Will Grab’s flywheel strategy take off?

Photo by Andrew Draper from Unsplash.

The “flywheel effect”. The term was coined by author Jim Collins in 2001, and famously embraced by Jeff Bezos, who used it to form the basis of Amazon’s world domination strategy.

Physically, a flywheel is a mechanical device that powers machines by storing energy. But to tech executives, it is another metaphor for what they think is a winning business model: Create a loop-like cycle by attracting customers with low prices, leading to more sellers, better customer experience, thereby leading to further traffic growth and lower prices.

Two decades later, the “flywheel effect” or “network effect” is a phrase oft-wielded by Southeast Asia’s tech investors and consumer internet bigwigs like Grab.

The company, which is set to list on the NASDAQ in the coming weeks at a $40-billion valuation, marking the world’s largest SPAC deal, has mentioned the term numerous times in its prospectus and earnings calls, calling its platform “unique” for connecting “millions of consumers with millions of driver- and merchant-partners”.

“As we add more offerings, consumer spending and engagement increases. We call this the “Grab ecosystem flywheel,” it wrote in its prospectus. To back up its claims, Grab said the ratio of consumers using more than one of its features rose from about 33% in December 2018 to around 55% in December 2020.

More recently, it cited the growth of its deliveries and financial services arm. Grab’s chief financial officer Peter Oey said in the second-quarter earnings call that 85% of its GrabMart users were also GrabFood users that quarter.

During the same call, Grab president Ming Maa said that the increasing number of financial services users and transactions were a reflection of its flywheel too. And in the third-quarter earnings call, Maa said a bigger stake in Indonesian digital wallet OVO will “accelerate our super app flywheel even faster”. Grab had increased its stakes in OVO to 79.5% from 39% in October this year.

Grab expects to be operationally profitable in two years’ time, with earnings before interest, taxes, depreciation, and amortisation (EBITDA) of $500 million – it did not give projections on a net basis – according to the prospectus. So far, its ride-hailing arm is already profitable on an “adjusted EBITDA” basis, and its deliveries arm is nearly there, its latest quarterly results show. And its ride-hailing EBITDA margin was 12% of gross merchandise value compared to Uber’s 5.5% in the same quarter.

But can it live up to all the fanfare? The Temasek-, Tiger Global-, and Softbank Vision Fund-backed company is still suffering from heavy losses, having recorded a cumulative net loss of $11.655 billion since 2018.

Comparing it to its already-publicly listed counterparts is no better too. An Economist calculation of nine of the world’s largest “flywheel” companies – Uber, Delivery Hero, and Didi, among others – found that while they were worth nearly $500 billion altogether, sales came up to $75 billion over the past year with operating losses of almost $11.5 billion.

Uber might have just made its first operating profit, but that was a tiny $8 million gain on adjusted EBITDA. Its stock has hovered around its IPO price of $45 per share since its May 2019 debut.

Kristine Lau, an analyst at investment research house Third Bridge, said the flywheel strategy makes sense since Grab and GoTo have emerged as the two dominant multi-feature players in Southeast Asia. But it is hard to quantify how much of a market share either company needs to attain before calling the flywheel a success.

One executive of an investment firm that backs Grab said the company is different from the pack because it is in Southeast Asia, where Grab has the first-mover advantage. In China and the US, companies doing solely just ride-hailing or deliveries had emerged alongside each other.

“Take Didi as an example. When they started to think about food delivery, there was already Meituan. When they want to do payments, there was Alipay, WePay. So they pretty much had to hone in as a single product platform,” said the executive who asked not to be named as he was not authorised to speak to the media.

“The ecosystem idea would have made sense in China but it was too late by the time anyone could do it because all the verticals had big players already.”

What makes Grab different?

Unlike Grab, Uber does not have its own payment system that ties consumer services together, the person added.

Grab’s success hinges on leading its base of consumers and merchants to use its financial services in a region with a large unbanked population, according to Lawrence Loh, a business professor who studies technology policies at the National University of Singapore.

Ride-hailing and deliveries are high-volume but low-margin businesses with immense competition, he said. Grab could increase the commissions – its ride-hailing take rate at 16.6% is still below Uber’s 22.3%. But in an environment with price-sensitive consumers, drivers and merchants – restaurants themselves run on razor-thin margins – used to years of venture capital-sponsored subsidies, assuming customer loyalty is risky.

Other types of financial services have a better shot at making money. A table by New York University finance professor Aswath Damodaran shows net margins of banking, non-bank and insurance financial services, and investments and asset managements at around 20%.

But Lau said it will take a few years before companies like Grab’s financial services will gain traction. For example, they will probably start as insurance distributors rather than actual underwriters. But like operating a digital wallet, which itself has very low profitability, these products build customer loyalty.

Features like the wallet are linked to Grab’s in-app rewards programme, which is much less liquid than outright cashbacks and encourages the user to stick to the app even more, she added.

Though banks and other tech giants such as GoTo and Sea are aggressively marketing their own digital wallets, the investment executive said payments is not a “winner-takes-all” game, as consumers are comfortable using multiple payment options.

Turning to digital banking, enterprise

Grab has secured a digital banking licence in Singapore and is aiming for one in Malaysia while it works with Emtek Group to acquire small banks in Indonesia.

Having a digital bank does not guarantee profitability, since most of the world’s 249 digital banks are not. However, most of the few success cases have come from Asia so far, including Korea’s KakaoBank, which became profitable in 2019 two years after its launch, on the back of its popular messaging app and trust in the brand. Its rival K bank also turned its first quarterly profit this year. 

The SPAC deal will bring Grab’s cash on hand to nearly $10 billion – a hefty sum to power its businesses further. But Grab will need to fend off huge rivals in banks with digital arms, internet giants like Sea and GoTo that have big financial services ambitions, and many other standalone fintech companies, while customer’s appetite for wealth management services, bookkeeping apps, and insurance policies would hit a ceiling.

With most apps and services easily accessible with a few clicks, industry observers acknowledge the competition. Loh said Grab will need to find a “differentiated sweet spot.” Being a company in different sectors allows it to bundle financial services with its other products, he said.

The company could also bank on its nascent enterprise division, where average order amounts are higher and customers tend to stay around longer with subscriptions. Enterprise is part of the flywheel since consumer data and routes feed into how Grab creates targeted advertisements, understands fraud, and develops a virtual map.

Grab’s fraud software, which services mobile apps, can plug a gap left by existing international mobile security companies. “This is already an area where there is a need for a lot of localisation,” said Lau.

But she said it is too early to say whether its fraud detection business will really be as big a hit as Amazon Web Services (AWS), Amazon’s money-printing cloud computing segment which it is often compared to, as there are questions about how it will use clients’ information. “If we think about the companies that need this kind of surface, they will be competitors of Grab. I have no doubt that they have tons of NDAs (non-disclosure agreements) in place…but this is an overall perception that they need to tackle.” Antitrust concerns have cropped up with AWS.

As for its advertising arm, it is a “natural adjacency” since merchants who have found Grab helpful will want to benefit further from the app. Advertising is lucrative as seen with Sea, which has attributed its rising take rates to marketing revenue.

The public market performance of tech companies relying on the flywheel has been a mixed bag. foodpanda’s Delivery Hero’s share price has gone up since it was listed, while Deliveroo’s has floundered. Sea’s has skyrocketed, while Bukalapak’s has dipped despite the excitement on its debut. Time will tell which side Grab falls on.

Note: An earlier version of the story had a comparison chart on Grab, Sea, and Uber’s revenues. We have removed that chart as each company recognise their revenue on different metrics. This story was also  updated to add information about Grab’s net losses. 

Singapore Reporter/s

In Singapore, we are looking to double our reporting team by this year-end to comprehensively cover the fast-moving world of funded startups and VC, PE & M&A deals. We want reporters who can tell our readers what is really happening in these sectors and why it matters to markets, companies and consumers. The ability to write precisely and urgently is crucial for these roles. Ideal candidates must have to ability to work in a collaborative, dynamic, and fast-changing environment. We want our new hires to be digitally savvy and ready to experiment with new forms of storytelling. Most importantly, we are looking for hard-hitting reporters who work well in a team. Collaboration and collegiality are a must.

Following vacancies can be applied for (only in Singapore).

Following vacancies can be applied for (only in Singapore).   

  • A reporter to track companies/startups that have raised private capital, and have the potential to become unicorns. SEA currently has over 40 companies with a valuation of over $100 million and under $1 billion.
  • A reporter who can get behind the scenes and reveal how funding rounds are put together, or why they’ve failed to materialise. She/he in this role will largely focus on long-format stories. 
  • A journalist to track special situations funds, distressed debt and private credit (from the PE angle) across Asia.

Singapore Reporter/s

In Singapore, we are looking to double our reporting team by this year-end to comprehensively cover the fast-moving world of funded startups and VC, PE & M&A deals. We want reporters who can tell our readers what is really happening in these sectors and why it matters to markets, companies and consumers. The ability to write precisely and urgently is crucial for these roles. Ideal candidates must have to ability to work in a collaborative, dynamic, and fast-changing environment. We want our new hires to be digitally savvy and ready to experiment with new forms of storytelling. Most importantly, we are looking for hard-hitting reporters who work well in a team. Collaboration and collegiality are a must.

Following vacancies can be applied for (only in Singapore).

Following vacancies can be applied for (only in Singapore).   

  • A reporter to track companies/startups that have raised private capital, and have the potential to become unicorns. SEA currently has over 40 companies with a valuation of over $100 million and under $1 billion.
  • A reporter who can get behind the scenes and reveal how funding rounds are put together, or why they’ve failed to materialise. She/he in this role will largely focus on long-format stories. 
  • A journalist to track special situations funds, distressed debt and private credit (from the PE angle) across Asia.