Daredevil Startups Are Finally Exposed for What They Are
Why the flimsy business models of Uber, Airbnb, and ClassPass are starting to crack under pressure.
Giuseppe Badalamenti, a pizzeria consultant outside Chicago, was flipping through the invoices of a particularly troubled client when a March statement from Grubhub, the food order-and-delivery app, made him stop cold. From 46 orders billed at $1,042.63, Grubhub had paid the pizzeria just $376.54 — a 64% cut going to the app. Among the deductions were charges for two types of commission along with fees for processing, promotions, and adjustments.
There has long been grumbling in Chicago pizza circles about the excessive fees charged by Uber Eats, Grubhub, DoorDash, and Postmates, but this was by far the largest Badalamenti had ever seen. On April 29, he posted the invoice on his Facebook page. “Stop believing you are supporting your community by ordering from a 3rd party delivery company,” he wrote.
The post has since been shared about 5,300 times and has more than 1,200 comments. Not everyone sympathized with Badalamenti’s client — among those defending Grubhub, one restaurateur posted his own April statement, which he noted showed the app claiming only 28% of his revenue. (He hadn’t run any special get-$5-off promotions nor did he have as many pizza orders returned, he explained).
Yet the app charges still resembled those of a ticket scalper to a rock concert. A growing number of cities are now cracking down, especially amid the Covid-19 lockdown, when restaurants are relying entirely on takeout and delivery. Last month, San Francisco and Seattle capped app fees at 15%; New York is discussing a 10% cap, and Chicago a 5% one. Some of the apps have initiated various fee discounts and temporary waivers to restaurateurs.
A stark tension has resulted: Restaurants say they can’t survive at the rates the apps charge. But Grubhub, the only profitable major delivery app, suggests its very survival is dependent on those high fees. In a statement, Grubhub spokesman John Collins said the caps imposed by the cities “threaten the sustainability of our business.”
Silicon Valley and Wall Street seemed to value them at such heights specifically out of bedazzlement with their ostensible shattering of rickety old ways, establishment of new paradigms, and altering of technological history, all as their brash CEOs rolled into new markets without asking permission.
A little over a decade after the birth of the gig and sharing economy, the coronavirus has left its major occupants in trouble: Business has cratered for Uber, which burst onto city streets with clean, fast, and reliable cars with super-polite drivers earning decent money on what was described as their own terms, and just announced it will cut 4,000 workers. It has collapsed for Airbnb, with its aspirational shared homes, and the better part of the country now sheltering in place, is now laying off 25% of its workforce. And it has vanished for WeWork, already in distress since its IPO fiasco last September and now dealing with an overnight work-from-home movement paired with a client base shifting into cost-cutting survival mode. Grubhub’s business started out shaky in the first quarter, but by placing itself at the center of the pandemic food economy, it has improved since last month, the company said in a statement ahead of a scheduled quarter earnings report tomorrow.
The difficulty faced by this class of companies is a deepening comeuppance for the very shared quality that brought all of them sky-high Silicon Valley valuations as “unicorns” — venture-backed startups worth $1 billion or more — in the first place. All gained prominence by following Facebook CEO Mark Zuckerberg’s motto to “move fast and break things.” In fact, Silicon Valley and Wall Street seemed to value them at such heights specifically out of bedazzlement with their ostensible shattering of rickety old ways, establishment of new paradigms, and altering of technological history, all as their brash CEOs rolled into new markets without asking permission. Their attitude made them daredevil unicorns, a special breed apart that seemed to justify a bad-boy VC premium.
Last September, there already seemed to be a reckoning for the daredevils. Juul imploded after a rash of vaping deaths, WeWork’s IPO was canceled, and Uber’s share price — valued at $68 billion prior to its IPO a year ago this week — slid after its own disappointing May 2019 launch on Wall Street. But now the coronavirus has seemed to single them out again. Uber may cut a fifth of its employees after losing an estimated 80% or more of its revenue according to The Information. WeWork has plunged to a value of just a couple of hundred million dollars according to Fortune, down from $40 billion less than a year ago. And SoftBank, the chief investor-enabler of all this value inflation, is selling off tens of billions of its assets after suffering massive losses.
There is no telling with certainty how long Covid-19 and the resulting depression-like conditions will last, but the most reliable estimates stretch into early 2022 and even 2023. That is a long time even with the big cash pile that most of the daredevils have. All seem deeply at risk, exposing the flimsiness of these businesses in the first place. “We got caught up with flexibility, gig workers, [and being] asset light. That ignores the bigger question of whether your business model makes sense,” said Len Sherman, a professor at Columbia University’s graduate business school. Ultimately, he added, “they are just a bunch of crappy businesses.”
The U.S. is at heart a daredevil country. The American self-image begins with the stories of huddled masses arriving in New York to start new lives and Lewis and Clark carving out manifest destiny on their way to the Pacific. We have a sketchier appreciation of the 19th-century robber barons — John D. Rockefeller crushing his competitors to bring order to the oil industry, Jay Gould and Andrew Carnegie doing the same with railroads, and J.P. Morgan with finance. But generally, we admire the iconoclast outsider who stands alone against adversity.
“The daredevil idea both has power as a mythos and also reflects something real,” says Margaret O’Mara, a history professor at the University of Washington, and the author of The Code: Silicon Valley and the Remaking of America. “The overthrow of hereditary monarchy was a pretty maverick endeavor in the late 18th century. Ever since, this has been a country where people have been able to escape old constraints of hierarchy and convention and build new things (with limits: American daredevils, past and present, almost unfailingly have been white and male). But it also has power as an idea, as a story — of a nation of rugged individualists, of self-made men, of cowboys, of entrepreneurs.”
But the coronavirus has gone further to expose a broader economy where daredevil capitalism is the accepted way.
But just as time tarnished some of that story and its giants, Covid-19 has cast a harsh light on their modern peers — the CEOs of internet platforms such as the delivery apps that siphon 20%, 30%, and more from the revenue of small businesses by managing to insinuate themselves as a linchpin between transactions.
But the coronavirus has gone further to expose a broader economy where daredevil capitalism is the accepted way. Perhaps the most glaring current example is the fast exhaustion of the $349 billion first round of the Paycheck Protection Program, established by Congress to help small businesses with no other option to keep paying workers, such as barbers, mom-and-pop shops, and non-chain restaurants.
The vast majority of applicants got no money — which drew attention to those who did: the Los Angeles Lakers, owned by the wealthy Buss family, received $4.6 million; Monty Bennett and his Ashford Inc., which runs some 130 mostly luxury hotels including Westins and Ritz Carltons, received $70 million; and Wave Life Sciences, a genetic medicine firm that paid its CEO, Paul Bolno, $5.8 million in total compensation in 2018 and received $7.1 million.
Once the publicity struck, all eventually gave back the cash. But the audacity of merely applying for it seemed to qualify them as daredevils. For three years, Treasury Secretary Steven Mnuchin has not seemed bothered with daredevil behavior in White House circles. But amid the pandemic, the disastrous public relations optics were too much even for him. When Congress released a second, $310 million tranche of the aid last week, Mnuchin warned daredevils they were unwelcome, threatening “criminal liability.”
T.J. Stiles, the two-time Pulitzer Prize-winning author of The First Tycoon: The Epic Life of Cornelius Vanderbilt, said capitalism drives two types of behaviors — one is business people who create inventions in the pursuit of lower prices to benefit consumers; the other group is out to “violate morality, laws, and to impoverish producers (often suppliers) with less power, which can be harmful for society.”
In an email exchange, Stiles said he found examples of both qualities in Vanderbilt. His New York Central Railroad, including a four-track corridor connecting Buffalo and Albany, seriously sped up passenger and freight traffic and saved tons of money. But in order to get into the position to build this corridor, Vanderbilt ended up in a death grip with rivals that resulted in an effective blockade around the entirety of New York City. Luckily, the rivals succumbed to a stock squeeze and had to surrender before the people starved. “Vanderbilt did not recognize a public interest apart from each person pursuing individual interests as aggressively and wisely as possible,” Stiles said.
Airbnb is not quite Cornelius Vanderbilt, but it is a hybrid in the sense Stiles describes, updated for 21st-century sensibilities: Generally, Airbnb does not have the brazen reputation of Uber founder Travis Kalanick or Amazon CEO Jeff Bezos. But it has horned in on hotels around the world, which has aggravated cities like Paris, New York, and Barcelona and resulted in restrictions on the company there.
As of now, to weather Covid-19, Airbnb, having lost most of its business, has laid off many of its contractors and cut its $800 million marketing budget. Among the collateral damage has been companies like Lyric, Sonder, and Wanderjaunt, luxury apartment-hotel services that had piggybacked expensive build-outs onto Airbnb’s platform. Now, they, unlike the asset-light mother ship Airbnb, are holding big lease contracts without the cash flow to pay the rent.
Airbnb says it is encouraged by a 200% surge of bookings last month in China compared with March. But once the virus has passed or there is a vaccine, there’s still a very long road ahead until people will be eager to stay in a stranger’s home, especially after other strangers have stayed there. For the hosts who manage to make it out the other side, they’ll have to spend a lot more money to meet the company’s new “cleaning protocol” — switching from what may have been a once-over with a vacuum and a mop to a formal disinfection operation. Even when they do, they’ll have to leave their place vacant for 24 hours between stays so that any airborne particles can settle.
Meanwhile, in April, with AirBnB’s long-awaited IPO plans shattered and its valuation plummeting, “the company raised more money even though it has $3 billion in cash on its balance sheet,” reported The New York Times. That is, it cut two deals: a $1 billion deal in debt and equity, followed by another $1 billion in debt.
Times are changing for the most daredevilish companies of all. In an April 30 report, Amazon said its first-quarter profit fell by 29%, mostly because of a 49% surge in shipping costs. Bezos said the company could actually lose money in the second quarter. The news caps something of a reversal in Amazon’s desperado reputation. Since Covid-19 struck, Amazon has been widely embraced as an essential, almost public service. It has been the subject of frequent worker protests including demands for higher pay and safer conditions, both at Amazon warehouses and Whole Foods markets. It has been denounced for firing workers for speaking out publicly, including last Friday, when Tim Bray, a senior Amazon engineer, resigned in protest of such dismissals. But all the former talk of splitting Amazon up on antitrust grounds vanished.
Until May 1, when the old narrative returned. Congressional investigators demanded that Bezos appear before the House antitrust subcommittee, suggesting that prior Amazon officials may have lied to the committee. The committee appeared to be investigating an April 23 story in the Wall Street Journal documenting a practice in which Amazon had taken advantage of its intimate inside knowledge of certain companies to replicate and sell competing products. In testimony last summer, an Amazon executive swore under oath that Amazon did no such thing. In a tweet, subcommittee chairman David Cicilline said he is considering a charge of perjury.
While Bezos is the most unabashed individual daredevil, SoftBank CEO Masayoshi Son and his Vision Fund are the biggest enablers of the daredevil economy. Son singularly drove up WeWork’s valuation and did the same with Uber.
As long as companies and CEOs like the daredevils have access to cash, times of trouble can favor them — them, meaning the CEO and its investors, though employees and partners might be sacrificed along the way.
Now SoftBank is on its heels. As of November 2019, it had $80 billion invested in 91 companies, but the coronavirus has been brutal, likely creating $24 billion in losses. In March, SoftBank said it is selling as much as $41 billion of its assets, including part of its crown jewel, a huge stake in Alibaba.
Are the daredevils dying — or only in hibernation? Experts in valuation say looks can be deceiving. Ilya Strebulaev, a professor at Stanford, long ago reckoned that the average unicorn is overvalued by 48%. Covid-19 has made this worse, he says. But that does not necessarily mean you can know in advance who will survive and who will die. It can depend on who has the most cash. “Companies with a lot of liquidity could survive and even thrive if their competitors fall away, and then they are left with the market largely to themselves,” Strebulaev said.
Among the cash-rich startups is ClassPass, an archetype of the daredevil app. Established in 2011, ClassPass’ eventual business thesis was that it was a solution to the problem of empty, nonpaying spaces in fitness studios. Yoga, cycling, barre, and boxing studios were struggling because they were not filling all the available time slots. ClassPass offered to fill them and argued that the payment — even if lower than the studio’s standard fee — at least was something.
In other words, ClassPass had inserted itself in the middle of the cash stream between businesses and their customers, the winning strategy of every platform. Just like with drivers for Uber, third-party sellers on Amazon, and pizzerias on Grubhub, ClassPass has ended up dominating its space with cut-rate prices that attract students because they are so cheap. But they also leave the studios themselves as effective bystanders in who will be in their classes and how much they will pay, heedless as to whether they are earning enough to survive, Vice reported in February.
The trouble is one common to the app economy, explains Sherman, the Columbia professor. To succeed, an app needs to satisfy three stakeholders — the customer, the business, and the app owner. If the profit is not sufficient for all three, the business can’t work. In the case of ClassPass — and Uber and Lyft as well — the profit is inadequate. After that, “it’s just a matter of who gets squeezed,” Sherman said. “In both cases, it’s the gig workers. That’s not a sustainable business model.”
Typically, Silicon Valley loves ClassPass. In January, the company raised $285 million in new venture capital, bringing its total raised over the years to $549 million and its valuation to $1 billion, thus making it a unicorn. Why did it need $285 million when it is only an app connecting students and studios? If your objective is an IPO, which in the case of ClassPass and investors it is, there is cachet to being a unicorn, having cash flow, and cash on hand.
Last month when Covid-19 hit — just three months after that raise — ClassPass cut half its employees in layoffs and furloughs, despite the money it has sitting in the bank. “There is no playbook for a pandemic, and we are doing everything we can to handle tough decisions with as much compassion as possible,” ClassPass CEO Fritz Lanman told Marker. As long as companies and CEOs like the daredevils have access to cash, times of trouble can favor them — them, meaning the CEO and its investors, though employees and partners might be sacrificed along the way.
The Covid-19 crisis, for instance, may give an added advantage to Tesla CEO Elon Musk, one of the purest examples of the daredevil CEO. Right now, with his share price sky high, Tesla is widely assumed to be on the cusp of a new cash raise on top of the approximately $8 billion he already has on hand. “Uncertainty and instability are good for disruptors because they shake up the status quo, and some disruptors will have an easier time now that older, more established companies are struggling to stay afloat and perhaps burdened by debt,” says Aswath Damodaran, a professor at New York University.
Perhaps the change we are watching is not so much something decisive with the daredevils themselves but with us. For centuries, we have invested daredevils with almost Olympian stature. In the late 19th and early 20th centuries, that meant the entire U.S. economy waited for J.P. Morgan alone to step in and set the economy right when a crisis loomed. But he could not stop the Great Depression.
The truth is that the crisis is larger than any one individual. “I wouldn’t say it’s the end of swashbuckling mavericks,” said O’Mara, the University of Washington professor, “but it may be the end of thinking that these mavericks can save us.”
Additional reporting by Courtney Rubin.
Update: This piece was updated to include breaking news about AirBnB and Uber layoffs.
