Startup Lessons From The Underpants Gnomes: PROFIT!

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Startup Lessons From The Underpants Gnomes: PROFIT!

 

Are you building a profitable business?  I’m not asking whether or not your business is profitable now, but whether it will ever be profitable?  More importantly, does future profitability enter into your current decision-making?  If not, you’re doing your business and yourself a disservice.  onstartups underpants gnomes

Leave the “no profits” model to the not-for-profits — they’re much better at it

For some reason, many startups treat profit as a 4 letter word.  The common argument goes something like this:  “We’re going to create something so fantastically wonderful that millions of people are going to flock to our site, and then we’re going to be fantastically successful.  Just like YouTube.  Or Facebook. Or Twitter”

This reminds me of one of my favorite Southpark episode about the Underpants Gnomes. 

Watch this clip if you haven’t seen it yet (or haven’t seen it recently). 

The business strategy for the Underpants Gnomes goes like this:

Phase 1:  Collect underpants

Phase 2:  ?

Phase 3:  Profit

Many startups have a business model that’s even sillier than the Underpants Gnomes.  Why?  Because the Underpants Gnomes are at least thinking about profits!

So, why do startups ignore profitability so often?  There are several reasons, some of them pretty good.  The most compelling one goes like this:

“We’re designing for high growth.  In the early days, we need to be focused completely on getting as wide an audience/reach/user-base as possible.  If we think about revenues/profits too early, it will undermine that growth.”

This is a reasonable argument.  There’s definitely a tradeoff that occurs between growth and profitability.  But, it’s short-sighted.  I don’t have an issue making strategic decisions that are solving for growth.  That can be fine (based on market opportunity, availability of capital, etc.) but I don’t think it’s wise to ignore profitability. 

I’d argue that there’s a big advantage to thinking about profitability from Day 1 of the business.  You can still decide to do things that are solving for growth, but you should at least be mindful of profitability.

Here’s what I would do:

Step 1:  When looking at ideas for a startup, make sure that you pick one that has a decent chance of being profitable some day.  Just because you’re not solving for profitability in the early stages, is no excuse for ignoring the future profitability potential of an idea.  It’s going to matter.  Trust me. 

Step 2:  When creating a product, make sure that you design and develop something that has hopes of being profitable some day.  This goes to functionality, pricing, positioning, etc.  Sure, you might give the product away for free and have zero revenues (like twitter) to start.  But, someday, you’re going to need to find a way to make money from the product. 

Step 3:  When building the business, try to lay the groundwork so that you have hopes of making the business profitable within your lifetime.  This often involves getting better at tracking the costs of delivering your offering.  Sure, in the early days, it’s common to lose money on each customer (and as the joke goes “we’ll make it up in volume!”).  But, your chances of survival/success go up considerably if you can get a better understanding of the economics of the business and what it will take to actually get to a point where you’re making money.

Here’s how we like to think about it at HubSpot.  As the business gets built, we keep a very watchful eye on the “time to profitability” number.  (This number is based on our level of capitalization and other factors).  Then, as we try to make decisions, like what features to add, how fast to hire, what new projects to pursue, etc. we see how that might impact our profitability timeline.  Often, we make a conscious choice to work on things that will not improve our profitability timeline — but we do that very deliberately.  We try not to take the Underpants Gnomes approach of “we’ll worry about that later”.  We invest in growth (vs. profitability all the time).  We also make wrong guesses as to what impact certain decisions are likely to have.  But it’s been very helpful to have a working hypothesis that can be iterated on.

I’d argue that profitability is important for all startups, all the time (unless you’re a not-for-profit).  You can choose to defer it, just don’t ignore it.  Particularly in these though times, being mindful of profitability is a good thing.

So, go forth and shoot for the stars in terms of pushing for spectacular growth — just stay mindful that you’ll likely have to get to profitability some day.  Not all of us can be a Facebook or a Twitter (and in fact, most of us won’t be).  And, there’s nothing wrong with making money.  We are, after all, building businesses, aren’t we?  AREN’T we?

What’s your take?  Do you think about profitability every day?  Every month?  Never?

 

Posted by Dharmesh Shah on Fri, Feb 27, 2009

COMMENTS

One of the first questions you should ask yourself if you plan to start any business is: Who is going to hand over their hard earned money for what I'm going to create?

posted on Friday, February 27, 2009 at 1:30 PM by Jeroen


Passing up profitability for growth can be a challenging decision, especially when your organization is self-funded or financed by personal debt (vs. VC backed). 
 
However, I think a willingness to assume the risk when others won't, especially when faced with enormous market potential, is one of the things that separates the good companies from the great ones.  
 
Thanks for the insight, as always. 

posted on Friday, February 27, 2009 at 2:48 PM by Paul Roetzer


Spot on. 
 
- Vasudev 

posted on Friday, February 27, 2009 at 5:54 PM by Vasudev Ram


I solve the problem of profitability by working on things that people are already accustomed to paying for. So, I don't have to think about convincing people to pay for my product or service. All I have to do is to convince people to choose mine over my competitors'.

posted on Saturday, February 28, 2009 at 10:10 AM by Syed Rayhan


Dharmesh, 
 
I had no idea that you were a South Park fan!? HA. 
 
This article really reminds me of a book I read last semester in graduate school "The Goal". Such a great book, but for those that haven't read it basically it's the idea that there is this company that is completely going down the tube and everyone is so worried about efficiency, work flow, and producing new products that they completely forget to align their business about the main function of a business, TO MAKE MONEY! In fact they run all these overly complicated reports and have these advanced robots to do things, but they completely forget that they are trying to produce things to make money instead of just producing them as efficiently and quickly as possible even when this isn't the market demand.

posted on Saturday, February 28, 2009 at 6:28 PM by Kyle James


I have a simple approach always continue to strive to get more out of people, customers and cash. Profitability is often talked about however I am often skeptical, because accounting figures can be manipulated to read better than any science fiction novel. Hard cash is always a great bed to build a business on. And I am sure that this is what you are intimating towards. Most people focus on the numbers turnover, volume, etc. More sales orientated. And what really matters is ... are you making any "real money".

posted on Sunday, March 01, 2009 at 3:34 PM by Philippa


 
Irrespective of wasting time on thinking too much about profitable business models.  
One should just start ,its better than wasting time thinking too much. 
 
Start acting ,build it , launch it and learn (portal ideas). 
 
Each step we do learn a lot, that things are not shiny as we thought ,  
All our Excel sheet figures where bull shit. Users are not attracted. 
 
At this point you figure our the real problems which you face. 
 
Filter our the troubling aspects . 
 
1, Portal sucks , hardly any users interested . 
2, Need to find a business model, Do some research 
3, Figure our marketing plans 
 

posted on Monday, March 02, 2009 at 3:22 AM by Baiju rahman


This point about profit is especially important in more challenging economic conditions. It’s easy to become fixated on turnover and overlook extra costs that erode profitability. You Survive on the Bottom Line, (not the top line)

posted on Monday, March 02, 2009 at 4:29 AM by Phin


I agree with Baiju. 
 
I guess it makes a lot of difference if it's your first start up or second and more. 
Profitability calculation won't be correct and quite frustrating when you have not real experience in doing those calculations. 
 
So sometime it would make sense to just Start it. 
 
Correct me please, I intend to first timer. 

posted on Monday, March 02, 2009 at 10:28 AM by Mot


Is there somewhere I can nominate this for "analogy of the year"? 
 
 
 
Brilliant, Dharmesh. And hilarious.

posted on Thursday, March 05, 2009 at 9:21 AM by Ben Perry


I agree with Baiju 
 
We have to give the first step event though the end point is not well defined. "The perfect is enemy of the practical". And this is true regardless of the size of the company, the most important issue is to move on.

posted on Friday, March 06, 2009 at 3:44 PM by Daniel Llamas


Great article

posted on Friday, March 06, 2009 at 4:32 PM by mikemike


i agree with few other comments, where they have mentioned startup should be easy and smooth enough to transform idea to an executable service.  
 
after getting into market, we shouldn't freeze our eyes on the growth alone, we should look for opportunities to reach, at least a break even point for the product's own expense, ie. server cost, maintenance cost, development cost and so on. 
 
i used to work in a company where they had other team to earn money (working in offshore projects) to feed in development team. so company management had less concern or less pressure to commercialize their existing products. rather they had so much time to bring luxurious features on the product. surprisingly most of the features were undiscovered by users. or they dont actually ready for use.  
 
the worst thing is when developers work for a long while in a project to get it's first release out, they feel pissed off, because at the end they see management is not focusing on commercializing the service rather focusing on developing another new service. 
 
actually, those who work in a startup company, they always get motivated by the commercialization success, because at the end of the game all had to count how much reputation they have earned along the money. 
 
thanks for nice writeup :)

posted on Saturday, March 07, 2009 at 2:03 AM by nhm tanveer hossain khan (hasan)


I disagree with you somewhat. 
 
The problem is not that startups are forgetting about solving for profitability. Rather, it is that they do not have the CONFIDENCE in their idea to charge for it from day one. 
 
I think the primary problem is that the customer base a FREE SERVICE gathers is fundamentally different then the customer base that a PAID SERVICE would gather. 
 
I believe that it is crucial for a startup to implement their business plan with profitability aspects included from day 1.  
 
It's ok! If your service is solving a GENUINELY IMPORTANT PROBLEM, then people will happily pay for it!

posted on Monday, March 09, 2009 at 2:06 AM by Leland Creswell


As with any type of product: The main issue is to create a product/service that solves a real problem rather than create a solution that is looking for a problem.

posted on Monday, March 09, 2009 at 9:50 AM by Daniel Llamas


Great article. I believe it's always good to do your research and find out how other business made their success. But the bottom line, you're going to have to take action and be proactive. Sure, you may fall (you will fall), but it's how you pick yourself back up and carry on is what makes the difference. Don't be afraid to test the waters and if something feels right - it probably is.

posted on Thursday, March 12, 2009 at 8:20 AM by Ray Vasquez


Underpants!

posted on Sunday, April 19, 2009 at 10:42 PM by Gnomes


Agreed on the profitability article. On attempting to launch a new start-up though, it's difficult to calculate profitability if it is to be revenues are to be garnered from ads. Any ballpark on what ads can bring in?

posted on Friday, May 08, 2009 at 1:53 AM by Monika Eliz


Here are a few more things they don't teach you in most MBA programs, and especially if you do your MBA early in your career, rather than wait about two decades as I did:  
 
 
 
1. The Strategy and Leadership courses are really important if you want to be able to answer: a) what business are we in; b) do we really think we are that inimitable in sectors other than the business we THINK we're in; c) if you're the leader, you must accept the blame as well as the fame; d) if you are texting, sleeping, recovering from hangovers, cutting classes on a regular basis when just showing up would benefit your brain more than you can imagine, then you really are wasting a lot of money for three little letters after your name. Some of this stuff really is that important, and it will come back to bite you when you are in your 40s, if you don't learn the landmines now. McKinsey is right about a lot of things, but mostly that the big mistakes aren't made in structure and systems but in strategy, staffing, skills, style and shared values.

posted on Wednesday, July 08, 2009 at 8:40 PM by Liz DiMarco Weinmann


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