There’s never been a better time to build ‘profitable’ startups in our ecosystem than right now. As VC funds dry up, the spotlight is firmly on sustainability metrics.
“Profitable growth requires a disciplined approach to expenses. Companies that lose control of their expenses in the quest for growth will inevitably find themselves in trouble.”, says Verne Harnish in his book “Scaling Up”.
Before I tell you how to go about reducing burn at your startup, I first want to tell you about the symptoms of startups that struggle with profitability. In our deep experience working at startups like Flipkart, Ola, and Myntra and across our considerable work with 350+ companies at xto10x, we see a repeating pattern of challenges:
- Low Gross margins due to product design flaws & poor pricing & discounting
- Supply Chain costs of ~15-20% because of inefficient network and fulfilment design
- High cost of performance marketing – often as high as 30-40% of sales, but significantly lower marginal return with increasing spends
- Corporate spending of ~25-30% largely on the back of excessive-tech investments and bloated leadership compensation (especially cash)
- High cost of capital because of poor working capital days management
Does this sound familiar? It may be reassuring for you to know that most startups, including unicorns, face exactly the same challenges. Here are some suggestions on what you could do to keep costs under control, not just now but even in good times:
- Improve your Gross margins: A startup we worked closely with, had 30% of its SKUs operating at negative gross margins leading to very poor overall gross margins.
From going back to the drawing board to redesign the low gross margin SKUs, to installing the planning function to minimize wastage due to demand-supply mismatches, to renegotiating sourcing costs for the raw materials with the highest spends, & using customized discounting (e.g. lower discounts for loyalists vs new customers) they were able to improve gross margins by 25% in a span of 4 months. - Streamline your Operations costs: A Series-B startup was spending 18% of its revenue on Operations against a benchmark of <10%.
Poor fulfilment & inventory design (85% of items being shipped cross country despite having 3 warehouses), a return rate of >10% (35% of all returns saw a delay in warehouse dispatch) & under-optimized packaging resulting in higher logistics costs were some of the identified areas to reduce operations costs by 30% within 2 quarters. - Optimize your marketing spends: A startup spent 35% of its revenues on performance (digital) marketing, and nothing on Brand or BTL initiatives.
Channel-wise (Google vs LI vs Fb Vs others like Magicpin) ROI analysis, and tracking customer cohort-wise spends (O1-O6 and S1-S6 analysis, acquisition vs retention vs resurrection) are some easy ways to identify opportunities to reduce perf marketing spends by half. Also, leveraging BTL (radio, flyers etc) is also a good way to reduce dependence on Perf marketing while ensuring sustained revenue impact. - Check excessive corporate spends: A startup’s corporate spends were as high as 28% of their revenue, and had only increased as a % of revenue over the past 24 months!
Some repeating patterns are excessive leadership cash compensation structures, much bigger tech teams than needed and little control over G&A spending. Best practices include fixing a comp ceiling (and using ESOPs for those who hit this), strong guardrails for special projects (this company had 25% of their tech staff on non-critical projects), and cutting all overheads (e.g. annual recruitment retainers) clinically. All this should allow corporate spending to reduce to ~15% of revenue and then reduce with increasing scale. - Analyze your working capital: A retail startup had up to 60 days of inventory making scaling extremely cash intensive.
25% of the SKUs contributed to 80% of sales and the bottom 60% of SKUs had 5% of sales, but 80% of the inventory. Analyzing SKU-level information can lead to redesigning your production lines, decisions on relegating poor-performing SKUs and tiered service levels for different SKUs (leading to lower inventories). Renegotiating terms of trade with suppliers for key items also goes a long way in improving working capital days.
Setting up the right Business Finance function and creating the right governance and review forums can go a long way in building a culture of cost focus and driving the right actions through the organization.
In case you feel the need to discuss this topic in your context, please get in touch with Sonali, our GTM leader, to plan an exploratory conversation.
