The Chasm

We live in an era of abundance. The rate of technological progress is accelerating at a blistering fast pace. New technological paradigms are developing sooner than we ever imagined (unless you’re Ray Kurzweil). We live in an increasingly more peaceful, healthful, free, and wealthy world than ever before. Is this the start of a utopian future or the calm before a perfect economic storm? Either way, we have a problem. There is a sizable gap in the road ahead.

The end of an era

One thing is clear, value creation opportunities in the current Web 2.0 paradigm are nearing an end. Amazon, once considered the underdog startup of the tech industry, is now well on its way to becoming the first trillion dollar business in history. Uber is one of the last unicorns of this era on the verge of going public and joining the ranks of the Fortune 50. It seems there are now more web applications than people to use them. It’s increasingly more rare for a purely Web 2.0 application to meet the remaining needs of humanity.

Dry powder

There is over a trillion dollars in “dry powder” eagerly waiting to be deployed in high risk ventures. We’re currently in what seems like a gap phase between an old and new technological paradigm. Many believe AI, robotics, and autonomous machines will rapidly transform our lives in the near future, and others are focused on blockchains, embedded sensors and 3D printing. The reality is that we’ll probably see a convergence of many of these technologies and industries that enables a vastly improved future. Meanwhile, the stockpiles of venture capital and private equity will continue to increase as investors anticipate and prepare for the right opportunities when new technologies and markets shape up and shake out.

Unsustainable ventures

In the process of researching, planning, and launching Subscribly, I’ve learned how this current business environment is causing irrational, unsustainable, and desperate business practices to become commonplace. Many of the greatest Web 2.0 businesses are network based. They are usually two-sided marketplaces, similar to what we’re building at Subscribly. Most two-sided marketplaces operate as a central intermediary, or platform. There are two broad classes of marketplace platforms. The first adds a lot of value to consumers’ lives and even enables new markets to exist. Netflix, Uber, Etsy, Airbnb, Amazon are all examples of game changing marketplace platforms. The second class of marketplace platforms enter otherwise efficient markets as middlemen that simply extract value from the market using aggressive and unsustainable tactics.

These latter businesses are in a race to the bottom and they’re becoming more common as we near the end of this era. The primary strategy is to grow users as fast as possible by subsidizing the cost of goods and services. They simply offer consumers an unbelievably good price for goods and services, so that consumers use the platform to make their purchase instead of going directly to the vendor. Many of the greatest marketplace businesses used this same strategy to bootstrap their networks, but in recent situations there is no value being created by the platform beyond the low, unsustainable price offered to consumers. It’s a sophisticated Ponzi scheme fueled by an unhealthy focus on user growth over value creation amidst limited investment opportunities.

The best examples are Groupon, ClassPass, and MoviePass. These are rent-seeking intermediaries that enter an otherwise efficient market, like local service providers, restaurants, fitness studios, movie theaters, and instead of building valuable new opportunities, they simply extract value from existing participants in the market. This is the classic mobster extortion technique (pizzo) cloaked in a veil of Bay Area disruption.

The top example is Groupon. The company started off providing a truly unique group discount model and grew rapidly. They laid the seeds that would germinate and blossom into thousands of similar discount voucher and gift card apps over the years, none of which seem to last. Groupon was one of the lucky few that made it to an IPO, and has been slowly losing market value since. The reason why is actually simple…they don’t create any value in the market. You may say they hire tons of employees, but that doesn’t add value to the marketplace where they operate. A few good examples of recent “breakthrough” businesses getting headlines will highlight what I mean.

Recently, MoviePass announced that it will reduce it’s unlimited movie ticket subscription business to just $6.99 per month. That’s amazing, right? How can you refuse such a good deal? Just go watch two or more movies per quarter and you’re saving money at the box office! Most consumers don’t care to look behind the curtains to see what’s really happening. MoviePass has about two million subscribers and hopes to grow to five million with this latest price drop. They have a virtually zero direct customer acquisition cost since what they are offering is so attractive it practically sells itself. But how do they sustain this business practice? The reality is, the company is about 6 months away from being insolvent and there is a high probability that if you paid for an annual membership you’re at risk of losing your “investment”. For every ticket purchased at the box office, movie pass has to pay the theater full price. They are losing significant amounts of money, but they have a plan. The plan is to keep showing subscriber growth to keep raising venture funding, to keep this elaborate scheme going. The eventual plan is to squeeze the movie theaters, which are already operating on relatively poor margins these days, to share their concession revenue. It’s a shameless business model. It adds no value to the market and is simply a way for a mobile app to insert itself in the middle of an existing, competitive marketplace and siphon off cash from the people providing the actual service and taking the operational risk required to bring you that movie you watch on the screen.

Buyer beware. My advice to people subscribing to annual memberships at MoviePass…you might consider paying for the monthly service while it lasts. The company is currently said to have about 6 months of runway before it will file for bankruptcy protection. That is a real possibility and in that scenario you’d lose out on your money since it went to pay someone else in the Ponzi scheme. Limit your risk. Pay a little more for a monthly subscription and hedge that risk.

ClassPass has a similar story. They were once a promising startup that now has to face the facts about the value creation dilemma I described above. The initial growth strategy, which was a completely unsustainable business practice, was to offer unlimited fitness classes for a monthly subscription of $99. Everyone wants something for nothing, so it works. They were effectively replacing your existing gym membership, plus the benefit of trying all types of new classes and getting personal instruction. They grew up quick and then realized that they needed to start producing net revenue to keep the business alive. So they’ve experimented with a number of business model shifts. Unfortunately, none of them have panned out so far. What they have done is similar to Groupon. They acquired a large consumer base by giving away services to consumers, then once they have the consumers they have to decide who to squeeze to make up their margins. Usually it falls on the service provider, like with Groupon and MoviePass. With ClassPass, they reduced the value of their monthly membership to a credit system where you get about 3-4 classes per month for $99 instead of unlimited classes, and they also squeezed their services providers, the gym owners, by giving them about $6 per class that gets booked. Where they will go is uncertain, but they are working super hard to come out with value adding products that leverage the brand they’ve built, like their ClassPass Live. Unfortunately, that product seems a lot like BeachBody which is now free on Roku.

HQ Trivia
This is the latest in the unsustainable business model venture game. I think HQ Trivia is interesting. They have some clever strategy to monetize through brand partnerships, etc., but time will tell if the $300,000 per month or more they are giving away in prize money will turn into a media franchise that gives them a decent ROI. With HQ Trivia, they do provide some entertainment value. With over 1MM people tuning in daily now, it seems they should be able to monetize that viewership enough to cover the $10,000 per day in prize money pretty easily, one would hope. I wish them the best of luck and enjoy participating in the daily trivia when I get the chance. At least in their situation, no local service providers are getting squeezed. More of the risk is on the founders and early investors that are building it up.

The road ahead

The struggle is real for any entrepreneur starting a web or mobile app today. The golden rule, “build something people love”, is your best guide. Decentralized apps are an interesting new frontier. They have the potential to solve a lot of the middleman problems that exist in today’s markets, but it seems most of the value and wealth is currently flowing to protocol developers, not decentralized app developers. Many of the best projects are open source and the ethos around blockchains and decentralization are not aligned with the control and profit motives of incumbents. I’m sure that will change. This marks the end of a significant era in our evolution. We’re now at “The Chasm”, looking forward to the Fourth Industrial Revolution, and we’re arguably witnessing one of the most exciting and significant transformations of humanity and society in millions of years.

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