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Why are (most) startups burning through so much cash?

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JASON LEMKIN

Competition.

For most software / internet companies, the gross margins approach 80%. That means for every $10 you bring in, you get to keep at least $8 for payroll, etc. after paying off expenses.

In the early days, that’s not a lot of money. You may need to work for a $0 salary, sacrifice, skimp, borrow money from mom and dad, etc.

But as you approach a few million in revenues — the power of those 70–80% margins should kick in — and two things should start to happen:

  • you should start to mint cash, absent other outsized increases in expenses;
  • you should finally have a brand, or at least a mini-brand in your space, and that brand should start to bring you in ever more prospects and customers, making it even easier to grow and mint even more cash.

Unless …

Your sales and marketing costs are very high.

Sales and marketing costs can be high for two reasons. First, price erosion due to competition makes sales more expensive. Brutal competition almost always drives price down from where it would otherwise naturally settle. And competition also means you lose more deals. Fewer of your leads close. That, in effect, drives your marketing costs up as well.

Second, going for a “land grab” and entering as many segments of the market, even those where you lack a brand and/or the most competitive solution, is very expensive from a marketing/sales perspective.

When the competition is weak, sales and marketing expenses aren’t that high.

But these expenses grow dramatically in hyper-competitive markets.

Look at Atlassian or Qualtrics or SurveyMonkey. They grew more slowly in the beginning, being bootstrapped, but then minted cash after they hit millions in revenue. And importantly — they didn’t enter sales & marketing driven death matches with the competition.

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Published on May 25, 2017
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