When a new startup crashes and burns, the reason is often down to what is known as “premature scaling”. This basically means they started growing some parts of the business too early, and were consumed by cash flow crises. Read all about it in this report from the Startup Genome Project.
Published in 2011, the report looked at data from 3200 startups to figure out nearly 9 out of every 10 new businesses will fail. Here are some of the key reasons:
- Spending big on customer acquisition before you have sorted out your product / market fit (and having to do it all again for a different customer segment later on)
- Building your product before you have validated the problem (and having to change it later)
- Hiring stacks of people before you have the cash flow to demonstrate your model works (and finding out too late that your sales forecasts are wrong)
- Not raising enough capital to do execute your business model, or raising too much and spending like an idiot
- Locking down your business model too early and finding it is too late to change once you have built a product and hired a marketing force
- Chasing revenue at the expense of profit (a small slice of something is better than a big slice of nothing
In each case, one of the 5 dimensions of a startup is out of balance: Customer (acquisition and marketing), Product (development and distribution), Team, Finance, and Business Model. The last one is typically about how you generate revenue and the stages you go through as you convert early adopters into a mass market of paying customers.
The report goes on to discuss some fascinating analysis of the data on what happened for their pool of 3200 companies, including observations about team size and revenue in companies that scaled prematurely Vs companies that scaled right. But how do you know when you should scale?
Knowing when to scale
The basic difference between a startup (which has not scaled) and a business (which has scaled) is that one of them has a business model that works whilst the other is trying to figure that bit out. Using the customer development cycle this means that a startup should be focused entirely on testing assumptions and discovering a business model that they can scale whilst a business should be executing a proven business model and refining it over time. SO when do you know when to stop looking and start executing? Here are some ideas:
- Number of paying customers: according to Ash Maurya, you should start selling right away, so all prototypes should involve paying customers. This way you can see which products and market fits work Vs which don’t.
- % rate of paying customer growth: along with the number of paying customers, this will tell you which products have growth potential and which don’t.
- Monthly cash flow: timing is everything when it comes to scale. Balancing your finances with growth opportunities is no mean feat. Monitoring your cash flow should help.
- Production costs: per unit costs should be a pretty good indicator of whether or not your product is viable, including knowledge of whether you have the right partners, suppliers and production methods
You’ll notice that the focus here is on customer discover first, and production second. This follows the two stages of a startup broadly mentioned by Steve Blank:
- Early stage: Find a product and market fit that genuinely meets customer needs
- Late Stage: Find a scalable business model with production, resources, distribution and cash flow all nicely sorted out
The key point is that during discovery, don’t just stop at the first idea you have…try out different products, customers, production methods and distribution approaches to find out which is best. Then monitor your results so you know when to scale.
Note: this is my first pass at a big area, I’ll come back to it again later. Feedback welcome.