Why lots of 'Uber for X' startups may be in trouble

The San Francisco Chronicle reported last week that Homejoy, a startup that provides on-demand house cleaners in the Bay Area, was being put up for sale after a period of slower-than-expected growth that left its finances in a “dismal” state.

Normally we wouldn’t blink at a story of a startup struggling, but Homejoy is no ordinary startup. It’s emblematic of the “Uber for X” phenomenon, a tech company that built a platform for jobs where the actual labor is outsourced to an army of contract workers. And it used the aggressive pricing model that is rampant among on-demand start-ups, which use their venture capital dollars to subsidize below-market rates on their services.

I ordered a Homejoy cleaning last year, after seeing ridiculously low prices advertised on Facebook. (The company has been known to advertise a basic house cleaning for as low as $19.) The cleaning wasn’t spectacular, but even so, I knew it was worth significantly more than I paid. And the Chronicle’s reporting confirms my suspicions. According to the paper, Homejoy “operates in the red, losing about $12 on every cleaning before even counting the cost of customer acquisition, according to the source.”

(A Homejoy spokesperson wouldn’t confirm those numbers, and declined to comment on the sale rumors.)

If it really was offering home cleanings for less than the cost of providing them, Homejoy was engaged in a kind of price dumping, a term from international trade that means, essentially, selling things at aggressive discounts to cost, simply to drive competitors out of the market. The good thing about price dumping is that, in the short term, it tends to work. Given the choice between a $100 house cleaning and a $19 house cleaning, most customers will go for the cheap one.

The problem with price dumping is that you generally need one of four things for it to work long-term:

(1) High-margin offerings that can subsidize the no-margin products. (This is part of the reason why Uber can offer such low promotional rates for UberX and UberPOOL — the margins on Uber Black and Uber XL subsidize the money-losing services.)

(2) A commanding enough share of the market that you can raise prices without losing a significant portion of your customer base.

(3) Investors who are willing to lose money in the short term, on the theory that the company will eventually be able to pull off (1) or (2).

(4) Lots and lots of money from some other source, such that the price dumping doesn’t really matter in the grand scheme of things.

Homejoy raised $38 million in venture capital 18 months ago, but it’s still a young startup, and it doesn’t have the kind of deep pockets that typically accompany an aggressive pricing scheme. (The reason that Rupert Murdoch, for example, was able to sell newspapers at a loss during the nineties is because he had billions of dollars flowing in from elsewhere.) Because Homejoy failed to gain Uber-like popularity or develop a successful premium strategy, the startup either needed to raise its prices and fatten its margins — which it tried to do last year — or go back for more VC money to keep the subsidies flowing.

The classic case of price dumping gone awry, of course, is the failed urban delivery company Kozmo.com, which famously lost $1.50 for every $1 it took in during the first dot-com boom. Kozmo wasn’t able to expand its service network quickly enough to grab market share from traditional rivals, and it didn’t upsell its customers effectively — and as a result, it died.

Thanks to technological advances and a more mature startup ecosystem, you probably don’t need as much money to price-dump today as you did in 1999. But you still need money. And lots of “Uber for X” startups could be encountering Kozmo-like problems very soon.

Just look at this CB Insights chart showing how many of these startups were funded in mid-2014, about a year ago:

About as much time has passed since those startups got their funding as passed between Homejoy’s last venture round and the point at which its margins became a problem. So if they’re subsidizing their services at the same rate as Homejoy, they may be starting to feel the crunch already.

Most of those funds were for seed or A rounds, meaning that the startups likely hadn’t yet gained significant traction in the market and so won’t be able to start raising their prices:

To make matters worse for on-demand startups, the giants are moving in. Amazon, which entered Homejoy’s home services market earlier this year, never has to make a profit on house-cleaning if it doesn’t want to. It has thousands of other ways to subsidize those costs with higher-margin parts of its business. And, more importantly, it has patient investors, which means it can price its goods below cost as long as market conditions will allow.

I suspect that, in the next six to twelve months, we will see a significant consolidation in the on-demand industry, as some of these startups’ runways begin to expire. Investors who were eager to pour money into on-demand start-ups in 2014 will decline to give those same companies follow-on rounds. Big public companies will mercy-acquire smaller venture-backed minnows. And while the on-demand giants (Uber, Postmates, Instacart) will likely be fine, lots of small and mid-sized companies will be washed out of the market.

Winter is coming, if you’re a venture-backed on-demand startup with an aggressive pricing scheme and slow traction in the market. And the “Uber for X” graveyard may start to fill up faster than anyone expected.