Speed Kills

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It was 1976 when the Meadowlands Raceway opened in East Rutherford, New Jersey. My father, who loved the horses, took my older brother and me to the races that night probably with the hope that we might bring him some luck. My father explained how the betting worked and asked us to choose a horse to win the next race. Not being educated handicappers we did what any kids our age would do, picked the horse with the coolest name – Ungawa! From the moment the bell rang to start the race we were jumping up and down screaming at the top of our lungs. Our horse went to the front on the pack and was leading down the back stretch. He was leading at the club house turn. And then tragedy stuck. I kid you not, Ungawa fell over and died on the track.

 I was reminded of this story after reading a very thought-provoking article that a friend shared with me, The Fundamental Problem with Silicon Valley’s Favorite Growth Strategy, by Tim O’Reilly. The author does an excellent job of dissecting Silicon Valley’s pursuit of monopoly and the “premise that if a company grows big enough and fast enough, profits will eventually follow.” At the center of his thoughtful analysis is the book, Blitzscaling, which advocates businesses achieving “massive scale at massive speed.”

The challenge with books like this is that they are often written before history has an opportunity to fully play out and the data analyzed. They also run the risk of becoming a playbook of sorts that young entrepreneurs attempt to implement without thought. O’Reilly puts it best, “blitzscaling isn’t really a recipe for success but rather survivorship bias masquerading as a strategy.”

This is not to say that blitzscaling doesn't work, but the conditions have to be right to support it. An abundant supply of low-cost capital is one of them. Venture capitalists essentially anoint winners in large markets where network effects become the competitive advantage. They plow capital into a couple of companies in a land grab with the hopes that a scalable business model with positive cash flow might evolve over time. This approach pretty much eliminates competition allowing one or two companies to grow the top line rapidly, block out competitors and achieve a duopoly.

O’Reilly claims that the book oversells the idea and I happen to agree. The mantra of “move fast and break things” promotes a careless, inefficient approach to business building that sometimes results in private data being exposed or platforms being abused. It’s too big to fail for the anointed ones.

Now we are about to witness a cavalcade of IPOs of companies that are massively unprofitable with no visibility into how or when they may become profitable. The early investors will make money, the founders and early employees will make money, but the retail investors who buy in at the IPO may not make anything at all if these companies can’t find a path to profitability. The current massive valuations are based upon revenue growth, but revenue doesn’t pay the bills operating cash flow does and to get that you have to control expenses. Controlling expenses might mean slowing growth. Slowing growth often resulting in declining stock price. Need proof? How about ZipCar? ZipCar went public in April 2011 earning a valuation in excess of $1 billion and a stock that traded around $28 per share. To support this valuation the company would eventually have to achieve after-tax profits of $100 million. By December 2012 the stock was trading at a low of $8.24. The company struggled to become profitable without slowing down growth. It was eventually purchased in January 2013 by Avis for a little less than $500 million.

What does the future hold for Lyft, Uber and other unicorns that profess speed over efficiency? Time will tell.