Ethan Lu is the founder of SMB Finance and a data scientist, growth engineer and investor focused on growth advising and investment capacity
Whether you’re a startup founder or just a spectator of the startup ecosystem, have you ever wondered how great startups are built? How do you turn a great idea into a billion-dollar conglomerate? There are many ways you can achieve that status, but based on my observations and work with startups, I’ve found there’s one formula that’s often optimized.
There’s no secret about how successful startups are built: They’re laser-focused on being the best in what they do. So if you’re a founder running a startup, how do you keep your team and yourself focused on the final prize and the things that matter? Here are four steps that made many startups into billion-dollar companies.
Step one: Focus on growing revenue.
You can use many metrics to track your startup’s progress, such as website traffic, social media followers, team diversity and sustainability. However, I think there’s only one metric that really matters: revenue.
As an investor and operator in many early-stage startups, I always tell founders that revenue should be the first thing that comes to your mind when you first come up with an idea, not when you’re building your startup. So how does this work in real life?
As soon as you have an idea, you should also think about your go-to-market strategies concurrently. The go-to-market strategy helps you to organize where you’re taking your idea and how you take it to the market in the sense of revenue. When going through your go-to-market strategies, you’ll review assumptions such as market size, sales funnels and operational setup for your startup.
Step two: Turn your attention to unit economic.
After taking your product to the market, your work as a founder doesn’t just stop here. It’s great that you have some people using your product, and you’ve likely collected some data either from your current or potential users. With this data, it’s time to optimize your startup. But, which part of your business should you start from? My answer always goes back to unit economic or gross margin. Why?
Let’s start with what unit economic is so we get any confusion out of the way. Unit economic is calculated as gross revenue from selling one unit of the product minus the cost of servicing that unit revenue. In traditional retail businesses, the cost of revenue is the cost of goods sold. In software businesses, the cost of revenue can be the cloud computing cost needed to keep the software running.
Unit economics essentially tells you the maximum profit you can make from selling a unit or a seat of your product. You would be surprised how many startups’ unit economics I’ve seen are in the red. There is nothing wrong with being in the red initially, but you just need a good plan to get out of it by leveraging economy of scale or increasing prices. The higher the unit economic is, the more money you can invest back into your business.
Step three: Set profitability as default alive.
After you get your revenue nicely trending up and have a good profit flow from your revenue, it’s a good time to aim for cash flow profitability—not just EBITDA profitability. A great business doesn’t burn cash forever but generates an insane amount of cash, like Apple or Amazon. I’ve found running on true profitability is also the best and easiest way to remove the risk of dependence on your capital partners like venture capitalists or private equity. It also gives you more leverage over your startup.
Step four: Prioritize management discipline.
When you have a fast-growing and profitable startup, the most significant risk you have now as a founder likely comes from within the company and yourself. Poor management is often what kills a great business. Disciplined operation philosophy includes not only in just treasury but also in the rest of the areas. At this stage of the company, your job as a startup founder is to make sure you allocate resources to the right place, whether in money or personnel.
After seeing thousands of founders turn something small into big businesses, I noticed that successful companies often follow the steps I laid out in this specific order. As a startup founder, there are lots of things you can build and optimize. But, it all comes down to priorities. When running a startup, you have the advantage over your competitors of being able to move fast and be nimble. However, it can also come with the disadvantages of limited resources. The key is pivoting your limited resources into a profitable startup by choosing what you should prioritize strategically.