When Good Eggs Inc. began delivering fresh, locally farmed food in San Francisco two years ago, the Web startup leased a warehouse and hired a team. Total cost: as much as $1 million.
The need for cash escalated as CEO Rob Spiro moved into Los Angeles, New Orleans and Brooklyn. To fund the expansion, investors backed Good Eggs with $2 million in April 2013, $8.5 million five months later, and $21 million a year after that, in September 2014.
“We’re building this as we go,” Spiro said in an interview. “The pitch is that we can build an operation on the ground that looks fundamentally different.”
Good Eggs is part of a growing breed of city-by-city Web startups that are hiring staff and setting up offices in every town they move into. Since they burn cash more quickly, there’s a higher chance of a bust when times get tough. While that reduces their appeal for some investors, other backers are betting that the first to build out operations will be able to fend off new competitors because of the high up-front costs.
(Good Eggs declined to disclose its costs, but based on the current number of employees, the company is now probably spending more than $3.7 million in San Francisco each year.)
The list of city-by-city startups includes mobile car-booking companies Uber Technologies and Lyft, food delivery startup Munchery, parking provider SpotHero, shopping service Instacart and laundry startup Washio. While they rely on technology to deliver new products and services, their business models are a departure from the low-cost ventures built by a few programmers working in a cramped office. Instead, they’re setting up kitchens, renting warehouses and hiring local staff.
Although Good Eggs started out as a software company, Spiro sought funding as he pivoted and rolled out distribution operations.
“The real value was in building physical distribution infrastructure city by city, driven by technology,” Spiro said. “Investors were open to it.”
Among the startups that raised a third financing round in 2013 or 2014, 14 are expanding from city to city and have attracted an average of $65 million in funding, more than double the amount raised by the rest, according to PitchBook Data, a financial information provider.
Uber is leading the pack, with a presence in almost 300 cities in 55 countries. Valued at $40 billion, the mobile car-hailing startup is on a hiring spree for operations staff, with more than 200 job postings for staff outside of the company’s headquarters in San Francisco, from Miami to Moscow.
CEO Travis Kalanick’s steady ramp-up has required Uber to raise an enormous amount of cash totaling more than $5 billion. In January, Bloomberg News reported the car-booking startup raised $1.6 billion in convertible debt, and that it was still on the lookout to collect more financing.
Some investors warn that cash-intensive startups are at risk of flopping, pointing to previous attempts by delivery companies Kozmo.com and Webvan, which also sought to expand city to city in the late 1990s, only to crash when the dot-com bubble burst in the new millennium. Marc Andreessen, Silicon Valley investor and startup veteran, cautioned last year that enterprises rapidly burning cash may be unable to survive in an adverse environment.
Apoorva Mehta, Instacart’s CEO, is betting his delivery startup will be nimble enough to avert a crunch. The San Francisco-based company, which raised $220 million at a $2 billion valuation in January, initially sold groceries to customers with a markup. Now, Instacart is more focused on cutting deals with food stores to deliver produce and other goods for a fee. Instacart needs less cash to expand (compared with Amazon, which also delivers groceries in some urban areas) since it doesn’t have to build warehouses or large stores.
“You have an operations team that is on a city-by-city basis, but you make sure your engineering team is not city-by-city,” Mehta said.
Such startups have an edge because they’re building sophisticated logistics operations, which are difficult to displace, according to their founders and backers.
That’s the bet Annie Kadavy, a partner at Charles River Ventures, made when she invested in food-delivery company DoorDash in 2013. DoorDash has deals with some restaurants to take a percentage of the total value of food orders. While margins are thin in the begnning, Kadavy contends that the company will make more money as the enterprise grows.
“Investing in companies with any level of overhead can be boiled down to simply understanding their unit economics, payback period and cost to acquire users compared to the life time of that customer,” Kadavy said.
Tony Xu, DoorDash’s CEO, said the company sends out a team to scout out a city before they start operations. Then another group of employees goes in as the company rolls out software and services for a new city. In Boston drivers use bicycles and in San Jose, California, cars. Each city is different, Xu said.
“You’re dealing with people and you’re not just sending bits flying around the world,” said Sequoia Capital’s Michael Moritz, who is on the board of Instacart. “The whole secret for this breed of company is to make sure that you understand the major issues that govern performance because it’s a complicated, logistical jigsaw puzzle.”
*Publish by Bloomberg Business on March 12th, 2015