Sharing economy

Working in a sharing economy company, I am fascinated by how this new model of business throws everything you knew out of the window.

In the process though, in a eureka moment I have come to realise something quite...crazy about this industry. It was bits and pieces of knowledge I knew which suddenly came together in one moment and it all made sense. Looking at the top companies out there, I suspect they have already long come to the same conclusion as I have.

Here's the train of thought.

Using Porter's five forces, we find that competition is extremely high in the sharing economy.

Most importantly, consumer's propensity to substitute is really high. This is in part because among the top sharing economy platforms, there is little noticeable difference in product quality. This is even less so for service quality, because in there is the exact same pool of suppliers between companies.

From a consumer point of view, there is literally no difference between taking Uber and Grab at the service level because the drivers drive for both apps.

So how do you decide between Uber and Grab then? You choose by price.

In the sharing economy, where top tier products have little difference, where the pool of suppliers is identical, the only way to compete is by a price war.

And that is exactly what Uber and Grab are engaging in now. You would think, that Uber and Grab are rich companies but take a moment to do a quick calculation on how much they are making and you will realise that both companies are bleeding cash.

Startups backed by investors, living on investment money. This is not about profitability. It is a war of attrition.  We assume of course, that they do not collaborate and raise prices together. They find themselves trapped in the prisoner's dilemma.

From here, we can look at the possible endings of this war. Again, we assume that the competing companies are great companies, not one ruined by bad management or a bad product etc, The first outcome is that one company eventually runs out of money.

However, who is to stop a new company from entering with such low barriers to entry? Who is to stop another entrant, backed by huge investment from entering in once again?

Additionally, why would the investors of Grab and Uber, having sunk so much money in want to give up? Would they not keep investing? Does this not mean that the war of attrition is never ending and companies will never hit profitability?

This leads to a second important conclusion. There will come a time where investors will lose confidence in investing in these sharing economy start ups. In fact, I may be late to say this, it has already begun. The tech startup hype is slowing down and it is now increasingly hard for new startups to get funding. Not just because of this whole sharing economy thing but many other reasons as well that suggest that perhaps this path is less profitable for investors than it may initially appear to be.

The first person who runs out of cash loses. That's scary, especially when you are talking about billion dollar valuation companies that have brands known globally. No matter how huge they seem, as long as they are not on the road to profitability, competing in this price war, they may be wiped off the face of the world.

There is a third ending however. And this is perhaps the most important thing that I suspect strong sharing economy companies already know. We know that in truth the products are not perfect substitutes. Uber and Grab may not be all that different, but they have their differences.

The sharing economy model thrives on the network effect. When supply goes up, service quality rises because the system becomes more efficient, therefore demand goes up. At the same time, when demand goes up, supply goes up because there are more opportunities for suppliers to earn.

It is a circular effect, a reinforcing loop. Increased demand causes supply to rise, and increased supply causes demand to rise.

A competitor wins the war when their network effect becomes so strong their service quality is seen to be better than their competitors, even when they are charging the same price. The automatically crowds out the competitor, and even if both companies do the exact same thing, the company with the stronger network effect will continue to increase in both demand and supply and eventually dominate the entire market.

Coming back to Uber and Grab's war of attribution, you realise that it is not just any simple war of attrition. These companies are fighting to win the war over the network effect.

Perhaps for these two companies, because they are both top tier, they may still continue to war for a long time, and perhaps they would really only end in a war of attrition as neither is able to break away from the pack and capitalise on the network effect to crowd out the other.

This third conclusion however, is very important for smaller, growing sharing economy companies that have not hit market saturation the way Uber and Grab have.

Dump all your cash if you have to. Make a fantastic product, build a fantastic team, and do it quick. Capitalise on the network effect before others can grow to your size, and you will win the war.