When the Music Stops: Pandemic-Adjusted SettingsBy Pablo Ricaud Arriola | Mon, 06/01/2020 - 09:26
Like G. Michael Hopf said, “Hard times create strong men. Strong men create good times. Good times create weak men. And, weak men create hard times.” Do not get me wrong, the crisis we are living in is a random, catastrophic event, but we surely can look at what could have been done better to survive it. The way I see it, we have two choices in life with anything that happens. We can let it destroy us, or make it define us. If you live by optimism, we have no choice but to look at the opportunities hard times bring and use them to teach us a lesson for the future. Crises are a natural course in everything. They always come after we find ourselves a little too comfortable, or, like Murphy’s Law states, when we are least ready, but they surely give way to stronger, better-equipped people and companies for the future.
COVID-19 has made us realize the world’s economy is largely sustained by “nice to haves,” meaning, non-essential products and services. From an investor’s standpoint, there’s a new risk to be factored in during investment decisions, and one we hadn’t seen during most of the 20th and 21st centuries: the dependency of a business on a fully functioning world.
Building a business is extremely difficult, but doing so during a pandemic proves to be a special challenge. The number of new ventures that have seen their investors back down on already committed capital is staggering. Investors are more risk-averse than ever, not only due to the witnessed black swan, but with the already popular trend to move back toward businesses with a clear path toward profitability.
Like a fire cleansing a forest, a crisis tears down the old and opens a path for the new – new mindsets and new ways of doing business. In this case, the path to understanding business through a new lens and how the resilience of essential sectors matters in a global interdependent world. This, hand in hand with the trend we’re seeing among investors to start focusing more on sustainable business models with mid- and long-term viability rather than innovative high-tech but unprofitable models, will see investor’s money shifting to more traditional industries with big opportunities and disciplined plans.
For the past years, the world saw a trend of startup companies operating around fancy buzzwords while burning unsustainably through investor’s cash with the excuse of user acquisition and a seemingly straightforward path to profitability once a big userbase is built. The question that arises is how to monetize a commodity, product or service (most of them tend to move toward that) when the underlying unit economics don’t work and the biggest differentiator is who subsidizes the end customer more?
It used to be the case that any business should have viable economics first, in order to scale and make way for growth, but somehow, scale and growth took more importance in recent years no matter the underlying economics of the business, giving us a suite of “unicorns” with millions of users, but with billion-dollar-losing operations. It’s odd how attractive it got for a company to take a money-losing machine and make it bigger and bigger while investors stood in awe and marveled at it. How beneficial it is to have millions of users with which you lose money at every interaction? “We’re huge,” you hear. Yes, huge money-losing machines.
This crisis has accelerated the trend, and it’s good to see we’re returning back to the traditional definition of a business; meaning, it needs to make money to be worth something.
Let me illustrate this dilemma in a simple manner: What if someone built an app that delivered US $100 to your doorstep at a US$70 cost? Would it be easy for it to gain millions of users very quickly? You bet. Later, and once 10 other competitors are doing the same, how will it monetize the innately money-losing unit (i.e. giving away money)? Is size and volume worth anything in this case? The resemblance these models have with a Ponzi scheme is dangerously close: New money paying for old money’s returns with an unprofitable operation that needs to keep the ball rolling (aka. growth) to justify time and time again for new money to pay for its non-organic “alpha”. When the ball gets too big to handle, the toll begins to be felt by their partners, contactors first, as they get squeezed more and more in an attempt for profitability.
This is exactly what a lot of startups did and are doing now, and investors seem to be finally catching up to it. Unfortunately, we’re seeing this loss of hype translated into a lot of people losing their jobs, people who bet their careers on these seemingly awesome companies that were going to conquer the world. It might seem COVID-19 is to blame, but in these cases it isn’t. Irresponsible, “hype at all costs” management and unsustainable business models are to blame. The pandemic just makes for the perfect cover to the already inevitable. It makes no sense for founders to be giving business and life lectures to people when they can’t even provide job security to their employees, plain as that. Being in a magazine cover as the latest “Rockstar” doesn’t mean anything if you don’t live up to the responsibility you have to your investors and your employees.
Good times have a way of spoiling us into thinking everything will continue to be the same. We just came from a 10-year bull run all around. Ideas were plentiful, access to capital was abundant. Inevitably, we took that for granted, and stopped being critical of what would happen if conditions might’ve reversed, and as always, life had a swift lesson to teach us, one that human beings have a hard time internalizing: Just because conditions behaved in a certain way in the past, it doesn’t mean they’ll be the same in the future. 2008 was the same. This goes beyond new ventures. A lot of big companies threw caution to the wind, acting like good times would never end. Stock buybacks and large dividends gave way to small cash reserves for a rainy day. Rainy days didn’t just come, they struck with an unprecedented force that caught most people ill-equipped, in some cases tragically.
Let’s use these times to be better. Those who don’t learn from them are, as George Santayana said, condemned to repeat it. We’ll come back readier this time. Cash is king, businesses should make money, essential industries have a premium in a world without borders, and finally, chickens always come home to roost.