Part 2 of 7. We look at common reasons startups fail. Case studies are included to provide real-world examples of the insights we discuss. Part 1 on competition can be found here.
Premature scaling is one of the leading causes of startup failures. According to a report published by Startup Genome, premature scaling accounts for 70% percent of all tech startup failures. If your business isn’t growing, it’s dying. But can growing too fast kill your business?
What is premature scaling?
Premature scaling happens when your business expands faster than you or your product is ready for it. Over-hiring, unmanageable customer acquisition and rapid market expansion are common examples of premature scaling. With unmitigated growth, problems are more likely to get swept under the rug and become harder and more costly to fix down the line. This results in technical debt — a serious issue every startup needs to be aware of.
Related: What is technical debt?
There are 5 key dangers of premature scaling that make it such a ruthless startup killer:
1. The customer: We often see startups allocating large sums of money to their marketing budget in an effort to acquire more customers. This is appropriate if the product is ready they have a proven business model. However, spending resources on customer acquisition before finding the correct market is a big mistake. You’ll fail to identify the target customers while dealing with hoards of unqualified, disengaged leads. This creates confusion and kills whatever momentum you might have gained.
2. The product: Another surefire way to fail is selling a product that does not provide any value to customers. Companies try to sell an idea — while their product doesn’t really do anything new or innovative. Established brands can often fall prey to this by attempting to solve stagnation through market expansion. Hastily developed products with little real-world demand. Premature scaling also includes developing additional unnecessary features and investing heavily in the product before the market is ready.
3. The team: The first thing many startups do when they launch is hire more staff. Sometimes they hire specialists and managers when there isn’t even a need for those specific roles. Adding qualified personnel will only help when the demand is serious. To quote Paul Grahm — “If your startup is growing well, but there are some things you can’t do because you don’t have enough people, that’s actually optimal. That’s what it feels like in every great startup.” You should allow your team to reach their limit before adding new members. Hiring in a rush can often lead to lower-quality talent as well. If there’s anything that can make or break your business, it’s the personnel you bring on board.
4. The business model: Startups often focus too heavily on profit, creating their entire business model with the singular goal of maximizing profit. Avoiding feedback and over-planing everything, the mission of the company becomes lost in an effort to squeeze every penny out of customers. Although this alone will not kill a startup, it can prevent a team from recognizing the potential that is hidden by the immediate opportunity for gain. In trying to be all things to all people, no core demographic is ever identified. This prevents a startup from ever reaching maturity with lifetime customers.
5. The funding: Too much, too early. An influx of cash can spell out trouble for undisciplined startups. Raising capital may be necessary for a business, but it can come with the temptation to spend unwisely — often worsening the other four aspects of premature scaling. Throwing money at problems rarely solves them long-term. Don’t expect problems to magically disappear once you have an investment — the added pressure of reporting to investors can negatively push founders further from their core value proposition.
Case study: Groupon
Started in 2008 by Andrew Mason, Groupon allowed users to get discounted goods and services by buying as a group. It pioneered the concept of early adopters by introducing coupons to the Facebook and Twitter generation, becoming known as the “fastest-growing company ever”. It was seeing extreme success. The fact that they had to start a “Groupon addiction hotline” for over-enthusiastic customers puts Groupon’s popularity in perspective.
As they rushed to scale quickly, however, things took a turn for the worse. After filing a very successful IPO in 2011, continual reports of huge losses ($37 million at the start of 2012) drove the share price lower and lower. In just a few months shares dropped from $20 to $9 a piece.
Mason claimed the company was still in its early days, but the truth was Groupon had an unsustainable business model. Groupon’s mistake was prioritizing new customer acquisition instead of customer retention. They had too much money and they didn’t know how to use it. They didn’t innovate or come up with new ideas to retain their customers. They hustled to scale quickly while not dealing with pre-existing issues. They failed to grow the value they provided to customers. Although not dead, today Groupon is hardly the behemoth it once was expected to be.
Case study: Amazon
Amazon was started in 1994 by Jeff Bezos, his wife, and a friend in their garage. They would check orders in the morning, buy the books in the afternoon, and by evening they would pack and ship the books themselves. They grew slowly, focusing on dominating one market, always careful not to scale too quickly.
They understood the importance of staying lean. In fact, some argue they were too prudent in the beginning. During their first Christmas season as a big corporation, Jeff didn’t hire any extra seasonal workers. This turned out to be a mistake as the number of orders skyrocketed. Employees had to work overtime. Some slept in their cars while others called their family to the warehouse’s parking lot so they could see them on Christmas. Having learned his lesson, Bezos vowed to never skimp on seasonal workers again.
Sustainable growth is crucial for any business. A growing company is met with increasing complexity and that brings the increasing risk for disaster. You can maintain a healthy pace by focusing on understanding existing customers before reaching new ones, continually improving the product, hiring quality staff only as needed, not chasing profits before identifying the target market, and raising and spending funds wisely. Although it may sound ideal to move fast and completely dominate an industry, more often than not this leads to an unsustainable pace and ultimately failure.
At SUPERTEAM, we help clients understand the playing field in order to maximize chances for success. If you’ve got a project or idea and need expert consultation to ensure healthy scaling, drop us a line at firstname.lastname@example.org, or visit our website at www.superteam.io