How Identity Crisis Is Killing On-Demand Service Startups

06/05/2017 04:59 EDT | Updated 06/05/2017 05:29 EDT

A single company disrupting the transportation industry has bewitched an entire generation of entrepreneurs. Eager to label their new on-demand service a "tech startup", many founders miscalculate their business model.

The fact is, most startups fail, and while it is easier than ever to acquire venture capital for such endeavours, the misnomer of "tech startup" is more likely to lead to dissolution than dollars.

The myth behind on-demand startups

The concept of an "on-demand economy" has proliferated over the last decade, and the advent of Uber and similar services have enabled instant gratification for consumers and companies alike.

From meal delivery to laundry service, young entrepreneurs and innovators rushed to build the next "Uber" of their respective industry.

But Uber built something out of reach for most startups. It applied technology to an existing transportation infrastructure that hadn't improved in decades, and seized an opportunity to completely disrupt the lackluster taxi industry. Today, Uber's valuation is higher than all other on-demand service companies combined.

With a ride home at our fingertips, we now expect food, accommodations, even dates via the swipe of a finger, and hundreds of companies around the world have attempted to capitalize on a generation of consumers willing to pay a premium for "right here, right now" service.

But after billions of dollars were poured into this hyper-growth industry, we are beginning to see some of these companies surrender. In the last month, two well-known food tech startups, Maple and SpoonRocket, shut down; Homejoy, a once promising startup, raised $38 million before ceasing operations.

It turns out, creating an on-demand service is not as easy as the click of a button, and there are key factors many struggling startups failed to understand.

Lack of understanding of unit economics

What's the cost of every product delivered? What's the cost of every customer acquired? On the surface, these are simple questions. Yet many startups rush into the on-demand service tech trend by superficially imitating Uber and Airbnb, rather than analyzing the basic economics that made them successful. By leveraging the network effect of built-in infrastructure and community, profitable on-demand startups have avoided many potential pitfalls.

The existing marketplace of transportation and lodging drove exponential value to Uber and AirBnB. Every time a user (the "demand"), or a driver or renter (the "supply") joined the network, Uber and Airbnb grew both its infrastructure and its customer base. Simply put -- the more people participate, the more valuable they become.

The whole network effect is reciprocal by nature. With Uber, passengers receive faster service, and drivers have more rides per day. With Airbnb, users have more rental options, and renters acquire more bookings.

My best advice is this: ask yourself who you are vs. who you are trying to be.

Failing companies, on the other hand, tend to overlook the cost of building up an infrastructure where there is none, and lack a community based referral system. Ultimately, they refuse to consider the unit economics of their enterprise.

Let's take the example of Maple. Seemingly, Maple is a similar service to Uber: with the touch of a button, they deliver locally sourced food to your door. Unlike Uber, the unit economics and network effect that makes Uber so successful just isn't there. Do note, that even UberEats hasn't found it's way into profitability.

There is no tangible reason for users to care how many people are using Maple, and therefore no reason to refer family and friends. In fact, one could argue that the fewer the users order from the app, the faster food is delivered.

The rate of adoption increases when products and services gain value from additional users. When customers have no incentive to push user adoption the likelihood of growth is minimal.

On the supply side, things are even more difficult. The end service for Uber is quite simple - "delivering" one person from point A to point B. The delivery is actually making money. But this is unique... for many service startups, delivery is a major cost.

bike city

Startups responsible for making and delivering their products take on a massive challenge. They have to build their supply chain and compete with corporations who have been operating for decades. Without a built in infrastructure, there is no way a startup can squeeze margin out of an $11 meal delivery.

On top of all this, startups are inefficient in the midst of figuring things out. They use VC dollars to patch holes in a flawed value chain while scaling operations to gain economy of scale. Some might even say that their definition of 'economies of scale' is really "we are bleeding money like crazy and we have no idea how to fix it." Successful tech startups go into business by utilizing existing infrastructure and with a clear understanding of the network effect.

Lack of understanding of its true competitor

Another mistake many service startups make is the erroneous belief they reside in a market of their own. As Peter Thiel said of a British restaurant in Paulo Alto, too many companies claim to be the only one in its industry when they are not.

Delusional market segmentations blind many new companies to their competitors. Foods startups that claim to be "the only organic pre-packaged meal delivery on demand" have to compete with grocery juggernauts. Subsequently, they have to compete with the long standing habit of buying food from a favourite grocery store, not other startups who offer the same thing.

Best technology or best service?

My best advice is this: ask yourself who you are vs. who you are trying to be.

Fewer on-demand startups will fail if they stop pretending to be in the business of building technology when in fact they are in the business of pre-packaging individual carrots and delivering them to people really, really efficiently.

If after careful consideration you decide you are in fact a technology startup, understanding unit-economics and the inherent value of the network effect are key components of a thriving business. Building an on-demand service company is not as simple as using one.

Follow HuffPost Canada Blogs on Facebook