Wednesday, April 17, 2019

How To Set A Balance Of User Growth Vs Profitability

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A question that I still hear debated often is whether a new startup growth strategy should focus on user count or profits. First of all, the glory days of “dot.coms” are gone, when investors “didn’t care” about profitability, and all the big money was focused on user count growth.

In the long run, everyone wants both profitability and user growth, but the question is which comes first. Most startups and investors I know don’t have unlimited funds, so the first question they should ask and do ask today, is “When is your company going to be profitable (self-sustaining)?”

Of course, growth is implied in that equation, and is also required for maintaining a sustainable competitive advantage. The challenge is not to undermine growth by a blind focus on profits. You might sell one of two of your widgets for $1 million each, entering profitability immediately, but then die because you can’t grow sales at that price.

I think you will find that most investors will relate to the following strategy for keeping the right perspective and getting the profit versus growth balance right:
  1. Pick an idea that has the potential to make money. That means it solves a real problem for real customers who are ready and able to spend real money. The number of current potential customers is large and growing. Solutions that may be viewed as “nice to have” or “satisfies a higher-level need” won’t get funded.

  2. Design a product or service that you can sell. Sure, you may need to give the product away for free to get traction, but assume you will have to sell something someday to get profitable and stay alive. MySpace, for example, launched in 2003 and boomed for five years without a revenue model. When their deep pockets went empty, Facebook stepped in, but demanded revenue from ads. MySpace wasn’t ready for this, and it soon faded. Don’t count on finding investors supporting growth alone on your new startup.

  3. Build a business plan for profitability in your lifetime. This simply means you need to be sensitive to costs, revenue projections, and a timeline, such that there is light at the end of the tunnel. Most Internet businesses should show profitability in two years, while new medicines may take ten years to pass FDA and other safety tests. Investors will look at competitors in your industry for the norms.

  4. Identify the total investment required for profitability. A very common mistake of early stage startups is to request a small investment to get started. They are usually thinking only of costs required to get “in business,” rather than the total costs of marketing, scaling up, and going international. Be ready to answer the investor question “Is that all you need to get profitable?”
So unless you are building a non-profit, I say focus on profit all the time, every time. Of course, growth is implied in every focus, and profit enables growth. But some of you will surely say “What about Facebook and Snapchat, who focused on growth first and are clearly successful?” So let’s take a look.

Facebook is indeed the largest growth site on the web, with well over two billion user accounts, all free. Yet it took almost six years to become profitable, with revenue only from advertising. What most people don’t realize is that the total outside funding to get it there is estimated at over $800 million, which is a bit more than you will get from any angel investor.

Yet I can’t argue their success in the value proposition, since they turned down a billion dollar offer from Yahoo way back in 2006, and their market cap today is around $400 billion. It has taken some very deep pockets to get to this point, so now you know why I smile when you tell me your plan emulates the Facebook model. Even Snapchat is now trying hard to generate revenue.

I’ve heard all the arguments that a push for early profits on new business models will lead a company to fall back to a lesser model that provides short-term results, but short-circuits risk-taking that could lead to more long-term value creation. That’s a great argument if you have unlimited funding, but if you are just one of the “rest of us,” I suggest you focus on getting to cash-flow positive first.

Marty Zwilling
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