The end of on-demand is nigh. The media cover down rounds and startups winding down on a weekly basis, and, as funding stops, it seems as if every “Uber for X” is doomed to fail.
Many people are questioning (fairly) whether software can eat services, which are fueled primarily by human capital. While convenience attracts the consumer, successful on-demand startups must generate technical leverage to unlock additional value in the cost structure. This newfound value should be utilized to empower and reward the service providers who are doing the heavy lifting, in some cases literally.
While fallout is inevitable in a downturn, there are many on-demand startups on a path to success. Looking at the cost components of traditional services can be informative, because specific categories have more margin flexibility than others, including personnel, real estate, supplies, marketing and administrative.
Most on-demand startups utilize technology to bring efficiency to supplies, marketing and administrative expenses. The degree of leverage around personnel and real estate is dependent on where a startup plays in the on-demand spectrum.
Across the on-demand landscape, skill level has a meaningful impact on personnel expense. As the chart below shows, human capital is often the largest expense for any services business, particularly for higher-end verticals.
In highly skilled categories, startups have greater potential for brand differentiation through exemplary service. Consumers are far more likely to go out of their way to find a leading physician than they are a great housekeeper or taxi driver.
However, the more it costs to recruit and retain individual service providers, the bigger piece of the expense pie personnel becomes. This dilutes the potential to leverage other cost elements for a margin advantage.
The exhibit below breaks out on-demand services by real estate strategy. It includes startups in which an individual service provider physically delivers a service to a consumer or enterprise customer. These are private, U.S.-based companies that have raised at least $5 million in capital.
This category addresses services that have been delivered to the consumer historically, so there is no significant real estate component.
These startups utilize a digital-centric approach to enhance consumer access to a liquid, community-rated pool of service providers. They often develop advanced logistics solutions to derive additional efficiency.
Transportation is the poster vertical of this category and has attracted the most investor attention. The proliferation of GPS-enabled handsets addressed the friction around drivers and passengers locating each other. That combined with the size of the market, the high frequency of use and the immediacy of need yielded a perfect on-demand storm.
The most successful startups in this category establish network effects with moats of liquidity that are typically expensive to build but hard to deconstruct. Uber is clearly the pioneer of this wave and has invested heavily in building a dominant supply base.
Just add delivery
This category layers a new or enhanced delivery solution on top of existing businesses. These startups may employ delivery professionals themselves or help traditional business partners manage them.
While nearly everyone prefers to have products or services brought to their doorstep, they are not all willing to pay more for it. Successful delivery layer models must target enormous markets like dining, grocery and shipping. They must find a large enough portion of the addressable customer pool willing to accept incremental pricing for convenience. Margin value may also be created by promoting endemic products, as well as through volume discounts with the requisite partners in this model.
This category is most susceptible to the growth of price elasticity in an economic downturn, particularly in disposable income verticals.
Optimize real estate
This category optimizes infrastructure, including the removal of customer-facing properties, the consolidation of industrial space and moving out to cheaper commercial zones.
In the restaurant space, some startups are removing public dining locations and consolidating operations with industrial kitchens. In grocery and big box retail, startups are providing delivery straight from the warehouse. In self-storage, startups are eliminating the “self” in storage, adding a delivery and logistics layer that pushes storage infrastructure from the fringes of the urban center out to larger, cheaper warehouses.
Some of these startups are adding delivery where it was not previously available. The lower real estate costs need to outstrip the added delivery and logistics expense to enable long-term success.
Eliminate real estate
Historically, many traditional services models required a storefront property or public office. An auto repair shop on a major thoroughfare benefits from awareness. A salon in a nice part of town gains high-rent-district credibility.
In our increasingly digital world, a new wave of on-demand startups is shifting the traditional point of service to the customer’s location. Demand can be generated online and serviced wherever convenient for the customer. This strategy benefits service providers, including beauticians, doctors, massage therapists and mechanics.
While some complex services within these verticals must be performed in controlled environments with heavy equipment, a large portion of visits can be administered offsite. Making house calls reduces the efficiency of working from one location, so it is critical that jobs and supply access are optimized at scale to minimize transit time.
Storefront removal eliminates a massive barrier for individuals to work for themselves. Not only is it more convenient for the consumer, but tremendous value is unlocked as a key element of the cost structure is eradicated. This can enable service providers to build their own book of business and capture a greater percentage of the revenue that they create.
The margin picture
There are varied economic characteristics within each category driven by size of market, average price point, frequency of use, mix of product and services, immediacy of need, workforce transience, etc., that demonstrate the margin disruption that’s possible in on-demand. However, the columns below are an attempt to represent normalized cost structure for mature startups that execute successfully.
Assuming a technology-enabled reduction in supplies, marketing and administrative expenses for all on-demand startups, some traits emerge. Many traditional services businesses have been ushered into the digital world by review aggregators like Angie’s List and Yelp, or booking platforms like Booker and MINDBODY; however, an outsourced approach often lacks the edge that an in-house engineering team can deliver to a vertically focused, on-demand startup.
This analysis assumes personnel expenses remain constant. You could argue for some reduction in base personnel costs, particularly with a 1099 workforce. However, if you subscribe to perfect market theory, there should be a general equilibrium around the cost of human capital over the long term.
Traditional on-demand versus connected on-demand
The comparison of traditional versus connected on-demand must be isolated, given the lack of real estate in either model. There are some property costs for administrators, but the vast majority of work is done offsite and thus not included as a core cost component.
The margin improvement may not be dramatic. However, in the case of a company like Uber, which applies its margin advantage at massive scale, the connected on-demand model can create tremendously disruptive value.
Traditional services versus on-demand services
In this comparison, delivery personnel and real estate have a substantial impact.
Delivery personnel are added for the just add delivery category, as well as for the optimize real estate category in situations where delivery is added or enhanced. A revenue increase is assumed for the just add delivery category, as this must be warranted by the customer base for these models to succeed. Just add delivery startups do not have the full cost structure exhibited below, but effectively share it with their traditional partners. Other categories can remain on par with traditional pricing, or compete on price if they are willing to cut into the margin.
The real estate cost lever can yield significant leverage. By efficiently shifting the point-of-service to a customer’s location, startups capture economic value historically tied up in infrastructure. This value can be shared among marketplace participants and creates a model that can drive substantially higher profit margins than the status quo.
Rewarding individual service providers
In theory, all on-demand categories have the potential to disrupt traditional services. However, all on-demand models are not created equally, and their potential for margin disruption should not be viewed through the same lens.
All of these hypothetical models require superb execution that satisfies the demands of both sides of the market. The potential for sustainable disruption is most ripe where margin can be recaptured and shared with the people doing the hard work. The cost to attract and retain a trained workforce is often underestimated.
Whether 1099 or fully employed, most workers’ desire to work for an on-demand startup depends largely on where they can make the most money. Can they capture more of the value that they create? Income typically trumps flexibility over the long term.
Startups can attract quality service providers and stem customer leakage with good technology. They can provide access to customers and supplies, optimized scheduling, payment processing, customer reviews and a steady supply of jobs. A carefully constructed on-demand startup can not only avoid customer leakage, but find that many of its service providers bring their own customers onto the platform for the added value and convenience it delivers.
Amidst the growing din of negativity, nearly $100 million has been raised in the past 45 days by four on-demand startups that are serving not only their customers but also their workers.
In early March, YourMechanic, which provides mechanics with the potential to earn up to 2-3x more than what shops and dealers pay them, announced $24 million in funding. Soothe, which offers massage therapists the ability to earn 2-3x what they make at a spa, raised $35 million. Soon thereafter, their competitor Zeel announced a $10 million round. These three companies fall into the eliminate real estate category.
Within the connected on-demand category, despite having less margin room to play with, Managed by Q was recently rewarded for sharing value creation with its workforce. The startup was one of the first to offer W-2 employment, and the company carved out 5 percent of its equity pool for service workers. Managed by Q’s strategy has worked and yielded a $25 million round announced in early April.
Ultimately, startups that redistribute their value creation, not only to the customer, but also to the individual service providers, have the greatest long-term potential to thrive in the on-demand economy.