The tech strategist Ben Evans has written an interesting essay which is relevant for investors like us who are obsessed about companies which generate revenues, profits and free cashflows (rather than companies that generate hype & publicity). Ben says that we need to distinguish between digital companies like Facebook (which he says is a ‘rocket’) and other digital companies Uber (which he says are ‘tractors’). So how does Ben comes up with these labels and what do they mean?
Let’s start with rockets: “In the early years of Facebook, a common criticism we heard over and over was that this company and many like it had little or even no revenue and were burning huge amounts of cash, even years after launching, and so they would clearly never make any real money. By extension, they couldn’t possibly be worth the valuations they were attracting. It’s worth remembering now that people said this not because they turned out to be wrong (people are wrong about tech all the time, on both the positive and negative sides) but because their premise was wrong. This was a misunderstanding of the nature of a consumer internet company with network effects and very little marginal cost.
For such businesses, knowing how, exactly, you’re going to make money might not be the most important thing to focus on. If you are acquiring tens or hundreds of millions of users with a new kind of service, and they are attributing value and attention to you, and the users, attention and value have network effects and hence probably winner-takes-all effects, and if they come with little or no marginal cost, then the revenue can and probably should come later. It is probably more important to focus on building the value than making money from the value – revenue is a feature, and you should build it later.”
In other words, rockets are awesome companies which very high profit margin potential and hence investors need to appreciate that and not bleat about the lack of profit generation today.
Tractors are the opposite of rockets: “….there are other companies that are not rocket ships, but instead look more like tractors towing a heavy set of equipment across a muddy field. … For a tractor, success comes down to the gearing ratios – you have 10 or 20 or 30 operating metrics, all interlocking, and their end result is the difference between £19.99 and happiness and £20.01 and misery. If Facebook or Snap were rocket ships, Uber or Instacart are tractors – it’s all about the ratios. For these kinds of companies, you need to have a pretty good idea of the unit economics before you start.”
Now, unless you and I have one drink too many over Diwali, we would categorise most Indian e-commerce companies are tractors. If Ben were in India, he would then ask whether these companies have viable unit economics. I think most Marcellus clients would know the answer to that question.
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