A business conceived at launch with negative economics accepted as fait accompli will struggle to reach profitability
India’s start-up ecosystem, comprising founders, investors and experienced start-up professionals, has lived through multiple phases in its journey. It has seen the euphoria of high growth and rising valuations. It has also battled the challenges of high cash burn and funding squeeze.
Through all this, a fundamental question has shaped up—should start-ups focus on rapid growth through increasing scale, or should they pursue profitability through a steady focus on unit economics? While there cannot be a universal answer to this, it is apparent that growth and profitability are not necessarily an either-or choice.
In the early days of a start-up, the unit economics is sub-optimal, with inefficiencies in sourcing, marketing and supply chain. But it is in these early days that the founding team needs to set the guardrails of unit economics. The founders must have the intent and a plan to get to the correct unit economics in the first year itself, even if the progress is incomplete. It becomes exponentially more challenging to fix it later on—it requires reorienting strategy, cutting scale and, to a significant extent, changing the company’s business model.
A business conceived at launch with negative economics accepted as fait accompli will struggle to reach profitability. A start-up may hope that, with scale, the unit economics will improve. While it does, it does not improve dramatically. It is rare to see a 10% gross margin business become a 50% gross margin business without structural changes.
I emphasise the timing of this because the business’s trajectory is set at launch in the same way that it is set for a rocket at launch. A few degrees off at launch will quickly translate into a wide departure from the intended target. It is the difference between arriving at the destination, drifting in space or blowing up.
Negative unit economics persisting or ignored beyond the formative period indicates a deeper malaise. The most likely reason for unfavourable unit economics is the lack of a product-market fit. If a business loses money every time it serves its customers, it is de facto paying its customers to buy its product.
By continuing to accept these losses, the business is postponing addressing the underlying issues. As the scale grows, so will the losses. It is a problem that time will aggravate, not solve.
An unresolved product-market fit, and the urgency to pursue growth regardless, is the path to ever-increasing losses. It is the path that founding teams choose, propelled by their desire to gain market share quickly, outpace competition or meet the implicit or explicit operating or financial milestones defined by the investors.
Negative unit economics leads to high burn and the need to raise more funds to fill the shortfall. It leads to more dilution for the founders and investors. Most importantly, it introduces existential risk.
It is never too early to pay attention to unit economics. In fixing these, the founding team will get to address many core issues about what kind of business it aims to build, what kind of cost structure its business can afford and how to align its business proposition with user needs.
Burn less, raise less: because there is no sight to profitability, businesses tend to raise more money than they need. Raising large sums of money to fund a large quantum of losses is a high cost to pay for both founders and investors. It leads to excess dilution for both.
Focus is the key to solving issues that matter. How the business can improve its unit economics is a problem that is hard to comprehend in a rapidly growing business. The possible solutions seem too remote, too hard and implausible. Finding and staying with the issue of embedding good unit economics is the starting point for success. Staying focused on one problem enables a business to understand user needs deeply and build moats that competition cannot hope to emulate. It is better to build one good, profitable business that meets user needs well than multiple businesses, all losing money in their constant attempt to discern customer needs and how to deliver the same.
Consistency and rhythm are integral to success. A successful start-up determines its own rhythm and does not always react to what others are doing at various points in time. Indian start-ups like Nykaa, FirstCry, Lenskart and Urban Company are great examples of building with clarity and conviction. Building a start-up is akin to running a 10,000-metre race—you need your own style, consistency and rhythm. If you try and complete the race in a series of 100-metre sprints, a few 500-metre accelerations and some slow plods, success will be hard and improbable.
In summary, start-ups do not need to choose between growth and profitability. An excellent way to start is to identify a part of the market that is underserved and build for that with good economics from the earliest stage. Unit economics as an afterthought or when pushed to the wall makes for difficult choices and painful execution. Quick accelerations and crawls have the same outcomes.
With the right unit economics, time becomes an ally. A start-up building with positive unit economics will accelerate later, but it would have built a solid foundation to support that growth. Founders need to set realistic time expectations to reach milestones and align on the same with their investors.
A start-up is not a race against time. It is running with technique, rhythm and stamina. A well-paced journey has greater chances of success and gives you (and everybody around you) the pleasure of enjoying the build-up, the steady pace and the acceleration.
The author is the co-founder of Titan Capital and Snapdeal