The growth phase of a startup is a unique time in a company’s development for many reasons. There is one particular element that has fascinated me recently that I would like to expose. Those who play poker will be familiar with the phrase being “pot-committed”. This is a time in a poker hand where you have already committed enough of your chips to a hand via previous bets or calls that it’s almost always worth staying with the hand to the end, even if you don’t think you’ll win. The reason is that the chance of spending a little more to win this entire pot is still more attractive than saving what little more you need to bet to stay in a hand and losing everything you have committed (plus the other players’ chips they have committed) and losing for sure.
Why am I talking about poker? Well, startups in their growth phase can create this same sort of scenario, especially if they’ve raised a healthy amount of capital. If a startup, while it is growing and not profitable, implements a strategy that is difficult and requires a lot of resources (either financially or personnel-wise) at this time i.e. a strategy that is likely not a profitable one, when the startup develops into a more mature, profitable business, most of the work has been done on this unprofitable strategy, and the cost to maintain it is much lower. The strategy has a much more likely chance to endure compared to starting the strategy later on when profitability is a concern.
Startups do this all the time with marketing spend, but not near as much with overall business strategy. Say, for example Groupon a few years ago. They bought almost every display and search ad a company can buy during that time. They knew it was unprofitable, but didn’t care because the goal was faster growth at any cost to outrun competitors. What’s an even smarter strategy is committing to an internal process that creates a superior product. Take Airbnb’s practice of sending digital photographers to every listing to get high quality photos. Airbnb knows high quality photos improve conversion rate and create a better product experience. Do they do so enough to make this practice profitable for them? Probably not, but once a photo is taken, it can be used for years as many listings will stay on Airbnb with their same owners. Since Airbnb is in the growth phase of its supply side now, this unprofitable strategy will be easier to maintain once the company already has most of the listings they need, and just needs digital photos of the few new units that come on each month (by the way, the folks at Apartments.com were on this strategy way before Airbnb, but only did it for some clients. Whoops!).
So, I would advise entrepreneurs heading into their growth phase to think about what good habits they can create now that will be unprofitable now, but create a competitive advantage in the future (or a positive externality, as defined in my previous post), when the strategy will also be easier to maintain. If you can generate some very positive sunk costs while no one is looking for you to be in the black, you may be able to create some more serious competitive advantages for your business over the long term.