Every marketplace is unique. But every successful marketplace is unique in the same ways. Historically it’s very hard to find a successful marketplace that wasn’t built on an underutilized fixed asset.
Airbnb is a canonical example of this. Someone has a guest bedroom. It’s always there, a fixed asset. But it’s unused and they make no money from it. Until Airbnb, they may not even have considered that they could make money from it. And then suddenly, with Airbnb it generates hundreds of dollars for them. It’s like an ATM they didn’t know existed in their guest room.
What Exactly are Underutilized Fixed Assets
To understand underutilized fixed assets (UFA) is to understand each component of the term.
Fixed vs Variable Assets
Fixed assets are those where the cost of them is constant, and independent of usage. If you buy a pan, it is a fixed asset. You have already paid for the pan. Whether you use it once or a hundred times, the total cost does not change. Having gasoline for your car on the other hand is a variable asset. If you don’t drive at all, you will not spend any money on gasoline. But the more you drive, the more you will have to refill your tank and by extension pay for gas.
This difference between fixed and variable assets is flipped when you look at their costs on a per usage basis. Variable assets are relatively constant in their costs per usage. While the more fixed assets are used, the cheaper their cost per usage falls. Usage of fixed assets is amortized across all usage of them, so they have a natural economy of scale.
There’s a third and more important way to view fixed assets. They can be viewed as assets that are already paid off. Any incremental uses of them are functionally free. Unlike variable assets, where incremental usage always still carries a cost.
Underutilized vs Fully utilized assets
Assets have a maximum amount they can be used. Both in terms of the frequency with which they can be used as well as the total number of times they can be used. There can be significant variance between two similar assets on their maximum utilization or even disagreement about what is a reasonable benchmark to use for max utilization, but those are in-the-weeds details. Underutilized assets are those that are not used very much, while fully utilized assets are those whose usage is close to the maximum possible.
Why are Underutilized Fixed Assets important?
Underutilized fixed assets are things with fixed costs that are not being used as much as they could be. They are important because they *can* be used more, and from their owner’s perspective all additional usage is free.
Unlocking early markets
The cross-side network effect of marketplaces is incredibly strong, but equally difficult to create. Convincing both sides of a market to to join on the promise of the other side being there is a constant struggle. And simultaneously building both sides is significantly more difficult than being able to focus on just one side of the market.
In the early days, many marketplaces have found an underutilized fixed asset to be an incredible boost to expedite building the supply side of their market.
The best way to think of underutilized fixed assets is as pure potential energy sitting in people’s homes, cars, and random tchotkes. Marketplaces take a tremendous amount of energy to get their flywheel spinning. But it’s easier when there is an external supply of potential energy that can be put to work.
Preferred Pricing
Unlike businesses, most people with underutilized fixed assets baseline their value at zero. Any money these assets turn out to be worth is money they found lying on the floor that they’re happy to receive.
This lets a marketplace bring on supply at a much lower cost of acquisition than expected. And these savings can be passed along to consumers as well.
Latent supply
Once a new underutilized fixed asset is identified, a startup can grow rapidly because there is so much latent supply of the asset initially sitting unused.
This supply tends to be mostly retail. It’s more fragmented sources of supply, with people who are less price sensitive since it’s not a business to them.
One downside with more fragmented supply is the complexity in bringing them online, making them legible, and handling logistics. This tends to work in marketplaces’ favor, however, as it’s the exact type of complexity that software is particularly good at, and allows them to unlock the underutilized fixed asset.
One way to look at marketplaces is a series of supply and demand acquisition elasticity curves. Finding a good underutilized fixed asset is a surefire way to bend the acquisition elasticity curve for a while.
Burn the Bridges
One under-appreciated advantage of underutilized fixed assets is that because they are a finite and arbitragable source of supply, it’s hard for new competitors to replicate once they’ve been discovered and tapped. It’s hard for a new Airbnb to emerge because people with empty bedrooms no longer are unsure what to do with their empty room–they use Airbnb. So a new competitor can try to go after these same potential listers, but they have to compete against Airbnb, rather than on the hosts doing nothing with the bedroom.
Case Studies
For many marketplaces the early patterns are the same.
Airbnb
Before Airbnb, hotels were the primary option available to consumers. Yes, there were some short term house rentals or communities like Couchsurfing, but these alternatives had low liquidity and trust.
This wasn’t due to lack of empty bedrooms available in cities. Every day thousands upon thousands of empty bedrooms and homes are unused by their owners. But these travelers and home owners never used to connect. There was no way for them to find each other, and even if they did, they would not trust each other.
Airbnb bridged this divide. They brought both sides online. They built trust into the platform by handling payment, customer service, and discovery, as well as by building up reviews and photos for each listing.
All of this made it possible to list people’s empty bedrooms and other underutilized fixed assets like this. These listings were often cheaper than hotel rooms since listers had already assumed the costs of their empty bedroom. They are also better positioned, neighborhood-wise, compared to hotel rooms.
Uber
Before Uber and Lyft, taxis existed to varying degrees in each city. Mobile ordering and dispatch made UberBlack originally possible. But it wasn’t until Lyft that driving was opened up to anyone with a car. Lyft’s main insight was that mapping and routing apps like Google Maps and Waze commoditized local knowledge in drivers. This made it possible for anyone to become a driver, massively expanding the pool of drivers to anyone with a car.
Ebay
Ebay was the first of the online marketplaces, and perhaps the most successful. They raised a total of $7M before going public as an already profitable company. Before Ebay, if you had random stuff in your house you either tried to sell it locally, perhaps at a garage sale, or just let it pile up in your house. By making it easy to list, review and discover items online, Ebay brought liquidity to their marketplace and made it possible for people to sell all the random unused things in their house.
New Startups
For every marketplace, in their early days they should be thinking about potential underutilized fixed assets that make sense for their platform.
For example, Hipcamp helps consumers find campsites to rent. Hipcamp adds supply by getting private landowners to list their land, and for many of these people their land was literally sitting fallow before Hipcamp made it possible for them to share it with others.
The Sequencing of Marketplace Supply
There’s something beautiful about retail marketplaces: two sided markets where both sides are just random average users.
They never last. So there’s a wistfulness to watching them, frozen for just a moment.
Look at all marketplaces as they scale, and you eventually find that the percentage of their revenue that comes from retail users on the supply side falls. Power sellers dominate Ebay. Uber is increasingly full time drivers doing it as their full-time job. Airbnb is increasingly full of individuals and now companies that buy properties and convert them into ideal Airbnb listings.
A constant debate persists around whether to embrace the professionalization of one’s platform or to stave it off as long as possible. There are deliberate product choices that can tilt the platform in either direction. These decisions are a subset of a burgeoning understanding of the life cycles of a platform, which I’ll cover more in a future essay. But few marketplaces are able to avoid this transition.
Things can only be underutilized for so long
Empty houses, random stuff in your house, and idle cars.
There is a natural invisible asymptote to these. Eventually, the growth of marketplaces built on top of these underutilized assets slows. They are a great playbook to enter a market, but there is a finite amount of unused assets–and eventually there are no more idling assets to utilize.
Profit drives new behavior
At the beginning, people with underutilized fixed assets dominate the supply side of a marketplace. These people will always have their place on a platform, because they have such a cost advantage. But eventually, others, or even some of the same people, realize that using the marketplace is so profitable that it’s worth it even if they have to bring new supply online.
There are natural economies of scale to this. Someone creating supply on a platform full-time will be better at many things like:
- Understanding the intricacies of how the platform works
- Understanding how to best make money on the platform
- How to best get listed, seen, and discovered on the platform
- The most attractive ways to invest capital for a return on the platform
Increasingly the best hosts, sellers, and drivers on the platform professionalize. They are already making the majority of their income on the platform. And whether or not they are the majority of sellers on the platform, given their professional usage they are very likely to be the majority of transactions on the platform.
Scaling is a business
To scale beyond a certain rate is difficult using underutilized fixed assets. Besides a finite amount of them, there is a natural limit to the rate at which they grow on your platform.
Professionalized sellers are very different. As long as it’s profitable for them, they’ll do everything they can to expand to meet demand. Underutilized fixed assets are nice because they have a low effective cost basis.
Professionalized sellers are nice because they are variable and will scale as far as can be supported. Large marketplaces gradually shift to professional sellers as they try to maintain their pace of growth.
The consequences of sequencing
Companies consciously or unconsciously make decisions that embrace or reject this professionalization of sellers to differing degrees and speeds. These choices have large impacts on the growth rate and unit economics of the business.
They also have large impacts on the relationship with supply on the platform and regulation by the government. For example, if you think of Airbnb’s regulatory hurdle at a local level, local landowners renting out their bedroom is far more attractive politically than fast growing companies buying up for sale properties to convert them into short term hotel rooms.
Appendix A: Crypto
Crypto is no different. When Satoshi created Bitcoin, they identified an underutilized fixed asset that could be used to bootstrap the cryptocurrency’s security. Bitcoin was set up so that individuals could have their CPUs, which were often left idle, mine Bitcoin when not being used. For early adopters, this was great. They hadn’t realized their unused CPU cycles were valuable–but now it was like they found free money they hadn’t even known about. And in today’s dollars, those who had their CPUs mining made substantial fortunes. And for Bitcoin, the deal was even better. Security requires something computationally hard. The Proof of Work system got others to provide the compute needed to scale security for Bitcoin without Satoshi needing to personally pay significant sums of money for their own compute. These underutilized CPUs were distributed among a very fragmented and large set of early adopters. Diminishing fears of miner centralization and having the very users be the source of security as well.
However, Bitcoin is also a good example of the limits of underutilized fixed assets. Though underutilized CPUs may be the cheapest source of compute (free). Bitcoin mining is a zero sum game. One’s return is roughly proportional to what percentage of mining you are. This is ideal for Bitcoin, because it makes a competitive red queen equilibrium, where miners must keep working to bring more compute to bear at as low costs as they can in order to keep pace, much less gain ground on their competitors. What matters is not having the cheapest compute, but having the most scalable compute that is still profitable. Underutilized CPUs were cheap, but they weren’t scalable.
Enterprising miners soon realized that they could utilize their GPUs for Bitcoin mining. And machine learning startups renting GPUs from AWS soon learned about this the hard way, as miners realized there was a perfect arbitrage by renting GPUs from AWS to mine Bitcoin–and quickly tied up all of Amazon’s GPUs until their prices rose to make it not profitable anymore. Though Satoshi had intended for a distributed user base mining with their personal computers’ CPUs, there were better places along the SLA-Price curve.
Since then mining has become even more specialized and economy of scale, with mining hashrate centralized around a small number of large companies that specialize on mining. These companies create their own ASICs, which are purpose built for mining Bitcoin, and allow for significantly more mining power at lower costs than even GPUs. This has made CPU and GPU mining prohibitively expensive and, even for those with spare CPU cycles, not very profitable.
Appendix B: Food Delivery
Underutilized fixed assets are the topic of this essay. But all the other variants, such as underutilized variable assets, are important to understand as well. Food delivery is a great example of this. Many people often express disbelief that food delivery startups, have been able to get as many restaurants to sign up for them while charging large take rates (sometimes north of 30% now) from the merchants. “How do these restaurants afford it?” these skeptics ask. What these skeptics fail to understand, is that restaurants do not view deliveries the same way they view customers dining in. There are many factors that restaurants are constrained on including, ingredients, labor, kitchen capacity, and dining space.
For walk-in diners, the primary constraint is dining space. There is an immovable cap on how many tables a restaurant has, and thus how many turns they can do a night [1]. This real estate space is a fully utilized fixed asset. So a startup bringing new diners to a restaurant is entering a zero sum game, especially during peak hours when a restaurant knows they can likely fill all their tables. If a restaurant accepts a diner from a startup and pays them a take rate, this replaces a diner that would have walked in for free. This is the reason why restaurants often don’t list their prime hours on sites like OpenTable. They know they can fill their limited number of tables, so why pay OpenTable a fee for it?
But delivery is different. Real estate space is not relevant to delivery orders. Instead the two main constraints for restaurant delivery are labor and kitchen capacity. Kitchen capacity is an underutilized fixed asset. Most kitchens can handle more orders than they handle each day, but never need to because there’s not enough space in the restaurant for more diners. Like all underutilized fixed assets, restaurant owners are very happy to have their kitchens handle more orders if makes sense.
The other constraint is labor. Restaurants may have some underutilized labor, depending on how busy they are. However, if they have any significant number of delivery orders, they likely would need to have their workers do more shifts, or hire new workers. So labor is an underutilized fixed asset up to some point, but then primarily a variable asset for restaurants.
So when a startup brings new delivery orders to a restaurant, their main question is whether the delivery will be profitable net of the variable costs like ingredients and labor of the restaurant. Other factors like real estate costs are already fixed and so not factored in by restaurants. If these delivery orders are profitable, restaurants are happy to do any and all incremental orders–and will happily pay a higher take rate in return for bringing them the customer. And if the startup brings more customers than they have workers to handle–they’re overjoyed to hire new workers, as long as the economics make sense [2].
Variable assets are great because they can scale well. However, they are far less preferable to underutilized fixed assets for a number of reasons. Their primary weakness is that they can be copied by competitors. Underutilized fixed assets when discovered are have a huge amount of stored value. The first company to properly use them can increase their value significantly. However, after they’ve burned through this arbitrage, future competitors must find a new way to get advantaged distribution fast. This isn’t true for variable assets as we can see in food delivery. The field is increasingly competitive with Grubhub, Uber Eats, and Doordash all competing in increasingly costly battles.
Endnotes
[1] In the US, most restaurants seem to view the number of turns possible per night as being fixed. Many Chinese restaurants, however, do not. Instead they view it as one part of the restaurant trilemma. Food quality, price, and service/speed are all in tradeoff with each other. Chinese restaurants often optimize for great food at low prices, opting to make it up by turning over tables as fast as possible. Often that’s why these places will get your orders before you’re seated, give you your check before you’ve finished eating, and rush you out the door the second you finish the last bite of food. While Westerners often complain about this bad service, it’s the ultimate service: all to maintain quality food at low prices.
It’s surprising that this is not common in the US. Perhaps it’s due to social norms around dining. However, perhaps this is beginning to change. One of the few reliably profitable areas of the restaurant industry, Quick Service Restaurants (QSRs) are all about improving how much throughput each location can handle.
[2] This is why delivery companies are not winner-take-all on supply. Restaurants are rarely exclusive with delivery companies, because they want any and all incremental demand they can get. In fact, it’s not enough to charge a lower take rate than your competitors, because restaurants will still accept all incremental orders they’ll make money off of–since they’re almost never over capacity. This is why delivery companies must compete to corner the market on demand if they want to be winner take all.
Acknowledgements
Thanks to Keila Fong for making sure that Kwokchain: Year 2 is not an entirely empty book.
Hello – I stumbled upon you on Twitter and listened to you speak on a couple of podcasts. Thanks for an interesting post. Operating leverage enabled by a higher proportion of fixed cost relative to variable cost is a well understood concept in economics and finance, but it’s really interesting to see it applied to the supply half of the marketplace business model equation. I think, however, perhaps the most interesting idea in your post has to do with underutilized variable assets, but not quite in the way you laid out. I think underutilized variable assets play a critical role in the supply dynamics of marketplaces, and this I believe is largely why you see increasing “professionalization” of the platforms as they scale. The key underutilized variable asset I’m referring to, of course, is your time (since labor is a variable cost), and individuals who are not professionals have an upper limit to how much they can scale the utilization of this variable asset. Airbnb is not merely letting a stranger come to your room and occupy it – it involves time and considerable effort to manage that activity properly. Uber/Lyft requires you to actually be in the car and drive it. Given the ease of access to credit these days I would even argue for ride hailing the key underutilized asset that is being exploited through the business model is not even the vehicle – it is your time. If what you say about underutilized fixed assets are true – namely that their perceived baseline value is zero and there is an ease with which the latent supply is unlocked once it is identified – then it’s astonishing that more people aren’t renting their rooms on Airbnb or driving Uber/Lyft, even very occasionally. I think the reason why is the key consideration for the supply side here is that given some fixed upper limit on the scalability of the underutilized variable asset (your time), its baseline value actually is fairly high for most individuals (roughly equating to how much value you assign to your leisure time), and therefore the financial compensation offered by these platforms simply does not justify using it this way for many people. Somewhat ironically, I think the example where underutilized fixed assets play the most significant role is actually food delivery, where the fixed asset is the kitchen capacity. Excess kitchen capacity above and beyond what is required to satisfy the dine-in demand is a fixed asset (assuming you have max labor within the physical constraints of the kitchen space), and there is no other variable asset at play here. This is why I am pessimistic about the food delivery businesses in general, because the degree of under-utilization of the fixed kitchen capacity correlates negatively to the quality of what it produces – i.e., the extra capacity should not be that great if the restaurant is a well-run business. A restaurant with a high degree of underutilized kitchen capacity is by definition one that is not doing so well, and there is little reason to expect that it will do well with deliveries, either. My feeling is at some point all of the food delivery businesses that exist today delivering food from brick-and-mortar restaurants will be replaced by vertically integrated businesses that specialize in food created specifically for delivery.