Apparently, unicorns just went extinct in Silicon Valley. That’s sad news for the small group of tech entrepreneurs who hope to cash in on the latest gold rush and build a company with a $1 billion-plus valuation.
According to CB Insights there are over 400 unicorns with a cumulative valuation over $1.3 trillion. Two stories describe the demise of the unicorn – the IPOs of Uber and WeWork. The latter’s epic collapse this fall is brilliantly detailed in Vanity Fair.
A few elements of WeWork’s story really stand out and perhaps help describe a bit of the magic and magical thinking surrounding the highest of high-growth startups. First, you have an incredibly dynamic founder who doesn’t believe that rules apply to them. Adam Neumann charmed everyone he came across, used company resources to fund an extravagant lifestyle, and believed that he was on par with world leaders.
Second, obscene amounts of venture capital were invested in WeWork with the expectation of insane growth. This money flowed from oversees sovereign wealth funds looking for huge returns in the hottest corner of the investment world. The lead investor, SoftBank, told Neumann (as they pumped $4.4 billion into the company) that he needed to “think bigger.”
And finally, there was no expectation of profitability during the growth stage. The investors expected an exit (IPO in this case, acquisition in many others) in advance of profitability. Last year, WeWork’s revenue was $1.8 billion, but it lost $1.9 billion. In the end, WeWork’s IPO was scrapped, its valuation plummeted, Neumann was forced out (with a fat check), and investors and employees were left with very little.
Ignoring profitability seems like cheating. As design thinkers, we apply the Three Lenses of Innovation: Feasibility, Viability, and Desirability to our client’s projects. Whether we are helping clients create a business model, a physical or digital product, or a service, we ask each other whether this “thing” is feasible. Can it be made or made to work? Is it desirable – do people want it? And is it viable – can you make money doing it?
If you don’t have all three, you don’t have a sustainable idea. So back to the idea of cheating. If venture capitalists don’t worry about the viability of a business model (“We will worry about that later… we just need to acquire as many customers as possible, as fast as possible”) they can essentially fool themselves about the true desirability of their product. Many times, the price of a new service is set so low (at a level that doesn’t cover the cost) that everyone will want it.
Amazon Prime at $100/year provides free overnight shipping AND a high-quality streaming service AND free music on your smart speaker. WeWork lets businesses sign short-term leases in highly desirable locations at below-market rates. Uber slashes the cost of a taxi ride. Dollar Shave Club almost gives their razors away. This is an amazing moment for consumers. Every service feels affordable … cheap even. But would you buy these products and services if they were introduced at a price that included margins high enough to guarantee a profit for the seller? Maybe not.
For the handful of companies that scale effectively, moving from a high-growth customer acquisition phase to a profitable operational phase, structural problems remain. Suppliers and workers are often squeezed to keep costs low (think Uber drivers or Wal-Mart suppliers). Prices start to creep up and customer satisfaction drops. As growth slows, competition grows. All these forces drive valuations down.
The end of the unicorn is a misnomer. There is too much venture capital floating around that needs a home, so startups will grow in value and still grow fast with inflated expectations. Investors will likely need to demand solid business models that move toward profitability much faster. Hopefully this transition will be smooth, allowing value to be created in Silicon Valley and other innovation hubs across the world without a huge bubble bursting.
In the meantime, if you are looking for a unicorn to invest in, can I recommend Josie? This robotic unicorn may be every kid’s dream toy. We worked on her pony cousin, Scout. And at $399, it will make Kid Trax and their investors money from day one.
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