“Venture Subsidy” versus “Growth over Profit”

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Essays

There is a subtle but very important distinction between venture capital “subsidizing” a service-oriented business, and a service-oriented business that has venture financing, negative cash flow, but positive unit economics. Both are losing money, yes, but there is falling and, to quote Woody from Toy Story, falling with style.

The former may be an emperor with no-clothes, in the steady state: maybe there isn’t a there there. Maybe there is a temporary, but ultimately unsustainable, feedback loop between customer demand and growth.

But the latter might just be re-investing every bit of gross margin in customer acquisition, HR, and other growth tactics. Here, a company can conceivably choose to ‘switch on profitability’ by not growing the team as quickly, or by entering new markets more slowly, because each sale has a positive gross margin.

The wrinkle: some companies, at different stages in their growth, may actually go in-between these phases. In highly competitive markets, a company may *choose* to run negative unit economics, selling their product/service at cost or even at a loss, so as to price out the competition, or grow a market. There are risks to this, of course, because the resulting expected rise in demand may be too elastic to stick around when the price rises, unless there is some sort of product lock-in or network effect. 

So consider this nuance before claiming that all of the “Uber for X” economy is simply venture subsidized and unsustainable in major cities, or by indignantly huffing that none of it is.

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