I received feedback from some of my readers that my latest post wasn’t easy to understand. So I spent the remainder of last week brainstorming ways to explain the concept better. The light switch moment occurred on Sunday while I was running the New York half marathon. I spent most of the race sketching out parallels between my racing adventure and the philosophy behind the post. I will attempt to put it all together below. For those who didn’t read the post, you can find it here.
In the article, I suggested that start-up companies should manage resources carefully in order to survive long enough and deploy cash in future high-return opportunities. My general thesis is that though critical for survival, early activities, which include set up, staffing, creation and launch of product, don’t generate a high return. One of the reasons is because valuation for high-growth companies is often calculated as a multiple of revenue. An article I read recently by one of my heroes John Maeda, although focused on leadership, captures my evolutionary philosophy rather precisely. The lesson from this article (and my race!) is that before a company can aspire, it must first survive and build the ability to compete effectively. A company should only splurge once there is indisputable proof that the investment will directly impact the primary value driver. The higher the correlation the better.
- Survive – For marathon prep, I had to overcome a few mechanical issues and injuries before commencing training and building the cardiovascular capacity required to survive the race. For companies, this preparation means translating the idea into a strategic plan and a product that serves a demonstrable market. Nailing these fundamentals allows a company access to investors, who provide the cardiovascular capacity a.k.a. cash to execute. High unit economics are a powerful survival tool because they reduce a company’s dependence on outside capital while simultaneously increasing the company’s appeal to investors
- Compete – During training, I took long runs on weekends, which served as proxy for the real race. I also started training for pace and other competitive tricks e.g., managing hydration. In business, this translates to arriving at a product that is sold to real customers and is profitable at the unit level. This process is called finding product-market fit. Peter Reinhart, CEO of Segment has an excellent article explaining this concept. Using the marathon comparison (again), a product that hasn’t demonstrated the ability to “complete the race” somehow – from production through to profitable sales – won’t succeed.
- Aspire – Aspiration is a privilege. After I became confident that I could finish the race at a 10 minute/mile pace, I then started to aspire to finish in under two hours. For companies that have mastered competition, pumping cash into the system can maximize growth, profits and returns. In aspiration mode, companies have the license to dream, go big and crush the competition!
In part 3, I will elaborate on the technical aspects that make unit economics a powerful driver of return on investment.