In December 2014, the first annual Source Code Capital Conference, also known as the Source Code Capital reunion, had its grand opening at the Commune By the Great Wall. It gathered a dozen Source Code Capital’s limited partners (LPs) and all the CEOs of the portfolio companies for in-depth discussions. Many LPs gave great speeches filled with knowledge and insights which we will present one by one. (All rights reserved. Any unauthorized reproduction is prohibited.)
In December 2014, the first annual Source Code Capital Conference, also known as the Source Code Capital reunion, had its grand opening at the Commune By the Great Wall. It gathered a dozen Source Code Capital’s limited partners (LPs) and all the CEOs of the invested companies for in-depth discussions. Many LPs gave great speeches filled with knowledge and insights which we will present one by one. (All rights reserved. Any unauthorized reproduction is prohibited.)
Chenchao Zhuang: How should startups compete and how to incur losses?
Qunar.Com (aka Qunar) has been fighting for the past few years, and we’ve been doing that from the beginning for about ten years now. We’ve successfully turned the entire industry to experience net losses. Even our competitor C-trip which has been a public company for 11 years is losing money. Today, I will talk about how companies should compete, what mistakes will the leading company usually make, where are the opportunities for the companies lagging behind, and how we should address price wars.
1. Growth Strategy
The main problem for Qunar is that we’ve been losing a lot of money since Qunar went public. We were in the red for about $200 to 300 million in cash every quarter, and about $500 to 600 million accounting losses, but our stock price has been fairly stable. Many people ask me, what are you doing? How can the public capital market accept this? Everyone believes that to go public is supposed to be profitable, but that is not true. Look back in history, when Amazon first became a public company. It was incurring heavy losses as high as 75% of cash losses in one quarter. We are basically controlling our loss rate not to exceed Amazon’s.
Why would the capital market tolerate losses? If you’re not yet the industry leader, or even if you are, if you can ensure that your business growth and revenue growth is over 60%, and incur losses for a fairly long period of time, then the market will accept it. Calculations will show that if you can maintain an over 60% growth rate, then you can multiply your business by 2.5 times in around two years, 6 to 7 times in about four years. This proves that if your business scope is still growing at a high speed, then the investments are very effective. The market space and addressable market are huge.
Next, everyone will say that with the 100% growth rate comes the addressable market problem – how long will the 100% growth rate sustain? The question that every startup needs to address, especially after Series C round, is to define how big your addressable market is clearly. Because in the early stages, everyone relies on a definite breakthrough in a certain area with some special features to open up the market. Once you’ve entered the high-growth period, however, you have to be clear where the growth ends. At least with your current product and strategy, where does it end? Growth cannot be endless after all. Like today’s airline ticket business, both Qunar and C-trip are profitable. The two companies combined make up nearly half of the entire Chinese airline ticket market. C-trip is currently growing at 40% while Qunar is growing at 60%. What does this mean? It means that this rate will continue for at most one more year, because if it continues on for two years, then our growth rate combined will exceed 100% which is mathematically impossible. Therefore, if your growth rate determines that your addressable market will not be able to maintain a growth rate of over 60% in the long run, then entering into a price war is meaningless.
Now back to the question of the leading and lagging strategies. Why is it that Qunar, founded six years after C-trip, still poses a threat to C-trip today? The biggest reason is that C-trip fundamentally miscalculated its addressable market. That is the same problem many Internet companies are making today. What is the real reason behind that? When C-trip entered the market, it kept on saying that online travel industry is its addressable market, but did anyone think about how the online travel market was growing at 40% to 50% every year? When you occupy 50% of the market share, no matter how fast your growth is, maybe it’s at 40% to 50%, but due to the fast growth of your market, there is still a lot of market space being created. If the market growth is coming going from offline to mobile, causing the online travel market to grow rapidly, then accurately define the addressable market during the speed up is key.
For example, if you define the addressable market as the entire travel industry, then there are resource limitations: there are only so many hotels, and they cannot be built at a rate of 40% to 50% overnight; the number of airplane seats is limited, the same goes for airline capacity and it cannot grow at a rate of 40% to 50%; the food industry might incur a high-growth, but with the current population in China, people eating maximum of three meals per day but usually having breakfast at home, the addressable market is fairly constant as well.
In my opinion, for many companies which have reached the high-growth phase, you have to define the entire market as a constant and fairly stable market when you’re looking at your competitors, and not define it as a fast-changing market. In a fast-changing market, if you are No. 1, it might look good, but this comes with huge hidden risks. If the market growth speeds up, then your business strategy and business model will potentially have to change fundamentally. Even worse is if another business model that comes in from another angle becomes big, it does not share the same business model as you, but it fundamentally solves the same problem.
Take meetings for examples. It started out with large conventions which have led many companies public in the past. Later, they were replaced mainly by video conference companies. Now, you can safely meet your needs through instant messages. Therefore, I think when you are trying to define the addressable market, you must continue to think abstractly about it – what a fundamental human need does it solve. You don’t have to think about it every day, but if your company has a valuation of over $100 million, a sizeable and stable income, and fast-growing business, then you should think about the questions every half a year. If I were to abstract this business further, what is it that I’m doing? Moreover, if we were to take the abstraction up a notch, what is this business and how many different plans do I have to meet the needs on this abstract level.
Take the restaurant business for example. Eating in a restaurant is one abstract layer, and group buying is another. The same goes for staying at hotels, but what is above the hotel layer? We need a place to stay when we travel, or we might have the need to book a place when we’re doing other spendings locally. Going to a higher level, Airbnb came up with the novel concept that, you don’t need to stay in hotels. The primary need is to identify a place to stay, and there are many solutions that can fundamentally solve the “staying out” problem.
I suggest that everyone continues to think about whether there exists a more fundamentally abstract layer that will bring you a different space. You can think about if your current business has the potential to maintain a 100% growth rate, or at least 60%, for the next three years. If you see that the current business model is coming to an end in the market, then your strategy will be completely different.
For instance, if you see that you’re close to a 50% market share, then you should look at whether the company is profitable, you have to prepare in advance to cut costs and to control costs. If you want to maintain high growth, then you need to think about solving the same fundamental questions, think about substitution plans, and whether there exist similar markets that can be expanded to address some basic and fundamental needs. It is not until you’ve thought these questions through, will you adopt a different strategy.
2. How to Fight in a Price War
Everyone talks about waging price wars as he or she can win market shares. They also talk about subsidies, but why do you want subsidies? When companies die, why do they evaporate? It is because they put price wars and costly investments as the only goals when chasing after market shares. My opinion is, occupying more market shares is always a strategic goal. The real question is, you need to have a concept of an endgame when you’re addressing this market. If you own 70% to 80% of the market, you have to think what are the key resources of this market, which resources cannot be expanded, and which ones are more exclusive. Once you’ve occupied the market, maybe others can no longer enter.
Take the travel industry for example. The most memorable examples are the number of seats and the number of hotels because hotels cannot expand rapidly, which makes it an exclusive resource. Like in the content business, copyright is an exclusive resource. If you are in the final stages of the game, you have to grab these exclusive resources to ensure the long-term sustainability of your business model.
When the time comes for you to occupy the resources, it must be executed in stages. With about 5%, you have access to some exclusive resources, which means you can use them. When you have 25%, you might have some control over certain exclusive resources. When you hit 50% of the market share, you might have total control over some of these exclusive resources. The layout of every market is different, but the key point is to understand clearly which are the exclusive resources in the addressable market you’re in and how much market share do you need to achieve a quantitative-to-qualitative change in the control of these resources. These have to be pointed out. Later, no matter if you go into a price war or if you put in a big investment to push the company forward, your entire procession will have a clear goal for every stage along the way. 49% might be meaningless, 52% might be excessive, and 50% is just perfect. If you have clearly laid out your plan, then you wouldn’t have to take it as they come. Many companies think they’re losing money to gain growth when that’s completely meaningless.
When you have a very clear goal such as my market share is 5% today and I think once we reach 15%, I need to achieve a quantitative change in resources, permission, or accessibility. When there is a detailed plan, the war plan should be to put down the money in one go, reach 15% in the shortest time span possible, and lock in the resources. That is why the speed of monetary loss should not be linear. A stepped or staircase-like pattern makes a much better plan. When you start to lose money, lose as much as possible and as quickly as possible, so that your competitors cannot follow suit. Once you’ve hit your target, you must stop immediately as the goal has been achieved. 50% is just right, and 51% is enough, then you anchor down and grab the resources.
Once you have the resources, you can wait when others are fighting for market shares again. Why? Because when you have 20% of the market, others might also be able to enter, and there’s nothing you can do. If you’ve reached 50% with your current capabilities and you cannot control the ecosystem, then you have to let others climb. You must control the tempo of the game, thus don’t be passively dragged through a price war, because you might get dragged into the ditch. As you don’t know what the others’ strategic goals are, you cannot wait to retaliate on others’ strikes. You must actively wage a price war and not be passively dragged into one.
However, before waging the war you have to be clear about a few things. First, what is your war strategy, how much market share do you want at every stage, how much resources you can lock in, and how to lock in those resources. Two, if you were to conduct this, what is the friction in time? Is this something that can be achieved in the short-term if you threw in 100 million, or does this naturally require time. Under the amount of time allowed, acquire the market shares you want in the quickest manner and stop immediately. That is a very important element in fighting a price war. You have to control yourself. Three, think about your return ticket. You might have had a great plan In the beginning, prepared 100 million for the war and if your competitor sees you putting down the money and fights back, then you might not be able to achieve the market share you wanted. You have to be clear then. You need an exit plan. For example, if my plan was to increase my market share to over 10% in one quarter and go for the resources. In two weeks after the fight starts, if I see that the progress is nowhere near planned, then this calls for an immediate retreat. Therefore, before we start, there needs to be careful planning that takes the competitors reactions and the industry’s reactions into consideration.
The price war is not the end goal. Even the market shares are not the ultimate goal. In reality, it is just a stepped function. Once you fought to a certain percentage and reached a definite stage, hold your position. Then you wait and evaluate the situation. When your company is fairly large, you might have diverse business lines that all need to quickly extract resources within a certain amount of time which requires coordination from the headquarters. Sometimes, there will be more resources and time taken when you had previously estimated every step of the way. This is, in my opinion, the most crucial point during the expansion period for everyone.
Some companies fail during the expansion period, because they only cared about market shares but did not densify the resources, and were without an exit strategy. Even if the company reaches a 60% market share, as soon as the war stops, the 60% will fall to 30%. That’s meaningless. What should we really do during a price war? We should be able to ensure that we might be able to grow from 10% to 13% with our best efforts during the war, but once we stop, we will still be able to retain more than 10%. That’s it. Nothing should be off to waste.
In the growth phase, if you are already a market leader, then you must pay attention to whether your business is still growing rapidly. I’m trying to say that, if you are already the market No. 1 and your business can maintain a growth rate of over 60%, then profitability and losses do not matter. If your losses are at 100%, so be it. You should only be able to make a profit under one situation That is you are already growing at 100%, and you have no idea how to spend the money, and you profit no matter how you spend it. Examples of such companies are Tencent and Baidu. This is the only acceptable situation, and I think it is almost a crime to be profitable in all other cases. You are giving away opportunities in droves to others. If you dominate your competitors and are triple their size, they’ll eventually be eliminated if you continue the fight. If you’re faced with stronger competitions, but you gave them opportunities as you’re trying to make a profit, then you may never be able to get rid of them once they reach half of your size.
Many companies fail immediately after their transition from being profitable to incurring losses, but a company that has continuously experienced losses will not be easily defeated. Why? When a company has been profitable for a while, the internal control and management of the company change, and you will start to control costs. Once a company experiences one to two years of profitability, especially after going public, the mentality will have transitions to be profit driven. When you’re trying to guarantee profit, then you’re giving more power to the financial departments over your business. As time passes, the more progressive employees will leave, and those who are more stable and balanced are left. This changes the entire DNA of the company. Thus, not everyone learns how to incur losses, and losing money is indeed a skill.