Houses built on sand

As a child I went to Sunday School and recall to this day being told the cautionary tale from the Bible of the foolish man who built his house on the sand.  The other half of the tale said that the wise man would build his house on rock.  In later life I actually owned a house that was built on sand and discovered that the reality was not quite so black and white and that the strength of the foundations depended on the structure of the sand.  Investing in a business is perhaps similar to this, and some recent events highlight this.

I do not want to turn this into the Cazoo column even though it probably would be possible to come up with several hundred words every week on the latest twists and turns in that particular story.  For those of you outside of the UK who read this blog, you might think that this is a specifically UK story and not something the impacts on business in your particular country, but my interest this week is not so much in the specifics of Cazoo, but on the risks of launching a business or investing in a business where the foundations are not just sand but the worst type of shifting sand, and nobody appears to have done a survey.

As a brief history of Cazoo it was launched by a highly successful internet entrepreneur, Alex Chesterman, who built and sold businesses in the entertainment and real estate sectors.  Looking for the next opportunity he identified used car retail as one which had “yet to benefit from any digital transformation”.  The business launched in December 2019 and had a highly successful flotation on the New York Stock exchange just under two years ago when the business was valued at US$7 billion.  Despite the subsequent history of missed targets, the IPO document is still available on the Cazoo website.  I can pick many holes in that document and the press interviews that were held with Chesterman at the time.  Perhaps the most significant were that there was such a thing as a European used car market, that customers were yearning to buy their used cars online, and that the incumbents were asleep at the wheel, failing to invest in digital.

Less than two years later, the money that was not spent on creating brand visibility through all forms of advertising and sponsorship has been written off as a result of acquiring businesses in the UK and continental Europe most of which have now been closed down or sold at huge losses.  In the latest restructuring announcement last week, volume ambition for 2023 has been set at 40,000-50,000 units in the UK (the sole remaining active market) compared to an ambition in the IPO document of 234,000 units of which 176,000 would be in the UK.  This revised target would make them the same size as Motorpoint, the largest independent used car retailer in the UK which follows a normal omnichannel model, and which has a market capitalisation of £130 million.  Gross profit per unit last year of £600, whilst an improvement on the previous year is still less than half the £1373 achieved by Motorpoint in their latest half year results.  Cazoo claims that it has enough cash to last another 18 to 24 months but will then need to raise new capital.  Given the under-delivery against promise to date, that may well prove to be the final crunch point for the business.

I could go on pulling apart the concept and execution of Cazoo, but that is not the point.  All the facts were available when the business was in the planning and launch to show the founders and the investors that the concept was flawed.  It was very clear that they were building on shifting sands, not rock, but it is unfortunately quite easy to find other examples of hope shutting out reality.  The money that was poured into autonomous car projects, not only by investors in start-ups but also by tech companies and manufacturers themselves, was similarly based on a naive hope that the technical, legal, regulatory and behavioural challenges could all be overcome in a matter of a few years.  We have been told many times the car ownership is dead and been urged to invest in mobility businesses which ignored the criticality of fleet utilisation and the overwhelming desire for individuals to have the keys to the car that they can call their own and which is full of their own stuff.

If businesses could only be launched when the foundations were rock solid then that would stifle innovation and we would see only slow, linear progress.  We do need entrepreneurs and investors who are prepared to take a risk, as that is how we can achieve breakthroughs, but that risk capital would be better focused on areas where we need breakthrough and the risks need to be properly highlighted.  Identifying, evaluating and mitigating the risks all take effort, but should provide more consistent and sustainable outcomes.  Unfortunately, there seems to be no shortage of investors who value a good story more than a good business case so I am sure that we will continue to see money put into start-ups that have been launched on foundations of sand, but I hope that we will see a swing back towards wisdom over foolishness as the economic climate becomes more challenging.