, it could be more difficult than calculated. If there’s another startup that competed with you and provide a kind of service, you will not be able to raise prices without losing the customers from competitors. Unless the service you really have a “lock” for the customer (for example ratings and testimonials online shop in the marketplace, would move to another marketplace? Not easy) but, most don’t have a lock like this. Use volume to lower the price (ask price is cheaper than the provider/supplier/merchant) may be able to walk, but again if there are similar, then the service provider that you have requested a discount could be moved to competitors who provide higher prices.

The point is, the only way so that this strategy could be running is you can get a monopoly position in the market and you are the only entity looking place/a living for the customer and supplier. But if you see the massive startup capital circulating on the ecosystem and the growing number of young entrepreneur who started the business with a variety of similarity, it’s not easy for most companies achieve a position of monopoly.

Yes, there will be some that are successful with this strategy, became the leading edge than competitors, gaining tremendous funds to kick competitors from the market, it will work well for some startup, but not as much as people think.

And most companies who use this strategy will find that the financier will someday lose patience with this strategy and forcing them to get a positive margin, where growth also means cutting growth and could-be zero gross margin but with “arouse” unusually large business valuation and this is seen by Gurley and Moritz. They are not alone.