The headlines have been rough for growth startups in recent months (insert link about WeWork).
It has been particularly challenging for growth startups and their investors looking to take their company public. For what were once the darlings of the investment, tech and media worlds, suddenly the music has started to slow, if not stopped (see Postmates).
In some ways we’ve now reached a peak when you have a twitter battle between a prominent investor and a professor on the merits of these companies’ existence and prospects of survival. It turned ugly (or entertaining depending on your seats) when they started to make wagers online to show “skin in the game”.
No, this post isn’t a takedown of VCs, WeWork, or any other VC-backed growth company.
What is rising from these debates is something more subtle and important – a discussion about how businesses are grown and their pathway to profitability or the “P-word”. (Sorry, I know many were expecting me to say pricing, but we’ll get to that)
Let’s go over how we got here and what to consider when thinking about the profitability question for your business.
How Did We Get Here?
A big part of the current debate has been around the strength of high-growth companies as a business. The concerns raised ranges from corporate governance, culture, business model and, yes, profitability (or any hope for profitability).
Many of these companies such as WeWork has through capital by investors with a “grow at all costs” strategy. Through this strategy many business fundamentals have fallen by the wayside. Greater scrutiny of how companies have developed as a commercial enterprise, beneath the veneer of technology, innovation or disruption – has been a deeper look into how, if ever, their business model will enable the company to ever make a profit.
For anyone following how these high-growth startups that did make the leap in the public markets by IPOing has not fared as well as they did in the private markets led by venture capitalists. The price the public market is willing to pay has differed considerably to the private markets. The exception appearing to be those companies with lower profiles but are profitable.
Despite all the bad rap many VCs and investors have been getting as of late, not all use the same strategies. Many are equal-parts about innovation, growth and basic business fundamentals.
Why is Profitability Important?
Profitability or at least the pathway to profitability asks some fundamental questions about the company. It looks at how the company is run, and will be run into the future. It’s not just about managing costs, but how equipped (and aware) the company is to capture and defend revenue growth opportunities.
Pathway to profitability of course looks at price. Many of these companies operate in highly competitive markets with new competitors emerging. To combat this competitive environment, many entrepreneurs engage in unsound business practices such as price cuts and discounts to acquire customers. This possible because investors are willing to subsidize them and this strategy. Unfortunately, the reality is this is not a sustainable strategy to keep customers.
Evaluating the pathway to profitability raises fundamental questions about any business, and whether the business model actually works. It is is incredibly insightful into not only the current state but also where the company will go. That’s why the question around profitability is so helpful when evaluating a business and its leadership.
Ways To Consider The Profitability Question Properly
Consideration #1: Remember, it is your choice, as the founder/entrepreneur, on how you want your business to grow.
There are tradeoffs for any decision you make as a business leader. Being aware of how you want your business to grow will define the commercial strategy you pursue. This will define what pathway, if any, to profitability your company will or will not have.
For those who believe you can not achieve unicorn scale and be profitable look at the incumbent in WeWork’s market – IWG. It’s possible, but it takes leadership to steer the ship in that direction.
If you are raising capital, this why the best investors always recommend founders to do as much due diligence on the investors they are seeking funding from. Everyone has their own definition of growth and success so understanding and making an informed decision is critical.
All this requires asking yourself the hard questions. This is both empowering and frightening at the same time. Many entrepreneurs are stuck in a chicken or the egg game, where they need capital to launch or grow, but may want to grow more slow and steady.
Consideration # 2: You need to build the right business model for a pathway to profitability.
There is no cutting corners on the building the right business model. It takes research and rigor to determine what model will best position your company for growth and profitability.
One of the most common realization companies face early and often is most customers don’t want to buy their product. This is usually a product of the data they are collecting, but more importantly the data they are not collecting.
To make better decisions on the business model, this means collecting the right information about the right customers. You need to know what elements of your product is delivering the most value that customers are willing to pay for. You need to know what is not working in your business model, and what to build (or not) build to achieve the optimal value exchange (you give them your product, and they pay you for it).
When you are not looking at the right customers, they are making you focus on the wrong things. So when you do invest in marketing or branding, you are making a decision on two unrelated things; which can be a costly exercise.
Consideration # 3: Pricing matters.
When most founders think about profitability they look at two big metrics – revenue and cost. Except when they think about that revenue figure they only see one side – volume.
It is often taken for granted that revenue is made up of volume AND price. This means there are two powerful levers companies can use to influence revenue and therefore your pathway to profitability.
In a survey we conducted of more than 100 startups from pre-seed to growth stage (Series C and later), only 31% were highly confident their prices reflected their customer’s willingness to pay for their product. In the same survey, more than 45% stated they were unsure whether their customers are willing to pay more for their product.
This is a lost opportunity for companies looking to build or accelerate their pathway to profitability. But it still remains one critical thing they can do today to change course.
Consideration # 4: It’s harder (and more expensive) to create profitability using a model not designed for it.
The challenge to pivoting towards a profitability mindset is both structural and psychological. The structural challenge is that the team and the way of growing has increasingly been engrained in the way of working. Targets and incentives have been designed around this.
When the goal has been to grow month-on-month 100%, but due to a shift in the business model or go-to-market strategy, growth “slows” to 70%. Is that bad? How does the team and stakeholders react?
That’s when the psychological forces kick-in. As founder and CEO of Bird – the unicorn scooter startup – Travis VanderZanden says, “I’m an ex-growth guy, and sometimes it’s painful for me”.
Profitability is slower and at times, feels like more work. It’s easier to find ways to fill all the seats in a restaurant, until you realize you made no profit and have no money to pay your suppliers and staff. In the long run, the work to install earlier components for profitability will pay off.
Consideration # 5: Creating (and achieving) a pathway to profitability creates a buffer to any economic downturn.
It goes without saying that when your company makes money – profit – it will put you in an enviable position in the event the economy goes south and what was more plentiful capital starts to get harder to come by.
More important, as an entrepreneur, you have the confidence in knowing you have a business model that can self-produce resources (read: money) needed to weather more difficult economic climate.
I recognize that these views may be a less popular perspective. It asks hard questions about the company and the foundation on which it is built (or being built).
Many of these questions have not been answered or attempted to be answered.
But more and more companies are facing the reality that no profits or no reasonable pathway to profitability is a difficult proposition to sell. This is true for startups that have raised billions, as it does to the new startup looking for its first customers and investors.
There is increasing scrutiny to not only the innovation and product you are creating, but scrutiny of ultimately what you are trying to build: a for-profit commercial company.
Profitability does not mean stifling innovation and disruption. Profitability means living another day to disrupt through innovation.
It can be a hard pill to swallow, even for the most innovative and well-capitalized companies such as Dyson. Famous for their vacuums and fans technologies, Dyson has been working on a fully-electric automobile and allocated more than $2 billion for development and production. Yet after building a team of more than 500 employees, Dyson has abandoned the plan because it was not ‘commercially viable’. No one would argue Dyson is not an innovator or disruptor.
While not all components of the business is developed and mature, it does mean the entrepreneur is ultimately responsible for knowing (or getting to the point sooner rather than later) how to build a commercially successful business.
As history has shown, pathway to profitability is one thing that rarely gets turned around in a good way – or without enormous pain – when the foundational pieces are not developed and managed.
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