Big Idea: Will Capital Kill Capitalism?

Big Idea: Will Capital Kill Capitalism?

2014 has been awash with capital. Showering money on young startups, VCs have become giddy, entrepreneurs dizzy, and sane industry observers aghast.

Right before Thanksgiving, however, Quartz published a story on the failing Fab, How Fab.com went from a $1 billion valuation to a $15 million fire sale:

Flash sales site and retailer Fab’s rise was as meteoric as anybody’s in Silicon Valley: it went from scratch to $250 million in sales in just two years. A little more than a year ago, it raised $150 million at a $1 billion valuation, bringing it to a total of $310 million in venture capital funding.
Now it’s set to be sold to Irish manufacturing company PCH in a deal that could be worth as little as $15 million, according to TechCrunch.

There is a reason why fundamentals are called fundamentals. They are, er, fundamental.

There was nothing inherently wrong with the flash sales business model. There are companies that have been successful with the model. It’s not that you cannot build a business on that model.

There is, however, something grossly wrong about ignoring fundamentals consistently, and building a business that doesn’t pay attention to profitability and sustainability.

You need gobs of capital to stay alive.

And guess what happens when that capital is no longer available?

You die.

In an earlier piece, I also raised the subject in the context of our industry’s current obsession with offering value for free:

The Internet is full of people who expect that everything should be FREE. In Economics, this phenomenon is referred to as the Free Rider Problem: when people consume value without paying their fair share. Obviously, some people DO pay their fair share. This makes the 'free riders' take advantage of those who pay, making the whole equation unsustainable in the long run. Creating value is expensive.
Capitalism assumes that value gets created with the understanding that those who consume that value are going to pay for it. If that assumption is violated, the system, eventually, collapses.
If you are an Internet or Mobile entrepreneur in the twenty-first century, chances are you are, somehow or the other, being affected by this challenge. The Media industry, in particular, has dug itself a gigantic hole and climbed straight into it by offering content for free. Now, the apocalypse has set in. The industry is doomed to oblivion for the most part.
The Education industry, with MOOCs, had started going down that path, but at least is pausing to think, thank heavens!
A recent Developer Economics survey offered the following observation:
A new 10,000-developer survey by Developer Economics says that 50 percent of iOS developers and 47 percent of Android developers are “below the app poverty line” and making less than $500 per app per month. That means “the majority of app businesses are not sustainable at current revenue levels,” Developer Economics says.
Why do you think this is the case?
Because, developers are confusing 'customer' and 'free user'. A free user is not a customer. Your goal is to get paying customers, not just free users.
If you have a product that customers don't want to pay for, but they want to use for free, then you don't have a business.
It's a charity.
So, please be careful about giving lots of value away for free if you want to be successful as a business.

The free-flowing capital, of course, is what makes the above phenomenon possible for entrepreneurs: to offer value for free.

Except, what happens when the capital dries up?

You go out of business!

Facebook has showered over $20 billion on a valuation without revenue company called WhatsApp that sent the market bonkers. All young entrepreneurs started dreaming of their own bonanza day.

Fundamentals grew out of fashion the day WhatsApp was acquired.

None of this would be possible if capital weren’t flowing so freely, so irrationally, so stupidly.

We’ve seen this movie before.

Conceivably, the bubble will burst. Capitalism will emerge triumphant, making mockery out of those who have ignored fundamentals systematically.

Will it though?

There is a tremendous concentration of capital in the hands of a few right now, including companies like Facebook, Google, Yahoo, etc. who are known to make irrational decisions.

And the VCs are also falling over each other to see who can be more irrational. The VC cycle, unfortunately, is very long. It doesn’t correct itself that quickly.

So, at the end of 2014, I ask you to think about the question: Will Capital kill Capitalism?

I am going to provide a few points as a discussion starter, but this is a discussion I am inviting you into, not a lecture that I am presenting.

First, there are a lot of free services that heavily venture-funded startups are offering for free or at very low prices that are making existing small businesses who have to focus on fundamentals unviable. From laundry to home delivery of meals to transportation, these online services are useful, but I am not sure why fundamentals need to be ignored in building these businesses.

The same applies to many business services as well.

The problem that we’re creating is twisted consumer expectations: everything is EXPECTED to be free.

We’re creating a free-rider society.

We’re creating a capital-funded free-rider dynamic that ignores one of the fundamental tenets of capitalism: producers create value, consumers pay to consume value.

Once this basic assumption fails, society goes on welfare.

Is that what we want?

Looking For More Hands-On Advice?

I receive many emails from entrepreneurs who want to discuss their specific businesses. I’m very happy to discuss your situation during my free online 1M/1M Roundtables, held almost every Thursday. During each roundtable, up to five entrepreneurs can pitch their businesses and receive my immediate and straightforward feedback.

To give entrepreneurs all over the world access to Silicon Valley’s knowledge, methodology, and network, I founded the One Million by One Million (1M/1M) global virtual incubator. 1M/1M aims to nurture a million entrepreneurs to reach a million dollars each in annual revenue and beyond, thereby creating a trillion dollars in global GDP and ten million jobs.

For those still testing the waters of entrepreneurship, I’ve written my Entrepreneur Journeys book series to inform and inspire. My newest book, Bootstrapping With A Paycheck, is now available from Amazon.

If you are interested in entrepreneurship topics and my writings, you can follow me here. I hope to publish three articles on LinkedIn every week.

Photo: Tax Credits/Flickr.

emerson castillo

yi Gestion Recycle

8 年

Bla,bla....

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Abhijit Hazra

Founder Director and CEO at Touchstone Tie-up Pvt. Ltd

9 年

Sramana, thank you for starting this debate. Acquisition of few companies like WhatsApp which offers products/ service for free, in huge valuation keep entrepreneurs dreaming for the same or similar business model. They ignore the fundamental rules of a business. No or unsustainable revenue model can not a be a business model either, even we have few huge success stories to vouch for.

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Nick Maravich

Product Manager - Data Science

9 年

Love this debate and invitation to participate! Will post my thoughts and questions on my blog. Seeking to both learn and share - Thank you for this post!

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Interesting post! I see netizens moving back to barter system - let me download your analysis content in exchange for downloading my music for free. Not every exchange needs dollar or bitcoin.

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Kevin Carney

Community link building

9 年

I messed up and somehow hit submit too early. The combination of the GI Bill and the Space Race created an enormous middle class who wanted cars, TVs, microwave ovens, bathroom remodels, private schools for the kids, etc, etc. The US has actually done this twice, with enormous results each time. The first massive "government welfare" program was the transcontinental railroad, which cost a staggering 3% of GDP. Interestingly enough this was also the first instance of "too big to fail" and many of these railroads had terrible business models, kept going bankrupt, and were bailed out by the federal government. Looking back it was a huge economic success. The next one was the GI Bill and the Space Race. When governments spend "correctly", the benefit is enormous. I live and work in Silicon Valley. There is a startup incubator in Menlo Park that has a tight relationship with the Dutch government, such that the Dutch government sponsors Dutch startups to come to Silicon Valley and plug themselves into our infrastructure. The Dutch government literally subsidies these startup efforts. There is another startup incubator in Palo Alto where the German government sends in the monthly rent check. In both cases startups that meet their criteria are literally subsidized by their governments. Why? Because those governments seem to understand that subsidizing innovation results in more innovation. Not only did the US once do that (back to the GI Bill and the Space Race) but we did it bigger than anyone else and the effect was enormously positive. It worked. Maybe we should do it again.

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