Jeremy Phillips missed a very important point in his Friday NYTimes piece The Rise and Fall of the Unicorn. It’s a point most overlook when considering the impact of a number INFLATES MARKET.

He pinned most of the valuation frothiness on a winner-take-all mentality. That if you back a single power-horse, the market return potential is exponential. This is true with one caveat.

A great number of the “unicorns” in focus are businesses with complex supply chain unit economics. These are businesses where the company does not control huge components of the fully loaded costs to deliver its services, the only control what they pay for it before selling it to a user, theoretically at a markup.

A black and white illustration is Uber. It controls price and what it pays drivers per mile, per pickup and as a minimum guaranteed hourly rate, for example. It does not control the cost of the car, gas, insurance, etc..

The theory in scaling is, as proven historically by businesses like Walmart, scale applies pressure on components in the supply chain all the way to the raw good (e.g. the metal in the car). And thus any imbalance between the cost the company wants to pay and the true cost of the product it is buying (e.g. Uber: buying the ride from the driver, Walmart: buying the toy from the manufacturer) will be short-lived. Market forces will solve the imbalance.

This approach works in markets where the company (e.g. Walmart) is by far the largest buyer of the good. What Walmart does will ripple through the supply chain and drive production costs down.

The flaw in Phillips’ piece and in most analysis like it is that it ignores the true supply chain costs of higher profile companies like Uber, HomeJoy, DoorDash and Instacart. It costs more for a human to deliver the service than the service is paying them. And the human cannot reach into his/her supply chain and push down costs. It takes X minutes to get from A to B with $X in gas in an asset that costs $X/day.

None of these companies will, for a very, very long time, have the scale to impact global oil prices or the macro cost to produce cars.

Why does this matter? Because when these companies operate at scale delivering a unique and mostly new product at an artificially low cost, they train consumers to believe that the product is only worth X. So even if competition is squashed, if the supply chain isn’t cheaper, then the subsidies must continue. Otherwise, consumers will balk at paying the true cost of the product and flock to alternatives.

When you invent a product and deliver at scale, you create the market perception of what that product *should* cost. And if you do that you must be sure your scale can drive down cost or your subsidies can continue in perpetuity. Otherwise, you’re toast.
