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Why Your Startup Needs to Spend Money to Make Money

Often in the startup world, you need to spend money to make money. My business partner, Roz Lemieux, and I raised our second round of funding, Series A, on the strength of our belief that we could expand the appeal of our product,, to the private sector. 

Our product had been inspired by products that were in the for-profit sector, and the idea was to bring some of that technology and customize it for nonprofits and their specific needs. Our product was as good or better than what some companies were using. We asked ourselves if there was a bigger potential market that could take our business to a different level. 
Traction and Burn
A natural tension occurs between traction and burn. You want to spend, or burn, your money in such a way that you’re achieving significant traction, either in an increase in sales or monthly users, however you measure your traction. The ideal scenario is your traction is greater than your burn. Your runway, or financial resources, is shorter than you think.
The other end of the spectrum is a startup’s nightmare. If you have high burn and low traction, if you’re spending a lot of money with zero or negative results, you will rapidly find yourself out of business. Low traction and high burn is a clear indication that you’re not good at this. You should stop what you’re doing, take a step back, and get help to figure out what you’re doing wrong. 
Most businesses fail in the first year. Of those that survive, most fail in their third year. We were in our third year and rolling along. After the second funding round, we had a sales person dedicated to business-oriented companies instead of nonprofits. Because we’d had success, we thought we could gain traction in the private sector. We were encouraged when we signed a Fortune 10 client, but when we looked at the numbers, the effort didn’t pay off for us. Our sales cycle was normally sixty to ninety days; however, large organizations tend to move more slowly, so getting to that number took a little longer. We tried hard, giving it close to a year to take off. We were concerned about letting down investors who believed in us, but we had to be honest with ourselves and our investors and admit that our efforts to enter the private market weren’t working. 
Tackling a Multifaceted Issue
When you’re having trouble gaining traction with customers, rarely is there one issue. It’s often an unfortunate combination of factors, and you need to analyze the interactions and think about how you can twiddle the knobs a bit or make a big shift in a different direction that’s going to make more sense for everybody. 
In our case, the combination was more competition, more products available for the for-profit sector, and customers who were happily using something else and didn’t see a reason to change even if our product was better. The for-profit sector was definitely more mature in its use of tools like The language we used to describe was geared for nonprofits. Even though the activities were similar, the way that nonprofits describe those activities is different, and even the goal can be different than corporate goals. Shifting gears was difficult for our sales team because we didn’t have the materials or lingo that appealed to the for-profit sector.
You can always “give it more time,” but every day that you spend working on something that doesn’t work means that you’re accelerating your burn and making it more of a challenge to stay alive when things get tough or when the well starts to run dry. The dream for most startups is to go big.
Any moment that you’re spending money and time doing something that’s not working means that you’re not doing something that might work. It’s fairly binary that way. There’s always a trade-off. Whether you’re going for a little higher risk and, therefore, a little higher reward or you’re trying to steer the rudder, keep the rudder steady and make what might seem like incremental progress. Of course, investors, all investors, are hoping for the moon shot where there’s kind of a big blowout. It’s a delicate balance between those two.
Finding Balance Between Spend and Earn
The challenge for any company is to make decisions that balance investing in existing markets and breaking into new ones. If you’re successful in your core market, it can make more sense to look for ways to expand that core market rather than break into new markets. For us, when we realized we weren’t gaining the traction we needed from the private sector, we stepped back and expanded in the nonprofit sector where we already had traction. 
If your traction isn’t defined as sales, make sure you’ve got something to show for it. For example, the traction for Facebook or Twitter when they started wasn’t sales; it was sheer audience and base. If you’ve got a burn going on, there should be something pretty dramatic on the other end that looks like traction, either in terms of users and customers, sales, or ideally both.
We live in a volatile environment today. You may have a reasonable ratio between burn and traction, and all of a sudden, something changes. For example, Twitter purchased one of the vendors for our information feed, and suddenly, the price for providing our product increased on the backend, and we had to shift our pricing model accordingly to keep up. You have to keep an eye out for those types of changes.
When you have good traction, you hire more people to maintain it, and depending on how well the staff is performing, your burn can start to increase. The ratio of burn to traction changes because you have more people. Those people have to be trained before they’re producing. You have to keep a constant eye on the traction, the rate at which you’re bringing in business, versus where the money is going and how fast it’s going out. You have to be in a position to spot changes in the environment and in your company and make appropriate decisions to stay on track.
If your burn is high because of low sales, look at your pricing model and structure. Pricing is a big deal for startups, not just the amount but also how to structure the pricing. For example, does a monthly or annual subscription model make the most sense for your customer? 
Consider experimenting to see if restructuring pricing makes a sale more of a slam dunk for customers. We worked hard on pricing in the nonprofit sector. We started off with a monthly payment and then moved to an annual payment because it was better for our cash flow and, surprisingly, an easier sale. 
Find the right balance for your business to ensure that the money you’re spending is worth the returns you receive.
This article was adapted from the book Mechanical Bull: How You Can Achieve Startup Success.

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