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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.

I recently came across a very interesting paper covering how entrepreneurs might think differently about the world. I have embedded a marked up version of it below. Allegedly, the very entertaining markups belong to to Vinod Khosla. I highly recommend it to people who want to start a business, are already doing so, or have to deal with founders (both personally and professionally). It might help and explain why they do certain things :-).

From my personal experience and talking to others who have started companies, what the paper calls ‘effectual reasoning’ is the only possible way of thinking in early days of a startup (especially if you are a first time entrepreneur with very limited resources). As the business grows though you definitely need to add some ‘causal reasoning’ to the mix otherwise you can’t scale the organization and the business. The bigger the company becomes (both in terms of people and revenue), the more you end up tilting your reasoning to the causal side.

However, you still need to keep the effectual reasoning in your arsenal beyond the very first days of the venture. It is an essential part of being able to expand your product offering, enter new markets, or even add innovative functionality to your products. The trick becomes maintaining a healthy balance of the two if you possess both. My current thinking is that 1 of out every 5 major initiatives at a company between $100M and $1B should be adhering mostly to effectual reasoning. What has been your experience?

Another interesting outcome of this paradigm is that you need to have a team that can execute on both types of projects. Early employees at startups by definition become comfortable with the effectual reasoning of the founders. That’s all they see everyday! However, as the business grows and new people join the team who have not been involved in these types of projects, it can create shocks when switching between the two. I have personally tried to put together mixed teams for these types of projects: bring some people with experience in effectual reasoning projects and have them play along with a few newbies. It has worked well so far in getting projects off the ground as well as making more people comfortable with the project type.

As a founder switching back to effectual reasoning every once in a while might come very naturally (you might even yearn to go back to it because it’s what you enjoy the most). Like anything else, the more you do it, the easier it becomes. But you need to keep in mind that not everybody on your team has had this type of practice. It never hurts to talk about the differences between types of reasoning and projects discussed in this paper. Sometimes I feel I am beating a dead horse when I try to talk about this topic with our team. And every time I do, I am glad I did it. You might not realize it, but you are probably not doing it often enough. And this paper gives you a very good framework to discuss the idea with your team.

Vote for my PanelPicker Idea! Based on my experience at Zoosk, I have submitted a panel to SXSWi conference for next year titled “Throwing Your Shoestring At Being Platform Agnostic“. I am planning to talk about what it really means to have a platform agnostic product and how can a startup afford to build their product for multiple platforms.

The selection committee has liked the idea enough to put it to community vote. Now, I need your help and votes to make sure it gets accepted. Please visit the panel picker and give it a thumbs up! Make sure you are logged-in or the vote won’t count.

See you all in Austin in 2010 :-)

A couple of weeks ago, Yi-Wyn Yen from Fortune Magazine interviewed me about the current state of Open Social, MySpace platform launch, and state of social network platforms in general. It turns out she liked how I was thinking about the problem and added a couple of quotes from our conversation in her article.

A cool by-product of this interview was that my name now appears (as far as I can tell) for the first time on cnn.com domain. Thanks Yi-Wyn!

This blog has been very quiet lately, but my life has been anything but! If you have been following my journey in entrepreneurship, you remember that I started a company called Pollection a couple of months ago. One of the products that Pollection built was a semi-dating application on Facebook, called Sex Appeal.

We got such a positive response to that product that convinced us we should reposition the company to tackle the dating market head on! So we went back to the drawing boards and came up with the coolest Social Dating product ever! That’s how Zoosk was born!

Zoosk was launched on Facebook on December 18th and since then what a ride it has taken us with her! You can follow the Zoosk story here. In a short span of time, Zoosk has grown to 2,000,000 members, has 15,000 fans on Facebook and we haven’t even started yet :-). This is going to be super exciting…

Well, just wanted to drop a line here so you don’t forget about me! The reason for slow (or not-at-all) blogging has been Zoosk keeping me busy but I will try to carve enough time to keep this blog alive!

Oh, and by the way I moved my blog to wordpress.com to not have to worry about hosting/updating/etc! It was a super easy migration. The new url is http://shayang.wordpress.com so update your links.

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