We watch in fascination as unicorn after unicorn is going through the same characteristic journey in the past decade. The cycle seems to be continuing unabated.

• Achieve rapid growth during the pre- Series A period, while making losses
• Raise a large funding round on the back of the growth metrics
• Hire hundreds, if not thousands, across all functions
• Continue chasing growth at all cost
• Ignore profits completely, and create a notional ‘path to profitability’ model
• Narrate the story of how rich profits can be reaped once they are the last man standing
• Scale down and fire people when an external event impacts the funding environment negatively
• Shut down or merge or have a distress sale to continue operations
• Or worse still, even if a duopoly is left at the end of a bruising battle, neither of the two companies are making profits because the market’s elasticity has been messed with. For example, even though MakeMyTrip and Ibibo merged, the merged entity’s losses have increased while competing with the other OTAs such as ClearTrip and Yatra. Nobody is making money despite consolidation

The distress sale of Uber Eats to Zomato (and the need for Zomato to buy it) and the layoffs at Oyo because of restructuring for rationalizing the different business units and geographies are the latest examples.

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One of the common points to notice is that most of these unicorns believe that such rapid growth at any cost is a necessary part of their journey because of one principle – that they are operating in a winner-takes-all (WTA) market. Historically, WTA markets were prevalent in the technology sector, and then later on, in the consumer tech products sector. If a company invented a new technology that changed the way communication happened (e.g., Cisco), or built proprietary IP that gave them an advantage to capture the market fast (e.g., Intel), or created a powerful social network that ended up having your whole friends circle (e.g., Facebook), it was a clear WTA market. Various studies show that in such a market, the leader ends up capturing about 90% of the profits from the industry and the second largest player captures about 8-9% and then the remaining companies end up getting barely any profits.

A product or service in a WTA market has a few characteristics:

1. Strong Network Effects – Each person’s value derived from the network increases as more people join the network. As more friends of a person joined Facebook, the value derived by that person increased
2. High Switching Costs – Any member of the service or buyer of the product finds it very hard to switch out of the product because it is difficult to switch, or the incremental benefits from switching are not so high, or porting out the data is complex, or their clients are on the same service which makes integration easy
3. Cost of Servicing Keeps Dropping – The cost of servicing the needs of a new user keeps dropping as more people use the product / service. For example, the cost of adding one more SME onto the cloud and servicing their go-live for a SaaS company would be marginal
4. Strong Feedback Loop – The outputs become the inputs. Drug companies invest in R&D, develop a molecule, enjoy the patented protection for usually a decade, and reap huge profits. Those profits propel more investments into R&D and the cycle continues
5. Virtuous Flywheel – Such a product or service will have different actors on the network engaging new interactions that drive additional value than that derived from merely being present on the network. For example, more investors on AngelList drives more startups to apply, which makes it lucrative to start a startup hiring service, and so on. Another example could be of a widely adopted point-of-sale (POS) network that processes humungous amount of payments, making it a rich source of data as well as an option to provide more up-selling opportunities through offers

If the product / service displays these attributes, it is imperative that there is rapid growth of the network along with heavy investments in infrastructure, headcount and technology to keep up with the pace. This growth will be at the cost of profitability, because profits will happen naturally in the course of time given the above described characteristics. Whoever is the fastest to do a land grab of consumers derives the most benefit, necessitating a mad rush to plant your flag in as much territory as possible.

The fallacy that is happening with many admired unicorns is that they are operating in a market that is potentially suited to be a duopoly or even an oligopoly, but they are operating as if they are in a Winner Takes All (WTA) market.

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Some examples:

• Payment Wallets & Methods – Does not meet 2,4,5 above. Having the most number of merchants on Paytm didn’t really serve as a switching cost for consumers once the payment infrastructure was in place through UPI because other payment companies emerged with very similar products and cash backs. Now Google Pay and PhonePe are adding merchants at a faster growth rate than Paytm and users have proven fickle and moved.
• Food Delivery – Does not meet 2,3,4. When UberEats entered a fast growing food delivery market with Swiggy and Zomato already entrenched, it was with an undifferentiated product. The cost of food delivery would only marginally reduce with more users in the same locality, and not drastically tend towards zero as in a software product because of the highly intensive people operations required
• Vertical E-commerce – Does not meet 1,3,5.  There may be decent switching costs if there is affinity with the product built over a period of usage. But customers can still be weaned off with better features or benefits. By definition, the frequency of transactions are also lower than in horizontal e-commerce
• Room Aggregators – Does not meet 2,3,4. The fact that Oyo scaled up rapidly and onboarded lakhs of rooms did not preclude other aggregators (Treebo, FabHotels) from entering the space and still surviving but at a more moderate rate of growth

The irony is that all of these are led by top-notch entrepreneurs who have executed brilliantly well and built great teams around them. But as long as this disconnect of operating as if in a WTA market remains, the positive unit economics, and thus, the path to profitability might sadly remain elusive.

Please share your thoughts in the comments below.