Unit Economics vs Growth
Welcome to the metaverse. After spending some time living and working in the metaverse, you decide to start a company. At some point you would have to make a resource allocation decision between focusing on Unit Economics or Growth — this is an important decision as it could have long or short term implications for your business.
This article would be geared mostly towards small businesses and/or startups — whatever the difference is.
To get grounded, we should understand what Unit Economics and Growth actually mean.
Unit Economics
Unit Economics describes a specific business model’s revenues and costs in relation to an individual unit, these units are then analyzed to determine how much profit or loss they individually produce. Unit economics could be positive or negative, this piece is going to focus on positive unit economics especially profit.
Some common measures of Unit Economics in business include Gross Profit, Total Revenue, and Lifetime Value.
Positive Unit Economics means a business is making more money per unit/customer than the unit costs to produce/acquire. Generally, a business achieving Positive Unit Economics shows that its business model is working.
Unit economics is instrumental in evaluating the economic sustainability and profitability of your business model. It provides insights into whether your business is generating sufficient value to justify the associated costs.
Growth
Growth for the most part means “it go up”
On a more serious note, Growth in a business refers to the increase in a company’s size, revenue, market share, and profitability over time— this in itself is a noble pursuit.
The pursuit of growth reaches its logical extreme when there is a Growth at all costs mentality. This mindset usually entails aggressively spending your resources to grow (most likely exponentially) a particular metric or a bunch of ‘em. the chosen metrics could be users, subscribers, sales etc. at the expense of profitability/ Positive Unit Economics. Hyper-focusing on growth is not necessarily evil. The goal is to achieve network or scale economies, which reduce unit costs or customer acquisition costs over time and increase the chances of profitability as a result of the increased volume.
While Positive Unit Economics and aggressive growth may seem mutually exclusive, a company can achieve both simultaneously. However, in most cases, companies tend to focus on one of the two at a certain period.
At a basic level, there are two goals investors have when they put money into a company: growth and profitability. — Clayton Christensen, How Will You Measure Your Life?
I hope you appreciate the flair in how I redirected the conversation from Unit Economics vs Growth to Positive Unit Economics vs Aggressive Growth. Talk about character development. Readers Delight!
Positive Unit Economics vs Growth at All Costs
As the founder of our beloved metaverse startup, If you had to choose between these two, which one would you pursue?
To be honest. When I started writing this piece, I was pretty convinced that pursuing Positive Unit Economics from the start was the way to go. In the process, I noticed a book on my nightstand — The Cold Start Problem by Andrew Chen. I remembered this book was all about Network Effects and I decided to dig in, I am happy I did because it has changed the direction of this piece. This is why it is very important to openly enage with an opposing point of view as it leads to more nuance on issues and an opportunity to rethink your stance on things.
Not sure how much the conclusion would be different but definitely a new path followed.
“Yes, of course you eventually want to figure profitability out. But for networked products, in the earliest stages, sometimes it makes sense to spend — often wildly — to pay up for growth. The goal is to get the market to hit the Tipping Point, driving toward strong positive network effects, and then pull back the subsidies. The result, if executed properly should be a fast-growing, high-monetization product” — Andrew Chen, The Cold Start Problem
My interpretation of the quote above is that, for some companies, especially those that rely on network effects (e.g., social media and marketplace businesses), it might make the most sense to burn more money than is made in the beginning to be able to subsidize the network effects, which would ultimately lead to positive unit economics. This is especially important in the world of web 2.0 where the way to win is to have the strongest network effects on your platform in order to lock in users/customers in your given sector, enabling you to extract close to maximum value from that user/customer base.
On a side note, these platform/user dynamics are undoubtedly fascinating, and I strongly believe that users should capture a larger share of the value within these networked products. This, in my opinion, is one of the major shortcomings of web 2.0, which is why I am a big advocate for web3, blockchain, and crypto. However, that discussion is better suited for another piece.
How can aggresive growth be used to fund network effects?
Aggressive growth strategies can effectively fund the development of network effects. This is achieved through various financial incentives offered to potential customers, such as subsidies and advances. For instance, platforms like Venmo have offered monetary incentives to recruit new users, while companies like Uber initially paid drivers $30 per hour to keep the app on, regardless of whether they were actively driving or not. This approach involves prioritizing growth spending, even at the expense of short-term unit economics, to gain market share or establish a presence in a particular industry. Once the product or service gains sufficient traction and market dominance is achieved, the incentives can be gradually reduced. While this may lead to short-term unprofitability, it sets the foundation for long-term market dominance and the potential for profitability.
However, for aggressive growers, especially those focused on network effects, long-term sustainability and survival necessitates a pivot or the discovery of a new business model that ensures positive unit economics. Network effects of course are a lot more than spending aggresively on growth. Apart from growth spending, network effects can be kicked up by building great features, For more on that I would highly recommend The Cold Start Problem.
Considering the logical reasoning behind network effects and the temptation to prioritize spending for growth at all costs, I still hold the belief that, in general, businesses are better served by prioritizing positive unit economics over chasing growth at all costs.
Why prioritize Unit Economics over Growth at all costs?
This section would not only talk about how focusing on unit economics is positive but also some of the perils of the growth at all costs mindset.
Founders who can tune out the latest tweet cycle on what is needed for a Series A and can, instead, focus on the nature of their own business will find that product market fit is more predictable and therefore discoverable. On the other hand, founders who focus first on growth without knowing the basic ingredients of their minimum viable company are more likely to fuel an addictive and destructive cycle around fake growth of their business. Ann Miura-Ko — True Product Market Fit is a Minimum Viable Company, Ann-Miura Ko
Just like the best houses are constructed upon a strong foundation, the same principle applies to building a sustainable and value-driven business. To establish long-term success, it is advisable to prioritize the development of a healthy foundation with positive unit economics. By focusing on profitability and ensuring that the core business model is economically viable, you can create a sturdy base from which to grow and expand your business with confidence. This approach leads to a more durable business, capable of withstanding challenges and thriving in the long term.
This mindset not only sets the stage for long-term success but also provides the optionality to prioritize your product, user/customer engagement, and overall experience over immediate revenue growth. By building a solid foundation with positive unit economics, you can afford to invest in enhancing your product, fostering meaningful interactions with your users/customers, and delivering exceptional experiences. This approach enables you to cultivate strong relationships, drive loyalty, and ultimately create sustainable growth based on a solid and engaged customer base, while retaining the flexibility to make strategic choices that align with the specific needs and opportunities within your industry.
Moreover, prioritizing unit economics also offers the advantage of building cash flow. In uncertain times, such as inflationary periods, an asset or intangibles-based valuation may not be defensible. However, having a strong cash position becomes crucial. Cash acts as the king in protecting the value of your business during inflationary times, providing stability and flexibility to navigate economic challenges. By focusing on positive unit economics, you can generate and preserve cash flow, safeguarding the value of your business and ensuring its resilience in the face of external pressures.
By combining the principles of prioritizing unit economics, fostering customer-centric growth, and maintaining a strong cash position, you establish a solid foundation for long-term success, protect the value of your business in uncertain times, and position yourself to thrive in a rapidly evolving business landscape.
Focusing on growth at all costs can’t be that bad right?
It is important to be mindful of the perils associated with the growth at all costs mindset, particularly for entrepreneurs. When prioritizing excessive spending on growth at the expense of profitability, entrepreneurs may find themselves trapped in a constant cycle of needing to raise funds. This heavy reliance on frequent fundraising can lead to a situation where entrepreneurs become essentially beholden to their investors, jeopardizing their independence and control over the business. As a result, decision-making and strategic choices may be swayed by the demands and expectations of investors, ultimately impeding the ability to steer the business towards long-term sustainability.
In addition, the excessive focus on growth can also have adverse effects on ownership. With the constant need for capital injections, entrepreneurs may find themselves spending more time and effort on fundraising rather than building and owning their business. This can result in a dilution of ownership stakes, where entrepreneurs end up owning less of the business as more investors come on board. As a consequence, the potential benefits and rewards of building a successful venture may be diminished.
Therefore, while growth is essential for business success, it is vital to strike a balance and consider the long-term implications. By prioritizing positive unit economics and sustainable profitability, entrepreneurs can foster a solid foundation that allows for organic growth and maintains control over the direction and ownership of their business.
The constant pursuit of growth can indeed have unintended consequences that can negatively impact consumers. A prime example of this is evident in the growth at all costs approach adopted by many social media platforms. These platforms, driven by the need to capture and retain users’ attention as a form of currency, have implemented algorithms that prioritize engagement at any expense. Unfortunately, this has resulted in several societal harms.
One consequence of this relentless pursuit of attention is the phenomenon of radicalization. Algorithms designed to maximize user engagement may inadvertently feed users with increasingly extreme and polarizing content. By tailoring content to reinforce existing beliefs and preferences, individuals can find themselves trapped in echo chambers that perpetuate their biases, leading to further division and polarization in society.
Additionally, the constant exposure to carefully curated highlight reels and idealized images on social media can contribute to lower self-esteem and feelings of inadequacy. The relentless pursuit of likes, comments, and followers can create a toxic comparison culture, where individuals constantly compare their lives to the carefully crafted personas of others. This can result in diminished self-worth, increased anxiety, and a distorted perception of reality.
The growth at all costs mentality was predominantly fueled by the Zero interest-rate policy (ZIRP) business cycle, which prevailed during a period of historically low interest rates. This environment incentivized outsized risk-taking as investors, hungry for higher yields beyond treasuries, eagerly pursued investment opportunities. Companies, benefiting from the availability of cheap capital, embraced the option to allocate significant funds towards growth initiatives, prioritizing expansion over immediate profitability.
However, the economic landscape has since undergone notable changes. As interest rates have shifted and the investment climate evolved, the dynamics of risk and return have transformed. Companies today face a different set of considerations, with an increased emphasis on sustainability, profitability, and efficient resource allocation. This shift highlights the need for businesses to reassess their strategies and strike a balance between growth aspirations and achieving positive unit economics in order to thrive in the current economic environment.
While the previous market regime rewarded growth at any cost, the message to companies has now taken a u-turn. Our advice to founders: profits and cash flows matter again, and growth must be balanced with attractive margins to create sustainable business models that will endure the test of time. — Chamath Palihapitiya, Social Capital 2022 Annual Letter
In conclusion, building a sustainable and value-driven business requires prioritizing the development of a healthy foundation with positive unit economics. By focusing on profitability, cultivating strong customer relationships, and investing in exceptional experiences, entrepreneurs can create a solid base for long-term success. However, the journey does not end there. It is crucial for businesses to remain adaptable and responsive to evolving market dynamics. As industries continue to evolve and new challenges arise, entrepreneurs must embrace a mindset of continuous evaluation, innovation, and adaptation. By striking a balance between growth and sustainable profitability, entrepreneurs can navigate the ever-changing landscape with confidence and resilience.
Let us remember that positive unit economics not only provides a path to profitability and cash flow but also safeguards the value of our businesses during inflationary times. As cash becomes king, maintaining a strong financial position can provide a competitive advantage and ensure stability in the face of economic uncertainties. Therefore, let us remain vigilant, consistently evaluating our business models, optimizing our strategies, and seizing opportunities that align with our long-term goals.
In embracing these principles and committing to a balanced approach, we can forge a new era of entrepreneurship — one that prioritizes sustainable growth, customer value, and lasting success. Together, let us build businesses that not only thrive in the present but also leave a positive impact on future generations.
Thanks for reading. Cheers!
