tl;dr: Building an on-demand company? Here are four things that you need to get right if you want to succeed.
The explosion of “on-demand” companies built over the last few years has been followed by consolidation.
A category in which raising capital was once as easy as claiming to be the “Uber for X” has now realized hard truths. Companies that raised large amounts of capital are now focusing on their path to profitability, while younger on-demand companies have stricter benchmarks they’ll need to meet if they want to raise more money.
I recently sat down with Mattermark’s Alex Wilhelm to discuss why so many on-demand companies have, or will, fail.
On-demand companies don’t need to fail. There are several market categories in which the model works, and success will permanently change those respective industries. However, even with a great team, if the core metrics don’t add up then there isn’t room for a company to exist.
Let’s get into the brass tacks.
The Big Four
For an on-demand service to have a shot at being a real business, the following questions are critical:
- Does the service fit the natural behavior of consumers?
- Is there enough margin in the business for you to exist?
- Are there realistic additional revenue streams?
- Do the courier and unit economics make sense?
We’ll take them in order.
Are You Solving A Natural Buying Behavior?
When Uber exploded onto the scene, many people thought that they could apply smartphone technology and the ensuing convenience to any industry and find success. They weren’t alone: Many really smart venture capitalists subscribed to the same belief.
Applying immediate convenience to categories that do not need it will likely result in failure. An on-demand service has to—at a minimum—address real and natural consumer behavior.
In practice this means that on-demand companies need to meet consumers where they are, but with a better service; on-demand groceries makes inherent sense as eating is something everyone does. On-demand giraffe delivery likely fails the natural buying behavior test.
At Saucey, we started with a hypothesis that people buy and consume alcohol in short periods of time, making delivery a natural fit for their buying behavior. We were right. Customers currently purchase six times as much on Saucey than they do from traditional retailers in the industry.
Is There Enough Margin For You To Exist?
The “take rate” for a service comes from a combination of the customer and the supplier. If a product is price elastic—meaning that there is high price sensitivity that affects demand—then the majority of the take rate needs to be covered by the supplier, because customers won’t pay an inflated price for the goods. In price inelastic categories, there can be more flexibility for an on-demand service to make money.
Groceries are price elastic for example. Parking is price elastic as well, as people tend to look for the cheapest parking. Alcohol, on the other hand, is price inelastic.
Next up: Margins. An on-demand service’s ability to make money is greater in high-margin industries. Where there is more margin, there is more space for on-demand startups to generate revenue between market pricing, and break-even sales.
Why do margins and price elasticity matter? In low margin, price elastic industries, it’s almost necessary for an on-demand service to have additional revenue streams. Those additional incomes may help keep things afloat as efficient delivery operations are scaled. However in higher margin, inelastic categories, companies have more room to extract dollars from any given order.
Many companies promised their investors that at scale their delivery model would make financial sense. The better those companies’ margins and price elasticity, the faster the services will reach profitability.
Are There Realistic Additional Revenue Streams?
To get delivery economics in shape, you need to nail the pickup process, order optimization, courier acquisition costs, and more. Having an additional revenue stream can give you flexibility as you scale and fine-tune delivery operations.
In off-premise alcohol, we knew that there was effectively no data on consumer purchasing behaviors and that information could be valuable to brands. Tying marketing spend to purchases would close the loop on alcohol advertising for the first time in the off-premise market.
This isn’t to say that data is a fit for all on-demand companies; other services will need to find their own realistic additional revenue channels to provide flexibility to their early operations. What is the industry lacking, and what can the on-demand startup do to uniquely fill that void? Simply saying that you’ll have data in an industry already ripe with information won’t be that valuable.
CCAC And Unit Economics: The Dirty Secrets of On-Demand Companies
Based on what we know about the courier acquisition costs of other services, I’d heavily speculate that many companies that tell the press about their “positive markets” are not including amortized courier acquisition costs and other expenses like transaction fees in their unit economics.
In case you need a refresher, unit economics has been loosely defined as:
Take Per Order – Cost Of Delivery = Unit Economics
Once you understand that equation, you can calculate how much it costs to acquire a customer and how long it takes to get paid back for that expense when including the cost of delivery. One or two years ago, companies weren’t pressured to prove their unit economics. These companies said “at scale” positive unit economics would be achieved. There are also a host of other factors that have to be considered when calculating unit economics:
- Take rate per order, and whether there is room to grow the figure.
- Delivery cost to the company per order.
- Cost to acquire a new courier.
- Average number of lifetime courier delivery.
- Orders per hour per courier.
- Materials cost of each order.
- Merchant and transaction cost per order.
These costs can add up. A study by Harvard Business School students Amit Arora and Nimi Katragadda estimated the courier acquisition cost for on-demand services to average between $150-650. Based on what I have seen across multiple third party courier recruiting platforms, that number is close to an accurate average.
If you take courier acquisition costs into account when calculating unit economics, along with materials costs and transaction fees, it’s likely that many “positive” companies are actually negative. That’s why it’s so important to not only run an efficient delivery operation, but one that couriers enjoy and respond well to. The result is lowering acquisition costs, increasing retention, and lowering churn.
Courier churn is a growing problem for on-demand companies. It’s also a top question for venture capitalists, who see startups spending heavily to acquire couriers while failing to retain those workers.
Building a simplified delivery process for couriers and being thoughtful about this from the beginning can result in major benefits. At Saucey, couriers don’t shop or pay for items. Instead, they head to a designated pickup location, helping them execute more orders per hour. The impact is that our firm can pull off more orders with fewer couriers. It’s a little more complicated than that, but courier efficiency has enabled us to consistently scale couriers and achieve positive unit economics including courier acquisition and other costs.
What Does Success Look Like?
Let’s say you nail all the above metrics, have a great team, and that there is a real business in play: What happens if you are successful?
What does an on-demand company’s success mean for consumers, its industry, and for the world? For Munchery or Sprig, I imagine it means being the next generation McDonalds or Chipotle that provides healthy food to people at a low price. For Shyp, it could mean displacing one of the major players, like DHL or UPS, with a simpler solution for consumers.
At Saucey, we had a thesis that by combining the pricing and selection of big box retail with the convenience of delivery, we’d address the majority of consumer’s off-premise purchasing behavior. We believe that the retail alcohol market is outdated and oversaturated, and by offering a better way to shop for alcohol, we’ll drive market consolidation across the $105 billion yearly United States retail alcohol industry. If we are right, the retail alcohol market will never be the same again.
Join thousands of business professionals reading the Mattermark Daily newsletter. A daily digest of timely, must-read posts by investors and operators.
Disclosure: It’s very likely that Mattermark shares a common investor with at least one of the companies listed above. As always, the Mattermark editorial team is externally and internally independant.