It should be counterintuitive, but one thing many “unicorns” and scrappy startups have in common is a whole lot of red on their balance sheet. Instead of the most famous tech companies being synonymous with the ones that make the most money, unprofitable companies are just as fawned over as those with so much money they’re stashing billions overseas to avoid paying taxes (we’re looking at you, Apple, Google and Microsoft).
These companies have taken the old adage “you’ve got to spend money to make money” to the next level. Instead, they are adhering to the belief that “you’ve got to spend money to raise more money.” They cling to the belief that they’ll capture enough market share to command billions in valuations before a splashy IPO or acquisition makes investors and employers rich- despite the fact they’ve never turned a profit.
This uniquely 21st century phenomenon has warped how technology companies view fundamental tenets of business. Executives aren’t worried about profit margins, ROIs and sound fiscal fundamentals- it’s all about gobbling up customers like a high stakes game of Hungry Hungry Hippos.
When the industry hails companies such as Amazon, WeWork, Spotify and Dropbox as disruptive innovators despite negative quarter after negative quarter, it’s easy to forget that this is not normal. Business schools aren’t churning out freshly minted MBAs educated in the art of burning through cash. Business plans aren’t supposed to spend more time on their exit strategy than their actual, you know, business.
Putting off profitability
Before delving into how to manage an unprofitable product, let’s first explore why this phenomenon is much more common today than in previous generations. Fundamentally, it’s all about an abundance of capital and an emphasis on taking big swings versus tiny nibbles.
For a new or growing company, there are many potential sources of investment. The venture capital boom is still going strong. Many firms are raising additional funds, successful partners are spinning off their own investment companies and more institutional investors are putting their money into high growth opportunities.
Additionally, after lots of successful IPOs and acquisitions, there are plenty of recently minted millionaires (and some billionaires) turning around and investing that money into other startups. Not to mention an older generation of angel investors continuing to hit enough lottery winners to keep putting dollars into promising new ventures.
We’re also seeing many investors who are happy to invest in later rounds than in previous generations. This allows companies to focus on cash infusions for growth versus having to rely solely on their own revenues. In an environment when it’s perfectly acceptable for a company to be valued in the billions while still being years away from any sort of exit or IPO, there’s simply less pressure to worry about near-term profits.
“I’ve recently noticed an increase in financial gearing to make money where investors come in and out at different rounds, taking their profit as capital,” Steven Hess of The Startup Leadership Program. “But for a business to be sustainable it must ultimately make a profit at the operating level, otherwise it’s just a house of cards. Maybe you need a critical mass of customers to achieve supply side economics, but it’s still a path to profit that increasingly is growing in importance.”
The other dynamic delaying a focus on profitability is the emphasis on companies trying to do big, meaningful things by creating or taking over industries instead of just carving out a niche of their own from existing territory. These major plays for world-changing transformation and disruption don’t worry about short-term profits, forgoing the issue to concentrate on market dominance.
“What drives the most successful start-ups isn’t the money, it’s the mission,” says Kevin Laws of AngelList. “The founders who go on to create the greatest value for themselves and their investors are those with a vision of changing the world in some way.”
Of course, once a company is generating significant revenues, “profitability” becomes more of a choice than an inevitability. Take Amazon, who almost never reports a quarterly profit despite their incredible size and success.
“Amazon has perhaps 1% of the US retail market by value,” says Benedict Evans of VC firm Andreessen Horowitz. “Should it stop entering new categories and markets and instead take profit, and by extension leave those segments and markets for other companies? Or should it keep investing to sweep them into the platform? Jeff Bezos’s view is pretty clear: keep investing, because to take profit out of the business would be to waste the opportunity. He seems very happy to keep seizing new opportunities, creating new businesses, and using every last penny to do it.”
Managing an unprofitable product
So what’s it like to be the product manager for something that has no intention of achieving profitability in the near future? It all starts with understanding what your company cares about when the obvious goal of profitability isn’t the primary focus (or in the picture at all).
Generally the top-line KPIs for these companies fall into a few categories, so let’s take a look at each of them:
Get big fast is a typical directive for startups. Acquire users, hopefully they stick around, then go get some more. Growth produces hockey stick charts that make investors happy and look great during a TED Talk.
“What makes a startup a startup is growth. What makes a successful startup a success is the speed at which it grows,” says Mat Sherman of PubLoft. “When it comes to investors and getting an exit, how often does a startup get acquired because it was profitable? Rarely, if not never. Startups get acquired because of the technology, product, team, or combination of the three. No startup gets a big win for their investors by ‘being profitable’. They get a win by building a kickass product, that solves a real-world problem, being executed by a world-class team.”
But while investors may be willing to delay profits, they’re won’t settle for a company that’s not growing.
“Venture capital isn’t right for many businesses, but if you do want to raise money from a VC at some point you need to understand that often investors often care more about growth than profits,” says venture capitalist Mark Suster. “They don’t want high burn rates but they will never fund slow growth.”
Growth costs money, which is often the reason many companies are willing to take losses instead of worrying about profitability. But the underlying economics should still make sense for the company’s eventual pivot to making money and not just adding more users, regardless of the chosen monetization strategy.
“Certain businesses reap substantial returns on the acquisition of new clients over the lifetime of such clients. Investing in marketing, and thus losing money on a unit basis at first, may make sense so long as that investment returns significantly more in time,” says Toby Clarence-Smith of Toptal. “One needs to be sure about the ROI of this marketing expense, and CLV/CAC analysis is one way of assessing whether this strategy may make sense.”
When growth is the goal, product management can set their sites on needle-moving new features that satisfy unmet needs or unlock new target markets and personas. Freed (at least temporarily) from the burdens of turning a profit, product teams can devote more resources and bandwidth to feature development and enhancements that prioritize adoption over cost reductions and optimization.
Product teams should be on the same page as the executive team about what the growth targets are and how they will measure them. Then, they should continually analyze the impact of different experiments and feature releases. Customer research should concentrate on how they can attract even more users to the solution while educating with the marketing and sales teams on what the product can do and helping shape the messaging.
Adding new users is great. But for many businesses the key is getting users to stick around and use the product on a regular basis. If everyone signed up for Facebook and never looked at it again they’d have tremendous growth but no way to make any money off those users.
For advertising-driven businesses in particular, it’s all about how much time and how often people are using their products. Even if the business side of the house hasn’t cranked up the actual advertising machine just yet. Getting new eyeballs and keeping them around creates a target audience brands will pay to reach, setting the stage for revenue and potential profitability down the line.
Product teams striving to maintain and improve usage should be aligned with management on which metrics matter most, such as daily average users, session length, frequency, churn, etc. After defining those KPIs, planning and prioritization can be centered around items that improve those metrics. When the monetization of that usage comes, the product will be optimized for maximum usage rates.
In many industries, customers will only buy from a limited number of vendors, and they’re all clamoring to lock up as much of the market as they can. Streaming media is a great example of this.
Netflix has lots of customers, a huge library of content and ridiculous levels of usage. But they haven’t raised prices as quickly as the market might have tolerated. They continue to pay billions in licensing fees for content and they invest even more money in generating original content of their own.
This isn’t just because they love their customers and want to create the best entertainment experience possible. It’s because they want to be the default streaming service for as much of the world as possible and keep receiving a monthly payment from millions of customers both today and for the foreseeable future. Investing in the customer experience while showing restraint in their pricing model has allowed them to stay far ahead of competitors such as Hulu and Amazon Prime.
Product teams can look to companies such as Netflix for inspiration as they try and capture and hold as large a market share as possible. It all comes down to offering a diverse menu of choices to make the product attractive to a wider and wider audience, continuing to add value so they stick around and aggressively pricing the product so users aren’t tempted to unsubscribe.
The ongoing waves of new capabilities at a low price point are made possible by plowing revenues back into the product and utilizing outside cash infusions. While this level of spending and investment may not be sustainable, the goal is to add what’s needed now to attract and lock-in users to secure a significant market position.
For the lucky product managers working on products that actually care about making money, the distance between revenue generation and actual profitability isn’t all that far. They don’t have to completely check their business instincts at the door when they start their workday.
Not all revenue is created equal, however, and this is something both investors and product managers should care about. The Cost of Goods Sold (COGS) and principles of unit economics still apply, and if left unconsidered will prevent a company from ever achieving profitability when the time comes for that.
For example, there was a recent boom in food delivery services enticing customers to order in with massive discounts and promotions that resulted in the companies taking a loss on every meal they delivered. Instead of creating great products, these companies were merely creating great promotions that never turned into customer loyalty or legitimate staying power.
“It seems that in the end people were less excited about the speed, convenience, and slick interfaces of food delivery startups than they were about having their meals delivered for absurdly low prices,” says Alison Griswold of Quartz. “In that sense the last three years have been less an innovation than a giant wealth transfer, from the VCs and startups they funded to the lucky consumers who got a free lunch along the way.”
Losing money because you’re investing in equipment, technology, marketing and headcount may be a sound business strategy. But losing money on every transaction because the only reason people are using your product is the lower price point is simply unsustainable, particularly in a market saturated with copycats. Product leaders must “do the math” and understand what would be involved in flipping the lever from “maximum revenue” to “sustainable business” and begin preparing for that future once their value proposition is locked in.
Profits must come eventually
Regardless of whether a product or an entire company is turning a profit today, at some point the expectations will change and the bottom line will become a top priority.
“We may delay profitability, but we are always keen to understand what the unit economics are,” says Jeffrey Housenbold of SoftBank. “We have a phrase that says, ’Nail it, then scale it.’ So we’re not just allowing them to spend money without an end goal.”
Product managers in these environments must still apply fundamental business principles to their products, pricing and go-to-market strategies, because eventually they will need to actually turn a profit. Assuming it will all just magically happen when the time comes isn’t a great long-term strategy.
For SaaS companies, the challenge is even greater, because most customers only become profitable after they’ve been subscribing for a certain period of time. If that payback takes many months or even years, growth will continue to cost the company money even after they’ve reached a stage of maturity where profitability would normally be expected.
Therefore product managers must consider ways to reduce the cost of acquisition and the cost to continually support their SaaS customers is profitability and larger margins are ever to come to fruition. “Making it up in volume” doesn’t work when every sale takes years to even reach breakeven.
The rules still apply
It might be fun to imagine that working on a product without having to worry about profitability means product teams can throw fundamentals out the window and burn cash with no regard for tomorrow. But these products still must adhere to basic business principles to be successful in the long term and to continue attracting investments to support the current money-losing strategy.
At some point the tide will turn and the product will have to start supporting itself financially or risk a sudden and unpleasant negative outcome. Product teams should be proactive and ready for this profitability pivot. It’s important to communicate clearly with management and investors about what efforts you are taking to hit today’s goals while still preparing for the day when losing money is no longer an option.
If the unit economics don’t make sense right now (or can’t be adjusted to something more rational quickly), investors and analysts will begin souring on the product’s long-term viability. Although profits may not be the goal right now, most companies would prefer to be like Amazon—taking revenues from one product and plowing them into a different one—than an Uber-for-X wannabe subsidizing every transaction with venture capital cash.