It is myth that to generate supernormal profits, a start-up needs to start generating revenue early. That’s often far from the truth.
Investors And VCs Were Attracted To Start-Ups With Early Revenue
A lot of investors and VCs are attracted to start-ups with strong early revenue, which seems great, because the first step to profitability is revenue right?
Well, not necessarily.
If you really look at the companies that end up generating supernormal profits with really high margins, you will realise that a lot of them do not generate any significant revenue during the first few years of their lives.
The first few years of their lives is spent iterating and trying to solve a problem so well that they solve it thoroughly and become the best at solving it, like Facebook and Google.
Maybe It Is Because Early Revenue Makes Them Easier To Value
Perhaps, having early revenue makes it easier for investors to value a start-up so they can put a dollar sign to it, but that doesn’t mean a start-up that doesn’t generate any revenue today won’t make tons of it in a few years.
It’s like building a shopping mall, you will have to spend the first few years constructing the mall and investing tons of capital without generating any revenue before you can rent out the retail space once the mall is completed.
Some businesses work that way.
Big Mistake — Early Revenue Is NOT A SIGN of Future Profitability
If you think that early revenue is a sure sign of future profitability, that’s a big mistake.
Sometimes, those that don’t make any revenue at the start are the ones that end up making the most profit, and the ones that make the most revenue at the start are the ones that end up being huge money losers.
Just Look At WeWork And Uber
A big part of what made investors attracted to WeWork and Uber in the early days is their tremendous growth in revenue, but that doesn’t mean that they would make hugely profitable companies.
As they are right now, they are losing money on each sale, and their business models at it is right now isn’t going to be very profitable due to the low margins and the need to pay the middle man and having a heavy physical aspect.
They could become very profitable if self-driving cars ever become a regulated reality and if WeWork could figure out how to generate significant value from its community, but that’s a story for another day and would probably take a long time for us to get there.
Zero Early Revenue Is NOT A Bad Sign
The point I am trying to make here is that having zero early revenue is not necessarily a bad sign. It varies from business to business.
Just Look At Google — Facebook — Instagram
Plenty of companies that did not generate any revenue for the first few years of its life end up printing money and generate huge profits once everyone in the world is using them everyday, just like Google, Facebook and Instagram.
To be fair, if you are in a mature market like Silicon Valley, it is possible to make some small money once you have an MVP. Facebook did make a little money from Microsoft’s experimental budget running simple ads, but it wasn’t significant. You still had to spend a lot more to truly build out your product before you can really start making money.
Losing Money On Each Transaction Is Much WORSE Than Zero Early Revenue
If you really think about it, having to lose money on each transaction is a much worse situation to be in than having zero early revenue.
Having a tiny profit margin on each unit sold is also not a very good sign, because any small fluctuation in the costs of running the business or demand would turn a profitable business into a money losing one in an instant, that’s why conventional businesses are mostly not valued very highly.
Most Super Profitable Companies Had ZERO EARLY REVENUE
The weird thing is, most super profitable companies in the world like Google and Facebook had zero or close to zero early revenue during their early days.
It goes against conventional wisdom, but that’s the truth and is part of what makes such companies so disruptive.
They Key Is To SOLVE A GLOBAL PROBLEM + Build Something Everyone Uses Daily
The key to building super profitable companies in the long run is actually pretty simple, and that’s to solve a big enough global problem, be the best in the world at solving it and build a solution so good that everyone uses daily.
If you are solving a real problem and providing real value, it’s hard not to make money.
Make Sure It Is Truly Scalable + A Real Tech Company + No Heavy Physical Aspect
But of course, you also have to make sure that your solution is truly scalable, a real tech company with real innovations and does not rely on a strong physical presence, because a heavy physical aspect to your business or solution makes you more of a conventional business than a truly scalable tech company.
If your business is a hardware tech company like Apple, then you will have to make sure that you also have extremely strong Intellectual Property (IP) in your hardware and have built a cult-like ecosystem to lock your consumers in.
Invest In The Right Start-Ups — Long Term Profitability — NOT Early Revenue
The truth is, a start-up does not need to generate revenue from the start to be super profitable in the long run, many of the world’s super profitable companies had no revenue in the beginning.
Investors need to realise this.
If you want to invest in super profitable companies in the long run, don’t be blinded by early revenue, it is often misleading.
Instead, invest in the right start-ups that are dead focused on solving a big enough global problem and are led by founders and teams who have the vision and grit needed to solve that problem thoroughly so everyone in this world would be using their solution daily.
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