Should Your Company Make Money?
Posted on May 22nd, 2018
“ It used to be that in order to survive, businesses had to sell goods or services above cost. But that model is so 20th century. The new way to make it in business is to spend big, grow fast and use Kilimanjaro-size piles of investor cash to subsidize your losses, with a plan to become profitable somewhere down the road.” From The Entire Economy Is MoviePass Now
There are a few reasons that people initially run their business like this.
- The business depends on the Network Effect. Social networks are the epitome of this. They have more value the more people are using them. If the business requires a large network to be valuable, then growing the network will be targeted, even if it means running a loss in the meantime.
- The business is focused on long-term growth and management is willing to invest the profits into growing the business: Strategic Reinvestment. A good example here is Amazon. This model can be sustainable, but will have lots of detractors if the company is public or has anxious private investors.
- The business is engaged in a more nefarious version of the above, called Dumping. Stereotypical examples of this are when Walmart enters a new market or how Uber has planned to dominate ride-hailing before massive movement to driverless technology. With dumping, the business is willing to take great short term losses to establish a monopoly.
- Investor Storytime, where a startup doesn’t really have a solid business value, but relies on marketing to investors to generate funding or buyout.
The first two cases (Network Effect and Strategic Reinvestment) are arguably solid business choices in many cases. The latter two (Dumping and Investor Storytime) are clearly problematic. Understandably, the line between Dumping and Strategic Reinvestment can be gray and unclear. People engaging in Dumping and Investor Storytime take advantage of this confusion and will often disguise their motives as pursuing Network Effect or Strategic Reinvestment.
What seems to be happening is that we have a growing fraction of businesses, especially in venture capital and especially in Silicon Valley, that are engaging in these fraudulent growth models. We have to learn to detect the bullshit and divest from these businesses.