One thing that the average consumer doesn’t think about when they start using the service or product of a new startup is the hard work and funding structure that was created in order for that product to exist. In fact,ds often, and in fact by definition, many startups are not operating with a profitable business model when they first begin doing business. The industry of venture capital exists to subsidize startups as they grow. The hope is that providing investment to startups until they have scaled to the point where they have a large usership will allow them to reach profitability.
While this makes logical and financial sense, finance in the startup world doesn’t always work like that. Many startups burn through VC cash and never manage to find a business model or usership that can support their offering. The startups that do manage to make the transition from VC money to organic revenue have often weathered a stormy period where the cost structure or offering has changed. But there is a lot to be earned by looking at the transitional periods of startups who are trying to reach solvency.
One example is the competitor bank Monzo, hugely popular with the UK’s millennial demographic. The company recently announced that one of its flagship features which users love—no-fee foreign transactions and withdrawals when traveling abroad—would have to change. As the company wrote to its users: “As the Monzo user base grows and evolves, people are increasingly using their Monzo Mastercard Prepaid Debit cards abroad. We want to build a sustainable, viable business that is around for many years to come. At the moment, the rising costs of foreign ATM withdrawals makes that difficult. So, in the spirit of transparency, we’d like to share the numbers behind these costs and three proposed solutions.”
In a sense, Monzo was coming clean to their users: the popular feature that had earned them so many users was only possible because they were being injected with VC cash and didn’t have a large usership. If the company wanted to grow and be sustainable, it couldn’t continue offering this perk.
Another example of this shift is food delivery companies. As Alison Griswold explained in Quartz, “For years now, we have been living in a golden era of VC-subsidized meals. As startups piled into the food delivery space, they showered customers with coupons and promotional offers made possible by generous investor financing.” The idea was that these promotional offers would turn first-time customers who loved the service into long term users. Investors piled money into food delivery startups on the expectation that this enthusiasm would continue even when the prices raised to a more realistic level. As Griswold went on to say: “Unfortunately these investors failed to heed another data point: how much most people are actually willing to spend. According to the same Morgan Stanley report from last June, 71% of people said they would pay no more than $5, excluding tip, for a $30 order of food that was ‘guaranteed to be delivered fast.’ Fifteen percent said they wouldn’t pay for delivery at all.”
So what’s the lesson here? Are all startups who take VC cash doomed to fail once financial reality hits? In Monzo’s case, the company seems to be surviving the transition quite well, rather than abruptly changing their policy and upsetting customers. They published a clear account of why the model had to change, and had their users vote on the best course of action. The result was still beneficial compared to a regular bank, and the goodwill they earned by engaging their customers will continue to stand them in good stead.
But in the food delivery category, the outcome hasn’t been quite as positive. Several major startups in the sector have failed, including Maple and Sprig, because they opted for the “jump off a cliff” scenario when they transitioned from VC cash to a sustainable business model, and their customers were less than pleased.
It seems that the lesson is to be transparent with your customers, and don’t get them hooked on a pricing structure that is never going to be sustainable.