Bronze Medals for Unicorns: A Philosophical Question

Deliveroo's Exit from Spain and the Pursuit of Market Leadership

Deliveroo recently announced its planned departure from the Spanish market, a decision that garnered significant attention. The company attributed this move to insufficient market positioning in Spain’s on-demand delivery sector to justify further investment.

However, a recent Spanish legal alteration, mandating the employment of delivery personnel rather than reliance on freelance couriers, was not publicly acknowledged as a contributing factor.

Market Size and Potential Upside

Edith Yeung of Race Capital offered insight to The Exchange, suggesting that Spain’s relatively small population may limit the potential benefits of achieving market dominance.

This assessment aligns with Deliveroo’s own reporting, which indicated that Spain accounted for less than 2% of its total gross transaction value (GTV) during the first half of 2021.

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The Importance of Market Leadership for Startups

While a single company’s exit isn’t necessarily noteworthy, Deliveroo’s emphasis on the necessity of market leadership—or near-leadership—to secure ongoing investment sparked curiosity. Is this a widespread reality for startups vying for market share, whether in cities or entire countries?

Many startup markets demonstrate a tendency towards monopolies or duopolies. The competition between Uber and Didi in China ultimately resulted in a cessation of rivalry. Similarly, Uber recently transferred its Uber Eats operations in India to Zomato.

In the United States, smaller competitors to Uber and Lyft have largely faded from view, with the two ride-hailing giants continuing their struggle for supremacy.

Consolidation Trends in Various Industries

This trend of consolidation is evident in other sectors as well. The food delivery industry, for instance, is dominated by a handful of major players.

Postmates was unable to sustain itself as an independent entity and was acquired by Uber. While Gopuff may attempt to establish a foothold, DoorDash and Uber Eats collectively controlled 79% of the U.S. food delivery market as of June of this year, according to Bloomberg Second Measure data.

The inclination towards monopolies or duopolies in certain startup markets is not surprising. Patents often protect intellectual property, restricting innovation to a limited number of companies for a considerable duration.

Monopolies can also emerge with the invention of novel technologies or business models, as exemplified by Google’s dominance in internet search.

Economies of Scale and Market Dynamics

In industries where economies of scale are significant, monopolies can form through the consolidation of smaller competitors, ultimately leaving only one or two companies remaining. The historical example of Standard Oil illustrates this process.

The on-demand delivery market presents a unique case, being both capital-intensive yet relatively straightforward to enter technologically. This has attracted numerous companies to the sector globally.

Consequently, on-demand delivery differs from patent-protected markets where monopolies are more predictable, or competition diminishes beyond the top two players.

However, economies of scale are crucial for profitability in this industry, and heightened competition can trigger price wars and increased advertising expenditure. This creates a favorable environment for consolidation, even in the absence of strong intellectual property protection.

Exploring the Dynamics of Startup Competition

The Exchange sought to gain a deeper understanding of the competitive dynamics facing startups, particularly in light of Deliveroo’s decision. Can venture-backed startups realistically accept a third or fourth-place position in competitive markets?

Or was Deliveroo’s departure a predetermined outcome rather than a deliberate choice?

To investigate this question, we consulted Hans Tung of GGV, Iris Choi from Floodgate, and Edith Yeung of Race Capital. Each investor’s firm has experience with startups navigating similar competitive challenges.

GGV invested in Airbnb, and Floodgate in Lyft. While Race Capital has primarily focused on cryptocurrency investments, Yeung’s background at 500 Startups and her expertise in the Chinese market provide her with valuable insights into these issues.

The Pursuit of Market Dominance

Peter Thiel famously advised startups to strive for a monopoly, clarifying this wasn’t about anti-competitive practices, but achieving superior performance where no close substitute exists. However, when questioned about aiming for monopoly power, Yeung offered a contrasting perspective, responding with a simple, “No.”

This divergence stems from differing priorities. A startup’s initial focus should be on foundational elements, with market position emerging as a consequence. Yeung emphasizes that early-stage companies – those between seed and Series A funding – should concentrate on three key areas: (1) precise target market identification; (2) market size assessment; and (3) the severity of the problems they are solving.

While product-market fit and addressing pain points are crucial, market size is also a significant consideration for venture capitalists evaluating investment opportunities. Determining whether a non-leading market position is viable is directly linked to the overall market potential.

Thiel argues that startups should aim to capture the majority of the value they generate, avoiding the dissipation of profits through intense competition. He points out that perfect competition eliminates profits, and advises entrepreneurs to avoid creating undifferentiated commodity businesses.

These successful companies often become “category kings,” as defined by Play Bigger – firms like Uber that establish, expand, and control new markets. But can a market support more than one dominant player? Choi confirms this is a frequent question for VCs.

Specifically, at the seed stage, investors must assess whether a market can sustain multiple companies valued at over a billion dollars, or if it will ultimately be a “winner-take-all” scenario, she explains.

Floodgate’s investment in Lyft serves as an example. They believed the ride-sharing market was large enough to accommodate multiple billion-dollar companies.

The number of potential dominant players varies by category, according to Tung. He suggests that “two or three” is often the limit. Certain markets, like search and mobile operating systems, naturally gravitate towards a duopoly.

However, other sectors, such as e-commerce, can support a greater number of large players, including Amazon, Walmart, Shopify, Etsy, Wayfair, Wish, Poshmark, and StockX.

Market size remains a critical factor. As Yeung observes, the U.S. ride-sharing market proved large enough for both Uber and Lyft to thrive. However, this may not be the case in all geographic regions.

Determining When Startups Should Exit a Market

Markets aren't uniform in their potential, often containing niche segments within broader landscapes. Consider major U.S. cities or the nations comprising the European Union as examples of this variability.

At what juncture should a startup conclude that success in a particular market is unattainable and discontinue its efforts to compete with established leaders? According to Choi, a startup should generally avoid accepting a third or fourth-place position unless it serves a more significant strategic objective.

What constitutes this larger objective? She suggests that startups aiming for “national reach” might allocate resources – including time, personnel, and capital – to operate in certain areas, even if profitability in those smaller regions is questionable.

This rationale could explain Deliveroo’s initial presence in Spain; the company may have envisioned a comprehensive, pan-European service accessible to users regardless of their location.

However, a broader strategic vision alone isn't sufficient justification for remaining a minor competitor in a challenging market. Choi emphasizes that the crucial question for startups is, “What must occur for you to achieve a dominant position?” This is vital because if dominance isn't attainable, “the financial fundamentals may never align, leading to capital depletion.”

Choi’s perspective highlights a valid reason for startups to persist in a market where they aren't leading, provided the investment supports a larger strategic goal. She also notes that in many venture-funded markets, a startup will eventually recognize that if it isn’t scaling effectively, its optimal outcome may be acquisition by one of the top two players, resulting in market consolidation.

Startups facing such circumstances can follow the path of Deliveroo in Spain, or as Postmates did, by being acquired by a larger entity.

The overall market size is also a key consideration. Tung explained to The Exchange that a “trade-off” often exists between the total addressable market (TAM) and achievable market share. While aiming for a top-two position is ideal, accepting third place might be viable if the market is sufficiently large.

Nevertheless, even securing third place can prove difficult. Tung states that it’s acceptable to initially enter a market in a lower position, provided the startup maintains a clear ambition for market leadership. He cautions, however, that continually investing in a market where one isn't among the top three, without a realistic path to becoming at least a top-two player, is inefficient from a return on investment perspective.

In essence, the insights from Tung and Choi suggest that startups may occasionally justify continued spending despite not holding a first or second-place position. However, these instances are exceptions rather than the norm. A strong finish – achieving either first or second place – is generally required for success.

It appears that achieving a bronze finish, or worse, doesn’t align with the aspirations of high-growth “unicorn” companies.

The Significance of Being First to Market

A consistent theme emerged across all our discussions with industry experts: the importance of a first-mover advantage is frequently overstated. Choi cautioned against relying heavily on this factor, stating it rarely constitutes a sustainable competitive barrier. It's a benefit that is often readily surpassed by competitors.

Yeung takes an even more direct stance, sometimes disregarding first-mover status altogether, particularly within niche markets. Even in larger markets, she expresses reservations, referencing the cautionary tale of Friendster.

The example of Friendster serves as a potent reminder for venture capitalists – and indeed, all industry observers – that all competitive advantages are ultimately temporary. This understanding fosters a mindset where no position, even market dominance, is considered secure.

Consequently, a belief in absolute market control is often misplaced. Yeung explicitly rejects the “winner-takes-all” concept, citing the experience of Didi, a once-dominant player that encountered significant challenges despite its substantial market share.

Transient Advantages and Market Leadership

The consensus is that market leadership, while desirable, doesn’t guarantee long-term success. Advantages, regardless of their initial strength, are subject to erosion over time.

This perspective underscores the need for continuous innovation and adaptation, even for companies that currently hold a leading position. Complacency can quickly lead to vulnerability.

Maintaining Momentum at the Top

Achieving a leading position in a category or market doesn't signal the end of a startup's efforts; rather, it marks the beginning of a new phase. Reflecting on Amazon’s “day one” approach, Yeung emphasized that complacency poses a significant threat to any organization.

She pointed to the transformative effects of companies like Tesla within the automotive sector and Airbnb within hospitality, asserting that current market dominance isn't a guarantee of future success. Maintaining the status quo is a risk, as leadership can shift within five, ten, or even twenty years.

Implications for Consumers

This perspective offers a positive outlook for consumers. If successful startups anticipate ongoing competition, even in scenarios leaning towards duopolies or greater market concentration, these dominant positions may not be permanent.

Re-emergence of competition is likely. For Deliveroo, this translates to potential disruption from innovations like self-driving vehicles, drone delivery systems, and the deployment of small delivery robots in their core markets.

Strategic Decisions and Future Challenges

Therefore, the company’s recent decision regarding Spain represents just one of the difficult strategic choices it will face moving forward.