Profits or Valuation?

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I often wonder about the new economy, new kinds of businesses, massive funding rounds for some of them and valuations. Infact, we all do. Are we missing something? How did these young companies become the world’s biggest companies so soon? Is this temporary?

I am an advocate for businesses that are profitable at the net level (not just with profitable unit economics). I believe they are an asset to the society as they generate an economic surplus, they are sustainable, and they help in creating economic balance by pricing output appropriately.

However, we can’t ignore the new businesses that have cropped up, who scale with funding, have huge valuations and are running in massive losses. Many people wonder if it’s a bubble economy or how it works?

Here is why I think, we need them and why do they operate this way – There is a niche of businesses for whom scaling/growing is more important than sustaining in their initial phase. Their moat is their scale. Example – all the social platforms like Facebook, Twitter, Instagram, LinkedIn. For these companies, the scale and the need for everyone to be on the platform are quintessential to creating value for them and their users. Similarly, for companies like Uber and Ola, it is important that they achieve scale before they focus on sustainability. The scale is essential for them to operate effectively. Cab drivers at Uber and Ola, benefit from a continuous stream of passengers and that would happen only when a lot of users are on the platform. This creates an incentive for drivers to sign up on Uber and Ola, and thus creating easy availability for users to find cabs nearby when needed.

If these businesses will focus on sustainability early on, without growing, then these businesses will lose the benefit of scale and will not create value for anyone – themselves, drivers or passengers. Therefore, they are required to spend significantly on acquiring customers first. Hence, huge losses in the beginning. Hence, the need for funding. As more people sign up on the platform, their valuation increases. Because that is their moat! Hence, investors are ready to give more funds to them to get more users.

However, this must end when the company has gained scale. There is no justification for a business to keep producing massive losses even when they have gained monopolistic status with their scale.

Besides, this doesn’t mean that all the businesses that get funded fall in the above category. For example, I have always believed that co-working spaces shouldn’t be allowed to operate at losses at the net level. Every single unit of these co-work offices should be profitable because the scale is not going to help here. Similarly, hotel chains like Oyo should also focus on being sustainable as the scale is not going to change their economics. When businesses whose scale doesn’t change their economics, raise massive funds, become huge and still lose money, then I think that’s an example of a bubble or investor misjudgment. I am not saying that they should not raise funds to scale, but that, they should have a focus on sustainable operations.

Many businessmen also ask this question. Should you focus on profits or valuation? Should you try to raise funds? In my opinion, it again depends on the nature of your business. Would growing change your business’ economics? If yes, sure. I would suggest starting with having a couple of conversations with investors. Get their opinion. If not, then grow nevertheless, but keeping the focus on profits would help 🙂