A little bit of success is dangerous for startups

A little bit of success is dangerous for startups

It can be dangerous to think we’ve made it.

Over my startup career, I’ve witnessed many instances where a little bit of success masked important problems and triggered precocious scaling. Resulting in costly mistakes.

The following are three scenarios I’ve learned to watch out for.

1. Positive feedback ≠ Guaranteed sale

Most startup founders have talked to at least one prospective client before building a product. If not a prospective client, then maybe an investor or industry expert. Insight from these individuals helps to gauge the likelihood of an idea becoming a business success. Call it market research. A critical step.

Yet market research can be misleading when the wrong questions are asked and when people are too nice.

For instance, before embarking on my first startup project, I asked for feedback from hospitality and tourism executives about whether forecasting travelers’ intentions (when and where a person would go and do) would be valuable. Almost all parties gave positive feedback and were interested in helping us design the tool. We therefore spent 6 months developing a prototype. As we went back to the same group of prospective customers, asking for a partnership to test and develop the platform, nobody signed up. Nobody wanted to put their job on the line by investing time and money into an unproven tool.

Beyond assessing the viability of a new product, companies also perform market research continuously evolve their product. The risk of being misled by customer feedback is therefore a constant threat.

At the latest startup I worked, we regularly asked customers how to make their lives easier, what features they’d like to see, what frustrated them. Yet even after developing features they had asked for, some customers still canceled their contracts with us.

Why? In my experience, some people are too nice and want to avoid conflict. If a client knows that they’re moving away from our platform eventually, because they fundamentally don’t need what we offer, or want to bring it in-house, it can be difficult for them to be honest and express that intention during a call. It has the potential of making the existing relationship awkward. So they say nice things to keep us at bay.

In my opinion, a much more accurate way to gather market intelligence is to observe customers, rather than asking questions.

Examples of startups that were misled by feedback abound. Here are two high profile ones:

  • Quirky: The community led invention / engineering business wanted to develop and sell novel products its users voted for. Yet votes didn’t turn into sales. It blew $185M.
  • Boo.com: The company burned thru $185M dollars in 18 months. They gained positive feedback and support from top fashion houses, newspapers, and even investors before even launching, but failed to actually build something of value to customers.

2. Getting funding ≠ ready for growth

I’ve often witnessed a tendency for startups to scale up operations right after a successful funding round.

As soon as the money hits the bank, dozens of new positions open up, the list of product features to develop swells, and the marketing budget grows exponentially.

In the best case scenario, this growth is proportional to growth in demand and the company scales effectively. Yet in reality, many startups outstrip demand. They end up cutting costs and laying off people as fast as they hired them.

Why? Let’s start at the source of the money. Rational investors invest in a company based on its growth potential. How investors assess “growth potential” varies, but is likely based on a company’s historical performance. So some founders interpret a VC investment as a vote of confidence for their business strategy, their business model, their product.

Yet investors are not customers. Getting funding does not mean that we have a successful business. Otherwise 9 out of 10 VC funded startups wouldn’t have failed.

We need to be careful.

So what do we do after getting funding? In my opinion, it’s best to continue testing market demand. Observe what product features and changes resonate with users. Experiment with small scale marketing campaigns to see what’s most effective at converting customers. Hire people only when we absolutely need to. Essentially, work as if we didn’t have funding. Be cheap.

Only scale up when there’s proven demand.

So what do we do with the extra cash? As we operate on a shoestring budget, we’re bound to break the limit of what we can support. The extra cash allows us to scale up supply when demand outstrips it. The latter part is key: Only scale up when there’s proven demand.

While this sounds easy, it is not. Investors look for a fast return on their money. Many will pressure companies to scale and grow asap. They want to see 100% growth month-to-month. It can be difficult to resist this urge.

A couple high profile cases of startups that scaled up too quickly and flopped include:

  • Fab.com: The flash-sale design retailer raised millions within months of launching. It then missed its aggressive sales target within a year. It thus had the option of scaling growth back and get the business model right in the U.S., or keep expanding globally with a target of 100% YoY growth. All board members except one pushed for the latter. The rest is history: It blew $336M in 3.5 years.
  • Color.com: The photo/video sharing app raised over $40M before even launching. They likely felt like a success from day 0. Yet they failed to acquire users, managed to spend $15M in a matter of months, and finally got acquired by Apple for a paltry sum of $7M.

3. Having early adopters ≠ everyone wants it

Some founders may still be careful about scaling up after receiving funding, but not many will refrain from it with a fast growing user base.

Startups solving a painful problem can experience fast customer growth very early on. These early adopters often overlook the immaturity of the solution and are willing to invest time and energy to make it work for them. The old solution is simply too painful.

Seeing this demand, the startup then scales up its operations and plans for hyper growth.

Yet I now know having early adopters doesn’t mean the rest world is ready for us. The number of early adopters, people willing to pay for an immature product, is limited. It plateaus and peaks. To scale up operations when the product only appeals to early adopters will inevitably outstrip demand. A better plan is to build a product that appeals to the masses before scaling.

Another threat to startups with disruptive solutions is the launch of competing products after they’ve proven a business case. These late entrants have the potential to create a mature product in less time by learning from the pioneer’s mistakes. They can offer a better product for cheaper. Strategy Professor Michael Porter explores in detail the benefits and risks of first-mover advantage in Competitive Advantage.

Nebula.com is an example of a startup that found early success, yet failed to find customers beyond early adopters. It blew $38M.


Recommended exercise

Ask yourself: Is capacity outstripping demand?


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