The threat of substitution is a common dynamic in many industries. Startups often compete in well-established markets by offering substitutes to traditional products, processes and services. How effective they are depends on many things, but the relative switching costs are vital.
Think about travel distribution in the context of competitive substitution. Online travel agencies hardly grew the travel pie but rather substituted for other, traditional channels. These traditional channels failed to see the substitution threat coming and, as a result, a massive transfer of wealth occurred. This dynamic was only made possible when the low-cost ubiquity of the Internet combined with the rich media capabilities of the Web and user-friendly browsers. Those elements collapsed the switching costs and truly transformed the playing field.
Threat by substitution is also playing out in the hotel space. We know from the data that slow supply growth and a recovering economy are driving favorable supply-demand dynamics and, as a result, revenue per available room is expected to accelerate. But are we safe with this assumption when we consider the threat of substitutes? Can we depend on controlled supply growth when Airbnb has expanded to 19,000 cities across 192 countries, spawning dozens of copycats? Shouldn’t we view the 10 million roomnights booked through Airbnb as “new supply” and isn’t this new supply driven by an accelerating substitution effect fueled by plummeting switching costs thanks to the social web?
Although Airbnb’s bite is relatively small in comparison to the global hotel sector, the fact remains that switching costs are falling. Yes, leisure travelers tend to be the sweet spot for Airbnb, but are we so sure the model won’t extend to the lucrative business traveler anytime soon? As more and more travelers experience Airbnb and as the company’s supply base broadens and segments according to traveler type … well, we’ll just have to see.
One area of particular interest is the $136-billion global vacation rental space–$85 billion in the U.S. alone, one-third the size of the hotel market. This highly fragmented and inefficient landscape is begging for organization and promises to become a serious substitution threat when switching costs fall to critical levels. Those switching costs, essentially a function of bookability, brand reliability and trust, are under attack by enterprising entrepreneurs deploying a range of creative strategies. If this massive block of “supply” should organize in such a way that the switching costs for travelers falls below a critical level, then, game on.
Venture capitalists think a lot about competitive dynamics. After all, emerging technology companies compete aggressively for their place in the sun, grabbing share from established players by exploiting their vulnerabilities. When companies misjudge those dynamics, however, they often fail quickly. In addition, breakthrough ideas typically spawn competitive backlash either in the form of copycats—think about the explosion of daily deal ideas that followed Groupon—or in the form of blistering counter attacks from threatened incumbents. Either way, maneuvering the minefield to success is tricky to say the least, especially given the long-term nature of our investment horizon.
In this way, we are not unlike hotel real estate investors who anticipate markets, bet on rising tides and do the best they can to forecast competitive events. Yet competition in the bricks and mortar world has historically been somewhat one-dimensional—it’s all about supply growth. What this paradigm fails to recognize, however, is the hidden threat of substitution, something that we think about in the venture world every day.
Will this have an effect the hotel industry? Will business travelers, for example, substitute condominiums, apartments or couches for a hotel room? Will families punt on the destination resort and book three-bedroom vacation homes instead? Imagine a world where every available pillow is bookable, where traveler reviews are the primary measure of value and relative switching costs are zero. This scenario is scary to many, thrilling to us and nothing but positive for travelers. Whether you read this as inevitable commoditization or a force of creative destruction, we can be sure of one thing: Bob Dylan had it right when he said, “Times they are a-changin!”
Chris has spent his entire professional life in and around startups and high-growth businesses in the hospitality, travel and technology space having founded six companies during his 25 years in business. Today he is a co-founder and Managing Director of Thayer Ventures, a venture capital firm investing in emerging technology companies in the hospitality and travel space. Immediately Prior to Thayer Ventures, Chris was founder and President of iCare Marketing (sold to Sysco Foodservice Corporation in 2012) and founder and CEO of Dynamic Payment Ventures (sold to Elavon, a subsidiary of US Bank in 2007).
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