The Next Step For Internet Businesses

Uber, the world’s largest taxi company, owns no vehicles. Facebook, the world’s most popular media owner, creates no content. Alibaba, the most valuable retailer, has no inventory. And Airbnb, the world’s largest accommodation provider, owns no real estate. Something interesting is happening.

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One of the largest trends which has hit the world of startups is the rise of the internet marketplace. To understand the internet marketplace, we must first understand the physical marketplace. A marketplace is essentially a physical space where merchants can set up stalls and transact with customers. Although each stall within the marketplace is owned by an individual merchant, to the regular customer it seems like the marketplace is a single entity which sells a multitude of goods. However, the marketplace does not actually own any of the goods being sold — it just facilitates the transactions between the merchants and the buyers by providing a physical space for them to meet and transact. The marketplace makes money by charging these stall owners rent.

Much like this physical marketplace, an internet marketplace works the same way in principle. Instead of providing a physical space, it provides an online space for merchants and customers to transact — this is usually in the form of a website or a mobile app. The most obvious online marketplace would be eBay, which is a website where anyone can post a picture of an item and someone else from anywhere in the world can choose to buy it. The genius of eBay was that it was not just a place where merchants could sell to customers, but it enabled anyone to buy or sell anything. This broke the old model of commerce where goods were traditionally sold by business owners to the regular man, because it now enabled every individual to become a small-time merchant without having to invest in the infrastructure needed to set up a physical store. It was no surprise, in hindsight, that eBay was to become one of the prominent internet companies of the 2000s.

Uber: A Case Study

As technology developed further, entrepreneurs invented more and more creative types of marketplaces. The advent of smartphones and mobile data allowed marketplaces such as Uber to exist. Uber is a marketplace for transportation — allowing any car-owner to become a merchant (driver) and anyone to become a customer (passenger). Uber facilitates these rides by maintaining a constant supply of drivers and passengers, so that both parties benefit. On the outside, it seems as though Uber provides these taxi services, but in reality they are just connecting drivers and passengers. Of course, they take a cut from each ride to sustain the company.

Because Uber does not need to own physical taxis, the capital needed to run the company is much smaller than a regular taxi company. This in turn creates 2 very powerful opportunities for Uber:

  1. They can provide the service cheaper than regular taxis.
  2. They can scale much more quickly.

In many cities such as New York, there is strict regulation on the number of taxis on the roads, regardless of the demand for them. This fixed supply and variable demand creates a shortage, and causes the price of renting a taxi and riding in one to increase. Uber, on the other hand, is able to provide taxi services for much cheaper than regular taxis because the cost of renting a taxi is much higher than the cost of driving for Uber. Since the costs are significantly less for the drivers, prices also dropped for passengers — making Uber superior to regular taxis in price for both passengers and drivers.

The fact that Uber does not need to own taxis also creates an opportunity for them to scale extremely quickly. They can reuse their software infrastructure across different cities and their only costs for expansion are hiring sales and operations people to ensure that the demand and supply of drivers and passengers in the new city is sufficient. In just a few years, Uber went from operating in a single city to being in over 600 cities — something unheard of previously.

These two benefits of not owning any physical assets, cheaper service and quicker to scale, are also applicable to the other marketplaces today. Alibaba connects businesses with manufacturers without having to do any manufacturing themselves. Airbnb connects tourists with places to stay without having to own any of the physical rooms themselves. Even Youtube is able to convey an extremely diverse range of content to viewers without having to own any studio producers — they only have to connect content producers with viewers.

2015 and Beyond

In theory, marketplaces are one of the best models for businesses in this Internet Age. There is relatively low start-up capital required, you can scale extremely quickly, and if you are successful you can create powerful network effects, keeping you in business forever. In essence, it is easy.

We choose to go to the moon in this decade and do the other things, not because they are easy, but because they are hard.

This legendary quote by Kennedy serves as a lesson not just for visionary leadership but for startups as well. If something is easy for you to build and execute, it is just as easy for someone else to do the same. For the case of Uber, they are facing extremely tight competition from various different companies across different regions: Lyft in the US, Grab in Southeast Asia, Didi in China, Gojek in Indonesia, and so on. This makes it difficult for Uber and the other competitors because each of them try to outdo one another in terms of price — it quickly becomes a race to the bottom.

Why Compete on Price?
One of the largest problems with marketplaces is that they are just a platform which their merchants operate on top of. This means that the marketplaces have generally quite limited control over their merchants. It is not uncommon for a driver to drive both Lyft and Uber, nor it is uncommon for a passenger to have both the Lyft and Uber apps on their phone. At the end of the day, to the customers, both services are almost homogenous except for price. There is very little that Uber can do to differentiate itself from Lyft in terms of service because they do not own the taxis nor the drivers, leading to the only option — competition on price. The ride-sharing companies are offering tons of subsidies to their passengers to keep them on their platform, and their competitors often follow suit, making it a race to the bottom.

In the case the other sharing-economy giant Airbnb, they are also unable to vastly differentiate themselves on anything other than price. They may be able to offer services such as insurance, security in payments, review systems, etc. but that is the extent to which they are able to control the properties that their guests stay in. They are unable to enforce 5-star-hotel level service and comfort due to the fact that they do not own these properties.

Not owning any assets is a double-edged sword.

Asset-Heavy vs Asset-Light

I believe that the new model for internet businesses will not be an asset-light marketplace but instead an asset-heavy business that will look similar to traditional businesses. By owning assets, be it cars, houses, rooms or content studios, a business is able to provide a service vastly greater than anything a marketplace can ever offer.

Amazon vs eBay: A Case Study

In the early 2000s, it was not clear which model was superior. Amazon was a marketplace of businesses selling goods to customers (B2C). eBay was a marketplace which allowed individuals to sell goods to other individuals (C2C). Although they were both marketplaces, they took very different paths and focused on different things. Amazon moved away from the 'pure' marketplace model to one which was more asset-heavy. They invested heavily in logistics — building warehouses & fulfillment centres and investing heavily in technology such as robots for their warehouses.

On the other hand, eBay focused on keeping the 'purity' of their marketplace and focused on scaling the company globally. eBay was available across the globe and was the household name for the second-hand market. Intuitively, which strategy is the better one?

Intuitively, it may seem like eBay's strategy was better. How could anything be better than successful world-domination? However, because of the fact that eBay was purely a marketplace, it essentially competed on price and did not have a stronghold of the quality of services offered to their customers. Because of this, competitors such as OfferUp in the US, LetGo in Europe & in the US, and Carousell in Southeast Asia spawned in different parts of the world offering free transactions and a better user experience on mobile — and there was nothing eBay could do about it. On the other hand, Amazon who invested heavily in physical assets such as robots and an extremely complex and advanced logistics system allowed them to have full control over their customer's shopping experience without compromising on price. Amazon was able completely distance themselves from any other e-commerce competitor due to their vast physical warehouses and logistics systems that operated much more efficiently on a cost-basis than anyone else. Although Amazon is still largely in the United States, they have built such a deep moat around their business in terms of technology that no one else can compete with them.

When you think about Amazon and eBay, it may seem that Amazon adopts a 'traditional' e-commerce model where they own warehouses and do the logistics, whereas eBay has a more 'modern' business model where they do not need to own any assets and can expand globally. However, I would argue that Amazon is a much more valuable company than eBay today.

The Next Step For Internet Businesses

If one consumes a lot of tech news and pays enough attention, it is clear that there are a few new innovative companies which look a lot like 'traditional' businesses in terms of being asset-heavy, unlike the marketplaces like Uber and Airbnb. One example is Opendoor, which touts the fact that one can sell their house on Opendoor in 3 days. The previous generation of property companies which were birthed in 2010 or before were marketplaces that enabled buyers and sellers of homes to connect with each other. This was a quantum leap in terms of property-tech because it allowed the previously-opaque property market to become transparent. However, that was all these marketplaces could do — improve transparency. If a home-owner had a bad property it would still not be able to be sold. However, on Opendoor, they guarantee that you will be able to sell your home because they buy it.

In this sense, Opendoor looks much more like a real-estate company which buys properties for below market rate and then sells it for a premium than a tech-company. However, they are much superior to traditional real-estate companies because they employ cutting-edge technology such as machine-learning techniques to price the homes more effectively than humans can. Opendoor should not be categorized as a tech-company nor a real-estate company, but instead a tech-enabled real-estate company *.
*credits to Kendrick for coining the term.

Opendoor looks very much like Amazon in the mid 2000s. Instead of seeking quick global expansion, they invest a huge amount of money in assets. This gives them better control over the service they offer their customers. Since Opendoor owns these homes, they allow customers to freely tour the homes at any time by installing security on each home and giving each home-viewer access to the houses through their app. They are in only a few cities in the US right now, but Opendoor has already crossed the billion dollar mark and are offering services to their customers which were previously unheard of in the property industry.

I believe that tech-enabled businesses is the next step for internet businesses across the globe. Uber has to build their self-driving fleet because that is the only way they can have full-control over their taxi services. Other examples of tech-enabled businesses include Flexport, a modern freight-forwarder and Affirm, a financial services company. On first glance, these companies look like they offer the same services that have been offered by their predecessors for decades — except now they are doing it in a technologically-enabled way. If this new technologically-enabled way requires large investments in physical assets, all the better because it creates a large moat that protects them against competition.

Implications For The Future

What does this mean for people looking to invest or start companies in the near future? I strongly believe that there will be a shift from marketplace websites to more asset-heavy tech-enabled businesses across all industries. The next big company in agriculture will not be a marketplace for farmers to buy and sell with wholesalers, but instead it will be a company that owns farmlands that are twice as productive because better crop technology. The next big company in job-search will not be a company that connects people who are looking for part-time work with companies looking for part-time workers. Instead, it will be an autonomous restaurant or coffee shop that does not employ any staff. The next big company in fishing will not be a better way for fishermen to sell their fish, but instead it will be an autonomous fishing boat.

Of course, these companies I have just described are just speculations of how the future will play out. My point is that these companies are not easy to build, they require large investment in infrastructure and will be very asset-heavy as compared to their marketplace predecessors. They are hard companies to build, but this is the future. So if you are still looking for a startup idea, stay away from ideas which are easy to execute and seek solace in technical complexity and difficulty.