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Economy

A question often posed to me as a startup founder is, “What will happen to your company — and others in the tech community — if the economy heads toward another recession?”

It’s a timely question. There’s a startling amount of evidence that the US (and global) economy faces a rough couple of years ahead. Fact is, even if the economy manages to avoid plummeting to what officials deem as ‘recession levels’, few will deny the upcoming years will see very slow economic growth overall. There is also a ton of macroeconomic evidence that the problem of high unemployment will remain unresolved regardless of GDP growth. From simply trying to remain afloat in tough times to seeking fundraising or some other exit strategy, there’s no shortage of available advice on how ones business might deal with rough economic tides.

But what I wanted to cover here is different. Rather than focusing on Basic Survival 101, I’d like to discuss how to minimize the impact of, or even thrive in, periods of slow economic growth. Among the myriad responsibilities any startup founder or CEO faces is the pivotal responsibility of how to economically position his/her business and product for longevity — which entails more than choosing the right markets to enter and the best products to offer, but includes ensuring that his/her business has a smart distribution strategy, a monetization strategy, internal team-building strategy, etc. And these decisions impact the business’s exposure (and response) to economic fluctuations.

Since I am most familiar with consumer businesses, I’ll limit the ensuing discussion to my area of expertise (certainly, similar parallels can also be made about B2B businesses — but I’ll leave that to experts :-) ).

Anatomy of a recession

At the risk of my macroeconomics professor taking huge issue with simplifications I am prepared to make here, let’s enumerate some of the things that happen when economy doesn’t do too well.

  • GDP growth slows down
  • Companies generally stop investing and start saving money
  • Companies are (usually) forced cut overall costs and at times reduce the number of employees or lower salaries, cut benefits, etc.
  • Unemployment and lower salaries (or lack of increase in salaries) lowers consumers’ expendable income
  • Consumers lower their spending
  • Lower consumer spending results in even lower GDP growth
  • And the cycle continues

Byproducts of a recession

A few major patterns emerge in this situation. The most important one is that consumers have less money to spend. Consumers stop purchasing items they deem to be overall unnecessary, and for products/purchases that are necessary, consumers will seek less expensive alternatives, like using Kayak and other travel search sites to lower ones travel expenditures. If your company offers a product that is clearly discretionary (say, video games) you’ll see the negative impact when consumers play their old games instead of buying the latest versions or find cheaper alternative entertainment. On the other hand, if selling coupons — deals for food in particular — is your business, then you’ll see a positive uptick in demand, like Groupon did during the 2008-2009 recession.

And if your company provides a less expensive alternative to a basic human need, you’re also in luck. Take dating. If you compare the cost of going out to bars or clubs to meet new people with using online dating sites like Zoosk, the savings consumers can realize by choosing the latter is obvious.

Recession-era customer acquisition

As businesses cut costs overall, marketing budgets are significantly reduced. Both online advertising and offline advertising face budgetary restrictions, but more so in the latter because branding budgets get cut before performance budgets on the web. And the cost of offline advertising remains significantly larger in absolute terms. So, if your monetization strategy is based on selling ads (specially brand ads) your business will take a massive hit, whether you’re an international behemoth like Google or a tiny social gaming venture. In 2008-2009 we saw a huge shift from ad monetization to direct consumer monetization in variety of industries, particularly games. Unfortunately, while bigger companies can afford to weather a downturn (provided it’s short-lived), startups cannot.

In contrast, if advertising is a cost item for your business, then you might benefit from the phenomenon illustrated above, because the cost of acquiring free users falls during economic downturns. When the demand for ad space drops, so does its price — both online and offline —  when decreased competition between bidders sets decreased prices. Insofar as potential customers are interested in paying you (see first part above), they can be acquired for cheaper.

Who wins then?

To summarize, if your business can provide a cheaper alternative for something people will need regardless of economic performance (basic human needs such as food and shelter, including spiritual needs like love and companionship) and if your company has a large customer acquisition budget (like Kayak and Zoosk), then your business remains well-positioned to be recession-proof.

Better yet, if we avoid recession and the economy makes a recovery, everybody wins :-). Entrepreneurs should however seek to build healthy businesses well-hedged to thrive in both scenarios. I hope the entrepreneurs out there take this opportunity to examine the fundamentals of their business and locate any areas that will be impacted by boom/bust economic cycles. There are always ways to tweak your model such that you are better positioned in both situations.

A very interesting and in-depth look at US economy by Mary Meeker (Partner at KPCB and former financial analyst at Morgan Stanley). you might not agree with all the assumptions and recommendations, but it’s worth reading. Very much enjoyed how she models the country’s finances. Unfortunately, the current political discussion doesn’t really address any of the major problems highlighted here. Do you think we will act in time?

USA Inc.: Red, White, and Very Blue

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