Network economy – Unicorns and donkeys

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I suspect many unicorns are actually donkeys in disguise.

  • The unicorn is a mythical beast of extreme beauty and rarity but recent events are indicating that many members of the start-up herd may not be genuine.
  • The latest event is Fidelity’s write down of its position in Snapchat by 25% from a $16bn to $12bn valuation.
  • This comes hot on the heels of:
    • Square’s IPO pricing range coming in 35% below the price paid by the last round
    • The failure of Deezer’s IPO
    • Question marks around Dropbox’s $10bn valuation following a 24% write down by BlackRock.
  • The problems are not just in the US as RFM research indicates that there are some concerns regarding the sustainability of Xiaomi’s $45bn valuation.
  • The Indian start-up market is also very hot at the moment and I suspect that it too, will also suffer from the same problem once reality begins to set in.
  • The financial definition of a unicorn is a start-up with a valuation of over $1bn but these are so common these days that a new term, decacorn, has been invented to describe start-ups with a valuation of more than $10bn.
  • The trouble appears to be starting at the decacorn end of the valuation range but if it continues, the smaller end will also take a substantial hit.
  • Almost all of these companies rely on the economy of the network to derive their value and make profit.
  • Metcalf’s Law of networking states that the value of a network is the square of the number devices that are attached to it which is why these companies have been so focused on acquiring users at all costs.
  • This means that these companies are going to be similar to online classifieds when it comes to their ability to make money.
  • Making money is what this is all about and hence I think that so-called unicorns that can’t make money are in fact donkeys with little value.
  • The essential problem here is that barriers to entry are very low meaning that competition will be brutal unless one player is significantly larger than all of its rivals.
  • A company in this hallowed position then becomes to the “go-to” place for the service in question and it is then that real monetisation can begin.
  • The rule of thumb that I apply here is:
  • A company that relies on the network must have at least 60% market share or be at least double the size of its nearest rivals to begin really making profit.
  • Facebook, Uber, Airbnb, Linked-in, Amazon and Spotify are all good examples of companies that meet or are close to this criteria and it is these that I would consider to be the true unicorns.
  • Those that fail to meet these criteria may be able to build a large user base but I would question their ability to really make profit because competition will grind down margin.
  • Without profit, there is no way that a would be unicorn will be able to sustainably justify its valuation in the public markets and this, I suspect, is the source of write downs and worries we are seeing.
  • Scrutiny is now almost certain to increase which is likely to reveal that there are a number of donkeys in unicorn’s clothing in the market.
  • It is the true and rare unicorns which will be least impacted when the day of reckoning comes and it is there where I would be hiding.


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  1. Pingback: Unicorns and Donkeys part III, Flight to Quality - Nylitik Blog

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