CFA Institute Magazine 26 June 2018
How the Rise of Crowd-Based Capitalism Will Change Economic Activity
How will crowd-based platforms change business models and even whole industries?
- Crowd-based capitalism “will stand alongside our 20th-century corporate model as one of the mainstream ways in which the world’s economic activity is organized,” says author and business professor Arun Sundararajan.
- “In many industries, the largest company in the sector is likely to be a crowd-based platform.”
- “Value creations will shift away from companies that are in the business of selling physical products and toward companies that are in the business of offering services and experiences. People will convert their tangible assets into commercial assets as well.”
Fueled by the likes of Airbnb and Uber, the sharing economy is booming. How will crowd-based capitalism affect traditional valuation models and the corporate-centric model of business? Arun Sundararajan is a professor at NYU Stern School of Business and the author of The Sharing Economy (MIT Press, 2016). In an interview with CFA Institute Magazine, Sundararajan shares his insights on investment valuation of crowd-based businesses, the parallel with franchise models, the move of consumers toward asset-light consumption and the resulting consequences for established industries, the growth of digital trust systems, and the rise of invisible, scalable infrastructure.
How does the sharing economy differ from crowd-based capitalism?
When people refer to the sharing economy, they’re almost always thinking about Uber or Airbnb. My conception of crowd-based capitalism is broader than what falls under the umbrella of the sharing economy. So I include Uber, Airbnb, crowdfunding sites like AngelList and CircleUp, peer-to-peer lending sites like Lending Club and Funding Circle, peer-to-peer car rental sites, crowd-based grocery platforms like La Ruche qui dit Oui, and even online video aggregators like YouTube. They’re all examples of a new way of organizing economic activity that I believe will stand alongside our 20th-century corporate model as one of the mainstream ways in which the world’s economic activity is organized.
At the center of crowd-based capitalism is a platform that is responsible for aggregating demand, providing consumers with some search and discovery capabilities, and typically providing trust or risk-mitigation services to both sides.
This definition describes YouTube pretty well, and it describes Airbnb and short-term accommodation. It describes Getaround and Turo in the peer-to-peer car rental space. It describes AngelList and CircleUp for equity venture capital (VC). I see this as a natural evolution of open-sourced, open-innovation, and crowdsourcing strategies that emerged 10 to 15 years ago. But what the sharing economy has done is allow the model to come of age.
How similar are companies in the space?
The delivery of goods or services comes from a distributed and heterogeneous crowd of providers. Some of these providers are large companies, some are small businesses, and some are individuals. Some of them are professional, some are amateurs, some are doing it for money, some are not doing it for money. It covers a wide variety of industries today.
Airbnb is now the largest provider of short-term accommodation in the world. China’s Didi Chuxing is the world’s largest private provider of transportation. So the model has attained scale to the point of industry leadership in some categories.
How big is the sharing economy?
The most recent numbers I’m aware of come from China, in terms of assessing the size of the sharing economy in China. The projection is that it will be a double-digit percentage of GDP by 2020. Crowd-based capitalism is growing faster in China—and is larger in China—than in any other country, both in absolute terms and in terms of a percentage of the economy.
Will the sharing economy replace the corporate-centric model?
I don’t see it completely replacing the corporate-centric model. However, in many industries, the largest company in the sector is likely to be a crowd-based platform.
If you take the short-term accommodation space, Airbnb is already the world’s largest provider. It has nearly 5 million listings, in comparison to Marriott International, which has 1.1 million rooms in inventory. Granted, Marriott has higher occupancy rates. However, on New Year’s Eve 2017, over 3.3 million people were staying in an Airbnb, which would make it 50% larger than Marriott, even if the hotel chain had two people per room and 100% occupancy.
In the transportation sector, I expect a much larger percentage of the population will soon have all their transportation needs met by using a car on demand. That fraction will grow significantly. In China, Didi Chuxing’s revenues will soon be greater than the revenues of the largest auto company.
How quickly is trust in crowd-based platforms evolving?
Twenty years ago, we had enough digital trust to buy retail on eBay. Now the trust level has evolved to where we’re comfortable getting into strangers’ cars and being driven to another city with them, or sleeping in a stranger’s spare bedroom, or handing over the keys of our apartment to someone we don’t know. We’re not yet where we trust our energy supply to a platform or make our health care choices by relying on digital trust. But I’m sure that day isn’t far off.
What will crowd-based health care look like?
There are already a few apps that connect doctors who have additional time [for patient care] with patients who want an experience that’s different from going to a hospital. A very early stage one, UBERDOC, is based in Boston. UBERDOC connects specialists directly with patients, bypassing the mainstream health care service, with each specialist specifying some number of hours they’ll make available to the platform. Nothing is insured, but the payment is a lot lower than if you had your insurance cover it.
Another crowd-based platform, called WEGO Health, provides patient expertise to drug companies. So if a company wants a pool of patients from which to learn something or to run clinical trials, WEGO finds patient experts and connects them to pharmaceutical companies.
How will these platforms affect traditional industries?
For hotels and autos, I think the changes are already quite significant for the incumbent players. For hotels, two things have happened. One is there’s been an overall expansion of the market. A significant fraction of people using Airbnb are traveling simply because Airbnb is available. But over time, there’s also going to be cannibalization of the existing market. As Airbnb goes after the corporate market, I think the hotel industry will lose a lot of its business.
With autos and transportation, the changes are a lot deeper. Consumers around the world are re-conceptualizing how they get the mobility they used to receive by buying a car. This is the biggest industry to be disrupted by digital technology.
To put things in perspective, Google and Facebook rely on advertising, which is a half-trillion-dollar industry. The auto industry generates more than $10 trillion annually. It’s a massive industry that is seeing a fundamental shift in how consumers receive the value they used to receive from buying a car. I think the pace of change will be slow because our behaviors are so deeply entrenched in the US, Western Europe, and Japan. I don’t think there is any chance that in the next 20 to 30 years, we’re going to go to a world where everybody is calling a car on demand for everything that they need.
But I think that there will be a significant shift in revenue away from the auto companies who are selling to consumers and who have positioned their product as a lifestyle product. Demand will shift to Lyft-like and Didi-like services, where you are simply getting the car that’s available when you need transportation, especially in the larger cities and in emerging economies.
What are implications for valuation?
The biggest disconnect is around thinking about employee base and assets. This isn’t a new issue. We faced similar challenges on how to value Google and Facebook and, even before them, Microsoft. The metrics that we typically use as the basis for building our models aren’t the same relative to investing in a ship or a plane or building a factory.
If you’re valuing Airbnb, its employee base is tiny. It has a few thousand employees. Its asset base is non-existent relative to a valuation model that you might use on a hotel franchise. So you have to find some middle ground between the valuation models that you use for software companies and the valuation models that you use for franchising businesses—even if a crowd-based business doesn’t seem like a franchising business at first blush.
We have to come up with new ways of assessing future value creation. In the sharing economy space, these companies seem to be in familiar sectors, but their business models are changing in fundamental ways that require us to take a different approach to assessing how much the companies are worth.
How can practitioners best understand these new models?
The best source I know is my colleague Aswath Damodaran, who has built a series of valuation models for Uber.
You can take those models and apply them to Didi, Lyft, and others in the space. But it’s not clear that you can apply them to Airbnb. The advice I have is to re-conceptualize the rules regarding assets and employees that you might be using in your model, carefully understand the nature of revenue that the company is reporting, and distinguish between the revenue that is passing through the platform versus the revenue that is being captured by the platform. Also, look to valuation models of franchised businesses as a starting point, because often you can think of sharing economy platforms as giant micro-franchising businesses.
Do we need sharing economy specialists?
Sector specialists are moving into covering the sharing economy platforms within their own space. So the transportation folks will be looking at Uber and Didi, analysts who cover hotels will look at Airbnb, and analysts who cover retail will look at on-demand retail models.
There may be some teams for assessing sharing economy companies that translate across approaches and platforms—thinking of them as franchise businesses and not expecting to see assets. Distinguishing pass-through revenue from the actual revenue that they book is important. This has come up with Amazon as well, because they have their own retail business, but they’ve also got the platform-based seller business.
At the end of the day, I think to assess how much a platform is worth requires a deep understanding of the industry. So someone who understands the hotel industry deeply is better equipped to make a call on Airbnb than someone who has done a lot of work on Uber.
What about crowd-based investment platforms?
The most direct impact I’ve seen is in small business lending and early stage VC, where there are successful crowd-based models that have filled gaps in the market. In small business lending, there’s a perennial gap in many countries where you can’t get a small business loan. You can get credit if you’re a consumer or a big company, but if you need $50,000, the banks don’t find it profitable. But now, sufficiently precise and sophisticated assessment of risk has evolved, relative to the risk assessment that exists within consumer credit issuing.
So we see platforms like Funding Circle in the UK. There’s another one called CreditEase. With venture capital, it’s AngelList and CircleUp, which dramatically expand the set of people who can become early stage equity investors. And now there’s Rally Rd., which is securitizing classic cars and other collectible assets.
The way in which investment practitioners evaluate an industry is also changing. There’s been a dramatic expansion in the scope of change that digital technology can cause.
Ten years ago, it was clear that digital disruption was underway in the media industry. Whether it was video streaming or books or magazines or music, the product itself was becoming purely digital. Today, on the other hand, every industry seems susceptible to digital disruption through the crowd-based capitalism model. Thinking through and understanding the scope of potential change that may be around the corner should be part of any sensible investment strategy into any sector, whether it’s real estate, tourism, autos, energy, or health care.
Will crowd-based companies hold IPOs?
Many of these companies have held mini private IPOs. Uber has raised over $10 billion in equity and a few billion dollars in debt, and Didi in China has raised $20 billion in equity from private investors, but neither has gone public.
That said, I expect that Airbnb and Lyft are likely to go public in 2018 and that Uber will likely go public in 2019. Didi in China, which is the most valuable company in the space globally, will also probably go public in the next couple of years.
What changes do you see in real estate?
There are two fronts—one is the rapid rise of co-working spaces. This is less a crowd-based model and more of a platform model, with WeWork being the leader in the space. WeWork creates a particular “design” that involves how space is laid out and engineered in a way that facilitates more person-to-person interaction. WeWork can take this design, imprint it on any physical real estate, and instantly increase revenue potential. That’s the significant change I see in commercial real estate.
In residential real estate, there are some very early signs of co-living—where I don’t buy or rent a home; instead, I live in a shared living space with other people. I expect this will become more popular over time, as cities get more and more crowded and the cost of housing rises to the point where even middle-class professionals can’t afford the space that they want.
For this to happen, some fundamental changes need to take place. People will have to answer questions like, “What is my personal space?” Then there’s the whole traditional rite of passage or coming of age when you’re supposed to own a house. These are behaviors that will take a while to change.
What is asset-light consumption?
A lot of the early excitement about the sharing economy stems from the changing behaviors of consumers, which are shifting away from ownership and toward rental. That’s where the term asset-light comes from. You just use a car when you need it, either by renting or by calling one that is driven by someone else. Increasingly, we will see this dynamic for other physical assets such as household items. The economics don’t work yet because of the logistics of delivery, but they will as better delivery technology and drones become commonplace.
Platforms like Postmates, DoorDash, and Uber Eats allow you to have physical goods delivered. It’s mostly food at this point, but it will soon be local retail, hammers and tools. Platforms will index what’s available in every local retailer and have an updated snapshot, as Instacart has for groceries.
The asset-light model has to do with an expectation that as the sharing economy gets more popular and these crowd-based models get more efficient, the need to own things in order to have access to them will diminish.
How will crowd-based platforms fuel the economy?
Value creations will shift away from companies that are in the business of selling physical products and toward companies that are in the business of offering services and experiences. People will convert their tangible assets into commercial assets as well. So, your car isn’t just your car, but it’s also a rental car for other people. All of this unequivocally points to higher rates of economic growth from an increase in productivity, because you’re using physical assets more efficiently. Higher growth also comes from an increase in variety, because you’re expanding the set of choices that people have.
If you’re leading an asset-light or on-demand life, then you can get different services that suit you—such as renting a Porsche for an hour and then picking up your kids in a more sedentary car. You can rent a limo for a special event or just share a seat in a car with three other people. As you expand variety, you expand spending, because there’s a greater fit between what you want and what the market is offering. Economists disagree about most things, but the two things we agree about are that productivity increases lead to faster economic growth and that increases in variety lead to more consumption, which in turn leads to growth.
I see both of these features as being central to the shift toward crowd-based capitalism and the sharing economy.
How will the energy sector be affected?
I think energy will be a rapidly growing sector in 5 to 10 years, once battery technology is good enough to reliably store user-generated solar power. It’s still on the fringes because the physical technology isn’t quite there. Currently, if you have solar panels at home and you generate excess energy, you can feed it back into the power grid instantly—and if you fall short, you can draw from the grid—but there’s a lot of inefficiencies associated with the grid as a backup.
In the platform-based model, you would be locally redistributing your power. Your neighbors would be getting power from you or someone a few blocks away. So you’re not dealing with all of the transmission and distribution losses from having a centralized power source. It’s not clear yet whether the model will take a purely crowd-based form—whereby the individual buys the panels and batteries and is the energy entrepreneur—or whether it’ll be a large company that comes and installs everything. In that case, individuals would lease their roofs to the energy company that installs the panels and the batteries, manages this process, and collects a commission.
What about professional services platforms?
There’s a platform for lawyers called UpCounsel that has over 20,000 lawyers. Some of them are full time, some are part time, some are stay-at-home parents, others are small boutique firms, and some are slightly larger businesses receiving extra demand through the platform. The typical individual on UpCounsel has over 15 years of experience, and 70% of them have worked for a Fortune 500 company. So this isn’t a fringe business. If you compare UpCounsel to the leading law firms around the world, it is among the biggest.
There’s a platform for management consultants called Catalant, which has more than 50,000 consultants. That still makes it a lot smaller than the big consulting firms, but it’s a sector that’s growing as well. Catalant used to be called HourlyNerd and started as a platform where MBA students could make money on the side by doing small consulting projects. Like many other platforms, it has evolved to form and manage relationships with small businesses and also some large corporations. Catalant has algorithms that can match client needs with consultant expertise, and it provides a bit of trust on both sides. There’s also a new platform for public relations called Spry that has just launched and mirrors the same structure.
What is invisible infrastructure?
For smaller cities or cities in emerging economies, it’s a way of re-conceptualizing physical infrastructure investment. For cities on the scale of Tokyo, London, and New York, you’ve got the population to justify spending billions building and maintaining a train-based public transportation system. But if you’re a city of 100,000 people, or a million people spread out over a large area, the economics of public transportation don’t work out so well.
If you reimagine infrastructure as not being physical steel and concrete investments but rather platforms that tap into assets that are otherwise used for other purposes and that are available on demand, then you can think of a Lyft-based or an Uber-based equivalent of public transit, where the infrastructure is not visible and physical but is platform based and in some sense invisible. The real appeal of this comes for infrastructure needs that tend to be seasonal or one-time in nature.
Which infrastructure needs are these?
There’s a need for parking around a sports arena once a week. These parking structures lie empty except when there’s a game. A successful company in London called JustPark is reimagining infrastructure by tapping into parking spots of people who live within walking distance of the event. They’ve partnered with churches and individuals to create an on-demand parking spot marketplace. That’s an example of getting capacity when you need it and having it disappear when you don’t need it.
There’s a platform based out of Paris called BlaBlaCar that operates in 21 countries and allows people who are driving from one city to another to sell seats in their cars the way you would sell a train ticket. BlaBlaCar now carries five times as many people every three months as the Eurostar train network does in France. On any given day, BlaBlaCar passengers more than double the number of Amtrak passengers. When the French train network went on strike, you saw a tremendous spike in the demand and supply of BlaBlaCar at the time. There was a sudden, unanticipated infrastructure shortage, and this invisible infrastructure became visible.
Think of the amount of construction that was needed to plan for the World Cup in 2014 and then the Olympics in 2016. That kind of infrastructure investment could be partially replaced by invisible infrastructure in the way Tokyo is thinking about for the 2020 Olympics. We don’t have to build all this new hotel and transportation capacity. Let’s instead build the platforms, turn them on when we need them, and then turn them off when we don’t.
How does this affect existing infrastructure?
For certain kinds of infrastructure investments, it expands the set of situations for which you can fulfill an infrastructure need. The fixed cost was previously too high. It also causes us to rethink how much value can you get from a massive physical infrastructure project and makes us ask, Is it really necessary?
In a decade, when people are thinking about large-scale power-plant investment projects, they’d be advised to take into account the fact that a lot of the power infrastructure may already be sitting on people’s rooftops and in the batteries they have in their backyards. Creating a platform that taps into these crowd-based assets may be the next-generation equivalent of building a billion-dollar power plant.
About the Author
Nathan Jaye, CFA, is a keynote speaker and member of CFA Society San Francisco.