In May, Uber chief executive Dara Khosrowshahi, sent a company-wide memo explaining the game had changed. Growth for growth’s sake was out, he said: “We have to make sure our unit economics work before we go big”. This is proving to have been a watershed moment.
“Unit economics” is becoming an albatross around the necks of tech-adjacent businesses that listed on public markets in recent years. Investor darlings such as Coinbase, Peloton, Stitch Fix, Redfin, Compass and Carvana have announced significant redundancies.
These businesses had earned massive valuations on private and then public markets with their upbeat growth narratives. Now capital markets have seized up, they can no longer fund losses there. That has two consequences. First, cost cuts. Second, acknowledgment — if only of the tacit kind — that their current operating models will not turn them into high-margin businesses.
Operating leverage is one way to evaluate how promising an enterprise is. It is a measure of how much operating costs rise as revenues increase. At fitness business Peloton, between the fiscal years of 2019 and 2021, revenues more than tripled. But sales, general and administrative expenses (SG&A) essentially increased by the same amount. Similarly at the likes of Compass and Redfin, both home buying apps, when revenues jumped costs rose commensurately.
Ostensibly, the beauty of technology businesses is their economies of scale. Revenues should keep trending upward with only little marginal extra cost.
Too many tech-adjacent businesses lifted top line growth merely by adding expensively-incentivised sales and marketing staff. With capital so abundant, growth-oriented investors had pushed them to expand, expecting profits to materialise following the land grab.
In this group, Coinbase, a specialist in a speculative medium, has ironically demonstrated the most efficiency. In the past two years, as revenue soared by nearly 14 times costs rose only six times. But its fees for crypto trading are highly volatile and now secularly crippled. So even here, the revenue side of the equation is fatally flawed.