Tutorial 7 Schumpeter The Flywheel Delusion Task Description: The tutorial article for this tutorial is the Economist Article and can be assessed at Moodle. Please read it and answer the following questions: Question 1: According to the article, what is a flywheel business? Question 2: Using examples from articles, explain if network effects are facilitating flywheels? Question 3: Which additional factors have undermined the self-reinforcing effect of flywheels?The Economist November 13th 2021 Business 69 Schumpeter | The flywheel delusion Uber, DoorDash and similar firms can't defy the laws of capitalism after all could make money by ordering its own food for a discounted price on DoorDash (which then paid back the regular amount). To justi- fy such profligacy, interested parties pointed to the huge "total ad- dressable market , another popular term in Silicon Valley. Bill Gur- ube Eats ley of Benchmark, an early investor in Uber, argued in in 2014 that the firm could vie for as much as $1.3trn in consumer spending if one saw it as an alternative to car ownership. Measured against such visions, the flywheel economy has pro- ven a dud. To be sure, the nine listed flywheel firms are still grow- ing nicely-at 103% on average in their latest reporting period compared to the same period the previous year. This explains why they are collectively worth nearly $50obn. But self-levitating they are not. Nor are they profitable. Sales for the group amounted to $75bn over the past year and the operating loss to nearly $11.5bn. As the firms have discovered, their businesses are less perpetu- al motion machines than real-world flywheels that inevitably lose energy to friction, says Jonathan Knee of Columbia Business School and the author of a book entitled "The Platform Delusion". The network effects in fact have proved much weaker than expect ed. Many users switch between Uber and Lyft. Drivers also flit be- tween them, or to delivery apps, depending on which model offers the best pay. This bargaining power from both sides means the N THE REAL world a flywheel is a mechanical contraption that system does not become self-reinforcing after all. stores rotational energy. In Silicon Valley it has come to mean Technology, too, has turned out to be less beneficial than ex- something else: a perpetual-motion business that not only runs pected. Data collected by the firms help optimise their operations, forever but is self-reinforcing. Thanks to powerful network ef- but are not the decisive factor some had hoped for. Regulators fects, the theory goes, a digital platform becomes more attractive keep pushing back. In London they have forced Uber to pay drivers as it draws in more users, which makes it even more attractive and minimum wages and pensions. In San Francisco they capped the so on. The end state is a venture that has gathered enough energy fees DoorDash can charge restaurants for delivering their meals. to self-levitate and throw off tons of cash. Uber's tortuous path to stemming losses should temper inves- The payout on one of the most richly funded bets of the past de- tor optimism. It eked out a profit of $8m on revenues of $4.85bn. cade or so revolves around whether ride-sharing and delivery That excludes expenses that are unlikely to disappear, such as firms-which once were part of something known as the "sharing stock-based compensation. The company has crawled out of its economy" but are better described as the "flywheel economy"- sea of red ink mostly by slashing costs, shedding technology as- can actually ever live up to their heady promise. The outcome will sets such as its autonomous-car unit, charging higher prices and matter to more than just venture capitalists who backed their increasing its "take rate", the share of the fares it keeps. As a result, growth. Whether these flywheels do gather unstoppable momen- an Uber is now no cheaper-and often more expensive-than con- tum is also of interest to regulators worried about technology's ventional cabs, plenty of which can be hailed via apps these days. propensity for winner-takes-all business models, not to mention What is more, the company, which has a market capitalisation paid-by-the-gig workers caught in its cogs. of $85bn, is now more of a delivery service than a ride-hailing app: Consider the results of Uber and DoorDash, the largest Western Uber Eats generates more than half of sales. DoorDash's own pun- ride-sharing and delivery apps respectively. Optimists will have chy valuation, of $65bn, rests on revenue that has grown more seen plenty to cheer them. On November 4th Uber proclaimed it than fourfold since the last quarter of 2019, albeit during a time was at last profitable, albeit only on the flattering metric of "ad- when people dined at home more often. But it also bakes in suc- justed EBITDA". Strong third-quarter figures from DoorDash, cess in new markets that it has recently entered, including grocer- which were released on November 9th, fuelled an already heady ies and pet food rally in its shares (the firm also announced the acquisition of Wolt, a Finnish food-delivery company, for $8bn). Circular economy But look deeper and evidence is mounting that business fly- Real business flywheels do exist. Software makers have managed wheels are not defying the laws of capitalism. The money that to lock users in and thus generate gross margins typically above went into building them recalls the railway mania among other 70%. Venture capitalists are hoping against all hope to find new past speculative investment crazes. The nine firms that have gone ones. They are already pouring money into the next generation of public so far-Uber and its American rival Lyft; Didi, a Chinese flywheel contenders: instant-delivery startups, which offer grati- ride-sharing app; and six delivery firms, from DoorDash and De- fication in 30 minutes or less. Coupon-collecting consumers in livery Hero, which is based in Berlin, to China's Meituan and In- cities such as New York now get at least a week's worth of groceries dia's Zomato-collectively raised more than $10obn. In most cas- for nothing from such services as Buyk, Fridge No More and Go- es, the capital was intended to jumpstart those network effects puff. Eventually, these firms' champions promise, their econom- and make market dominance a self-fulfilling prophecy. Seemingly ics will be far better than those of an Uber or a DoorDash. In the fly- bottomless pits of investors' cash went to subsidising rides and wheel economy hope and hype spring eternal, at least as long as deliveries to juice demand. This reached absurd points: a pizzeria interest rates remain low and capital is essentially free. Reproduced with permission of copyright owner. Further reproduction prohibited without permission