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Startups are Evolving to Manage Growth Alongside Profitability

February 15, 2022
Company Building

As more tech companies are going public to seek additional capital and provide liquidity for their early investors, the increased transparency and disclosure have drawn doubts from more mainstream investors questioning their profitability and sustainability.

Given the investor skepticism, we have observed the following key trends as tech companies around the world evolve to see to these concerns.

Moving beyond demand-side innovation

Building a defensible moat is essential for long-term success of any startup. In the case of undifferentiated tech-enabled services, like food delivery or mobility, user exclusivity is challenging to attain. This is because one is catering to a rather flirtatious customer base with low to none switching costs. In such cases, innovating just for the customer’s demand might not be enough. It is interesting to note that startups are now focussing on supply-side innovation to build a long-term competitive advantage.

One of the success cases is DoorDash, a relative latecomer to the food delivery scene in the US that has managed to edge out Grubhub gradually and catch up with the major rival, Uber Eats, in the US.

Market Capitalization — DoorDash vs. Uber

Source: S&P Capital IQ

Instead of just focusing on user (demand-side) acquisition, DoorDash endeavors to empower its restaurant partners and help them grow their businesses, for which it has launched several services.

For example, DoorDash Drive is a white-label flat-fee delivery service launched by the company. Merchants who want to protect their brands and customer relationships can generate their own orders and use DoorDash Drive to execute the deliveries.DoorDash Storefront allows restaurants to create their own online stores (on DoorDash) to take pick-up and delivery orders. It provides restaurants with customer data, which other third-party delivery platforms usually do not share.

Such initiatives and value-added offerings by DoorDash have increased restaurant partnerships (supply-side) and their exclusivity on the platform. This, in turn, improves user retention and engagement.

Similarly, the leading food delivery company in India, Zomato, has also launched the merchant/B2B initiative, Hyperpure, in FY’19. Hyperpure is a one-stop procurement solution that supplies fresh, hygienic, quality ingredients directly to restaurant partners from farmers, producers, mills, etc.

Although Hyperpure still only represented a small part of Zomato’s business for now (accounted for around 10% of its total revenue in FY’20), the company is planning to further invest more than $50 million in Hyperpure in the next 18- 24 months.

Besides Hyperpure, Zomato also has plans to offer more services to its restaurant partners, similar to DoorDash, to foster a stronger partnership. The company is currently in talks with restaurant Point-of-Sale players and e-vehicle fleet operators. One of Zomato’s long-term strategies is to invest in companies in the food ecosystem.

Creating an ecosystem of offerings to maximize value

Historically startups have always been advised to focus on one problem and be the best at solving the problem. Lately though, we are seeing the trend of tech companies developing an ecosystem of offerings to help address different (but related) pain points for their customers.

One of the major benefits of having an ecosystem for the users is convenience, as they do not have to switch between different platforms and apps for solutions. For companies, this could open up new potential revenue sources, gain more insights into their users, and greater loyalty and retention.

For example, Airbnb might seem just like a platform to match property hosts and guests on the surface. But behind it, there is a whole ecosystem of services and offerings that support owners in hosting their properties on the platform.

It has its own insurance program (Host Protection Insurance) for the hosts. Its trust and safety initiatives help hosts perform background checks and risk scoring on guests, prevent fraud and scam, etc. Various complementary startups and third-party businesses are also there to complete Airbnb’s ecosystem that solves property owners’ different pain points when it comes to hosting.

Select Examples of Third-party Complementary Businesses on Airbnb

In India, Razorpay has also been building an ecosystem of services that cater to the SMEs in the country, instead of just being the payment gateway and infrastructure for merchants (its initial core product).

The following is a snapshot of its ecosystem and current service offerings, which also aims to assist its merchants in managing and growing their businesses.

Razorpay’s Ecosystem

With various offerings in place, businesses and clients can come into the company’s ecosystem driven by different pain points. This allows Razorpay to maximize the value of its offerings to clients over time.

Similarly, in Southeast Asia, Nium has become the first B2B payment unicorn in the region, also thanks to its “payment + ecosystem” business model.

The company’s initial business model focused solely on international payments. While cross-border payment infrastructure is still its core product, Nium has expanded to offer a full suite of Banking-as-a-Service solutions for its corporate customers. Customers now use Nium’s platform for international payments, card issuance, payment collection, and so on.

Accelerating profitable non-core operations

Besides attracting scrutiny from being a public company, the pandemic has also made founders and investors realize the importance of building a resilient business.

Moving on from pursuing growth at all costs, companies are building more synergistic offerings from non-core operations which have higher margins compared to their core businesses. This helps them improve their profitability as a whole, so the business can be more sustainable in the long run, without having to rely only on external capital.

The trend is most apparent among more established tech companies since they have a user base that can be further monetized by providing additional offerings.

For example, Square (recently renamed as Block), a leading digital payments company in the US that generates most of the revenue by processing users’ payments and transactions, has expanded its offerings to provide subscriptions and services. Square’s subscription and service offerings include software subscriptions by sellers, Instant Deposit function that allows both customers and sellers to instantly deposit funds into their bank accounts, and Square Card (a prepaid Visa card).

Subscription & services part of the business operates at almost double the gross margin (82%), compared to its transaction based services (44%), and we are seeing a steady increase in its contribution to business, up from 11% in 2017, to 35% in the first 9 months of 2021.

Square Net Revenue Breakdown & Gross Margin by Segment

Source: company financial reports; Note: net revenue excludes Bitcoin revenue. Figures in grey boxes indicate Gross Margins

In Southeast Asia and India, some leading tech players have also embraced such an approach lately. But, since many of their initiatives are launched in recent years, the impact on their overall business models is yet to be seen. For example, Grab’s enterprise and new initiatives segment was launched in 2018 with GrabAds, which is the company’s advertising and marketing offerings to merchants. In 2020, GrabDefence, the second product of this nascent segment, was launched. GrabDefence is the company’s self-developed fraud detection and prevention technologies that are offered to third-party businesses.

In India, Paytm also launched financial services and wealth management businesses in recent years by capitalizing on the users it has accumulated through the payments business.

What does it mean to tech startups in Southeast Asia and India?

In our opinion, these three trends, whether it is about boosting profitability from non-core operations, focusing on supply-side innovation besides demand side, or maximizing value by building ecosystems, point to one common theme — being more sustainable and resilient. So, instead of pursuing growth at all costs, founders and management should consider building a more sustainable business in the long run, rather than just focusing on the next round of capital raise.

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