The urge to quickly grow your startup is tempting, especially when investors are chomping at the bit to see a return on their investments. However, moving too quickly may result in a company's demise before it can really get off the ground, new research suggests.
Startup Genome, a San Francisco-based startup accelerator, and researchers at the University of California, Berkeley and Stanford University analyzed the growth of 3,200 technology startups and found that a common problem was linked with many failed tech companies: premature scaling.
In the report, serial entrepreneur Jim Pitkow defined "premature scaling" as growing in anticipation of demand, instead of growing in response to demand.
In addition, the research found that successful startups often shared several behavioral traits.
Here are some of the most important lessons Business News Daily took away from the research, both on how to avoid premature scaling and how to emulate the most successful patterns of behavior.
How premature scaling adversely impacts startups
According to the data collected by Startup Genome, nearly 70 percent of companies scale too quickly. Further, researchers say growing too quickly is a major contributor to the high failure rate of tech startups. But what does premature scaling look like, and why is it so bad for a young company? It turns out that there are a number of ways companies look to grow prematurely, including the following:
- Hiring a large staff or offering generous compensation before stable revenues are established
- Hiring specialists or managers too early
- Failing to bring on skilled salespeople to establish an initial revenue stream
- Focusing on growing the wrong segment of the market or cultivating users who do not greatly impact profitability
- Sustaining or growing marketing spending without established metrics of success
- Pursuing growth efforts prematurely, without truly understanding the market
- Lacking a mechanism to monitor the market's reaction to the product, or being unable to adapt and capture a larger segment of the market in a cost-effective manner
- Attempting to increase revenue or capture additional customers at the expense of the profit margin
- Overbuilding the product with "nice to have" features
"Only when a startup objectively demonstrates that product-market fit is achieved and a pattern of revenue generation is clearly identified, it makes sense to scale the business model and grow," said Amir Banifatemi, founder and managing partner of venture fund K5 Ventures. "A startup business model, even when established, needs to be flexible enough to evolve constantly with market conditions, competitive moves, alternative offerings, and customer maturity and evolution."
Premature scaling can kill companies that have great products and positive initial feedback, and even those that have already received adequate funding, the report found.
"Premature scaling is putting the cart before the proverbial horse, and in the case of startups, this can potentially relate to both engineering and operations," Michael A. Jackson, a serial entrepreneur, said in the report. "Getting venture money can be like putting a rocket engine on the back of a car. Scaling comes down to making sure the machine is ready to handle the speed before hitting the accelerator."
Some of the major consequences of premature scaling include the following, according to the report:
- No startup that scaled prematurely passed the 100,000-user mark.
- Startups that scaled properly grew 20 times faster than those that scaled prematurely.
- 93 percent of prematurely scaled companies did not top $100,000 in monthly revenue.
- Prematurely scaled startups outsourced four to five times as much of their product development compared with those companies that did not scale prematurely.
Expending resources without first gaining market validation and a real understanding of your company's future growth potential puts your startup at a high risk of scaling prematurely and facing these critical problems down the road, experts agreed.
Avoiding premature scaling as a startup founder
Although the startups that scale prematurely may seem to outperform others early on, that growth inevitably comes crashing down, and the "slow-and-steady" companies invariably see increases in users and revenue when they finally scale up operations, according to the report. Here are some ways the researchers identified to help you avoid scaling prematurely:
- Put your product and the market fit first. Make sure you have a product that solves a problem and meets consumer demand.
- Streamline new customer acquisition processes and strategies before attempting to scale.
- Increased sales should track proportionally to costs. Don't cannibalize your own profitability just to drive more sales.
- Remember the tortoise and the hare: Slow and steady growth is often far more sustainable than a fast pace out of the gate.
- Keep your product focus simple. Don't throw in bells and whistles until the core features of the product are perfected.
- Remain flexible. The ability to pivot with the market as needed is key to long-term success.
- Keep your team small until it's time to scale up operations. A large overhead early on can cripple growth later.
"In terms of infrastructure, both technical and HR, premature scaling is investing too much up front in building up the capacity, which might turn out to be unnecessary if the product/market fit is not to be found," investor and serial entrepreneur Krzysztof Kowalczyk said in the report.
Sometimes, it's better to leave that startup capital untouched until the moment is right, the researchers found. That means setting observable metrics and milestones, tracking them closely, and listening to the market through customer feedback and identifying unmet needs. Your investors and your company's bottom line will thank you for your patience later on.
Lessons from successful startups
Startup Genome researchers suggested that a tech startup is based around five characteristics: product, team, business model, financials and customers. Keeping those elements in balance is imperative to a young company's success, they said. Growing a customer base, for example, is not prudent when the product isn't ready to scale. Likewise, hiring a large team is unnecessary unless your company is ready to scale the user base as well. All of these categories are symbiotic and should be grown proportionally to one another, the study found.
Here are some of the key traits that successful startups often have in common, according to the report:
- Learning: Successful startups utilized mentors, thought leaders and performance metrics to educate themselves. Those that exhibited a propensity toward learning and challenging their assumptions earned, on average, seven times more money and experienced 3.5 times greater user growth.
- Flexibility: Companies that were able to adapt and pivot when the market deemed it saw a huge payoff. These startups saw 2.5 times more money and 3.6 times greater user growth, and were 52 percent less likely to scale prematurely.
- Team: Founding teams that were balanced with both business and technical experience earned 30 percent more money, experienced 2.9 times greater user growth and were 19 percent less likely to scale prematurely compared with teams that were heavy on either business or technical experience.
- Founders driven by the experience or impact of their company, rather than profits alone, were often more successful.
- Dedication: Full-time founders saw four times greater user growth and 24 times more money from investors than startups with part-time founders.
Above all, it is key for startups to listen, the report states. Constantly check your product against the market, soliciting feedback and analyzing new data, to challenge your preconceived notions about what works. If your idea of the market's demands is inaccurate, your product will not fit, and thus scaling will be flawed or impossible, the researchers said. Always "listen" to the market, and keep an eye on shifting landscapes and emerging trends in order to increase your chances of long-term success and sustainable scalability, the report concluded.