Last week, Deliveroo made news when it announced it was preparing to leave the Spanish market. The recently listed Deliveroo couched its explanation in market terms, noting its market position in Spanish on-demand delivery wasn’t sufficient to warrant continued investment. Left unmentioned: A Spanish legal change requiring companies that previously depended on freelance couriers to hire their delivery staff.
Race Capital’s Edith Yeung helped explain the Deliveroo choice to The Exchange, saying the Spanish market doesn’t have a very large population, which may mean that the “potential upside for being #1 in Spain has [a] ceiling.”
While she noted that she doesn’t have access to Deliveroo data, her statement jibes with the company’s own comment that Spain made up less than 2% of its aggregate gross transaction value (GTV) in the first half of 2021.
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One company exiting a market is not a big deal, but we were curious about Deliveroo’s comments regarding the need for market leadership — or something close to it — to warrant continued investment. Is this the common reality for startups battling for market position, no matter if those markets are cities or countries?
Some startup markets have trended toward monopolies or duopolies. The Uber-Didi battle in China led to the companies agreeing to stop competing. Uber also recently sold its Uber Eats business in India to Zomato. In the United States, Uber and Lyft’s smaller competitors have long been forgotten and both the American ride-hailing giants continue to battle for dominance.
There are other familiar examples of this trend of consolidation. The food delivery game is concentrated amongst leading players. Postmates failed to survive as an independent company, winding up as part of Uber’s operations. Perhaps Gopuff will manage to claw out a spot in the market, but DoorDash and Uber Eats together accounted for 83% 79% of the U.S. food delivery business in June this year, per Bloomberg Second Measure data. (Data point corrected after publication.)
It’s no surprise that some startup markets lean toward monopolies or duopolies. Many countries protect intellectual property via patents that can constrain new innovation to one or two players for an extended period of time. Monopolies can also arise when a new technology or method of business is invented — Google’s internet parsing search tech led to a nigh-monopoly in many markets, for example.
In businesses where efficiencies of scale have a large effect, monopolies can form when leading players consolidate smaller competitors until just one or two companies remain. Standard Oil is the canonical example of this process.
What’s interesting about the on-demand delivery market is that it is both incredibly expensive but isn’t very technologically difficult to get into, which has meant that many companies have jumped into the sector around the world. This means on-demand delivery is the opposite of other patent-protected markets from which we might expect monopolies to form or competition to be extinguished past the top two players.
Yet, it’s also an industry where economies of scale can play a key role in profit generation, and increased competition can lead to price wars and advertising tussles. It’s a ripe market, then, for consolidation, even if it lacks an exploitable IP base.
The Exchange wanted to better understand the dynamics of startup competition in light of the Deliveroo decision. Can venture-backed startups ever be content with third or fourth place in competitive markets? Or is Deliveroo’s decision more fate than choice?
To dig into the question, we reached out to Hans Tung of GGV, Iris Choi from Floodgate and Race Capital’s Yeung. Each investor’s firm has put money into startups that deal with the sort of competitive dynamics that we’re interested in. GGV invested in Airbnb, and Floodgate in Lyft. While Race Capital has largely focused on crypto investments to date per available data, Yeung’s time at 500 Startups and her China expertise has meant she has experience with startups grappling with questions very similar to our own.
Monopoly money?
“If you want to create and capture lasting value, look to build a monopoly,” Peter Thiel famously told startups. This nugget was accompanied by the clarification that he wasn’t referring to “illegal bullies or government favorites,” but rather to “the kind of company that is so good at what it does that no other firm can offer a close substitute.” Still, when we asked Yeung whether she thought that startups should aim for monopoly power, she said, “No.”
The nuance here has to do with priorities — market position can be a byproduct of the other fundamentals that a startup needs to focus on. Referring to her portfolio companies, Yeung said, “Seed to Series A companies don’t have time to think about monopoly or duopoly. They should think hard about (1) Who exactly is their target market; (2) How big is the market? and (3) What pain points are they addressing and how painful is it?”
While her answer mentions pain points and product-market fit, it also mentions market size, which is clearly a key factor when VCs evaluate a company. As it turns out, market size also helps startups evaluate whether a lower than leadership market position would ever be good enough.
Back to Thiel: One of his main points is that startups should endeavor to capture most of the value that they create rather than seeing it vanish due to competition. “Capitalism is premised on the accumulation of capital, but under perfect competition, all profits get competed away,” he wrote. “The lesson for entrepreneurs is clear: If you want to create and capture lasting value, don’t build an undifferentiated commodity business.”
Such companies often manifest as what consultancy firm Play Bigger calls “category kings” — companies such as Uber that “define, develop and dominate new markets.” But is there ever space for more than one king? It’s definitely a question that VCs ask themselves, Choi confirms. “At seed stage, we have to consider whether a market can sustain multiple billion-dollar-plus companies or if it will ultimately become winner-take-all,” she says.
Referring to Floodgate’s investment in Lyft, she noted that they “felt that ride-sharing would be a large enough category to make multiple billion-dollar companies.”
Okay, but how big is that multiple? According to Tung, the answer depends on the category, and can often be “two or three.” Some markets such as search and phone OS are clearly about the top two players, he noted. “But in e-commerce (like in retail), it’s more — Amazon, Walmart, Shopify, Etsy, Wayfair, Wish, Poshmark, StockX … etc.).”
Market size is critical. As Yeung noted, in Uber and Lyft’s case in the U.S., “the pie is big enough for two big players.” But things might be different in other countries.
When should startups leave a market?
Not all markets are created equal, and there are often smaller markets within larger ones. Take major cities in the United States, for example, or countries in the European Union.
When should a startup decide it’s simply not going to manage in a market and it should cease its efforts to challenge leading players? Choi thinks it is “challenging for a startup to be content with third or fourth place in a market unless it is in service to a larger cause.” What sort of large cause does she have in mind? Startups pursuing to offer “nationwide coverage,” she said, may spend time, and human and financial capital to operate in certain areas “even if it’s otherwise not economical for it to offer the service in smaller regions.”
This may be why Deliveroo was in Spain at all — it may have envisioned a pan-European business that serviced its users regardless of where they most recently took a train.
But pursuing a larger strategy is not enough to assuage concerns about being a smaller player in a competitive market. “The challenge” for startups, Choi argued, “becomes: What do you believe will become true so you become a dominant player?” That is important, as it’s likely that if a startup can’t become a dominant player in a particular market, “the unit economics may never work in [their] favor, [and] so [they’ll] run out of capital.”
Choi’s comments outline a plausible reason for startups to stick in a particular market where they don’t lead, provided that the expense is in support of a larger play. But she also said that there “comes a point in many venture-backed markets where a startup realizes if they are not getting to scale, their best outcome may be an acquisition by one of the two biggest players, and thus markets consolidate down to a handful of players.”
Startups in lagging positions can do what Deliveroo did in Spain, or Postmates themselves to a larger player.
Market size matters in this calculus as well. Tung told The Exchange that there can be a “trade-off” between total addressable market, or TAM, and market share. You want to be a top-two player, Tung said, but you may be willing to “settle” for third place if a market is large enough.
But even third place can be hard to swing. It’s fine, Tung says, to start in a market in a lower position as long as the startup has market leadership in its sights. He cautioned, however, that it is simply not “efficient from an ROI standpoint to keep on pouring money into a market where one is not in the top three, without a chance to be at least [top two] later” on.
To sum up what Tung and Choi said, there may be times when startups want to keep spending despite occupying a position lower than first or second place. But those situations are the exception, not the rule. More simply, it’s silver medal or bust.
Unicorns, it seems, don’t look very good in bronze or worse.
What about first-mover advantage?
All our sources agreed on one point: First-mover advantage shouldn’t be overestimated. “We’re always careful because it’s definitely not enough of a moat, and often can be overcome,” Choi told us. Yeung even dismisses it entirely in some cases: “I don’t care if you are a first mover if it’s a small market.” and even in bigger markets, she sounds skeptical: “You could be Friendster (versus Facebook).”
Will Didi’s regulatory problems make it harder for Chinese startups to go public in the US?
You may not remember Friendster, but VCs do — or should — and it taught the best ones that all advantages are transient. As a result, nothing can be taken for granted, even market leadership. “I don’t believe in winner-takes-all,” Yeung said. “You can be the biggest player in the biggest market (Didi) and still get into trouble.”
No rest for the leading
Once a startup manages to achieve category or market leadership, their journey has only just begun. Yeung echoed Amazon’s “day one” philosophy, saying that “being content is detrimental to a company.” She cited Tesla’s impact on the car business and Airbnb’s impact on the hospitality industry, arguing that “even if you are No. 1 today, you may not be No. 1 five, 10 or 20 years from now. You cannot be content with the status quo.”
In a sense, this is good news for us consumers — if the smart money expects even startups trending toward duopoly or higher to stay vigilant, such market moments may prove transitory. Competition will reemerge. What does that mean for Deliveroo? It means self-driving cars, drone deliveries, and even small robots may eventually disrupt its business in markets it leads.
The company’s Spanish decision, then, is just one of the hard choices ahead.
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