Editor’s Note: Nicole Gelinas is a Chartered Financial Analyst (CFA) charterholder, contributing editor to the Manhattan Institute’s City Journal and author of After The Fall: Saving Capitalism From Wall Street—and Washington. The opinions expressed in this commentary are her own.
After weeks of grappling with a failed initial public offering, the board of WeWork this week forced charismatic cofounder and CEO Adam Neumann out of his post. The strange rise and apparent fall of the office-sharing company may represent a turning point for the economy – and a much-needed correction. The past decade has seen the emergence of an odd, and not particularly healthy, strain of capitalism: supposed corporate superstars that not only lose billions of dollars, but don’t expect to earn profits anytime soon.
This trend is distorting the definition of success in a free-market economy. And the more distorted markets get, the harder it is to convince the public that capitalism is working.
The fact that WeWork almost went public is absurd. WeWork is a commercial real-estate outfit that rents big blocks of office space from landlords in cities such as New York and London and then turns around and re-rents the space out to small companies after some interior decoration. But though office rental is generally a profitable business, and has been for hundreds of years, WeWork operates at a huge loss: It burned through more than $1.5 billion in the first half of this year.
WeWork is not alone. Uber and Lyft, the ride-hailing companies, did go public this year despite recording billions of dollars in losses. Uber was able to list itself on the public market without proving its business model was commercially viable. The company has reported $6.2 billion worth of losses in its first two quarters as a publicly traded company. Lyft, its 7-year-old rival, reported $1.7 billion in losses during its first two quarters.
Of course, all of these money-losing companies claim that their business models will work somehow, someday, and that’s when the profits will flow. But traditional capitalism operates under a key disciplining force: profits. If a company cannot profitably make a product or sell a service at a price that customers will pay, that company will go out of business, leaving room in the marketplace for more efficient competitors.
Just look at the story behind Ford Motor Co. In early 1903, Ford issued 1,000 stock shares, raising $28,000 in cash for what was, at the time, a risky startup. That July, Ford sold its first Model A car. By October, the company turned a profit of $37,000.
That profit was important. It demonstrated to investors who might put money into the firm that Ford was capable of earning a return. People wanted to buy cars, and Ford could make those cars at a price that allowed it a profit; this was a sustainable business. And Ford reinvested early profits and investor dollars back into the company and become one of the biggest drivers of the 20th century transportation revolution.
Over a century later, Uber and Lyft are supposedly this generation’s version of Ford and GM — they want to transform how people get around. They contend that transformation will take time. Yet other tech companies were profitable early on in their revolutions. Facebook, which went public in 2012, was profitable in its first year as a publicly traded firm. Google, which issued stock in 2004, also returned immediate earnings.
Amazon was the exception. But in 1997, it was only 3 years old, and it was reporting growing revenues and a slim loss, relative to total sales. Amazon’s 1997 loss, nearly $28 million, was 19% of its $148 million in total sales.
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Contrast this figure with Uber. In the most recent quarter, Uber’s loss was higher than its total revenue of $3.2 billion — a “profit margin” exceeding negative 100%.
A ride in an Uber or Lyft and a desk at a WeWork space may be more convenient and comfortable than hailing a cab or using a phone to call for an old-fashioned hired car — thanks only, though, to the billions of dollars in investor subsidies these companies have commanded to cover losses. Making it easier to hail or call a car is not the same as designing and popularizing an internet search engine. As for claims that Uber and Lyft have upended the taxi industry: they have done so only because of their ability to incur losses which allows them to provide a level of service that is otherwise not economically feasible.
WeWork, Uber and Lyft, in other words, aren’t the products of profit-seeking free-market capitalism. They are partly the product of the distortion western governments have created in keeping interest rates at record lows for years, to help the economy recover from the global financial crisis more than a decade ago.
Indeed, their valuations are the result of more than a decade of near-zero interest rates. Capital crosses borders, and in an environment in which the United States has kept interest rates near zero, and the European Central Bank and Bank of Japan have kept them below zero, it’s hard to earn a good return on less risky investments. So investors have been seeking out ever more exotic bets, including pouring money into companies that lose money indefinitely.
If investors don’t mind pursuing payoffs that are far in the future, if they exist at all, is it really a problem? Yes. The longer the situation persists, the harder it is for old-fashioned and smaller businesses — companies that can’t command billions of dollars in global capital — to compete and succeed.
How can a traditional small-business taxi service compete against Uber when the traditional small-business taxi service cannot command billions of dollars in investor capital to provide a service at a permanent loss? How do traditional real-estate companies know how much office space the market demands, when WeWork can distort this market – and drive up demand – by throwing money at loss-making leases? Before its failed IPO, WeWork had committed $47 billion to landlords, thereby pushing up the price of rental space and property values — not on sustainable profit-earning terms, but due to excess investor capital.
When a “startup” loses money for a decade on end, it’s fair to wonder whether that company is spurring others to improve to compete – or just hoping that investors continue to throw money their way.
