Ramnath Iyer, Managing Director, MSCI Inc
The recent furore over startups reneging on their campus offers poses two questions, one if the much touted unicorns are more hype than reality and two why all the bright minds in these organizations could not forecast their people requirements scientifically and why they took the easy path of backing out from offers made in premier campuses. This piece only considers the easier of the two questions and will not attempt the answer if unicorns have any future!
All of us know, most of us have experienced business cycles and some of us learn that an organization growing in revenues and profits perplexingly is not the same as the organization doing well. This is explained better by understanding how business cycles work; when an organization experiences increased demand for their products/services, they start expanding to meet the spurt in demand. The expansion shows up as increase in investment, production, number of staff, amount of sales and profits. With increase in sales and profits also come higher salaries and employee benefits. All organizations in the industry gear up to meet demand and each of them assumes a certain market share, often more than the current share when planning their capacity increase and when the business cycle turns, the same organizations scramble to re-purpose the capacity or reduce costs and increase productivity.
For startups however business cycles don’t apply initially and the reasons for this are many; startups are typically disruptive and create a market instead of occupying an existing market, their primary differentiator is innovation and the demand itself grows exponentially instead of a linear growth seen in mature market segments. The initial startup (7-10 years) business cycle (graphic from startupcommons.org) is all about establishing a niche, creating customer loyalty and scaling to meet market demand and they are used to burning a lot of cash while doing all of the above and seldom are they accountable for traditional business metrics of percent margins, EPS, dividends, etc. during this time.
This is where the complexities begin; as soon as a startup proves a concept and establishes a market, it opens doors for competition. Often today competition is not with other startups but with established giants who in the past have been caught napping and had to answer a lot of uncomfortable questions or with international players from which the startup had initially borrowed the idea.
When organizations with deep pockets and staying power enter the market, the startups which have become touted Unicorns suddenly experience unprecedented levels of competition and their forecasts start to go haywire. With the tumbling forecasts come tumbling valuations and the investors begin to mark down their investments and simultaneously ask the management in the Unicorns to show more accountability and do everything to meet their business plans, leading to knee jerk cost control measures.
These cost control measures manifest in the form of high profile management exits, delays in on-boarding expensive talent, slashing of ad/promotion spends and reduction in discounts/increase in platform fees.
In summary, startups in the scale up phase seldom expect competition and business cycle to hit them simultaneously and when it happens the outcomes are unpleasant to all stakeholders and to address this reality they need to institute the following in their scale up phase:
1. A strong financial control function that seeks a justification of every $ spent and evaluates the cost benefits before approving spends
2. Market and competitor assessment function that reports directly to the CEO and is tasked by the board to provide an independent and pragmatic view on market developments
3. Operations that can scale without increasing fixed costs, even if it means the operating costs are marginally higher
4. A customer base that is brand+service and not discount loyal
Some of the above steps will curb the unjustified euphoria and ensure that the startup scales its business entirely on market fundamentals instead of perceptions and easy availability of funding and in the bargain prevent many stakeholders from myriad disappointments.