The Dichotomy of Market-Making vs Frictionless Platforms: A Dissection of Convoy’s Downfall

Every time a startup fails, I am overcome by a sense of melancholy. But the collapse of supply chain startups is particularly disheartening. Convoy, a Seattle-based digital freight network founded in 2015, shut down and sold its assets to Flexport, another troubled supply chain freight startup. 

So what’s the root cause of its failure? Is it related to the way it behaved as a platform? Is it related to its dependency on the supply chain sector? Could it be both? Let’s delve in.

Navigating the Complex Lanes: A Dive into Convoy’s Journey to Disrupt Truck Freight

The behemoth of truck freight, with its annual expenditure of almost $800 billion, operates as the lifeblood of the U.S. economy, ensuring the seamless transport of raw materials and consumer goods across the vast stretches of the nation. Yet, it remains entrenched in inefficiencies and is extremely fragmented. Amidst this disarray, brokers emerge as the linchpin, orchestrating the movement of goods, albeit at a significant cost, both in terms of time and financial resources. 

This is the market that Convoy set out to disrupt, and the stage was set: a transition from clunky, manual operations to a streamlined, digital marketplace. The following infographic illustrates the main players showing roughly 100K shippers and 3 million drivers. But the brokers and trucking companies in the middle create the inefficiency that inspired Convoy’s model:

Convoy’s approach sought to replace the manual, broker-driven matching process with an automated, software-driven solution. The vision was to significantly pare down the booking time, minimize empty miles, and propel the industry toward a more sustainable, efficient operational model. 

But as is usually the case, these intermediaries are deeply entrenched in the industry, so the journey was fraught with several challenges —a testimony to the complex, multifaceted nature of the truck freight marketplace. Admittedly, the process was quite different than the straightforward demand-supply dynamics of industries that other platforms such as Uber or Airbnb tried to disrupt, so in order to “cut out the middle man”, the firm had to develop a comprehensive strategy aimed at alleviating systemic supply shortages, confronting the volatile pricing models, and, above all, scaling amidst a geographically fragmented market. 

Convoy’s main goal was to transition toward a more transparent and cost-effective framework, shedding the hefty 15-20% brokerage fee that once loomed over every transaction. Convoy’s model, grounded on the spread between a shipper’s willingness to pay and the carrier’s pricing expectations, promised a new dawn of upfront, transparent pricing.

It also had a sustainability angle to it as automation not only slashed the broker overhead, but propelled a reduction in empty miles from a staggering 35% to 19% —a leap toward optimizing the utility of every mile traversed.

However, in order to get there, as the unit economic analysis above shows, the scale of operations had to match the diverse needs of shippers, transcending the regional barriers that once constrained the industry. The goal was to aggregate demand and build a network that promised reliability, efficiency, and, above all, a significant reduction in operational costs, as illustrated by the following flywheel:

So what went wrong?

Market-Making vs. Frictionless Platform

As mentioned, Convoy embarked on a mission to redefine the freight industry through an automation-first approach, akin to the seamless matchmaking model of Uber, with a vision to reduce costs while also reducing carbon footprint. This vision not only sought to disrupt the old-school freight industry but also to encapsulate a frictionless platform where shippers and truckers could connect effortlessly.

In the process of trying to become a frictionless platform, however, Convoy became a market maker instead. Let me clarify the difference: 

A frictionless platform acts as a conduit for buyers and sellers to interact, minimizing the intermediaries and, thereby, the friction in transactions. On the other hand, the notion of market-making manifests when a firm steps in to facilitate the buyers and sellers of a marketplace, often taking on additional risks to ensure market liquidity and continuity.

Convoy initially veered toward the former, but as the company grew, it started showing traits of a market maker. They began leasing trailers and developed a “drop and hook” marketplace to manage pre-loaded trailers for drivers, thereby taking on more operational risks and responsibilities. Moreover, Convoy’s shift in focus toward long-term contracts with big companies like Unilever, further entrenched it into a market-making role, as it now had to ensure a consistent supply to meet these contracts, diverging from its original model of a frictionless platform.

It becomes apparent that the firm’s operational model oscillated between market-making and a frictionless platform, which bred confusion among its employees, as well as operational inefficiencies. This duality was evident when the company struggled to define its identity, as Convoy’s founders frequently iterated that the frirm was both a technology company and a freight broker.

But what propelled this transition?

“Jeff Tucker, chief executive of New Jersey-based freight broker Tucker Company Worldwide, said Convoy’s technology was best suited to so-called transactional business—shipments owned by customers that will switch between brokers and carriers for relatively small differences in price. ‘It’s trying to make money in the least profitable freight,’ Tucker said. ‘There’s zero margin in that and a lot of headaches.’”

The problem: Most freight transport occurs under contracts, as opposed to the spot market that digital startups are targeting. Industrial freight can be complex, it holds significant value for its owners, and requires human intervention in instances of shipment derailments or delays.

Convoy, primarily a brokerage platform facilitating connections between shippers and carriers, earned revenue from the difference in rates. However, the company faced a meager 7% gross margin in 2021, with an operating loss of about $190 million, mainly due to challenges in competing with traditional freight brokerages and adapting to market changes swiftly. 

And here comes the second issue: the firm over-relied on automation in situations where automation might not have been the right approach. In the long run, when the market is fully on-board, automation may be effectivce, but not yet. The firm’s emphasis on automation didn’t align with the industry’s preference for human interaction, especially among large Fortune 500 companies. The situation worsened with supply chain disruptions during the pandemic, where, unlike other brokers, Convoy struggled to renegotiate rates amidst fluctuating demand and pricing. This scenario often left Convoy’s account managers and sales representatives making uninformed decisions on shipments, leading to unprofitable deals.

The lack of agility, which resulted in prolonged periods of miscoordination, highlights the inherent challenges in the tech-company-as-market-maker model. This model often leads to adverse selections in market transactions due to delayed or incorrect pricing adjustments, which was exacerbated in Convoy’s case given the thin-margin nature of the freight industry. This is not a problem (or at least it’s less of a problem) for platforms like Uber, where mistakes made by the algorithm can be corrected in a short amount of time. In the market-making model, however, it is an issue when there’s a time lag between the pricing decisions and the feedback from the market. 

In fact, in Convoy’s case, not only did the firm stop acting as a frictionless platform, but it also took on additional risks. In other words, on the one hand, Convoy transitioned into a market maker, bearing a significantly higher cost of production while overly-relying on algorithmic pricing, when algorithms are not as nimble as humans. Primarily, as market conditions become volatile, algorithms are not always the best solution, and even more so in the case where relationships matter. 

Convoy’s story really highlights the need for picking a lane - either dive into being a market maker with solid plans for handling the risks, or stick to a hassle-free platform model and keep things simple. Convoy messed up by hiring too many people, renting too much office space, and not reacting quickly to market shifts, showing a shaky operational model that couldn’t decide between market-making and keeping things frictionless.

The Balancing Act: Unfurling the Intricacies of Market-Making in Modern Platforms

I’m not here to blame the venture capital model for this, again. But maybe I should. This is yet one more example of the price paid for trying to grow at all costs while also building a model that is instantly scalable. 

Let me delve a bit deeper into the notion of scalability of platforms. 

In the dynamic realm of digital marketplaces and platforms, two pivotal concepts often surface, shaping the trajectory of emerging and established players alike – “the cost of production” and the “scalability paradox.” These notions, while distinct, intertwine when incorporated in the broader canvas of market-making and the quest for building frictionless platforms.

A quintessential trait of a thriving platform is its ability to distance itself from the direct cost of production. Unlike traditional business models, platforms act as facilitators, orchestrating interactions between various stakeholders rather than immersing in the production chain themselves. This detachment, while fostering a lean operational model, also nurtures an ecosystem where the value is co-created and exchanged sans the cumbersome overheads associated with production. Yet, this facet demands a delicate balance; a platform must ensure a seamless, reliable experience without being entangled in the production intricacies. As we have seen above, this was not the case for Convoy. As the firm failed to grow fast enough, it got deeper into taking these costs on. Of course, these are viewed initially as a necessary evil. As part of the Go-To-Market strategy of the firm. Only to realize that these are the actual reality rather than a temporary tactic. 

Things become even more extreme when the allure of instant scalability often beckons platforms toward a trajectory where the human touch and the personalized interactions are overshadowed by the race toward exponential growth and instant scalability. This is the crux of the scalability paradox. In an earnest bid to exhibit instant scalability, firms might inadvertently overlook the essence of human-centric differentiators. 

The Bullwhip Effect: Supply Chain Reverberations and the Casualties Among Startups

But this is only part of the story. The issues above were accentuated by the specific industry the firm was trying to disrupt: supply chain. 

Supply chain dynamics are often synonymous with the bullwhip effect, where small disruptions create significant ripples down the line. These issues usually plague retailers, and suppliers have become a crucible for startups, especially those like Convoy, venturing to innovate within the logistics and freight sector. The upsurge in e-commerce and subsequent port shutdowns during the pandemic fostered an environment ripe for tech-driven logistics solutions. However, as the pendulum swung back with the easing of supply chain pressures, the stark reality of a “freight recession,” as termed by Convoy’s CEO, revealed the precariousness of the startup ecosystem within this traditional industry.

Convoy’s journey, emblematic of the boom-and-bust cycle, epitomizes the trajectory of startups that soared on the wings of pandemic-induced supply chain disruptions only to plummet when traditional supply chain mechanisms regained their foothold. With a peak valuation of $3.8 billion in 2022, Convoy was poised as a torchbearer of tech-driven disruption in the freight industry. However, the unraveling of supply chain bottlenecks, accompanied by a slump in freight volumes and the obstinate high costs for carriers, notably the surge in diesel prices, and lower supply chain pressure (as seen by the graph below), heralded a harsh winter for Convoy and similar startups like Flexport.

These startups banked on getting a significant volume of shipments and constantly bringing in new customers, but this plan hit a wall when the market shrunk. The changing spot rates (as seen in the graph below), which looked like a money-maker at first, became a trap when the rates tanked. This led to making less money per truck, and for businesses already scraping by on slim profits, it turned into a major money headache.

Moreover, the financial architecture of Convoy, bolstered by a venture debt deal and a hefty line of credit from JP Morgan, started to resemble a house of cards as the revenue streams dried up. The venture capital landscape, once a fertile ground for supply chain tech companies, witnessed a stark retreat, with a nearly 70% drop in deal value in Q2 2023 compared to the previous year, as evident in the graph below:

The VC pullback, particularly pronounced in the freight tech segment, underscored a growing realization of the chasm between Silicon Valley logic and the capital-intensive, old-school freight industry.

Convoy’s story is a manifestation of the bullwhip effect on startups, where the initial uptick in demand, fueled by external disruptions, led to aggressive growth and fundraising. However, as the market dynamics reverted, the downside was a steep cliff, exacerbated by the high fixed costs and the evaporation of venture capital. 

The financial commitments which initially fueled the firm’s growth, turned into a chokehold as revenues started drying up. Nevertheless, this wouldn’t have happened if the company’s valuation wasn’t determined at the bullwhip’s peak (i.e., based on revenues that the firm has very little to do with) and the firm needed a cash infusion at the bottom of the bullwhip where the revenues are lower than expected (again, something the firm couldn’t be completely blamed for). 

In retrospect, the oscillation of supply chain pressures during and post-pandemic underscored the inherent volatility in the logistics and freight sector. Startups like Convoy, albeit with robust tech-driven models, found themselves ensnared in the broader market dynamics that transcend technological disruption. The pullback of venture capital is perhaps a somber acknowledgment of the resilient nature of traditional industries like freight and logistics, which, as the tale of Convoy unveils, demand more than just a tech-driven overhaul to navigate the vicissitudes inherent in the supply chain.

In conclusion, Convoy’s story is a heads-up for startups diving into the old-school freight and supply chain worlds. The pandemic’s chaos, along with market shifts, highlight a road filled with both big chances and unexpected challenges. It’s crucial to blend fresh ideas with a solid grasp of the existing market vibes to make a lasting splash in these traditional, cash-heavy industries, where who you know can be a big deal. And as Convoy shows, missing the mark on this balance can lead to a rough ride.