Reminds me of recent Instacart news.

http://www.bloomberg.com/news/articles/2016-03-11/instacart-...

Here's the money quote: "[Instacart] said 40% of the company's volume is profitable - meaning most orders still lose money. It also said that it will be profitable globally by summer. However, its calculation for profitability doesn't include the cost of office space, the cost of acquiring shopper workers, or the salaries of its executives, engineers, designers or other employees..."

In other words, a $2b company figured out how to "not lose money" 40% of the time when their lowest paid workers deliver things. Ignoring those pesky cost centers that are developers, designers, hiring managers and executives. When every corner deli within 10 miles of me delivers (often for free) and presumably does so profitably (disclaimer: I live in a major metro area).

Technology has a peculiar ability to light gigantic piles of money on fire. These are strange times we live in.

At traditional restaurants and cafes, not every item on the menu is a profitable one.

Often some items are actually loss-leaders, enticing you to come in more often, or to pair it with a more profitable item that makes up for its cost.

Sometimes it is, even more, obvious that something is a 'loss leader'; such as at fancy dinners where they'll simply give you bread for free while you wait for your meal or bars where they give you salty snacks like popcorn to encourage you to buy more beer and not leave to have a real meal somewhere else.

A loss leader is one thing, but imagine a restaurant that only sold 40% of their meals above cost, and the 40% that are above cost only have enough margin to cover the minimum wages owed to the waiters.

I think part of the problem here is failing to use correct terminology. We might say, in GAAP terms:

* For 40% of the orders, they achieve a positive gross margin * We anticipate reaching positive gross margin on 100% of orders by the end of year * Even after reaching positive gross margins, non-COGS operating costs are sufficiently high to result in a negative EBITDA

To expand: non-COGS operating costs would include SG&A costs (Selling, General, and Administrative), among others. It's how a company like Box might have healthy gross margins on its unit sales but be unprofitable due to considerable marketing expenses as it tries to capture market share in a growing market.

That sounds taken out of context, or misquoted. Its reasonable to talk about the marginal profitability of an activity. E.g. Given employee base (shopper workers already hired), current app and backend (no marginal cost for developers/executives) then the sales price minus cost-of-sale was positive. Very important number! Means the company would be profitable after scaling that part of the business enough to cover fixed costs.

Most startups are actually looking for that magic formula. They spend spend spend until they find it, then scale scale scale to become a profitable business as a whole.

Doesn't look like a misquote to me. And while, yes, unit economics are a thing, there can be a huge gap between being unit profitable and profitable as an organization. A bunch of delivery companies flew into the ground during the first crash under the same circumstances (including a few grocery delivery companies).

If you're running a company with 500 employees an a big office in San Francisco (where employees average ~$100k a year, fully loaded), and each of your deliveries nets 1% of a $50 order, on average ($0.50; not a ridiculously low net margin for the grocery industry, even in logistically optimal scenarios -- which delivery is not), you've gotta be doing (500 * $100,000) / .5 = 100 million sales a year just to break even. AKA, $5 billion a year revenue run rate.

So then you say: "OK, we'll just cut some of those expensive SF people, and we'll bring the curves closer together!" And that could happen. Or you could discover that getting those margins was only possible with X million sales a year, and getting those requires at least 500 employees to run operations without dropping the ball. And then your investors stop throwing money at you, because the business economics look scary, and the funding climate has changed. And then you die.

Again, this is not a made-up story.

When huge investors get involved in land-grab businesses before they're profitable, they're all betting that their horse will be the next Amazon. But there's only one Amazon. And even Amazon isn't that profitable. And Amazon started by competing in a high-margin industry.

$100K fully loaded sounds low for SF.

Agreed. I was trying to low-ball it, just to head off the criticism that I'm exaggerating.

Yeah it was a pretty big stretch.

While I agree that marginal probability is important, I think it is a fallacy to assume all of those other costs don't have some variable component as well. There will always be shopper worker churn that will grow as the business grows, additional (albeit low) costs in software to scale and add new regions, etc.

In a business with sizable margins, it may be OK to discount some of these other things, but in a business with teeny tiny razor thin margins like grocery delivery, one should have a very healthy skepticism about hand-waving away real costs.

Yeah their story was a pretty big stretch.

"Technology has a peculiar ability to light gigantic piles of money on fire."

Just wanted to say thanks for the laugh! It's not often than a comment on HN makes me laugh out loud. As in laughing with you, not at you...

Peapod looks like it hasn't changed in 10 years and basically does the same thing as instacart but cheaper and better.

Ignoring the app, and disruptive gimmick, I have to wonder what your average diner could have achieved with $13.5m in funding. You could build a small, well branded chain. Probably selling food above cost to boot! :)

Food service has a terrifying reputation as a business sector—restaurants routinely go out of business in their first year. Deep funding would create a buffer and help it grow, of course, but I still wouldn't want to bet on a restaurant.

One of the amusing ironies of the food-delivery bubble for me was that you're taking the crappiest part of a crappy industry's economics, and scaling it.

It's all of the costs and logistical pain of running a restaurant, with none of the margins. Brilliant!

Indie restaurants, maybe. But for franchises, the opposite.

Depends on the franchise. Subway, for example, is apparently an absolutely brutal franchise to run, whereas Chik-fil-a is super careful about who they give them to.

Restaurants, not junk fast food chains. He or she was probably referring to corporations like Bloomin' Brands (OSI) and Brinker International.

I happened to pick two fast food chains because I know they're on polar ends of the "How nice is it to be a franchise" spectrum. The core of the point is that not all franchises are created equal.

But it matters which franchises you are talking about. A restaurant like Maggiano's, or Bonefish Grill is as far removed from Subway as Subway is as far removed from a 7-Eleven.

It's worth noting that Bonefish Grill operates a "managing partner" system, vs an ordinary franchise. The corporation owns 85% of the business, while a location's managing partner (who invests some money to get started) owns 10% (a regional manager owns the other 5%).

IOW, they're not, strictly speaking, a franchise.

What is the upside for owning only 10%? Seems that the only asset that you have is that interest which you can sell to someone else, that is managing partner, with approval of corporate.

In the bonefish grill's that I have been at (several), the managing partner is typically present at the restaurant when I have been there. As such this is in a sense like buying yourself a job. (You could say the same about some franchises but somehow I see this a bit differently..)

I agree. The benefit of this system is primarily that of the corporation. You get a manager, sell them a small percent, which helps cover some (a small amount) of the location's launch costs, gets the manager committed and makes them feel like a real owner, which makes them focus on success much more... with little serious upside. Not to mention, it puts the manager at a financial loss (their initial investment), if they quit within 5 years.

I knew a managing partner of a Carrabba's. He quit something like 2 years later and bought this little burger drive through. It must have been really bad at Carrabba's...

AH, but you couldn't get any investors for that.

You could absolutely get investors.

Just not any VCs.

Nothing is impossible: Philz Coffee has raised $15m [1] and The Melt (grilled sandwich chain) has raised money from Sequoia [2]

[1] http://techcrunch.com/2015/02/18/philz-coffee-funding/

[2] http://blogs.wsj.com/venturecapital/2014/11/12/sequoia-backe...

In fairness, that's because VCs can't really make money investing in companies like those.

I think it's just that the VC model is predicated on finding that fraction of a percent of investments that gives you astronomical ROI as opposed to more conservative investors seeking lower returns more often (the type of person who would invest in a restaurant just to get a check every month). They are willing to get nothing back a majority of the time while the more conservative investor would probably be bankrupt if even 50% of his investments netted a total loss of investment.

Right. If you're going to accept a 50% failure risk, your average return from the companies that don't fail has to be better than 2x. If 70% of them fail, even 3x isn't enough.

Chipotle, even after getting hammered in the recent past, has a market cap of 15.5 billion dollars. It's rare, but it's possible.

That's not the point. VCs are interested in quickly (5-7 years) getting to 15B in market cap, not 22 years.

Chipotle went public 13 years after it was founded at half a billion dollars in market cap. While not as flashy as some of the unicorns, that would still have been a pretty decent showing.

In fairness, that's because VC culture is a parasite on normal society.

Are they really? The high failure, high return model has allowed many programmers (and others within VC-backed companies) to have employment that wouldn't otherwise exist. I'm happy to be outside of SV, doing well in a 100% bootstrapped company, but I think VC culture has had the opposite effect of a parasite (or at worst, I'd call it a symbiote)

Yes, in many many ways.

They are money losers. It only looks like they are not because of a temporary bubble. This bubble is popping and their losses are becoming clearer. There are many that will personally make money despite running a fund that loses money.

Their culture is steeped in groupthink. Which by definition results in malinvestment and destruction of wealth. This wealth comes from pensioners who can't get sufficient returns from lower risk investments.

At some point pension funds and pensioners are going to run out of money which will be bad.

Specifically for bootstrapped companies. VCs increase the input cost; labor and rent etc. And they subsidies competitors. E.g. Customers who would normally pay you for services get it free from a VC funded startup. Then VCs run out of money and competitor goes bust. This induces boom and bust cycles that mask steady improvements with hype. This hurts the market.

Programmers would be much better of with a steady market where there is a discoverable market value for their work.

Pension funds invest tiny, tiny portions of their portfolios in venture capital, and they do it deliberately, as part of a strategy to diversify asset classes. Venture capital is probably not going to mess with too many people's pensions.

The Kaufmann report on venture capital (which is not, to put it charitably, aggressively pro-venture-capital) is a good place to start on this.

As for bootstrappers (I am one of those, and have been for ~12 years now), I think @Pinboard has a thing or two to say about the VC threat/menace.

They could (and do), but the prospect is longer-term and riskier, which makes it far less appealing.

Even with as risky as opening a restaurant is I think getting VC-level returns out of a startup if far riskier.

Less likely != more risk.

Blue Bottle Coffee.

https://www.crunchbase.com/organization/blue-bottle-coffee

Yes, but on a serious note the difference in potential upside between investing in this vs. a traditional restaurant chain is like that between investing in Amazon vs. a traditional book store chain. If you can find a way for the business model to work it is operating in a way where the inventory and distribution are handled in fundamentally different ways than in the past.

Your average diner knows NOTHING about scaling a business to a national or international level, nor about venture capital and the pressures of shareholders.

From the look of things around here, your average tech company ain't much better.

"Positive unit economics; couldn't cover engineering salaries, marketing, or G&A" is how I'd read that.

This is notable because some of the on-demand companies are engaged in a bidding war out of perceived land-grab economics, either on the supply or demand side (or both), so they price the customer-side service or the supply-side cut in such a way that the company loses money on most or all orders.

Think like: We'll deliver you a $8.50 sandwich for $10.25 and a $1 delivery fee, with a guaranteed payment to the driver of $5.00 per order.

If that's a little gobsmacking, suffice it to say that there are a lot of people with Uber envy, and that this is part of the playbook in expansion phase for them, too. (They are presently engaged in a bidding war against an Uber-for-China which is transferring billions of dollars from investors of both firms to drivers/riders.)

That's the way I read it as well. They were selling food for more than it cost them make/buy it and deliver it, but not enough to cover all other expenses.

Under sane conditions, I'd presume this is the type of company that could get money, either through debt or equity. The business model works, it just needs scaled. However, that also assumes scaling the business does not also scale those other expenses at a ratio well below 1. If the ratio is closer to 1, it's a bit dubious to not count those towards the unit costs.

Maybe the Uber playbook shouldn't be used for every on-demand service or maybe it would be smart for on-demand services to offer a non-commodity product so their success is a lower bar than shooting the moon.

"contribution margin positive" ought to win a creative writing award.

Actually, this is standard finance terminology for "if I add X revenue to the business, how much flows to free cash flow" - what we can reinvest/pay back to shareholders.

I, for one, am surprised they shut it down if they in fact had achieved positive contribution margin. Probably just couldn't tell a good enough story for how they'd grow, and demonstrate good upside, for new money in, given all the preferences/dilution/creditors already in their capital stack.

Are you suggesting that my read was incorrect, and that they are cash flow positive after not just food costs but logistics as well?

From wikipedia:

>> Contribution margin, or dollar contribution per unit, is the selling price per unit minus the variable cost per unit. “Contribution” represents the portion of sales revenue that is not consumed by variable costs and so contributes to the coverage of fixed costs.

So, positive contribution margin should imply they covered all the fixed and variable costs, the way I read it.

But then, why do they need to shut down? It looks like their def on "contribution margin positive" is something else after all.

https://en.wikipedia.org/wiki/Contribution_margin

Interesting. I stand corrected, thanks to HN for teaching me something. Contribution margin is only for variable costs, it doesn't cover fixed costs -- so it doesn't mean positive CM goes to free cash flow, only to fixed cost coverage.

Which brings up another interesting point...I'm not sure how companies like this do cost accounting. When running a traditional business, say, a restaurant, variable costs (labor, food inputs) dominate vs. fixed costs. On the other hand, places like Microsoft spend a ton of cash to build a huge fixed asset (Windows) that gets sold to millions of people over time without any depletion, practically the very definition of a "fixed asset".

I wonder how Spoonrocket allocates their platform R&D in unit economics; how they do this will make all the difference in whether their "contribution margin" is in fact, positive, or not.

It's important to realize that even if a business is, strictly speaking, "profitable", it doesn't mean it's a good business. I don't stand on the corner selling newspapers because it's not a valuable use of my time vs. other pursuits, and a comparable argument can be made for use of shareholder capital, too.

Fixed no, variable yes (or else they would just be profitable).

An explanation with an example can be found here[0].

But let's throw out some easy (but completely false numbers).

Assume:

The fixed cost for the entire operation for one month is $1000.

The operation makes 1000 widgets in one month.

A widget can be sold for $2.

Analysis:

If the company sells all 1000 widgets that it made in a month, then it will have revenue of $2000. If each widget had no variable costs, then each widget sold 'contributes' $2 to paying off the fixed costs of the company. $2 is greater than zero, so the company has a positive contribution margin.

Take the same assumptions as listed above, but the variable costs for each widget is $3. If the company sells all 1000 widgets, then it will have a revenue of $2000. However, each sale of the widget contributes -$1 towards the fixed costs of the company. Thus the company has a negative contribution margin.

So the first situation boils down to "we sold a widget for more than it costs to make", and the second situation boils down to "we sold a widget for less than it costs to make". Where "costs to make" includes just the variable costs. Which is what the article implies, "SpoonRocket had reached a positive contribution margin — it was selling meals for more than it cost to cook them."

Note also having a positive contribution margin also doesn't mean the company will ever realistically be profitable. Imagine a scenario where the fixed costs are $100.000 per month, and the contribution margin of each widget was $0.01 (ex: variable costs per widget $9.99, sale price $10). Each widget has a positive contribution margin, but the company would need to sell 10.000.000 per month to actually cover the fixed costs and become profitable.

Edit: had fixed/variable backwards on the first line.

[0] - http://www.accountingcoach.com/break-even-point/explanation/...

"So, positive contribution margin should imply they covered all the fixed and variable costs, the way I read it."

That's not what the passage you included says. It says it only covers variable costs.

Passage no, but TC report says they were contribution margin "positive", which, they way I understood it, implies it should cover fixed costs, otherwise it is still contribution margin-negative (vis-a-vis fixed costs)

So, the passage explains what contribution margin is, but TC is talking about being "contribution margin positive". How would you understand the second term?

As I mentioned in an example above, just because you have covered all of your variable costs doesn't necessarily mean that you have the ability to cover all of your fixed costs at a reasonable sales rate. Contribution Margin Positive just means that each widget sold contributes towards fixed costs (as compared to negative, where each widget sold reduces the amount of money available to pay fixed costs), even if that contribution is one cent. So you could be positive by selling a product for $10 that has a variable cost of $9.99, but damn if you'll ever make a profit (where contribution margin * widgets sold > fixed costs).

> So, the passage explains what contribution margin is, but TC is talking about being "contribution margin positive".

TC has a terrible reputation for using business terms that aren't really generally considered business terms.

The reason it's called contribution margin is because it contributes to the other costs of the company.

I've only ever heard contribution used in the sense of COGS, not foxed costs.

Negative contribution margin would be if your sales did not even cover your variable costs.

It appears they were still at the "do things that don't scale" stage. Every company goes through this, even a diner. Why it took $13+ million to get there, though, is the real question.

Some companies (e.g. in biotech, autonomous vehicles) may take significant upfront costs, but anything requiring massive scale to be profitable means the margins are going to be razor thin (see: Amazon vs. Jet.com, freight shipping, payment processors).

I'm pretty sure you are, that's serious bubble talk

"But due to other costs" < aka paying for people, the website, the delivery, marketing, etc?

Reminds me of that famous Marion Berry quote, "If you take out the killings, Washington [DC] actually has a very very low crime rate."

Maybe its criminals being killed?!

No, it is pretty bog-standard analysis.

Over the long term, this is necessary but not sufficient to build a business line that makes sense. You also have to control all the other costs... which can be difficult if your business model requires large scale growth.

The former. The logistics/overhead costs were what damned them.

Just as well they worked that out after burning through only $13.5M in funding, and not after the IPO.

Only?

Seriously. I could run my lab for years on 13 million.

Those are "lifestyle businesses", this is a "startup". They're different, because reasons...

Most non-fastfood resturants actually price their food at or near cost after the overheads are factored in. Profit actually came from (overpriced) beverages and drinks. If a startup is to compete with them there is no way for them to make much money.

"If a startup is to compete with them there is no way for them to make much money." Selling overpriced drinks? If a startup is in an area where "there is no way for them to make much money" then what the hell are they doing there?

The line of thought was probably that they may reach a scale that can overcome these overheads since they don't have to pay rent or hire full time staff for every outlet.

It makes sense if you consider very early examples like Amazon which took more than 10 years to become profitable. Unicorns like Twitter and Dropbox are not profitable and are unlikely to become so in the near future, but they have reached a scale that their finances are relatively secure for now.

Yes - I assume there is some cooking labor and other items (electricity) factored in. So yes, they're on par with the deli. :-)

With early stage companies, many haven't even gotten to that point though. The first step is "Will someone pay for this?" Then the second is "Can we make money on each unit they sell." True profitability is "Can we sell enough units to cover our fixed costs"

What makes this interesting is the norm for a while was to fund #1. (And good ideas are still funded that way) #2 used to be the bar to get further funding, but now it looks like #3.

I would guess that the customer-acquisition costs alone are way higher than the food itself...

There are lots of startups that expect to lose money for a lengthy period of time while they attempt to capture the market or grow to a sufficient scale that their business becomes profitable.

In fact, it's not even limited to startups. I worked for Red Bull many years ago and when they open a subsidiary in a new country, the only metric that matters for the first few years is how much money they are SPENDING on marketing & promotion - sales just aren't that important until the brand has been established.

Good. It's not just me that reads this stuff and constantly wonders at the the complete lack of reason in Silicon Valley. (silly con?)

"All logistics costs" being delivery? That does sound like what they are suggesting.

I find it strange when companies use this terminology:

"We were exploring different strategic options, but deals fell through last minute."

Of course deals fall trough last minute. It's not like they would fall through a few months in advance.

Why not? Deals can easily fall through in early stages. "Last minute" basically means the details were pretty much hammered out, everybody was just about ready to sign, then something happened to scuttle it.

I think he was suggesting that when something falls apart it's always at the last minute for that something. Kind of like how you always find something in the last place you look. I guess it's kind of accurate since you wouldn't describe an early stage deal as having "fell through".

That doesn't make any sense. If the deal falls through in the middle of negotiations, you would never describe that as "at the last minute" even though it turned out to literally be the last minute for that particular deal. That phrase means "right before we would have completed the deal," not "right before we stopped."

Sorry, I wasn't intending to say it was correct, only that I think it's the only way to read what he wrote as internally consistent.