Capital Hacking - Time to Look Beyond VCsI am skeptical about most On-Demand start-ups as I see most of them as tech-enabled convenience that treats human capital as just a commodity. But this did not keep me from meeting up for coffee last week with my friend Ryan Spong, who is the Co-Founder and CEO of Foodee, a Vancouver-based Goods Delivery company.  For Ryan’s company is different as it is more about the Sharing Economy than the On-Demand Economy. His delivery force is made up of employees, not contractors, and he is building a long tail of under-utilized restaurant capacity to bring “the food culture to the work culture” and make high-quality food accessible to time-deprived office workers.

I congratulated Ryan on his Series A round of $6 million, which is pretty impressive given venture capital is becoming more scarce. In fact, only 4 of the 75 Sharing/On-Demand Economy companies in my database raised capital in 1Q16, versus 18 companies in 1Q15. I also confided in him how disheartened I was to discover that Storefront, a commercial retail space Corporate Asset Sharing company founded in January 2012 with the social mission “to make retail space more accessible, empower store owners/merchants, and foster local economies”, had just closed its doors.

With rumors of unicorns at risk of turning into “unicorpses” and “donkeys”, I told him I was becoming increasingly skeptical that the marketplace model will translate for most start-ups. The low barriers to entry, attractive economics, and recent flood of capital to these start-ups has led to the perfect storm in terms of Porter’s five forces. Due to the unique dynamics of a marketplace, the heightened competitive environment is leading to increasing bargaining power for both suppliers and buyers. As a result, we are starting to see a double jeopardy of rising acquisition costs and increased attrition on both the supply and demand side.

If you remember, although the ecommerce model did not translate for most of the dotcom start-ups, it did translate for traditional companies. So while the marketplace model may not translate into profitable economics for many of the Sharing/On-Demand Economy start-ups, it will translate for established companies, as they will be able to plug the marketplace model into their existing corporate infrastructure. Excited to share with Ryan the final draft of my book “UBERNOMICS: The Next Generation of Business Strategy”, I turned to Chapter 7 and showed him the Ubernomics Hidden Value Canvas I developed to help companies visualize the different ways they can unlock hidden value by collaborating with Sharing/On-Demand Economy start-ups (i.e. partnering with, strategically investing in, acquiring) or collaborating with their corporate stakeholders (i.e. employees, customers, suppliers, partners) to build their own marketplace.

Ryan told me he had actually started to put together a list of potential strategic partners for Foodee (drawing upon his former life as a Wall Street investment banker) and asked whether I had developed an Ubernomics matrix to help start-ups. I had not, but Ryan inspired me to start doing some research. Based on looking up the CrunchBase investor list for each of the 75 start-ups, I discovered that just under a quarter have raised capital from strategic investors, from 9 of the 10 verticals. It’s interesting as of the seventeen companies with strategic investors, only four received just financial capital – as seven also received supplier capital, five received customer capital, and one received structural capital.

The first option is a supplier capital hack. Ironically, the supply side represents one of the biggest risks for companies as they do not own or control the inventory of assets, goods, or services. And many start-ups’ business models face challenges in terms of having a high marginal cost of supply, a low marginal utility of demand, and low market liquidity. One of the best supplier capital hacks was by Mark Gilbreath, the founder of office workspace sharing company, LiquidSpace, who brought in GPT Group, CBRE Group, and Steelcase as investor in early 2013. Interestingly, GM, which recently invested in Lyft, was actually an early strategic investor in RelayRides (now Turo) back in late 2011. But companies need to do their due diligence as GE claims in Quirky’s December 2015 bankruptcy-court related documents that Quirky “…caused substantial damage to the reputation of GE and to its trademark”.

The second option is a customer capital hack. Although many of the verticals started out as blue oceans of demand, many of them are starting to turn bloody red as more players enter the waters. As customers become more difficult and costly to acquire, this is leading to demand risk, as start-ups have to build their customer relationships from scratch. And many start-ups’ business models face challenges in terms of having a low marginal utility of demand, low fidelity of demand, and the absence of corporate buyer exposure. In September 2015, Whole Foods Market partnered with Instacart to “offer its customers the convenience of delivery without having to handle the logistics themselves” and then made an undisclosed strategic investment in the company in February 2016. Another customer capital hack strategy for start-ups is to seek financing from their own customers like Getable (four construction companies) and Hourly Nerd (GE Ventures). Or they can seek to form an exclusive partnership like did with Petco who has invested in its Series B to Series E rounds.

The third option is a structural capital hack. For example, Roadie sought out UPS Capital to provide it with an insurance solution and brought in UPS as a strategic investor. But ultimately, if a start-up discovers it is lacking the structural capital to profitably originate, extract, and capture value, it might be better off to forget about capital hacking and find an exit through a strategic buyer. For example, in January GM acquired the shuttered assets of Sidecar, which wasn’t able to effectively compete against Uber and Lyft and was unsuccessful in its strategic pivot in August 2015 to the Goods Delivery vertical.

If venture capital remains scarce, this could jeopardize the Sharing/On-Demand Economy as I count there are 25 start-ups, representing a third of the universe, that have not raised any capital since the end of 2014. But as I realized from my discussion with Ryan, it does not have to be a doomsday scenario as there could be a light at the end of the tunnel. Capital hacking could provide start-ups with access to the capital they need in order to survive – not just financial capital, but more importantly supplier capital, customer capital, or structural capital.