I received some skepticism on my previous article. Let me give you a gist of the article here –
The article aimed to answer why would investors fund loss making businesses, how can loss making businesses today become profitable tomorrow and when exactly is your startup declared a failure. I had defined “Economies of Scale” as the startup success formula. It basically means that your average cost per unit goes down as your quantities increase. This requires you to play around with your fixed costs, variable costs and marginal costs in your business model. Moreover, due to a number of possible reasons, when you start spending more and more with increasing quantity, you have hit diseconomies of scale and this is when you fail your startup.
The skepticism came questioning, what is adding to my confidence when linking this concept to startup success. Also we are used to reading articles with a long list of ideas and tips for startup success then why am I attempting to highlight a single aspect.
To assert a business concept with confidence, let me do what professors do – Throw a Case Study.
The Ola Case Study
I am sure the readers of this article are aware of the Ride Hailing market leader in India – Ola Cabs. The company went off to a good start becoming one among the few Unicorns (startups valued over $1 Billion) of India. People were always skeptical of Ola Cabs because of its unbelievable prices along with highly paid drivers. But it was valued at $ 5 Billion in 2015, astonishing the common man. But now in 2016, it is expected to raise funds at a much lower valuation of $ 3 Billion.
So, we have a big question – What has changed here? Though you can answer by comparing Ola with its rival Uber, I would throw some financial analysis. As everything about a business is reflected in its “Marks Card” i.e., the financial statements.
|Revenue in INR Crores||Cost in INR Crores||Cost/Revenue %||Valuation||% Change in Valuation|
|2012-13||16.00||38.80||243%||USD 1 Billion in 2014||–|
|2013-14||51.05||85.26||167%||USD 5 Billion by March’15||400%|
|2014-15||418.25||1,173.12||280%||USD 3 Billion in 2016||-40%|
- Bloomberg Article (November 25, 2016)
- Livemint Article (Jun 23 2016)
- Business Standard Article (December 11, 2014)
Ola Cabs charges based on KM and time, so revenue earned is an indicator of quantity or scale. The cost per revenue ratio of Ola Cabs was going down with increasing revenue in 2014. This reflected the potential to scale the business and make it sustainable – Economies of Scale. Hence its valuation had jumped up.
However, later in 2015, the cost per revenue ratio had gone up with the increase in revenue. This reflected a skepticism on scalability, or it reflects a possibility of Ola hitting Diseconomies of Scale. That is, they start spending more and more, with increasing quantity. The market is again reacting to it.
Why define this Success Criteria (replacing the “formula” word here)
You can go through a number of startup tips, experiences, strategies, market sizing, etc. But how do you start measuring success? To progress with something you need to define the criteria to measure your progress. Right from the beginning, aspects of your business model – how much you spend? and on what? what you do and what you don’t? how you earn? and so on – are critical to the success of your business. All the little metrics that you track need to lead you towards a single goal of business success. Obsessing with Market size and leading on market share can not take you far unless you are complying with the success criteria of Economies of Scale.
I hope this enforces the importance of Economies of Scale for Startup success. I would welcome comments, feedbacks, criticism, etc. Looking to gather your views here.
P.S. Let’s keep the “No” Revenue businesses out of context for now. We will touch on that later.