Venture Capital Firms Invest In Unprofitable Business Models
COVID-19 and China
DiDi 2018 Tech Day in Beijing. PHOTO: Credit to Didi Chuxing

Mar 30, 2019 /EqualOcean/ - Venture capital firms and commercial media are indifferent to whether specific business models can be sustainable. Start-ups such as Lyft, Uber, WeWork, and Bird are predicted to be permanently sliced after their moment of glory, according to Tencent Technology News.

Over the last twenty years, valuations of start-ups have quickly soared and collapsed. Apparently, a new era for start-ups has arrived. Unlike before, venture capital firms are investing heavily in unprofitable but high-growth companies. Some examples of these types of companies are the ones mentioned above. To understand why these types of brands are changing the rules of the game, looking at these companies’ historical growth is key.

While the companies mentioned have different target markets, the article addresses that they have three characteristics in common. According to the article, this helps to explain their financing capabilities and their final closure.

First, each brand offers a compelling brand story that appeals to media, venture capital firms, and consumers. Second, the companies do not have the expertise, processes, business models or target markets needed to achieve sustainable profitability. Lastly, with the help of venture capital firms, each company is convinced that they can dominate the market and achieve large-scale development and profitability before their funds are exhausted.

A company’s brand story is another questionable factor. As society is often obsessed with great stories, it has led venture capital firms to gamble on a great story despite seeing a negative cash flow. In 2018, US venture capital firms reached USD 130 billion, an 90% YOY increase. The emphasis on development rather than profitability extends to public capital markets. For the first three quarters of 2018, 83% of companies listed in the US was losing money for 12 months before listing.

In addition to the companies mentioned above, Didi Chuxing (滴滴出行) is another that requires attention. Didi is a Chinese transportation company that functions similar to Uber and caters to more than 550 million users and has expanded globally to Australia, Brazil, Japan, and Mexico. In fact, Uber is one of its established partnerships. As the company utilizes big data, machine learning, cloud computing, and more intelligent systems to operate, it arguably plays the AI card to win public and investor support.

Didi’s mission sounds revolutionary: to “redefine the future of mobility” which is a phrase that sounds appealing when coupled with AI. However, in the past, the company has been hit with safety issues regarding its passengers and its drivers. According to BBC, Didi had to suspend its carpool service after a woman was killed. Despite the company taking measures to increase safety standards, it’s still a widely debated issue. Therefore, it can be argued that Didi needs to become more efficient in monitoring its supply chain.

In addition, it “doled out about [USD 1.7 billion] in subsidies and discounts to passengers and drives in the first half to neutralize hard-charging rivals,” according to Bloomberg. Ironically, it also lost CNY 4 billion in the first six months of 2018. Didi is also backed by Softbank, a large venture capital firm, which according to Tencent Technology News allowed WeWork to achieve its vision and is the largest player in investment activities.

According to Statista, ride-hailing revenue has been increasing. However, YOY growth is steadily decreasing.

While users are expected to amount to 380.8 million by 2023, Didi can arguably fall into the unprofitable but high growth company that capture the hearts and wallets of investors.

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