The fact that startups are going into IPOs later than ever before has been flogged to death in hundreds of articles about the changing venture capital industry. The coming (very late stage) IPOs of UBER, Lyft and AirBnB in early 2019 has led to another news cycle taking on this topic. In the forefront: Silicon Valley and its ability to summon up massive private equity funding in the billions.
When the reasons for this funding dynamic are explored, two arguments keep surfacing. They are both true, but they are not the whole story. Yes, we have seen private capital pouring into Silicon Valley startups, at levels that are historically unprecedented since the Dot Com Era. New sources of capital have made this possible, for example, the Saudi Public Investment Fund’s engagement in UBER. Surely, the ease of raising capital privately compared to the regulatory restrictions and transparency requirements surrounding IPOs matters, too. And public markets don’t have the same appetite for risk; so big hairy plans are more likely to be funded by private than public equity.
What is also going on in venture capital, however, is that many of the newer consumer startup business models simply require more funding to fly than before. The driver of this has been the development from pure marketplace and listing models to what we call “managed service platforms.” Managed service platforms combine digital cost efficiencies and scalable platform characteristics to provide highly competitive, flexible and disruptive consumer services. But they are not pure play marketplaces or listings, because the services they provide require a degree of managed handholding to work for consumers. They are active in areas where trust matters.
Andrew Chen (@andrewchen) and Li Jin (@ljin18), investors at the blue chip venture capital fund Andreessen Horowitz, recently described this trend in an excellent blog post. The terminology used by Chen and Jin is a little different from the one used here, but the conclusion stands: Pure marketplace and listing business models, such as eBay, Etsy, Craigslist or Yelp simply don’t work as startup investments any more. The low hanging fruit is gone. Newer consumer service offerings require far more handholding.
The trend towards managed service platforms is not exactly sparkling new, but it is becoming more and more pronounced as service platforms enter a wider range of sectors and more regulated territories like healthcare. UBER may have at one point of time characterised itself as a marketplace for mobility services, but it is clear UBER is a managed services platform with specific responsibilities over the services it provides, it’s drivers and their cars. In part, regulation forced UBER to take these responsibilities, but mostly they are intrinsic to the business model itself. Even AirBnB, which looks more like a marketplace than its contemporary peers, has strong managed service characteristics along its value chain, from professional photography when homes are featured to customer service. We will know more at IPO time, but the Financial Times’ Lex Column (“Airbnb: sharing is wearing”) writes that while AirBnB has the same estimated revenue as Hilton Worldwide ($35bn), it is far less profitable, with a 3% margin compared to 47%. Remember, this is comparing a digital platform to a hotel chain (!). Even newer service startups will have the same or even higher opex requirements.
Huge billion-dollar investments are required to achieve global dominance for these types of business models. But there is a paradox here. The larger funding requirements for global growth also translate into local opportunities for exactly the same fundamental reason. Each country requires its own dedicated team, specific know-how and unique approach. What makes global so expensive also makes local into an opportunity.
Managed services need to build up local competence and need far more “boots on the ground” than the low-friction marketplaces of the past. Local regulation has to be navigated. In the future, we might see Silicon Valley funded companies arriving too late at the scene, with national startups having built the business faster. In Germany, for example, promising managed service platform startups are coming up quickly, such as Careship in elderly care, Homeday in real estate or Zenjob for student jobs. One of Germany’s lighthouse success stories, Flixbus, provides bus mobility services. Managed service platforms are a real opportunity for national venture capital funds (and also newer funding approaches like ours at German Media Pool).
In managed service platforms, we have a business model where local funds have a competitive advantage compared to the big names of Silicon Valley. Obviously, local gems and national champions do not offer the potential that global domination does. The risk/ reward equation obviously is different and this should be reflected in lower valuations (just a hope… let’s see about that). What we have here is a massive 2019 local investment opportunity, nonetheless, in many, many different business segments.