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Our memory of the rise of startups like Sony, Microsoft, Apple, and HP, from garages, university dormitories, and repairshops to mega corporations is still vivid. The main asset of startups is ideas-intellectual assets. Digital technology core combining smartphones, laptop computers, internet connectivity, software tools, and access to cloud platforms does not require much capital. Hence, digital startups are supposed to demand relatively low-risk capital. However, contrary to this common belief, startups pursuing digital technologies have been asking for growing investments. According to Crunchbase, global startup investment grew from nearly $130 billion in 2014 to $700 billion in 2021. Investment has grown across all stages, such as angel-seed, early, late, and technology growth. Unfortunately, instead of growing ideas for making their offer better and cheaper, they have been asking a growing fund for creating market of their primitive alternatives through subsidies. Does it mean digital startups are plagued by the wrong thesis about how to grow ideas into profitable businesses?
Instead of reporting profitability, the digital startup space is busy making press releases about how much funds have been raised based on an increasing valuation of loss-making startups. Reaching a billion-dollar valuation for gaining the title of unicorn has become the ultimate milestone of digital startups. Unfortunately, according to some studies, as little as eight per cent of unicorns are profitable. Those days are gone when personal and family savings were good enough to turn creativity into a profitable business. Instead, burning millions of dollars for inflating valuation has become a new normal in the digital startup space.
Unfortunately, their subsidy-centric customer acquisition for inflating valuation to grab more investors' funds has started facing a bleak reality. For example, in one of the less developed countries, there have been recent media reports of a drop of 70 per cent in startup funding. Besides, it's speculated that if the Government withdraws tax exemption, many digital startups will likely collapse. Why should investors keep pumping money if there is no sign of reaching profit and a scalable growth path? Similarly, why should the government keep giving tax exemptions?
Startups are after offering alternatives to existing products around emerging technology cores. Their innovations are supposed to be better and cheaper, unleashing creative destruction wave. Consequentially, tiny startups emerge as disruption forces to incumbent behemoths offering matured products. GE, Sony, Intel, Microsoft, and Apple are some examples. However, have digital startups pursued the mission of providing better digital alternatives of goods and services following a similar approach to past startup successes? Unfortunately, most of them are not. Instead of focusing on improving their innovation, most digital startups, notably in less developed countries, are plagued with the wrong thesis of creating digital disruptions.
Their thesis has been to disrupt incumbent products through predatory pricing and subsidy-led customer acquisition to inflate valuation and fraudulence. For example, digital poster child Uber has been after grabbing the market of taxi services through massive subsidies. As a result, in addition to burning billions of dollars of investors' funds in offering subsidies, Uber has been facing class action lawsuits. This digital poster child recently settled a lawsuit in Australia by paying $270 million. On the other hand, e-commerce startups have been plagued with the reputation of fraudulence.
Let's draw lessons from essential characteristics of innovations pursued by startups and the underlying challenge of reaching a profitable growth path. As mentioned, startups aim to offer alternatives to existing mature products by reinventing them. They pursue ideas of changing the mature technology core with emerging alternatives. For example, Netflix pursued the idea of replacing video tapes and DVDs with digital content and replacing their physical distribution by streaming over the internet. Similarly, Edison pursued the idea of replacing the technology of producing light by burning liquid fuel in oil lamps or hurricane lamps by heating filament through electricity. On the other hand, Sony's idea of offering a better alternative to film cameras was to replace film with an electronic image sensor.
Invariably, reinvention ideas such as digital alternatives emerge in an inferior form. However, due to the uniqueness of the emerging technology core, they have latent potential to grow as better alternatives. For example, despite the convenience, Jeff Bezos's idea of retailing books over the internet was costlier than conventional book retailing shops due to the added cost of mailing each book. Hence, Amazon's e-book idea started the journey at a loss. However, there was a latent potential of converting physical books into digital form and delivering them over the internet, making the postal cost irrelevant. Hence, instead of subsidising physical book delivery by getting orders over the internet, Amazon focused on additional ideas for tapping into the latent potential. Consequently, Amazon succeeded in turning the loss-making e-book idea into a profitable business. Unfortunately, most digital startups in less developed countries have been failing to follow this basic thesis of developing loss-making reinvention ideas into profitable businesses.
Successful startup history indicates that they all started the journey at a loss. Initially, their reinvented products appeared in a primitive form. Unlike most digital startups, instead of offering subsidies to create a market for those inferior alternatives, they focused on improving them through a flow of ideas. Instead of following this proven path of creating success, digital startups have been after increasing their valuations of offering primitive alternatives so that they can offload their shares to new investors and quickly get rich. They are also under the belief that if they keep getting funding and incentives, they will reach profit by creating a market of primitive digital alternatives through subsidies. However, no analysis suggests the merit of such a thesis. Such a thesis may bring quick windfall profit to entrepreneurs for offloading the shareholding of loss-making digital startups to new investors. However, investors will not get the money back, as such such an approach will not turn those loss-making startups into profitable businesses.
On the other hand, due to wrong thesis, society will be deprived of the possibility of creating wealth from intellectual assets, creating jobs, and creating an idea economy. Besides, society suffers from unhealthy competition, market distortion, and fraudulent activities. Hence, it is time to return to the basics of wealth creation from the emerging technology core. It's high time for digital startups to give up the wrong thesis of increasing the valuation of their loss-making offerings by creating a market for their initial primitive digital alternatives through subsidies, tax exemption, and government incentives.
Rokonuzzaman, Ph.D is academic and researcher on technology, innovation and policy.