Local Startups Need to Focus Less on Consumers, More on Businesses

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Earlier this month, Square announced plans to shut down Order, the six month-old application that was meant to succeed the company’s shuttered mobile wallet product. While the decision is not the end of its consumer aspirations, the move marks yet another step in founder Jack Dorsey’s quest to build a consumer brand alongside the company’s core merchant services business.

Square’s fascination with the consumer is not unique to its founder. That consumer-first mindset is common among entrepreneurs approaching the local market. Founders (not necessarily just Dorsey) interpret the investment thesis of the local technology industry —  the billions in local spending moving from analog systems to digital networks — and see a chance to rethink the way we buy before fully considering the vast changes occurring in the way the supply side of the market operates.

Here’s the reality: the supply-side — not consumers — will dictate the course of the local technology industry for the next few years.

The Local Web 1.0
The fascination with consumers stems in part from the Web 2.0 experience. In the 2000s, the challenge facing the Internet was far different than the challenge facing the local technology industry today. The Internet during the 2000s was adolescent — the tech industry built the commercial foundation of the web during the late 1990s, demonstrating its value as a marketplace, but the platform was in need of exploration and application to create value for consumers.

But the local opportunity — what I’ll call the connected local economy — is currently at a much younger stage in its development. In many ways, it’s closer to the Internet during the dotcom era where the bulk of the innovation focused on building and exploring the new ways we could sell goods with the Internet. Ecommerce, where users bought goods online which were sent via mail a few days later, won out, but plenty of other models emerged, and failed, during the period.

Today, we are in the infrastructure phase of the local web — the time when companies lay the commercial foundation for decades of innovation. That, in part, explains the recent renaissance of some of the most aspirational and notorious business models of the dotcom era.  It’s why companies such as Grubhub and Seamless, which have been around for a long time, are back in the spotlight. And it’s why delivery and logistics startups — and the premise that connectivity can change the way we move goods throughout the city — are back in favor with investors.

It’s also why the local commerce sector, which includes both software firms such as Square as well as on-demand plays such as Uber, may see a sharp sell-off in the next few years. Infrastructure technologies are high-risk, high-reward endeavors (often resulting in large gains and large losses). These products often require dramatic business model innovation that adds additional risk to even the most successful companies.

Some of Silicon Valley’s most notable investors have already warned of rising burn rates at startups. In a number of private conversations, sources within the industry have raised concern about the profitability of the hundreds of new on-demand startups attempting to scale large service organizations as if they were software businesses.

To understand the development of local tech, we need to explore the often causal relationship between commerce and advertising — namely, that commercial innovation necessarily precedes marketing innovation.  Consider the growth of the television industry in the second half of the twentieth century: mass media exploded in large part because of the development of the interstate system and the emergence of national and regional consumers.

The same can be said about the Internet industry. In the Dot-com era, companies built the commercial infrastructure for the web: PayPal allowed consumers and businesses to contract; Amazon taught the world about the power of the ecommerce model; and some of the largest retailers invested heavily in developing their own ecommerce initiatives.

Over the course of three years at the turn of the century, the percent of retail sales in the U.S. spent online grew sixfold, increasing from $1.9 billion in 1998 to $8.2 billion in 2000. That $8.2 billion in commerce spending shrank somewhat after the bubble burst, but it formed the foundation, the nest egg, for the subsequent growth of search, social media, and other Web 2.0 industries that generate revenue through advertising.

The local marketing industry is in need of its own digital commerce nest egg. Last year, the industry reached a turning point: web-influenced offline sales, purchases made offline which consumers researched online, became the largest category of commerce. But in many ways, that metric is only half of the picture. In order for the local technology industry to see a robust consumer-facing Web 2.0-like period, a meaningful percentage of sellers — everyone from small coffee shops to national retailers — need to shift from legacy to cloud-based transactional and business management software.

Businesses are just now starting to use the Internet to sell locally. A batch of new software as a service companies — Square, Revel Systems, Shopkeep and others — have built quickly growing businesses selling cloud-based software to a previously underserved small business segment.  Meanwhile, venture capitalists have begun to invest in startups developing new approaches to selling services locally. In the last year alone, venture capital investment in on-demand mobile services, which includes companies such as Uber, Handy and Homejoy,  grew to somewhere north of $1.3 billion.

Once that foundation is set, and millions of local business are connected to the web, the applications are nearly endless. Even more important, though, the cost of developing those applications will decline exponentially.

But the industry is not there yet. Entrepreneurs who overlook the critical lack of infrastructure in local in favor of potential consumer applications will find their startups struggling to create meaningful experiences without burning immense amounts of capital in the process.

Steven Jacobs is Street Fight’s deputy editor.