Profit Is Not Always The Point in Start-ups
By TRISOFT team
We are surrounded by startups and if you are not very familiar with the concept, you might imagine a group of hipster guys starting an incredibly innovative business in their basement. But really, this is just the cinematic view of the startups. The startups of reality are quite different from the one you have in mind.
Because startups are business structures that, although small and initially financed and operated by a handful of founders or one individual, are created to solve a problem by delivering a new product or service under conditions of extreme uncertainty. It may sound a bit complicated, but when you talk to long established entrepreneurs and renowned businessmen, you will hear that their definition of startup goes around notions such as culture and mentality one needs in order to build upon innovative ideas and solve critical pain points.
Real startups (not just small companies) offer a product or service that is not currently being offered elsewhere in the market, or that the founders believe is being offered in an inferior manner. They are fast-paced, small and adaptive, and carry a great deal of risks for the participants.
Should Startups Focus on Growth or Profits?
A startup is a company designed to grow fast. Being newly founded does not in itself make a company a startup. Nor is it necessary for a startup to work on technology, or take venture funding, or have some sort of “exit.” The only essential thing is growth. Everything else we associate with startups follows from growth.
This definition belongs to Paul Graham, founder of Y Combinator, who has actually simplified the notion of startup by associating it with growth. And if you look at things from this perspective, you will learn that growth is actually the key in establishing a solid startup.
But that is not all. A perfect balance should always be found between profits & growth. In order to grow in today’s financial circumstances, you need resources. You need to be able to fund growth that may not come for 6 months to a year.
No profits, but worth billions
Shouldn’t All Companies Want to Be Profitable? Not necessarily. Here are 5 well-known companies worth billions despite making no money:
1. Snapchat: At $10 billion, fast-growing Snapchat is one of the world’s most valuable private tech startups. Yet the messaging service generates little revenue — let alone profits.
2. Instagram: Facebook acquired Instagram for $1 billion back in 2012, but analysts say the photo-sharing app is unlikely to be profitable.
3. Zynga: The fact Zynga (ZNGA) is trading roughly 75% below its 2011 IPO price shows just how hard it is to consistently churn out mobile games people actually want to play.
4. Pandora: After its shares skyrocketed in 2013, Pandora (P) has come back to earth as the music company grapples with huge content costs.
5. Zillow and Trulia: Both are huge names in the online house-hunting business and both Zillow (Z) and Trulia (TRLA) are unprofitable.
How do you do it?
Well in order to learn how to do it yourself, you might need to learn about how others do it successfully.
Some recent articles we went through on the topic brought out different approaches taken by emerging Web 2.0 leaders. One focused on social networks and it described how Facebook recently reduced its revenue targets to focus on growing its user base. One board member told BusinessWeek, “If we stopped growing, we could make money, but it makes no sense for us to stop growing.”
On the other hand, leading rival MySpace, which is owned by the News Corp conglomerate, has more of a profit focus. It has a smaller overall audience than Facebook, but a stronger overseas presence and about twice Facebook’s revenues.
Another article, in The New York Times, talked about emerging models in so-called microblogging, where users blast short updates to friends, family, and followers. Twitter has become an industry leader. “If we spent time monetizing early on,” its Chief Executive told the Times, “it would have meant we weren’t doing other things that made the product better for users.”
Rival Yammer, on the other hand, has only 60,000 users. But it has a clear revenue model. It plans to charge corporations who want to use its micro-blogging offering to efficiently distribute internal information or facilitate collaboration. By paying one dollar a month for each authorized user, companies get more security and the ability to control how employees use the system.
So which company is better run?
The answer is that you have no way of knowing. One needs to get passed the naive phase of thinking no profit means ruin, but at the same time take note of the fact that even while losing money, you can be profitable.
It’s true however that cash flow is critical to the survival of a small business, so when managing a startup you will definitely need to handle this aspect carefully.
Profits and cash
Here’s an idea: profits do not necessarily get translated into cash. An entrepreneur can make profits without making any money since the first priority of most startups is to reinvest everything back into the business for growth. There are lots of accounting tricks to make you profitable, but it takes real cash to handle everyday expenses such as payroll, utilities and rent for office space.
Even when the economy is strong, entrepreneurs may find it challenging to secure cash to cover the startup costs. This goes for profitable companies as well. Sometimes they have all their money tied up in assets and aren’t able to pay their expenses. Efficient management of working capital is critical for the business health of all companies.
Experience has shown that the startups who have managed to keep their model asset-lite are the ones who emerge as profitable in a short span of time compared to other ventures.
Why do startups succeed?
So how is it that some manage to be successful and others don’t?
Here are 9 key factors for success we identified in The Ecommerce Genome by Compass in their Startup Genome report, which looked at 650 internet startups:
1. Founders are driven by impact, resulting in passion and commitment
2. Commitment to stay the course and stick with a chosen path
3. Willingness to adjust, but not constantly adjusting
4. Patience and persistence due to the timing mismatch of expectations and reality
5. Willingness to observe, listen and learn
6. Develop the right mentoring relationships
7. Leadership with general and domain specific business knowledge
8. Implementing “Lean Startup” principles: Raising just enough money in a funding round to hit the next set of key milestones
9. Balance of technical and business knowledge, with necessary technical expertise in product development
At TRISOFT, we believe that beyond profit-making and growth, businesses should focus on a third variable: learning that helps them iterate towards a sustainable, scalable business model. Understanding profits is essential, as well as knowing that investors value growth, so proper planning can help establish better control on cash flows and eventually help us reap profits.
The key might be to test and measure what works and what doesn’t, because no strategy works perfectly every time.
The bold entrepreneur launching a startup today should be able to say — If you don’t, somebody else WILL!