OnStartups

Startup Lessons From The Underpants Gnomes: PROFIT!

Posted by Dharmesh Shah on February 27, 2009 in strategy 19 Comments

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?