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The World is a Supply Chain

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Lisa Morales-Hellebo, and Brian Laung Aoaeh. Kicking off #SCIT2019, June 19, 2019 in NYC. Photo Credit: Ray Neutron.

Originally published at www.refashiond.com on Friday, October 18, 2019.

Note: 3,749 Words, 14 Minutes Reading Time

Authors: Brian Laung Aoaeh, CFA, and Lisa Morales-Hellebo

The world is a supply chain. It’s that simple. 

But what does that really mean?  Whether we like it or not, current economic, political, social, and technology trends will compel more people to think about the implications of that statement more consciously each day.

In this blog post we;

  • Share a definition of supply chain,
  • Put the challenges confronting supply chains in context,
  • Discuss why socio-cultural forces will act as the leading catalyst for the innovations that will define supply chains of the future,
  • Explain why the refashioning of supply chains matters,
  • Explain why the technological transformation of supply chains is an economic issue, as well as one driven by evolving consumer preferences,
  • Describe the role that early stage technology venture capital can play in the transformation of supply chains,
  • Describe how individuals, private sources of capital, and governments can play a role in the transformations that will lead us to the supply chains of the future. 

What Is A Supply Chain?

First, let’s answer the question: What is a supply chain? 

A supply chain is a network of organizations that work collaboratively to move products and services from producers to consumers. At a high level, the business of supply chain can be subdivided into: 

  • Supply chain management;  which is about supply chain network design and management; 
  • Supply chain logistics; which is about the storage, transportation, and movement of physical goods from one place to another;
  • Supply chain finance; which is about ensuring that producers, and other supply chain participants and intermediaries get paid for the value they create and deliver to consumers.

Supply chains play two critical functions: 

  • First, they enable the flow of goods and services from producers to consumers. 
  • Second, they facilitate the transfer of information about the movement of goods and services between every entity that is part of the supply chain network.  

The world we’ve become accustomed to will not exist without supply chains.  And further, the world is a mechanism for providing humanity with the resources we need to survive on Earth.  We know this to be true — “when supply chains function, societies thrive”.

The Challenges Confronting Supply Chains

Today, we face an inflection point as our world confronts some big crises. If current trends hold, between 2015 and 2050 the world’s population is expected to increase by about a third, to roughly 10 billion people. According to Our World in Data, the world’s population stood at about 190 million people in the Year 0, and approximately 4 billion in 1975. In other words, the world’s population will jump by about 6 billion people over the 75 years between 1975 and 2050 after having only climbed to 4 billion people over the previous 1,975 years. This is happening, according to Our World in Data, despite the world’s population growth rate peaking at 2.2% per year in 1962 and 1963, and then declining to its current rate of about 1% per year. 

While this rapid increase in the world’s population is occuring, global supply chains face some big challenges: 

  • An ongoing increase in the frequency of severe weather events that cause large-scale disruptions to local and global supply chains. 
  • Trade disputes threaten to dismember the system of world trade established following the end of World War II. 
  • The growing world population has created a critical need for significantly better dynamic resource allocation throughout supply chain networks in every industry around the world. 
  • Changes in consumer behavior are putting the world’s supply chains under increasing strain and business competitiveness is increasingly tied to supply chain mastery.

Socio-cultural Attitudes Will Be The Catalyst For Supply Chain Innovation

Perhaps counterintuitively, innovation in global trade and supply chains will be driven most immediately by changing social attitudes towards climate change. A recent poll of adults and teenagers in the United States conducted between July 9 and August 5, 2019 by The Washington Post and the Kaiser Family Foundation offers some early evidence of the changes taking place. 

When asked if human activity is causing climate change, 79% of the adults polled responded yes, while 86% of teenagers responded yes. When asked if reducing the negative effects of global warming and climate change would require major sacrifices, more than 30% of adults, and more than 40% of the teenagers surveyed said yes. Also, at least 70% of adults and nearly 80% of teenagers said that technological advances will be able to reduce most of the negative effects of climate change. 

There are more conversations than ever about decarbonizing supply chains. At about the same time this poll was published, Quartz reported that two states in India have said they will not build new coal power plants. Earlier this year, governments in Europe called on the fashion industry to tackle its waste and pollution problems more aggressively and some are looking at passing legislation to that end. In Asia, more governments are moving to address issues around plastic waste imported from abroad. Starting in January 2020, the International Maritime Organization will begin adopting new regulations to curb harmful emissions from the container shipping industry. 

Another example of the rapidly evolving social and cultural attitudes that will drive innovation in supply chains and global trade is the growing movement led by young people such as Greta Thunberg, Jamie Marglois and others like them. Political, business, and technological leadership is shifting into the hands of a generation of men and women who do not want to leave a more inhospitable planet as their legacy to their children and grandchildren.

What does this mean? 

In the next half-decade or so we will see political and business leaders facing increasing pressure to adopt policies and business practices that reflect how voters and consumers feel about climate change. Those who do not risk losing political power and market share, respectively, to their opponents and competitors who do. As this social and cultural movement gains strength, it will accelerate the economic drivers of innovation, which in turn will propel the drivers of technological innovation in global trade and supply chain. 

In his August 2011 article, Why Software is Eating The World, Marc Andreessen said: “Companies in every industry need to assume that a software revolution is coming.” The process he described has only accelerated over the intervening 8 years, and that statement is more true now than it was then. As information technologies that were pioneered in the 1950s have reached maturity, technology startups around the world are developing new innovations to solve some of the supply chain problems that seemed intractable in the recent past.

Why The Refashioning Of Supply Chains Matters

However, before we can understand why the confluence of software and hardware engineering is going to be transformative to the supply chains on which the world runs, we must understand why that matters.

Supply chains exist to connect producers and consumers in an ongoing exchange of value. As a result, innovations in supply chain drives innovations in the rest of the economy. Given that supply chains are about the back-and-forth movement of physical goods, services, and information, it is easy to understand why advances in information technology must necessarily precede cycles of innovation in supply chain.

Because innovation in supply chain acts as an accelerant for increases in production and consumption, supply chain innovation acts as an economic multiplier. Every dollar of innovation in supply chain innovation leads to more than a dollar of total economic output. It is not a coincidence that countries ranked highest on the Worldbank’s Logistics Performance Index tend to have the most developed economies, while those ranked lowest tend to have the least developed economies. 

Supply chains are to human civilization what oxygen is to life; When they work well, no one notices them. It is only when they start to fail that we realize there’s a problem. It is easy to assume that there’s no room for innovation in global supply chains and trade, but this is simply not true. Here are four examples. 

  • As governments and people around the world awaken to the issues posed by climate change, there’s a growing social, regulatory, and economic push for innovations in supply chain logistics that will significantly reduce the amount of pollution created by the transportation industry. Some of these innovations involve the application of machine learning to the analysis of data obtained from connected devices in transportation and supply chain networks in order to make the operation of such networks more efficient and optimized. This needs to be done in a way that ensures that the transportation of people and merchandise does not destroy the environment. 
  • There is an ongoing shift away from linear supply chains in which the materials that remain after consumption has taken place are discarded, and more towards circular and regenerative supply chains that place an emphasis on using post-consumption waste as raw materials for new products. This shift relies on advances in materials science – both in the creation of new materials that did not exist before, and in the processing of materials that we have become accustomed to, but which we now recognize pose a growing threat to the environment as waste accumulates in quantities that the world can no longer sustain. In order to reduce or eliminate waste and pollution, the focus here is on developing supply chains around the repair, renewal, regeneration, and recycling of materials and products.
  • Manufacturing is undergoing a transformation of its own, one which will make the changes happening in transportation and materials that much more impactful. With the recent shift in political attitudes towards global trade, more companies are beginning to consider regionalized and localized manufacturing as a path towards avoiding costly tariffs. Such a transformation will rely on a mix of emerging and mature manufacturing techniques in order to keep costs within a manageable range. These advances in manufacturing will rely heavily on manufacturing goods to fulfill actual demand, rather than manufacturing goods in anticipation of future demand.
  • Invariably, software is being used more than ever to create new methods of collecting, storing, and analyzing data to augment human decision making in every industry. These technologies are being applied in industrial supply chains as distinct as: Pharmaceuticals and industrial chemicals – to simulate new compounds and test them more quickly and inexpensively; They’re also used in agriculture – to manage the production, storage and distribution of food and other agricultural produce in order to minimize food loss and food waste; And in energy – to aid in the production, storage, and distribution of energy from increasingly complex power grids that incorporate renewable and non-renewable sources of electrical power. 

The way we make things, the way we consume things, the way we move things, and the power that is required to make all that possible is changing dramatically thanks to advances in software and hardware technologies. Solving the foundational problems that plague global supply chains is a daunting task. Moreover, global GDP, most recently estimated at about $88 trillion, rests on our ability to solve these problems. 

Technological Transformation of Supply Chains: An Economic Problem, An Economic Opportunity

In our conversations with other people, we are often asked the question; “Wouldn’t this be easier if the transformation of supply chains were driven more by economic forces and consumer needs?”

In The Supply Chain Economy: A New Framework for Understanding Innovation and Services, Mercedes Delgado and Karen Mills state that; “The U.S. supply chain contains 37% of all jobs, employing 44 million people. These jobs have significantly higher than average wages, and account for much of the innovative activity in the economy.” 

Similar conclusions hold true in every other region of the world, and there is ample evidence to support that belief thanks to work by a number of global. Multilateral organizations like the World Economic Forum, The World Bank, The International Monetary Fund, various agencies of the United Nations, and others.

For example;

  • According to Growing Better: Ten Critical Transitions to Transform Food and Land Use, a September 2019 report by the Food and Land Use Coalition;  “The hidden costs of global food and land use systems sum to $12 trillion, compared to a market value of the global food system of $10 trillion.”
  • According to Long-Term Macroeconomic Effects of Climate Change: A Cross-Country Analysis, a July 2019 paper by researchers at the University of Southern California (USA), the University of Cambridge (UK), Trinity College (UK), the International Monetary Fund (Washington DC, USA), and National Tsing Hua University (Taiwan); “Our counterfactual analysis suggests that a persistent increase in average global temperature by 0.04C per year, in the absence of mitigation policies, reduces world real GDP per capita by 7.22 percent by 2100.” Furthermore the authors state; “We also provide supplementary evidence using data on a sample of 48 U.S. states between 1963 and 2016, and show that climate change has a long-lasting adverse impact on real output in various states and economic sectors, and on labour productivity and employment.”
  • According to Impact of the Fourth Industrial Revolution on Supply Chains, an October 2017 report published by the World Economic Forum; “Disruptive technologies are transforming all end-to-end steps in production and business models in most sectors of the economy. The products that consumers demand, factory processes and footprints, and the management of global supply chains are being re-shaped to an unprecedented degree and at unprecedented pace. Industry leaders who were consulted believe that new technological solutions heralded by the Fourth Industrial Revolution – such as advanced robotics, autonomous systems and additive manufacturing – will revolutionize traditional ways of creating value. As the costs of deploying technology continue to fall, international differentials in labour costs will no longer be a decisive factor in choosing the location of production.” 

Other examples are not difficult to find. 

A company’s supply chain is an integral part of that company’s customer experience, and consumers all over the world will continue to become more demanding, not less. The supply chains of the future will become a reality precisely because the refashioning of global and local trade infrastructure is an economic issue that is driven by consumer preferences.

That being said, it is important to recognize why conversations about the transformation of supply chains are less straightforward than one might hope.

In Disaster Mitigation is Cost Effective, a world development background note by Ilan Kelman, he states that it is easier for politicians who tend to seek visibility for themselves to pursue after-the-fact measures rather than pursue prospective and preventative measures related to disaster risk reduction. After-the-fact measures are more visible, while prevention is intangible and difficult to quantify, resulting in less of a boost for the personal ambitions and ego of individual politicians.

We observe a similar pattern of behavior among corporate executives, who tend to pursue highly visible, customer facing, short-term, tactical initiatives at the expense of long-term strategic initiatives that will help their companies develop and gain mastery over their backend supply chain operations. On the other hand, we observe that the companies that have become globally dominant are also those that have developed superior supply chain mastery within their respective markets and industries. We believe that companies with inferior supply chain operations will continue to fall victim to a degraded customer experience. We also believe that companies with inferior supply chains will lose market share to established, and new, competitors with superior supply chain capabilities.

Early-Stage Technology Venture Capital Will Play An Important Role

Surprisingly, the men and women who set out to tackle these problems usually find a lack of sufficient early-stage venture capital to support their efforts at the earliest and riskiest stages of their work – as they take that work out of academic research labs, or small apartments and houses, and start the often arduous process of commercialization. 

That is when there is the greatest need for venture capitalists who understand the nature of the problems, who recognize the potential commercial opportunities, who have a willingness to do the necessary hard work required to help these entrepreneurs succeed, and who have developed relationships with prospective commercial partners willing to investigate new technological innovations for long-standing supply chain problems.

This is changing, but it is not changing fast enough. The world needs much more risk-seeking capital to fund these entrepreneurs – the market opportunity is enormous. As we have already pointed out, global GDP rests on a foundation built entirely on physical and digital supply chains.

For these innovations to succeed, governments and traditional industry must become more open to partnering with venture capitalists and technology startups. Unlike innovations in information technology, the technological innovations that will transform global supply chains and trade interact with the real world. As a result, it is not enough for policies and regulations to lag innovation by years. Instead, regulators and policy makers must work hard to create regulatory frameworks that help to nurture innovation rather than assist in suffocating it. Correspondingly, venture capitalists and entrepreneurs must partner with community organizations, politicians, and regulators to help them keep up with advances in technology and innovation. 

One might ask: “Are there really enough opportunities for early-stage investments in supply chain?” Yet, once one understands what a supply chain is, a few minutes spent thinking about that question illuminates the misconception. 

The recent success of funds like Lux Capital – which announced that it raised a billion dollars distributed across two funds, and DCVC – which announced a $725 million fund, suggests that there are significant financial returns to be harvested by limited partners who have the foresight to invest in the small handful of venture funds that are now choosing to focus on funding early-stage startups solving the sorts of problems we have already described. 

The longevity of Supply Chain Ventures, established in 2001 by Dave Anderson, also suggests that this is a market that is ready for more early-stage venture capital, not less. This is assertion is based on how many advances in computational and information technologies have occurred since 2001, and how much easier it is now for such technologies to be implemented in physical supply chains. That observation is also based on the rising interest, relatively speaking, in issues surrounding supply chains within the general population.

Our conversations with corporate executives responsible for meeting demand from customers suggests that there is a growing appetite for new technology to enable companies to meet the expectations of an ever more impatient and demanding customer base. Also, our conversations with government officials point to a growing desire by public servants to seek new innovations geared at solving the problems that plague large and growing urban communities, and the suburban communities that surround them. 

What Can You Do?

There is a lot that one can do to participate in the coming transformation of supply chains;

  • Individual Consumers: As individual consumers we can all continue to become more active and engaged about understanding how our consumption affects the finite world around us. Social media and information technology makes it easy for attitudes and beliefs about consumption, production, sustainability, the environment, and climate change to spread. In Consumer attitudes towards sustainability and sustainable business: An exploratory study of New Zealand consumers., a 2015 master’s thesis by David Anthony Thompson at Lincoln University in New Zealand, he states; “From a purely pragmatic perspective, this study has indicated that consumers are generally likely to be supportive of not just purchasing sustainably produced goods and services, but that they feel positively towards companies that demonstrate sustainable social and environmental behaviour. This has implications for reputation building for organisations and in turn hints at benefits when it comes to securing supply contracts, recruiting staff and relationships with their physical communities. The study also suggests that understanding and knowledge play a – 56 – contributory role in forming these attitudes, therefore supporting the value in education and information strategies for sustainably run businesses.”
  • Sources of Private Capital: As we have already discussed previously, investing in early-stage innovations in supply chain transformation is an opportunity that remains largely under-resourced in terms of risk-seeking capital relative to the size of the opportunity. It is an area that is ripe for increased allocations of capital within the private equity asset allocation targets of family offices, endowments, foundations, and pension funds.
  • Governments: During #SCIT2019, The Worldwide Supply Chain Federation’s inaugural global summit on supply chain, innovation, and technology held in NYC on June 19 – 20, 2019, Samuel Chan, Regional Vice President, Americas, at the Singapore Economic Development Board provided attendees with a sense of how the Government of Singapore is thinking about the role that supply chain, innovation, and technology can play in Singapore’s economic development. Supply chain occupies a central position in Smart Nation Singapore, and specifically in its Smart Logistics initiative. As we have stated previously; It is not a coincidence that countries ranked highest on the Worldbank’s Logistics Performance Index tend to have the most developed economies, while those ranked lowest tend to have the least developed economies. Increasingly, the countries and regions of the world that will continue to experience the strongest economic growth will be those that are quickest to embrace and deploy the still nascent and emerging engineered systems that reflect a tight integration of computation and physical supply chains, in every area of economic activity.

If by now, the reader is beginning to conclude that the future of supply chains will be driven largely by supply chain enthusiasts, we agree.

We Will All Be Supply Chain Enthusiasts

So who is today’s supply chain enthusiast? A supply chain enthusiast is;

  • Someone who recognizes that the world is a mechanism for providing humanity with the resources it needs to survive. 
  • Someone who recognizes that each of us has a responsibility for ensuring that this supply chain that we are part of is managed in a way that ensures that humans continue to thrive. 
  • Someone who understands that collectively, we must summon the political will to begin the effort of arresting, and then reversing, the harm that we have caused to the environment. 

We will all become supply chain enthusiasts, not because it is the fashionable thing to do, but because with every year that passes it will become an issue of increasing and critical necessity. As more people become aware of, and start to understand that how we produce, store, transport, and consume things has a profound impact on our environment, enthusiasm about supply chain, innovation, and technology will become more socially and culturally mainstream. 

At that point, “The world is a supply chain.” will become a rallying cry everyone innately understands.

Note: “The world is a supply chain.” is a trademark owned by The New York Supply  Chain Meetup.

About The Authors: Brian Laung Aoaeh (@brianlaungaoaeh) and Lisa Morales-Hellebo (@lisahellebo) are co-founders of REFASHIOND Ventures, an early-stage venture capital fund that is being built to invest in startups creating innovations to refashion global supply chain networks. They are also co-founders of The Worldwide Supply Chain Federation, a growing network of grassroots-driven communities focused on supply chain, innovation, and technology.

#MarketVoices | Introducing My Weekly Column at FreightWaves

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Brian + His Pencils

According to the International Monetary Fund, the world’s economy is worth $88 Trillion as of 2019. The Conference Board estimates that the global economy will grow at an annual rate of about 3% between 2019 and 2023, and at about 2.8% between 2024 and 2028. None of this is possible without supply chains; The networks of interdependent organizations that cooperate and collaborate with one another to move goods and information between producers and consumers. In the past this mission-critical activity was relegated to the unsexy confines of the business world – back office operations. That attitude is changing and it is changing fast.

The changes taking place in attitudes about supply chains are due to a combination of factors;

  1. Changes in consumption patterns driven by economic growth in China, India, Brazil, Russia and other markets outside North America and Western Europe.
  2. Changes in the buying behavior and consumption patterns of individuals and businesses around the world, accompanied by increasing awareness about how the production and consumption patterns of the past may be affecting climate change and the future of our planet.
  3. The inexorable forward march of technology, as it evolves to solve the problems that have arisen due to the preceding two factors; Connected devices, artificial intelligence, autonomous vehicles, predictive data and analytics, 3D printing, blockchain, advanced manufacturing, and advanced materials. These technologies, and others, have finally matured to the point where they are being tested in the world’s supply chains – to solve problems that could not be solved in the past, to eke out efficiencies, and in some cases to completely overturn how things have been done in the past.
  4. The politics of tradewars, tariffs, and geo-political groupings and alliances brings the interconnected, interdependent, and fragile nature of today’s global supply chains into stark relief for even the most uninformed citizen.

These concerns are not some theoretical or imaginary distraction; Supply chain is the basis on which corporations win or lose competitive advantage. In the space of a few decades Amazon has become one of the world’s most valuable companies at the expense of Walmart, Toys R US, Barnes & Noble, and other retailers, largely on its superior supply chain management,  and its expertise in technology. In its heyday, the same was said about Walmart. There are many more examples

Well functioning supply chains are also positively correlated with economic development: Regions of the world with well developed infrastructure and supply chains tend to experience superior economic growth in comparison to parts of the world with poorly functioning infrastructure and supply chains.

My column will study, analyze, and highlight the innovations that are being brought to market to solve problems in supply chain management, supply chain logistics, and supply chain finance, with a particular focus on how they are inextricably interdependent on one another. I will examine this topic across industries, and across regions of the world. Where possible we will look to data to help inform the discussion. Often we will highlight the specific individuals and organizations doing interesting work tying supply chain, innovation, and technology together in ways that create value for businesses, for individuals, for countries, and for the world; A 1% efficiency improvement in global supply chains represents aggregate value-creation of roughly $880 Billion.


The column will appear on FreightWaves once a week. If you have ideas you want to see me cover in future articles, send them to me via Twitter @brianlaungaoaeh or via LinkedIn. I believe that the best ideas come from the most unexpected places, so I want to hear from FreightWaves’ readers and anyone else who is obsessively enthusiastic about supply chains, innovation, and technology.

Updates – Industry Study: Freight Trucking (#Startups)

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Brick by brick . . . Solve it one step at a time.

Note: John Azubuike (@jnazubuike) and I are currently conducting research on software startups in the ocean freight shipping market. We expect to publish that towards the end of January 2017.

Our blog post about freight trucking startups opened the door to numerous conversations that we may never have had, with people who know more about the freight trucking market than we do. This update is my attempt to augment our original article with some of what we learned from those conversations. If it comes across as somewhat unpolished, that’s because I decided arbitrarily that I should not let 2016 end without this update being published.

So without further ado . . .

  1. The barriers to success for startups pursuing the “Uber for freight-trucking” business model is even more fraught with danger than we were able to convey in our article. It is even more clear to us that brokers do a lot more than field a couple of phone calls, and that assuming it will be easy to cut them completely out of the picture is probably a dangerous assumption. We heard numerous anecdotes about the difficulties freight trucking services marketplace startups are facing . . . Yes, that including some that have been lionized by the tech press. Presumably, many are running on borrowed time.
  2. Compliance is as acute a problem as we have imagined. In fact, Walmart Transportation was hit with a $55 million settlement only 5 days after we published our article. Many settlements and fines do not attract the attention of the news media. If Walmart is stumbling, imagine how tough it must be for less sophisticated trucking companies to stay abreast of the complex state and Federal regulations. Compliance software that is easy to deploy, and easy for fleet managers and truck drivers to use is a necessity. A number of new entrants into the market are taking that path. Notable among them; San Diego, CA-based Platform Science whose co-founders previously ran OmniTracs, the fleet management software division of Qualcomm that was sold to Vista Equity partners for $800 million . . . in cash.
  3. Ty Findley, a member of the GE Ventures team covering Advanced Manufacturing, Logistics, and Supply Chain pointed us to the 2015 patent lawsuit between Fourkites and Macropoint, two developers of Fleet Management Software that enables fleet operators to track and trace the activities of individual trucks. In this lawsuit Macropoint accused Fourkites of violating patents held by Macropoint. The court ruled in favor of Fourkites; dismissing the Macropoint patents as invalid under the United States Supreme Court’s Alice Corp. vs. CLS Bank Int’l ruling of 2014. It will be interesting to see what forms of intellectual property prove most valuable in this market. If you have an interest you can read my work on Economic Moats in order to understand how we think about these issues.
  4. Based on her years of experience with technology innovation in the freight trucking market Debra T. Johnson of Eco-Edge discusses what she calls the “invisible barriers to innovation” that impede the success of startups in this market. She groups them under; Product, Customer, and Sales. Overcoming all of these invisible barriers to innovation requires founding teams that have; strong technical experience in order to build a product that works for this market, AND sufficient industry experience in order to build trust, and win credibility with potential customers.
  5. Stefan Seltz-Axmacher of Starsky Robotics sent me the following comments by email – modified, and paraphrased for clarity. Starsky is a Y Combinator startup.
    • The huge inconsistencies in data about the industry are really frustrating. It would help to know what the most authoritative sources of industry data are.
      • I agree. We generally relied on data from industry associations, and then we extrapolated to fill in the gaps we wanted estimations for. Our estimations could be wrong. We relied mainly on: OODIA Foundation, and American Trucking Association. Data from the Bureau of Transportation Statistics is more difficult to parse if one is in a hurry. We did not have access to proprietary sources of data on the industry, but some times I wonder if they are any more accurate than data that is available from public sources.
    • The market map was a bit odd in terms of how you classified some of the startups, some of the startups may have been misclassified.
      • I agree. We expected this to be the case, since the way an investor thinks about a market is often not entirely congruent with how others see it. Our market map was only an approximation about how we think of the market – for example, we would group “truck automation” together with “automated cars” . . . Since the way we see it the key outcome is “automated land transportation” which can then be applied to trucks and cars – by the same startup/company, with adequate modifications to account for the structural differences between a truck and a car. Think smart-phones versus tablet computers; iPhone versus iPad. Or, think laptop computers versus tablet computers; MacBook Air versus iPad. That being said, we’ll take another look at the market map when we feel it makes sense to give it a major update. There are many startups we did not know about when we put it together.
  6. Craig Fuller, CEO/Managing Director of TransVix stopped by our office to tell us about what they are doing to solve the dynamic assignment problem using the contract theory approach by building a derivatives market for trucking, rail, and containers. If you believe their estimates, this could be a $1.4 trillion opportunity in the United States, and possibly an $8.0 trillion opportunity globally. Yes, you read that right. Trillion, with a “capital tee”. Craig shed further light on some aspects of the trucking industry that we did not fully understand. He also laughed at me when I told him I had developed a headache as we were trying to unravel some of the mysteries of the maritime freight shipping market. He gave us some good ideas for paths along which we might conduct some research.
  7. We also heard directly from startups based outside the United States that are building software for domestic freight trucking markets in; Israel, Brazil, Germany, India. We heard anecdotes about startups in the Middle East and Eastern Europe.
  8. These news reports caught our attention in the days and weeks after we published;
  9. Daniel Burrows, founder and ceo of XStream Trucking, a seed-stage tech startup – thinks about the problems in the freight trucking problem from the fuel efficiency side of the profitability equation. Fuel costs account for as much as a third of the operating expenses of a truck fleet. The team at XStream reports that its technology can generate fuel savings of between 2.5% and 8%. You can see the potential for those savings to add up to something significant for the industry when you consider that, according to the American Trucking Associations; ((Source: http://www.trucking.org/News_and_Information_Reports_Energy.aspx. Accessed on Jan. 03, 2017.))
    • Trucks consumed 52.3 billion gallons of fuel for business purposes in 2011; 37.2 billion of that in diesel fuel and 14.8 billion in gasoline,
    • The industry spent $143.4 billion buying diesel fuel in 2011

This seems to be a market that will remain active for sometime to come, and we are eager to see what new developments occur as time progresses.

We’re studying startups building technology for the ocean freight shipping market. We expect to have made enough progress to publish it in a few weeks. Stay tuned. Better yet . . . Send us ideas; @brianlaungaoaeh and/or @jnazubuike.

Update: January 3, 2017 at 17:30 to include insights from Daniel Burrows at XStream Trucking.

Industry Study: Freight Trucking (#Startups)

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Co-author: John Azubuike (@jnazubuike), KEC Ventures.

Note: This article does not necessarily reflect the opinion of KEC Ventures, or of other members of the KEC Ventures team.

Note: Updated on October 2, 2019 to remove charts from Statista because the data has been moved behind Statista’s paywall and no longer adds any value. I’ll look for relevant data when I have time. (Brian)

Introduction

In 2015, the United States freight trucking industry collected gross revenues of $726.4 billion. That accounted for approximately 82% of the total for freight carriers. The freight trucking market is so large because trucks play a critical role in moving merchandise of all kinds between points of production and points of consumption. They also move merchandise between different types of freight carriers – rail, maritime, air.

This post synthesizes what we have learned about the industry since Brian started becoming interested in startups trying to solve problems for the United States trucking market in the summer of 2014, and since John joined KEC Ventures a year later.

In the rest of this discussion, we will refer to “startups” as distinct from “companies”. To ensure we are on the same page;

  • A startup is a temporary organization built to search for the solution to a problem, and in the process to find a repeatable, scalable and profitable business model that is designed for incredibly fast growth. The defining characteristic of a startup is that of experimentation – in order to have a chance of survival every startup has to be good at performing the experiments that are necessary for the discovery of a successful business model.
  • A company is what a startup becomes once it has successfully navigated the discovery phase of its lifecycle. This is the phase during which relatively fixed organizational structures start being built in order to facilitate the firm’s work on behalf of its customers, employees, shareholders, business partners, and society.

KEC Ventures invests in early stage startups. Therefore our primary purpose in studying the freight trucking market is to gain adequate context for the instances when we might assess startups trying to solve problems in this market. We have not yet made an investment in any of the startups in this market.

In the rest of this post we;

  • Describe the freight trucking market,
  • Discuss its market structure,
  • Describe the economics of operating within the market,
  • Describe and discuss the opportunities that startups are pursuing, and finally we
  • Discuss some threats such startups might encounter.

Writing this post is primarily an exercise in documenting what we know in order to identify gaps in our knowledge so that we can fill in those gaps. So if we have missed anything please let us know. If you are building a seed stage startup in this market we would love to hear from you. If there are companies we have not heard of yet, we would love to know that too. You can leave a comment in the comments section below, or you can email us directly;

  • Brian – brian@kecventures.com, or
  • John – johna@kecventures.com.

What Is Freight Trucking?

Freight trucking comprises the handling and transportation of goods of all kinds – providing an important link between producers and consumers. There is an industry adage: “If you bought it, a truck brought it.”

The market can be segmented as follows;

For-Hire: This segment of the market is made up of companies that provide freight trucking services to other companies for compensation. Participants in the for-hire trucking market are subject to state and federal regulation in the United States.

In-house: In-house freight trucking keeps freight trucking within the confines of a company’s business model rather than outsourcing that activity to a for-hire trucking company.

Truckload (TL): This form of freight trucking involves the movement of merchandise that fills an entire truck container.

Less-Than-Truckload (LTL): This form of freight trucking involves the movement of merchandise is too small to fill an entire truck. This means that a number of shipments for different customers can be combined to fill a truck, and the cost of transporting the merchandise is apportioned among the different customers. LTL can be further categorized into parcel carriers and dry van shipping. Parcel carriers carry merchandise made up of units weighing 150 lbs or less. Dry van freight involves shipping merchandise in a standard trailer that is adequate for shipping many different types of good and merchandise.

General: This form of freight trucking involves the movement of any merchandise that does not require specialized equipment.

Specialized: This form of freight trucking requires specialized equipment to move merchandise. Some examples; flatbed trucks, tankers, refrigerated trucks, and hazmat trucks.

Local: This form of freight trucking restricts activity to within a metropolitan area. Local trucking services are characterized by same-day trips, or by trips serving a region within a 150-mile radius of the freight trucker’s operating base.

Long-Distance: This form of freight trucking provides freight services between multiple metropolitan areas, and often crossing several states. Long-distance truckers generally serve regions that are beyond a 250-mile radius of the freight trucker’s operating base.

Intermodal: This involves equipment that can shift between different modes of freight transportation without the need to directly handle the merchandise that is being transported. In this case, merchandise is containerised to make it easy to move from ship to rail to truck for example. Intermodal freight trucking interacts with container ships, railways, cargo aircraft, pipelines, and barges. Intermodal freight trucking is critical in the formation of land bridges.

How Is The Trucking Industry Structured?

According to the American Trucking Association’s Trucking Trends 2015 the United States’s trucking market is characterized by the following statistics:

  • In 2015, trucks moved 10.49 billion tons, or 70.1%, of all domestic freight.
  • Freight trucking collected $726.4 billion in revenues, accounting for 81.5% of all freight transportation spending in 2015.
  • There were 3.63 million Class 8 trucks in operation in 2015. ((Class 8 trucks belong to the highest Gross Vehicle Weight Rating (GVWR) assigned by the US Department of Transportation (US DOT).))
  • The industry employs more than 3 million truck drivers.

Approximately 80% of all trucks in the trucking market belong to fleets with 50 trucks or fewer, 97% belong to fleets of 20 trucks or less, and 90% of the market is represented by fleets with 6 trucks or less. Estimates suggest that there may be as many as 1,200,000 companies in the US trucking market. The largest 50 companies account for 40% of total industry revenues. Owner-operators represent about 10% of drivers in the trucking industry. ((Owner-operators own and operate their own trucking business. Most own 1 truck and 1 trailer.))

About 50% of the freight trucking market operates in the for-hire segment. We assume that the vast majority of owner-operators exist in the for-hire segment. Roughly 15% of the for-hire freight market is LTL, while the remaining 85% is TL.

Brokers serve as a liaison between shippers and carriers by matching the unique needs of the shipper with a registered freight trucking carrier capable of fulfilling the shipper’s needs within established and agreed constraints. By some estimates, truck freight brokers earn as much as $50 billion or more in revenues each year.

What Are The Economics Of The Trucking Industry?

Freight trucking is a challenging business that is characterized by net margins of 7% or less, with most carriers earning margins of about 5%. The main operating expenses that carriers have to contend with are; ((2014 estimates, developed from American Transportation Research Institute’s An Analysis of the Operational Costs of Trucking: 2015 Update.))

  • Fuel Costs: 34.2%
  • Truck/Trailer Payments: 12.6%
  • Repair & Maintenance: 9.3%
  • Truck Insurance Premiums: 4.2%
  • Permits & Licenses: 1.1%
  • Tires: 2.6%
  • Tolls: 1.3%
  • Driver Wages: 27.1%
  • Driver Benefits: 7.6%

Other cost-drivers in the trucking industry include;

  • Driver shortages and workforce retention issues,
  • Federal and state transportation regulations,
  • Environmental regulations, and
  • Technology for fleet management.

What Opportunities Are Startups Pursuing?

Startups are pursuing opportunities in the freight trucking industry for a number of reasons;

  • First, it is a huge market.
  • Second, industry outsiders perceive it to be highly inefficient and hence, ripe for “disruption”.
  • Third, from a technologist’s perspective, there’s a lot of room to apply technology to fleet management and operations, freight brokerage, and compliance.
  • Fourth, it is highly fragmented – making it an attractive candidate for the types of software platforms that have already transformed the way business is done in other markets.

Before we discuss the opportunities that startups are pursuing, it may help to get a sense of the investment landscape in which such startups are competing for capital.

Based on the data from CBInsights in the 2 charts that follow, we see that there has been a significant increase in the aggregate amount of capital investors have deployed into startups in the freight trucking market each year since 2009. We also see that this trend is reflected in the average and median deal size, respectively. The data is as of mid-November 2016.

Funding to trucking startups has steadily increased YoY since '09 and is up more than 27% since 2015
Funding to trucking startups has steadily increased YoY since ’09 and is up more than 27% since 2015.

Average and Median deal size are both up significantly this year as well.
Average and Median deal size are both up significantly this year as well.

To put the data from CB Insights in context, a quick search on AngelList yields 149 startups described as “trucking startups” with 522 investors. A cursory inspection of that list suggests that most are based in the United States, with a few in other parts of the world such as the United Kingdon, India, Canada, the Middle East, Bulgaria, Germany, and Brazil – the opportunity is global.

Some of the more notable investors in freight trucking startups include; the United States Energy Department’s Advanced Research Projects Agency – Energy (ARPA-E), SandHill Angels, Band of Angels, Nokia Growth Partners, Intel Capital, UPS Strategic Enterprise Fund, Volvo Group Venture Capital, Institutional Venture Partners, Pritzker Group Venture Capital, Kleiner Perkins Caufield & Byers, GM Ventures, Capital One Financial, Wells Fargo & Company, Google Ventures, Index Ventures, Sequoia Capital, Harrison Metal, Accel Partners, DFJ Growth Fund, Draper Fisher Jurvetson, Andreessen Horowitz, Bessemer Venture Partners, FirstMark Capital, Fidelity Investments, SV Angel, Goldman Sachs, Lowercase Capital Benchmark, First Round Capital, Industry Ventures, Wellington Management, Founder Collective, BlackRock . . . etcetera etcetera – investors believe that big companies will emerge from the startups in this market.

Broadly, the following categorizations can be used to discuss the areas in which startups are most active. ((Startups listed are obtained from CBInsights, as of Nov 15, 2016. The authors developed the categories into which the startups are grouped. With only a few exceptions, each startup is listed under the category the authors believe represents the majority of each startup’s business activity based on publicly available information.))

  • On-demand Commercial Trucking Services: These startups match shippers directly with carriers by cutting out the freight brokers who act as middlemen in the industry. Brokers can command fees as high as 40%, or more, of each transaction. Also, the process by which a broker connects a shipper with a carrier is manual and time-consuming. On-demand trucking startups build apps that promise to remove the inefficiencies that arise from dealing with a broker. Typically such startups say they are “disrupting” the truck freight brokerage market. Some of the startups in this category are; Convoy, Cargomatic, Cargo Chief, Deliv, Keychain Logistics, Kanga, Optimal Dynamics, RenRen Kuaidi, Roadie, Schlep, and Transfix. ((On-demand trucking apps and electronic load boards fulfill the same function, though people think of them as different. Electronic load boards aggregate carrier capacity listings, as well as shipper loads, in one web-portal that freight trucking market participants can access.))
  • Freight Tracking & Fleet Management: These startups provide telematics solutions that enable truck fleet operators to track the location of vehicles in their fleet in order to increase the overall efficiency of their operations. Some of the startups/companies in this category are; Fleetmatics, Telogis, Teletrac, Cloudmade, Drivefactor, Peloton Technology, OmniTracs, OnFleet, Convey, Supply Chain Integrity, Traansmission. The product that truckers pay for is often a bundle of hardware and software, with a monthly subscription for the software.
  • Compliance & Safety: These startups provide hardware and software products that enable freight truck operators comply with state and federal regulations in the United States. The benefit to fleet operators is that these products minimize the number of times a fleet is found non-compliant. They do this through; Compliance related safety reporting and monitoring at the individual driver level, compliance related safety reporting and monitoring at the fleet-wide level, and efficient reporting and monitoring through the reduction of paper and pencil record-keeping, and the creation of electronic audit trails for safety and compliance. Non-compliance can result in the grounding of an entire fleet while the operator tries to fix the problem identified by regulators. Some of the startups in this category are; Big Road, Keep Truckin, Trucker Path, GreenRoad Technology, SmartDrive Systems. The product that truckers pay for is often a bundle of hardware and software, with a monthly subscription for the software.
  • Delivery Platforms & Last-Mile Parcel Delivery: These startups build platforms for large enterprises and for small-and-medium sized businesses to enable them to offer shipping price comparisons, on-demand pick-up and delivery, and other services related to shipping merchandise and products to end-use customers.  Some of the startups in this category are Darkstore, Dispatch, Kanga, Doorman, Rickshaw, Bringg, Narvar, Shyp.
  • Autonomous Vehicle Platforms (Trucks): These startups develop and build automation technologies and platforms for the trucking industry with the goal of lowering costs, improving safety, and generally increasing efficiency and productivity in the freight trucking industry. Typically, a software-focused startup partners with an established truck manufacturer to build and test a self-driving system. The Chinese government is encouraging this nascent market as a means of tackling some of the problems that confront its freight trucking industry, where, for example, driver-related costs account for about 40% of operating expenses. According to CB Insights, the following startups fall in this category; Mobileye, Otto – which was acquired by Uber, Peloton Technology, Drive.ai, Quanergy Systems.

First Analysis Securities Corporation estimates that: ((Howard Smith and David Gearhart, Internet of Things/Machine-to-Machine: Fleet Management Solutions. January 2014.))

  1. Fleet management software generates about $5.5 billion of revenue globally, with growth estimated at 21% compounded annually between now and 2023, bringing the market size to $37 billion in 2023.
  2. Fleet management software in the United States generates about $1.6 billion of revenue, with growth estimated at 19% compounded annually till 2023, growing to $8.6 billion.
  3. They estimate a theoretical global market size of $92 billion and $11 billion for the global and US markets respectively, suggesting 6% and 14% penetration in those markets respectively.

Freight Trucking Software Startups

Threats

To a naive observer, the opportunities in the freight trucking market appear ripe for the taking of early stage startup companies intent on “disrupting” it. Moreover, it would also appear that incumbent players in that market are slow, lumbering, and clumsy organizations incapable of keeping up with the threat that startups pose. While some of that is true, there exist a number of threats that might take some early-stage startups and their investors by surprise. Below, a broad outline of those threats that we pay the most attention to when we encounter such startups.

Nice-to-Have or Necessity?

As a result of the thin margins earned by freight truck operators, products targeted for sale to owners of truck fleets must be seen as necessary for ongoing operations as a result of regulatory changes, or as a demonstrable catalyst for increased profitability. In the latter case, the startup that seeks to sell the product must be in a position to quickly provide a return-on-investment to a fleet operator after the decision has been made to adopt the new product. Closely related to this is the issue of ease of use;  Can individual truck drivers or fleet managers learn how to use the product quickly, with little or no training? In markets that have frontline workforce characteristics similar to that of the freight trucking market, psychological lock-in to incumbent products is extremely strong. As a result, attention to UI and UX design is an important determinant of success or failure.

As an example; The Federal Motor Carrier Safety Administration (FMCSA) enacted a regulatory change in December 2015 that mandates and requires automatic electronic logging devices on all commercial vehicles. All trucks have to become compliant within 24 months of the adoption of the new rule. Industry estimates are that 125,000 – 150,000 trucks need to be brought into compliance every month during that 24-month grace period. Once the grace period ends, noncompliance will incur fines and other penalties that could go as far as the grounding of entire fleets for each incidence of noncompliance that inspectors discover.

Trustworthy or Trustless?

The insistence by early stage startups that they will “disrupt” the freight brokerage market overlooks the most important function brokers play; They are arbiters of trust between shippers and truck operators. By using a broker, the shipper outsources the headache of vetting the freight truck operator to whom the shipper’s merchandise will be entrusted while it travels between locations. Furthermore, brokers and shippers have completely aligned interests since both groups stand to suffer adverse consequences if misbehaving truck operators are allowed to remain in business without the implied threat that they stand to lose a significant amount of business. It is not clear if shippers feel that their interests are aligned in the same way, or as strongly, with the interests of truck operators.

Startups pursuing a business model predicated on eliminating freight brokers need to have thought about how they will solve this problem, or if they will solve it at all.

Truckers have a love-hate relationship with brokers. But what I learned is—brokers aren’t going anywhere anytime soon because brokers own and manage the relationship with shippers. And a point that cannot be overstated—shippers, too, have complete faith in and reliance upon their brokers.

–  Jason Cahill, Why The WSJ’s “Reinventing the Trucking Industry” story got it wrong. Jason is the founder of Traansmission, a Brooklyn, NY-based startup in the freight trucking market.

By some estimates the freight brokerage market is worth more than $50 billion in annual revenues. Given the popular perception that brokers are an unnecessary part of the industry, we expect that several startups will continue trying to eliminate brokers altogether.

Will The Startup Solve The Dynamic Assignment Problem?

The dynamic assignment problem arises when customer demands for a service arrive continuously and randomly over a period of time, requiring a dispatcher to assign and send a service agent to satisfy each demand request. The number of service agents is limited relative to the potential number of random customer demands. The fulfillment of each task imposes a cost on the dispatcher, and extreme surpluses or shortages of tasks or service agents impose system-wide costs that can result in system-wide failures.

The dynamic assignment problem is a resource allocation problem. More specifically, it is a problem of allocating resources in an optimal manner, given uncertain conditions.

It should not be difficult to see why this problem arises in the freight trucking market. On one hand, shippers randomly demand freight services, to move merchandise between locations. On the other hand, freight carriers must satisfy that demand in a manner that maintains trust and meets shippers’ expectations.

The Stochastic Optimization Approach

Professor Warren Powell of the Computational Stochastic Optimization and Learning (CASTLE) Labs at Princeton University has studied the problem of optimization under uncertainty extensively. Specifically, the Transportation and Logistics Laboratory at CASTLE Labs has been working on trying to solve this problem for those markets since 1981. Their work spans stochastic fleet management in trucking, rail and air, real-time dispatching, routing and scheduling, and spare parts management, among others.

In his paper; A Stochastic Formulation of the Dynamic Assignment Problem, with an Application to Truckload Motor Carriers, he delineates the dynamic assignment problem in freight trucking into a supply management problem and a demand management problem.

The supply management problem is a capacity management problem related to serving the customer – in this case, the shipper. To solve this problem, fleet operators must;

  • Assign different drivers to handle different shipping requests,
  • Reposition idle drivers and trucks from one region to another in anticipation of future shipping requests,
  • Determine how a load of merchandise should be handled once it has been picked up by a driver – move the load directly to its destination, hold it temporarily till a new driver can be assigned to move it to its final destination, or move it to its final destination using a relay network of drivers.
  • Manage the flow and inventory of trailers that will be needed to move freight.

It should be obvious that driver management is an important dimension of the capacity management problem. This observation is further supported by the fact that driver-related costs account for 34.7% of the operating costs of a truck. Solving the driver management requires giving consideration to;

  • Driver work rules,
  • Driver pay,
  • Returning drivers home,
  • Driver skills, and
  • Driver quality.

The demand management problem arises because the shipper calls the carrier, or vice versa. Prof. Powell divides shippers into 3 broad categories;

  • Primary shippers – the carrier has an obligation to move any merchandise that the shipper needs moved,
  • Secondary shippers – the truck operator is obligated to move merchandise for that shipper only in certain traffic lanes, e.g. only southeast freight, and
  • Tertiary shippers – the carrier may accept or reject a request to move the shippers merchandise.

To solve the demand management problem, carriers must solve for 2 aspects of the fleet management problem;

  • Load acceptance or rejection, based on real-time capacity constraints or fleet-balance considerations, and
  • Load solicitation, to correct short-term surplus capacity in certain regions that the carrier serves.

Solving the fleet management problem requires that carriers have a means of quickly;

  • Assessing the profitability of loads tendered by secondary and tertiary shippers – “spot” loads as they are known in the industry,
  • Anticipate areas of surplus or shortage within the carriers’ fleet of trucks, and
  • Make trade-offs between current and future demand, especially if future demand may come from a primary shipper.

Given the low-margin nature of this business, it is not difficult to see why these considerations matter. The difference between a year that ends in the black and one that ends in the red may amount to relatively no more than a few loads of merchandise. ((This is a reality I encountered in the general aviation industry, between 2008 and 2012.)) A product that solves the profitability problem and the optimization problem has superior chances of surviving the vagaries of this industry. This suggests that a startup that incorporates stochastic optimization into its freight trucking platform has a better chance of success over the long term than its counterparts that do not.

You can read more about the work being done at CASTLE Labs on this application of stochastic optimization in the papers listed below;

The Contract Theory Approach – Real Options

Professor Warren Powell’s approach is one way to solve the dynamic assignment problem. Another approach is proposed by Mei-Ting Tsai, Jean-Daniel Saphores, and Amelia Regan in Freight Transportation Under Uncertainty. This approach applies concepts from financial derivatives markets and real options theory to craft Truckload Options. A truckload option is an option to buy or sell freight services on a specific route, at a predetermined price, on a specific date. ((A derivative contract is a contract whose value is based on the value of an underlying asset.))

A truckload call option gives its holder the right to buy freight services on a specific route, at a predetermined price, on a predetermined date. The decision to exercise the call option will be made by the holder based on information available leading up to the exercise date. A shipper will exercise the option to buy freight services if the strike price of the truckload call is less than the spot price, otherwise, the truckload call is allowed to expire. The total cost to the shipper is the option premium plus the cost of shipping.

A truckload put option gives its holder the right to sell freight services on a specific route, at a predetermined price, on a predetermined date. The decision to exercise the put option will be made by the holder based on information available leading up to the exercise date. In this case, a freight carrier will exercise the option to sell freight services only if the strike price of the truckload put is greater than the spot price, otherwise, the put will be allowed to expire.  While put options are possible in theory, in practice they are unlikely to be widely used.

Generally, options are less beneficial when uncertainty is low, and this is also true for truckload options when system-wide demand uncertainty is low. However, Mei-Ting et al argue that the system-wide benefit of truckload options is positive. This suggests that there may be some competitive advantage to be derived from implementing a truckload option pricing mechanism as part of an on-demand trucking services marketplace.

A Rake Too Far?

The argument may be made that expecting a startup that operates an on-demand freight services marketplace to solve the dynamic assignment problem is asking too much. After all, such marketplaces mainly target owner operators.

Based on our back-of-the-envelope calculations, owner-operators probably represent 5% of the overall freight trucking market. Given the economics of operating a truck, it seems to make sense for startups to think about how a product might eventually migrate beyond that initial customer base in order to include operators of small, medium, large fleets, and possibly freight brokers too. In other words, the minimum viable product does not need to solve the dynamic assignment problem. But, if the startup is to survive and become the big, dominant company in its market, it ultimately needs to solve the dynamic assignment problem. Doing that will eliminate, or minimize, the probability of deadheading which is a source of much of the friction in the spot market. ((Deadheading occurs when a truck is operated while it is empty. Such a trip is described as a dead leg.))

Will Freight Services Marketplaces Offer Freight Factoring Services, Directly Or Through A Partner?

Given the economics and structure of the freight trucking market, it is not difficult to understand why owner-operators and some fleet operators will find services that enable them to sell their accounts receivables assets in order to meet cash needs as part of a multi-sided marketplace highly desirable. In a typical accounts receivable financing transaction the receivables are sold at a discount in exchange for certain cash. Alternatively, the accounts receivables can be used as collateral for a short-term loan. ((Technically, accounts receivables factoring is the outright sale of the asset. Invoice discounting – assignment of accounts receivable, is using the asset as collateral for a short-term loan.))

Typical services would include; credit checks, credit risk management, freight insurance, accounts receivables collections and management, receivables financing . . . as described above.

According to Factors Chain International, in 2015 factoring revenues amounted to $104 billion. The domestic only portion of that market was 84%.

Everything being equal, a freight services marketplace that also offers these kinds of financing options should win over its counterparts that do not.

Cargomatic is forced to pivot from its "Uber for Truckers" business model.
Cargomatic is forced to pivot from its “Uber for Truckers” business model.

Wrapping Things Up

Estimates suggest that the global transportation services market is worth $12 trillion annually. In the United States, that market is believed to exceed $1.0  trillion each year. As we have already stated, freight trucking accounts for more than $700 billion of that total. Thanks to the friction, inefficiency, and opacity that characterizes the market startups will continue building products to solve problems that freight truckers and their customers face. Some of the business models that these startups implement will face more threats than others as they attempt to navigate the path from discovery, to becoming big and market-dominating companies. But, the opportunity exists, and it is big, and it is global . . . and holds tantalizing promise for the startup founders and venture capitalists who succeed in solving the puzzles it presents.

Writing this post was primarily an exercise in documenting what we know in order to identify gaps in our knowledge so that we can fill in those gaps. If we have missed anything you feel is important please let us know.

If you are building a seed stage startup in this market we would love to hear from you. If there are early-stage startups we have not heard about yet, we would love to know that too. If you invest in or have invested seed-stage startups pursuing any of the opportunities we have described above, or others in the freight trucking market, we’d love to collaborate with you on future investments.

You can leave a comment in the comments section below, or you can email us directly;

  • Brian – brian@kecventures.com, or
  • John – johna@kecventures.com.

Update: November 24, 2016 at 07:30 to include data from AngelList and representative sample of investors from CB Insights.

“Liking” Facebook’s Business Model – The #EconomicMoats Remix

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Facebook Employee Sign Hack: Pride 2015 (Image Credit: Facebook)
Facebook Employee Sign Hack: Pride 2015 (Image Credit: Facebook)

Note: I published “Liking” Facebook’s Business Model on December 26, 20011 at Tekedia. This article updates that discussion by incorporating developments since then. It also folds in discussion of the economic moats that Facebook has developed around its business. Large segments of this article are exactly identical to the post that was published by Tekedia in 2011.

Introduction

The primary purpose of this post was to demonstrate how one might apply the Business Model Canvas in trying to understand Facebook’s business model. Assuming we understand the business model, I then apply the Economic Moats framework to thinking about Facebook.

It is a fair critique to accuse me of playing “Monday-Morning Quarterback” since it is easy to pick on an extreme success like Facebook and use it as an example. However, from my perspective as an early stage venture capitalist who is basically teaching himself the trade that critique ignores at least one benefit of this kind of case study – mainly that it is useful for trying to recreate the path I might have followed in thinking about Facebook had I been introduced to Mark Zuckerberg in 2004 when he was raising his first outside capital from investors. Think of this as the self-taught early stage venture capitalists’ version of working in a science laboratory, trying to recreate the experiments and reproduce the results that have brought us the advances of the past. Such work is what lays the groundwork for original scientific discoveries in the future.

Also, I should point out that I do not have direct access to inside-information about Facebook’s early days. This case is constructed on the basis of information, reports, and data that are in the public domain.

Okay, with those disclaimers out of the way . . . On with our case study.

According to Michael Rappa; “In the most basic sense, a business model is the method of doing business by which a company can sustain itself – that is, generate revenue. The business model spells-out how a company makes money by specifying where it is positioned in the value chain.” Alex Osterwalder and Yves Pigneur say that; “A business model describes the rationale of how an organization creates, delivers and captures value.”

What problem does Facebook solve?

My son’s paternal grandparents live in Nigeria, as does his uncle – my younger brother. His aunt – my younger sister lives in Ghana. His grandfather has never met him, nor have his uncle and aunt. His grandmother paid him a visit for three months soon after he was born. He was only two months old when she visited.

I had been asking myself the question; “How can I ensure that his grandparents, his uncle, his aunt and other members of his extended family do not miss out on his childhood entirely?” My desire to answer that question in a comprehensive way helped me to overcome my objections to Facebook. I joined Facebook in November 2009.

Facebook enables its users to connect with one another through the company’s social networking online portal. Users connect socially with their “friends” in a “social-network” to share status updates, articles, videos, music, photographs and other content through Facebook.

Facebook’s users can interact with one another in a number of different ways:

  • Users can connect directly as “friends” – this allows the highest degree and freedom of interaction subject to privacy controls that each user can put in place to govern their activity on Facebook.
  • Users can connect to one another as subscribers/followers – this is a one-way connection. Subscribers will see and can comment on the public posts by the person to whom they have subscribed. This feature was a recent addition when I wrote the original post in 2011.
  • Users can interact with one another through Facebook Messenger, an instant messaging app that has evolved since the function was first introduced to Facebook’s users in 2008. 
  • Facebook acquired Instagram in 2012 Instagram built a social network for sharing photos.
  • Facebook acquired WhatsApp in 2014. WhatsApp is a mobile instant messaging app that is popular in developing markets.
  • Facebook acquired Oculus VR in 2014. Oculus VR is  a virtual reality technology startup. 

Founded in 2004, Facebook’s mission is to give people the power to share and make the world more open and connected. People use Facebook to stay connected with friends and family, to discover what’s going on in the world, and to share and express what matters to them.

– Source: Facebook, as of March 2016

The following list highlights some of Facebook’s features:

  • User profiles and homepages – users post status updates on their homepage or wall.
  • Messages, Chat and Social Hangouts (video chat).
  • Photos + Videos – users can tag one another in photos and videos.
  • Games + Apps – people can play games with one another, or share other information through specialized apps.
  • Groups and Pages – people can form a group or create a page for sharing information around an issue of interest.
  • Events – people can use Facebook to plan events and invite others to participate.
  • Credits – this is the virtual currency for transactions on Facebook.

Reports in the press suggest that Facebook has about 800 million active users around the world. An active user is a user who has returned to Facebook’s website within 30 days.

ComScore reports that 82% of the world’s 1.2 billion online population participates in some form of social networking. Social networking eats up 20% of the time people spend online. Facebook’s users account for 75 percent of the time spent on social networking websites. Facebook’s users also account for more than 14 percent of the time people spend online around the world.

December 2015 Update: 

Monthly Active Users: 1.59 billion monthly active users as of December 31, 2015

Daily Active Users: 1.04 billion daily active users on average for December 2015

Mobile Monthly Active Users: 1.44 billion mobile monthly active users as of December 31, 2015

Mobile Daily Active Users: 934 million mobile daily active users on average for December 2015

How Does Facebook Make Money?

Facebook does not charge its users a sign-up or monthly fee. So, how does Facebook make money if users like me get to use it for free? There are three sources of revenue for Facebook;

  • Advertising – Facebook can deliver targeted ads to its users based on information that they provide during sign-up or as they interact with their friends.
  • Games + Apps – Facebook is paid a 30 percent fee by companies that develop games and applications for its user base. This fee is applied to in-game or in-app sales.
  • Virtual Goods – Facebook earns a slice of revenue from the sale of virtual goods to its users.

Reports in the press speculated that Facebook’s 2011 revenue would be in the neighborhood of $4.5 Billion. Advertising should account for the majority of that amount, followed by revenue from games and apps. Virtual goods account for only a small portion of Facebook’s revenues.

March 2016 Update: Revenue for the full year 2015 was $17.93 billion, representing an increase of 44% over revenue for the full year 2014.

The Business Model Canvas – The Building Blocks of Facebook’s Business Model

Note: Business Model Generation was not published till July 2010, nearly 6 years after thefacebook.com launched. Still, using the business model canvas to analyze Facebook’s business Model is instructive.

Customer Segments

  • Mass market – any one that uses the internet and wants to connect and socialize with family, friends and other people that are online.
  • Advertisers – big, medium and small companies that wish to advertise to the hundreds of millions of people that spend time on social network websites. Reports estimate that people spend about 3 to 4 times as much time on Facebook as they spend on Google.
  • Developers – apps, social games, and virtual goods.

Value Proposition(s)

  • Enable users to connect and share with family, friends and other people with whom they share a common interest.

Channels

  • Website
  • Mobile App

Customer Relationships

  • Network effects – users will gravitate to the social network where most of their friends are already users.
  • Relatively high switching costs – users are less likely switch to a competitor after sharing a lot of content on Facebook.

Revenue Streams

  • Advertising – fees generated from online display banner ads delivered to users through Facebook.com. There are probably two or three different categories of advertising.
    • Not entirely clear if this will work, but the team has been pitching this to advertisers since it was two months old. Might need to verify this assumption with someone in the advertising industry.
  • Facebook Credits – 30 percent share of in-app and in-game transactions.
  • Virtual goods – straight virtual goods sales not connected to use of an app or a game by the user.

Key Resources

  • People – employees, and Facebook’s more than 800 million active users.
  • Technology – software, servers and other cloud-based services that Facebook must purchase from other companies to support its operations.
  • Brand – people have to trust in what Facebook represents.

Key Activities

  • Developing and improving the Facebook platform – both the frontend user experience and backend data processing capacity. The company was reported to have started working on proprietary server designs to support its operations – reports suggested the company might be worried about the speed at which conventional server designs allow it to serve content to its millions of daily users.

Key Partners

  • Third party developers – apps, games and other features to enable people connect and share with one another using Facebook’s platform.

Cost Structure

  • Employees – Facebook reportedly has between two and three thousand employees spread across offices in 15 countries. The company seems to be preparing for a burst of growth in the size of its workforce.
  • Technology – server maintenance, software latency and optimization issues; this will continue to be a concern as people generate and share more and more content using smartphones.

The company says that more than 50% of its more than 800 million active users log onto Facebook on any given day. Nielsen estimated in a report on social media that American internet users collectively spent more than 53 billion minutes on Facebook in May 2011. The average user has 130 Facebook friends. The company also says people interact with more than 900 million objects on the website and that the average user is connected to 80 community pages, groups and events. On the average day Facebook’s users upload 250 million photos. Facebook is available in 70 languages, and 300,000 users helped to translate the site by using Facebook’s translations app. On the average day, Facebook’s users install apps 20 million times. During the average month, half a billion people use an app on Facebook or experience the Facebook platform on other websites (e.g. to share this story from Tekedia with your friends on Facebook). In all more than 7 million apps and websites are integrated with the Facebook platform. There are 475 mobile operators globally working to promote and deploy Facebook’s mobile products through their mobile networks and on their mobile devices (for example Facebook’s Android, iOS and Blackberry apps). More than 350 million active users currently access Facebook through a mobile device.

Facebook was launched in February 2004. As the preceding paragraph clearly demonstrates, the over-arching elements of Facebook’s business model that we have discussed have led it to unbelievable success. This success has occurred in spite of the fact that Facebook was not the very first social networking company. MySpace launched in August 2003, and before that Friendster was founded in 2002. Classmates.com, SixDegrees.com and Makeoutclub.com preceded Friendster. One may argue that Facebook benefited from technological advancements that its predecessors could not exploit. One may also argue that Facebook launched at a time when millions of people had become accustomed to the concept of social networking. I suspect there’s a lot of truth in both of those arguments. However, I would also argue that Facebook did a better job of understanding the intricacies of its business model better than its predecessors, and then executing that business model more effectively than any of its predecessors. Put those three arguments together and one can see that Facebook’s phenomenal growth is not completely outside the realm of possibility.

Facebook Menlo Park HQ (Image Credit: Facebook)
Facebook Menlo Park HQ (Image Credit: Facebook)

Economic Moats Analysis

I am now going to pretend that I have travelled back in time, to September 2004. As fortune would have it I am a reasonably well-liked early stage VC who invests in startups raising their very first round of capital from institutional investors. Someone I know has introduced me to the founder of The Facebook; and describes it as “a web directory that the college-kids are going crazy about.” I agree to meet in two weeks, when some time opens up on my schedule. In the meantime I start doing some cursory reading about this “thing.”

The issues I am most concerned about are, in order of priority;

First, how do I know that thefacebook.com has proven that its value proposition will hold? Around that time reports in the press highlighted how addictive thefacebook.com had become to its users. Here are some examples:

Even those who don’t know why they love Thefacebook can’t stay away.

“It’s a stupid, stupid website, but I am completely addicted,” freshman Emily Bruckner said. “I just go around and look at all of my friends and see who they’re friends with. It’s like a contest to see who has the most friends.”

Source: Thefacebook.com Opens to Duke Students, Duke Chronicle; April 14, 2004.

Value Proposition – The bottomline: Users love thefacebook.com, and there is plenty room for growth. The are millions of college students around the world that thefacebook could target as users.

Second, do I have a sense of how the team intends to grow the business? Will the team’s ideas about growth work? Based on reports in the press, it appears thefacebook is growing rapidly, and so I have to assume the team has figured what it will take to grow within the market on which it has chosen to focus initially. There may yet be some work to do here, but so far so good. Each user is encouraged to invite some friends upon first signing up for thefacebook, and the website also suggests people that new users might know who are already on the site. Friendster is doing well within the general population, so there’s one example of how thefaceboook too might grow beyond college-campuses . . . when that makes sense.

Growth – The bottomline: The team seems to have figured out a method to accelerate growth on college campuses. That’s a good sign. There may be a few outstanding questions, but this is probably a good point at which to consider making a investment if growth can continue to accelerate.

Third, and finally . . . How does the team believe thefacebook.com will make money? This is a critical question since it speaks to thefacebook.com’s future prospects for becoming a self-sustaining entity. The team has been pitching itself as an online marketing service to advertisers . . . It will be interesting to see how advertisers react to this.

Revenue – The bottomline: Murky. Not clear if this will work. But Google is having success selling ads online through its Content Targeting Advertising. So not out of the realm of possibility. But no definitive answers at hand.

Economic moats help early stage technology startups preserve and enhance the advantages they enjoy over their competitors as time goes on their business model matures. There are five ways in which a startup can build an economic moat; Network Effects, Switching Costs, Efficient Scale or Cost Advantages, Intangibles, and Brand. Note, that I discuss “brand” under the heading of “Intangibles” but it stands alone as one of the 5 sources of an economic moat.

  • Brand: High. Becoming known as the platform for college students for intra- and inter- college social networking. Highly sought after by students at colleges where it is yet to launch a community.
  • Network Effects: High. Platform gets more useful for users as more of their friends sign-on to become users.
  • Efficient Scale or Cost Advantages: High. Users invite friends. Word-of-mouth seems to be spreading and helping keep costs of acquiring new users relatively low.
  • Switching Costs or Buyer Lock-in: Undetermined. Need more data. But should increase as people interact more and more on thefacebook.com. Described as addictive. Wonder how long that addictive quality will last. Need to get better understanding of user-perception of value.
  • Intangibles:
    • Intellectual Property: None necessary right now, but might be needed in the future to solve technical problems caused by growth. TBD.
    • Research and Development: Need to figure out revenue model. Also, what problems has Friendster run into that might be relevant for thefacebook.com? How is the team thinking about this?
    • Culture and Management: TBD. Young team, college students. Mark has prior experience building social-networking applications.

Conclusion: So, would I have invested? I do not know. There is more that goes into a decision like that one than the preceding analysis. However, at first blush there are no “smoking-gun” reasons not to take a closer look. To avoid saying no at this stage it would help to keep the following lessons in mind – they are adapted from Andrew Chen’s discussion about his decision to pass on making an early stage investment in Facebook when he had the opportunity to do so after he convinced himself that “Facebook would never be a billion dollar company.” Note: I wrote about this in April 2012 in a post that was published at Tekedia. The following discussion is adapted from that post.

  • Lack of experience and lack of knowledge are two distinctly different things. Do not confuse them with one another. Pass on making an investment because of a lack of knowledge, do not pass only because of a lack of experience.
  • Do not take solace in data and statistics without first verifying that such analyses are relevant within the given context. Data and statistics often inspire unjustified confidence, but calculations are useless if what you are calculating is wrong, irrelevant or simply inapplicable to the startup’s situation and future markets.
  • Do your own homework. Treat data and statistics from others with extreme skepticism. At the very least, try to interpret third party data based on your own analyses.
  • By definition, your past experience might be useless in understanding the most promising startups that you will encounter. Start from first-principles. Understand the fundamentals of what the startup is trying to do before you leap to conclusions grounded in your past experience. Don’t let your professional history and learned logic become a hindrance.
  • Business models matter, but execution matters more than the relative attractiveness or unattractiveness of the business model that exists at the time you encounter and early stage startup.
  • Heuristics are useful, but only up to a point. See the point on “past experience” above.
  • Keep an open mind, peel away the layers . . . Lack of conformity with the stereotypes you have become familiar with is an insufficient reason for passing on a startup.
  • Lastly, set all the analyses aside and spend some time thinking about what would happen if the team succeeds in accomplishing what it is setting out to do. If that happened, is that a story you’d want to be part of?

 

 

Connecting The Dots: Economic Moats & Early Stage Technology Startups

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I started writing about economic moats in September 2014. Since then I have written about Network Effects, Switching Costs, Intangibles, and Efficient Scale and Cost Advantages. The purpose of those posts was to outline how I think about economic moats while I am studying a seed stage startup and trying to determine how things might unfold in the future.

This is how I define an economic moat in relation to early stage startups:

An economic moat is a structural feature of a startup’s business model that protects it from competition in the present but enhances its competitive position in the future.

In this post I will wrap things up with some final observations;

First, in relation to economic moats, my responsibility as a seed stage investor is to identify startups that can build or acquire an economic moat as their business model matures and as the startup becomes a company. Directly tied to this, I have to make an assessment about the founders’ willingness to conceptualize and build such a moat if things go well. There’s no point worrying too much about a moat if the rest of the world is apathetic about what the startup is doing.

Second, An economic moat is not the same thing as a competitive advantage. A competitive advantage is temporary. This is because a competitive advantage is typically designed on the basis of Michael Porter’s Generic Competitive Strategies. A durable economic moat is unique, and typically can not be duplicated by others.

Third, to withstand the effects of sustained challenges from incumbent and new-entrant competitors startups need an economic moat that is derived from more than one source. In relation to Internet and other software technology business models, indirect network effects can prove to be as important as direct network effects.

Fourth, some of the strongest foundations on which a startup can build an economic moat are also some of the most difficult to come to grips with. Mainly, these are lumped together as “Intangibles” . . . Among the sub-items under intangibles Management & Culture, and Research and Development stand out to me as being things I should look out for at the seed stage because everything else emanates from those two.

An organization’s ability to learn, and translate that learning into action rapidly, is the ultimate competitive advantage.                                                      – Jack Welch

Fifth, cognitive costs are a real barrier to entry and till an early stage startup has established itself within a market, uncertainty works against it but in favor of the incumbents. This is especially true for startups building products for sale to other businesses. These aspects of buyer lock-in might be nearly impossible to articulate or measure, but that does not mean startups and their investors can afford to ignore them. At the outset a seed stage startup must find that niche of potential customers for whom the sum of cognitive costs and uncertainty is a minimum. It is worth thinking about this at the outset of product development.

Sixth, thinking about cost advantages has to go beyond the obvious advantages it confers on the startup in terms of its operations. The most important consideration is how a cost advantage enables the startup to create more value for its users or customers. A cost advantage that does not yield increased value for users and customers is not one that will last.

Lastly, as a startup scales it must pay attention to how that is affecting the macro environment in which it finds itself. A bad market can remain unfavorable far longer than any startup’s ability to scale its way to a profit. It is one thing for a startup to find product-market-fit, but quite another for that startup to scale efficiently in that market. Finding product market fit does not automatically lead to conditions that favor efficient scale. Extended unprofitable growth is one sign that a market might not have the characteristics to support efficient scale, or that the startup has not thought its business model through enough.

When I study a seed stage startup I am trying to answer a number of general questions about how the future might unfold for that startup, thinking about economic moats gives me a useful framework for doing so.