I hate to see, from a customer’s perspective, investors coming into a growing Web startup.
Because it only means rising prices.
The logic is this: 1) the investors need a positive return, and 2) the startup is growing because it has created something valuable, in most cases significantly more valuable than what it is charging from the customer.
Therefore, the investor logic is to raise the price and narrow down the extant value gap, i.e. charge according to the value provided (or, closer to it). However, most customers will still stay, because they keep getting more value than what they pay, even with increased prices, and therefore the startup can maximize its revenue. In addition, there would be a switching cost associated with finding a new provider, such as learning the new tool, configuring it, exporting/importing data, etc.
So basically, this strategy is a form of value transfer from the customer to the startup — or, more correctly, to the investor.
Next, we’ll explore what this means for investors and founders.
1. Implications for investors
The major implication for an investor of course is that it makes sense to identify startups which are growing fast but have not optimized the value capture part of their business model.
However, a major difference lies in between having some revenue and not having revenue at all; in the latter case, the growth might be just an indicator of popularity, not business potential. (See my dissertation on startup dilemmas for a thorough elaboration of this topic.)
2. Implications for founders
The major implication to a startup is that if you seek funding, price your product well below the value provided, thereby sacrificing unit-level profitability for growth. But if you want to stay away from investors, experiment with rising prices – that way, it’s only you keeping the surplus. Obviously, this is “ceteris paribus”, so it excludes the potential revenue uplift from scaling with investor money.
As we know, the only reason to bring in an investor is to grow the size of the business and thereby also increasing the founder’s personal profit, regardless of stock dilution.
Dr. Joni Salminen holds a PhD in marketing from the Turku School of Economics. His research interests relate to startups, platforms, and digital marketing.
Contact email: [email protected]