I just read Fred Wilson’s piece on growth vs. profit here. Here’s the summary:
tldr: The highest quality startups are in the upper right quadrant. But there are many more well funded startups in the top left quadrant and these days, all startup operating plans he sees are in this quadrant with no interest to move over to the right [and focused on fundraising]. However, it’s possible to shift, in case founders aren’t trying because they think it’s not.
I’m sure there are lots of founders who focus on growth and not profit because they don’t think it’s possible but I think there’s something else going on too.
Startups are hard: the competition edition
Startups aren’t built in a vacuum. Look at some of the most well funded startups and they are usually other well funded startups that are competing in the market. FanDuel and DraftKings. Uber and Lyft. Blue Apron and Plated.
When your competitor raises a big round and uses it as a competitive advantage to fight a war of attrition, the natural counter is to raise a big round and go toe to toe.
The economist and pioneer of game theory, Martin Shubik, who I helped as an admin many years ago, calls this the theory of escalation of commitment. From a NY Times piece:
The dollar auction game was invented by a pioneer of game theory, Martin Shubik of Yale, and it illustrates the concept of “escalation of commitment.” Once people are trapped into playing, they have a hard time stopping. (Consider Vietnam.)
The dollar auction game perfectly illustrates this concept:
To start, the professor offers to sell the class a $20 bill. Bidding starts at $1 and goes up in $1 increments. The winner pays the professor whatever the high bid was, and gets the $20. Here’s the catch: the second-highest bidder also has to pay, but gets nothing in return.
The key here is that you don’t realize you’re in this sort of game until you are in the middle of it and there’s no easy way out of it.
When I look at what’s going on out there in tech, it makes me wonder, are we in a period that resembles the dollar auction game?
How did we get here?
Traditionally, raising a big round was considered a competitive advantage. Here’s some thinking around the thought process of fundraising as a competitive advantage:
The more capital you bring in and the higher your valuation goes, the more you squeeze out others in your industry, reinforcing your position. VCs will hesitate to fund competitors if you are heavily funded. Who would fund a Slack competitor today?
So imagine a landscape where that is the traditional thinking and then what happens afterwards when the supply of later stage money balloons, as it has recently. It becomes easier for startups to raise big rounds so they raise because they can.
And the escalation escalates.