Look, I’m Growing!
Hey <<First Name>>,
I received a tremendous amount of feedback after last weeks newsletter regarding the growth prospects of “niche companies." Now let’s check out the opposite spectrum. We get approached by a multitude of companies experiencing hyper-growth that are in the process of raising A or B round funding.
We’ll receive decks showing continued exponential growth and often inexplicably to valuations of more than $1 Billion. Unfortunately, there are numerous ways to achieve short periods of growth with tactics rather than strategy, as two-thirds of the fastest growing companies ultimately fail. There is a .00006% chance of building a billion dollar company.
Creating a company from zero to $50MM is an accomplishment, but building a company from $50MM to $1B is an entirely different proposition.
Massively successful startups have a clear competitive advantage that is extremely hard or expensive to replicate. This is the term coined by Warren Buffett as a "MOAT." This unfair economic advantage allows companies to continue to dominate their industries and stave off competition for a considerable amount of time.
The companies that don’t continue hyper-growth at their initial rate generally face two issues. First, their growth was fueled primarily by a first mover advantage which they enjoyed by being first to market with their product or service. Success breeds competition in every market and without a distinct MOAT, the cost to acquire new consumers increases as more competitors enter your marketplace. That cost increase has an adverse effect on your profit margin, which invariably leads to slower growth.
Over the last five years, we’ve seen the explosion of direct to consumer (DTC) and digitally native vertical brands. Billion dollar brands such as Warby Parker, Away Luggage, AllBirds, Jet.com, Bonobos, and Dollar Shave Club pioneered today's venture-backed brand-building trifecta: hyper-growth, quality product, and customer data. Fueled by the scale of Facebook and Google, these brands have an instant global reach.
The new DTC companies flushed with scale-hungry investors and oceans of venture money have primarily paid for all their consumers on Facebook, Instagram, and Google. Their customer acquisition costs on these platforms are soaring as they fight for limited advertising space. As these companies grow, so do costs of acquiring each additional customer. Advertising on Facebook has become 70% more expensive between 2017 and 2018, while ad spend on Facebook grew 40% during Q2 2018.
The recent internet age has seen the perfection of this specific fraud by companies: 1. Raise initial capital to sell a product or service on the Internet. 2. Use the funds to buy consumers. 3. Show increasing growth. 4. Raise new funds on that growth to buy more consumers. 5. The cycle continues, and valuation soars during each fundraise. 6. Now the cost of acquiring the consumer on your trusted social platforms rise exponentially, and you can’t show the same growth metrics, and profit margin decelerates.