The $16t blind spot VCs ignored for decades

This article summarizes an episode of Sourcery with Molly O’shea’s video series featuring Marc Bhargava, managing director at General Catalyst.

Marc Bhargava, managing director at General Catalyst / Photo credit: Sourcery with Molly O’Shea

Marc Bhargava, managing director at General Catalyst, argues that traditional service companies are the next big opportunity for investors. His plan turns these businesses into companies that make a lot of profit and grow steadily. This goes against the typical investment focus on software and private equity.

The overlooked services economy

The venture capital industry has generally overlooked service businesses. These companies often report lower profit margins, making them less appealing to investors compared to software firms that can grow more easily.

A US$16 trillion blind spot
The math seems simple. A market worth trillions should attract significant investment. But for decades, VCs have avoided service companies. They preferred to invest in software, which makes more profit and can grow quickly.

Bhargava explains, “We think services industries globally [are a] US$16 trillion opportunity. On the software side, software globally is like a US$1 trillion opportunity. So, it is 16 times larger. Well, why hasn’t everyone in VC rushed to invest in services businesses? They historically have not been that profitable.”

The profitability puzzle
The main challenge is labor. Service companies usually require many people, and human work is harder to replicate than code. This has always limited the profits of service companies, making it difficult to achieve the large returns that VCs expect.

Bhargava notes, “Our thesis is that these unsexy services industries that were break-even or [had] 15% to 20% EBITDA margins… can look like software from a margin profile. Once you take out 30%, 40%, or 50% of what people do and free them up… your margin profile now looks much more similar to software.”

The automation threshold

These higher profits are only possible with AI. General Catalyst discovered four types of work that AI can already automate effectively.

From abstract tech to concrete tasks
The firm’s plan isn’t based on assumptions about what AI could do. It is based on a detailed review of what today’s AI can actually do. The team started by breaking down what AI can do in general into specific business tasks it can handle automatically.

Bhargava says, “We were able to figure that out by first saying, ‘What can AI automate?’ One was customer success and support. A second was data entry and evaluation. A third was creating content and copy. And then a fourth bucket… is basic logic and reasoning.”

The automation sweet spot
Too little automation doesn’t increase profits enough, while too much gets rid of the human service part that gives the company an advantage.

“One thing we’re careful about in the AI-enabled roll-ups,” Bhargava argues, “is we target 30% automation at least, but we actually don’t want more than 70% automation. If something is approaching 80, 90, or 100% automation, then there’s really not the people-services part of it.”

The AI roll-up playbook

This ability to automate work needed a new plan to make it happen. General Catalyst designed a process with several steps to start, test, and grow these new companies.

A rejection of private equity

The new workforce dynamic