startups

The Invisible Line Between Tech And Tech-Enabled Companies – Forbes


The shelter-in-place orders in multiple parts of the U.S. have highlighted the importance of delivery services. Names that were well known before have become even more familiar, including Instacart, Uber Eats, Grubhub and DoorDash. But the pandemic experience is also highlighting how some of these companies are vulnerable to marketplace phenomena like collective bargaining and shopper strikes.

In a similar context, a lot of questions were raised when WeWork overused the term “technology” in its S1 filing last year because its financials told a different story. Concerns were deep enough that WeWork had to drop its IPO plans.

This got me thinking about the differences between a technology company and a tech-enabled company. I have come up with a three-pronged test to make it easy to determine.

The first two prongs are obvious: market size and margin. A company needs a large enough market to scale. The more a company scales, the more its gross margins matter because costs like R&D do not scale proportionally to revenue.

  1. If gross margin is in the 70%-80% range, it’s a technology company.
  2. If gross margin is around the 20%-30% range, it’s a services company.
  3. If gross margin is in the single digits, it’s a commodity. This fall from grace can happen to either No. 1 or No. 2. No one is immune.

The Invisibility Test 

“When change went invisible, the speed of that change would increase exponentially.” – Dr. Buckminster Fuller

The third test is to determine how invisible your product is. The more tangible the product is, the more friction it will have to scale. You can overcome this friction by spending a lot of money, but at every stage, that friction will need to be overcome with more money. WeWork and other shared workspace companies are on the one extreme of being very tangible. Real estate is real. Shared workspaces benefit from technology enablement, but so do banks. And here’s the news flash: Technology enablement does not make either one a technology company.

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Technology hardware companies suffer from a similar challenge. They have a tangible product that is mobile and therefore has less friction (and better margins) than real estate. These are true technology companies in theory. In fact, no technology can be built without great technology hardware. The tangibility increases the shelf life of an innovation. You can see it across technology infrastructure. It takes some time for competition to catch up. But once it does, commoditization starts, and so does the race to zero when it comes to margins.

Few companies defy this trend by building different types of moats. Intel, as an example, has deep technology and, so far, has been able to stay ahead of the innovation curve. Public cloud providers have converted their technology infrastructure to services. This has made hardware less relevant and has given these companies, including AWS, Microsoft Azure and Google Cloud, the opportunity to reach a scale that cannot be achieved by competitors even by spending billions of dollars.

On the other end, grocery delivery companies have built massive scale using deep pockets and technology enablement. The issue is they still need shoppers who are humans (for now). Humans are tangible and more mobile. The other issue is that they can unionize and threaten already limited margins in those businesses.

Pure software companies have an invisible product, and therefore margins are in the 80% range.

Conclusion: Value Versus Valuation 

There is no doubt that all tangible product companies bring great value. The problem comes when the stock market overvalues them. Overvaluation leads to expectations of higher profit margins or scale, or both. This leads to disillusionment, which we see with various startups.

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And too much disillusionment leads to a startup that can never get out of the lockdown.



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