Is it better for a start-up to purse profitability initially, or go for growth? Advocates of that second, get-big-fast approach inevitably point to companies like Tumblr (the company founded by a high school dropout that Yahoo! just acquired for $1.1 billion before it had even $20 million in revenues) or YouTube (which was sold 19 months after its founding to Google for close to $2 billion), or other companies whose hyper-growth attracted suitors before a viable business model emerged.
But it’s important to consider how incredibly rare these examples are. For every Tumblr there are dozens of companies that had some success but never broke through — and hundreds more that never really got out of the starting block. Research by Harvard Business School senior lecturer Shikhar Ghosh, in fact, has found that fully 75% of venture capital-backed startups — presumably the crème de la crème of the startup world — failed to return the capital invested in them to their investors (let alone generate positive returns).
A pure focus on growth carries risks. If you are a growth-obsessed startup and venture capital financing dries up and buyers grow scarce, you can run out of money. If you are inside a big company, profit-draining ventures are typically early sacrifices in corporate cost-cutting exercises.
Why then do so many people doggedly focus on growth? There’s a term in the psychology literature for this — the availability heuristic. Big events are endlessly discussed and analyzed. They lodge in our memory, fooling us into thinking that they happen more frequently than they actually do. An oft-cited example of this phenomenon is the difference in perceived risks between getting on an airplane and getting in an automobile. Airplane crashes tend to be major news events; automobile accidents aren’t. The worst year for airplane fatalities was 1972, when more than 3,000 people died in plane crashes. That’s roughly the number of fatalities in automobile accidents in a typical month in the United States.
Growth is great, but profits are more convincing proof of long-term viability. Sufficient profits make a business self-sustaining, inoculating ventures against the need to pry money from tight-fisted venture capitalists or often-skeptical corporate investors.
Read the rest at Harvard Business Review.
Scott Anthony is the managing partner of Innosight.