The article was written by Zhu Xiaohu and first appeared on the WeChat official account GSR Ventures. It’s published by KrASIA.com with the writers’ consent.
Zhu Xiaohu is a unicorn hunter who had the foresight to invest in the now hugely successful DiDi Chuxing and Ofo.
According to Zhu, whether a company is operating under a sharing economy model or engaged in a rental business, it’s more important to figure out its asset model and whether its business model can translate into genuine profit.
This is the Part 1 of a 2-Part Series.
Link to the Part 2.
There’s little new in the U.S. consumer internet sector these years.
Video chat apps like Houseparty, Marco Polo, and Monkey, may have generated some buzz, but are also quickly cooling off.
Meanwhile, sharing economy is all the rage in China, found in everything from shared wardrobes and phone chargers to mini karaoke booth and workout units.
The contrast has led some U.S. media to make the somewhat cynical argument that Chinese entrepreneurs and investors are glorifying traditional rental business as sharing economy.
I have never dwelled much on what we should call these emerging businesses. In fact, I don’t think it matters.Instead, I care about three things:
First, whether a business is hacking an acute and common enough consumer pain points.
It’s been only two years since the bike-sharing services came into our lives, yet Ofo and Mobike, China’s top two bike-sharing operators, are already handling over 20 million transactions a day each.
To give you a benchmark, Alibaba’s e-commerce website Taobao.com spent a decade to bring its daily transaction volume to between 30 million and 40 million.
It’s a demonstration of how fast a business can grow when it’s addressing a regular consumer pain point.
Second, whether there is a viable business model that can translate into genuine profit.
Whatever business you are in, the ultimate goal is always profitability. To run a business like a public service is not only a disrespect to investors, but also an indifference to what entrepreneurship stands for.
Therefore, it’s important that startups know their chances of achieving profitability from the beginning.
Third, whether the company is able to pick up large amounts of market share quickly.
The internet is all about speed. A company must be able to expand rapidly to fend off competition. Specifically, I think whether a consumer internet startup can amass 10 million daily active users quickly enough is a decisive factor for its success.
Choosing between sharing economy and rental business
How to know which one is right for you, sharing economy or rental? Well, it depends on whether you are operating an asset-light or asset-heavy business.
For example, the asset-heavy DiDi and Airbnb have opted for the C2C sharing economy model.
After all, even a low-end automobile costs some 100,000 yuan. The figure would be astronomical for DiDi, despite having raised an unprecedented $15 billion, if it was to purchase 1 million cars itself.
On the other hand, asset-light businesses like phone charger provider or bike operators may well choose the B2C rental model. The advantage of the B2C model is obvious – fast deployment and substantial control over the supply chain.
The model gives a company better control of the deployment process and allows it to expand its presence quickly by offering standard products.
The cost of an Ofo bike is some 200 or 300 yuan. The investment needed to deploy 1 million bikes, which amounts to between 200 and 300 million yuan, is acceptable for a startup.
It’s even more so with the business of shared phone chargers, as a phone charger costs only a few dozen yuan.
If people say the B2C model doesn’t fit into the definition of sharing economy, then let it be, as long as the model allows a company to establish a market presence quickly.
In fact, Ofo had considered the option of C2C operation. The company recycled bikes from seniors at Peking University and even enlisted the school authority’s support in collecting the bikes left behind by graduates.
However, progress was slow. It was impossible to tell how many students were willing to share their bikes. Besides, bike conditions vary widely, leading to the inconsistent riding experience.
In contrast, a one-year-old automobile doesn’t differ much from one that’s been in service for three years which is another reason why DiDi can go C2C.
Profitability – the ultimate goal
Profitability is at the heart of all business models. We see it as a crucial factor for a worthwhile investment. It’s essential that a company has an explicit business model from day one.
If entrepreneurs tell potential investors that they will see themselves as having done a public good if their businesses fail eventually, I believe no investors will be interested.
Failure is acceptable, but to show respect to investors, you must at least theoretically prove that your business model is viable.
Additionally, since there is always a gap between theory and practice, a high margin of safety will be a plus as it means a company has a good chance of turning a profit even when things don’t go as planned.
The calculations are simple. Profit equals revenue minus cost; income per transaction multiplied by transaction volume is total revenue, and purchase cost plus maintenance cost is the total cost.
It’s best if a business can break even in three to six months.
If it takes, that is to say, two years for a project to recoup the investment, it runs the risk of evolving into a Ponzi scheme. In the internet industry, there’s so much that can happen in two years.
An extended payback period also means that a company will be highly dependent on external financing in the expansion, which is undesirable because external capital injection dilutes the equity of existing shareholders.
Many entrepreneurs argue that although their main business is not yet profitable, they can generate profit from subsidiary financial services and deposits.
But my opinion is that a business model is risky if it relies on its subsidiary businesses for profit. Profit made by the subsidiary business can only be seen as a bonus. A business model is a healthy one only if the main business is profitable.