Businesses fail because...

I've analyzed dozens of startups on this channel, and they all have one thing in common. Growth comes in six distinct phases. It doesn't matter if we're talking about a massive multinational tech company like Google, or a tiny startup with nothing more than an idea. They all fit perfectly into this simple growth framework. If you can progress through all six of these levels, you'll wind up running a massive company with a soaring stock price. But these aren't easy steps, and I should know. I've been an entrepreneur for the last decade and I'm still stuck on level four. Very few companies have what it takes to really go the distance and knock down all six milestones. But when they do, they inevitably wind up becoming worth hundreds of billions of dollars in the process. It doesn't matter if you're still just coming up with your very first business idea or running a startup worth billions. You need to have good answers for how you're going to get through each of these stages if you want to grow your business. So let's walk through the entire entrepreneurial journey from idea to IPO and beyond. Level one should be the easiest part, but a surprising amount of entrepreneurs fall short here. They come up with an idea, but they can't build a real product. And until you have a product, you really can't move on to the later stages. Well, some companies try to move forward without building a real product, but they always fail. There's even a term for fake products like this. Vaporware. You don't want to wind up working on a vaporware project. It never ends well. Just look at Theranos. Elizabeth Holmes was able to attract investors, employees and even customers, but she couldn't deliver a functioning product, so the company crashed and burned. So when you're starting out, you need to have a clear vision for your product and what skills will be required to actually get it built. If you want to build the next great social network, you'll probably need some talented software developers on your team. Ideally, you'd be a solid programmer yourself. Just look at the founding teams. Behind every successful social network, there's always at least one computer scientist on board from the earliest stage. Now, it is possible to build a technology company with only a business background. But the deck is going to be stacked against you in a few key ways. First off, investors are well aware that technical teams tend to win, so they will be less likely to fund you. And second, developers don't like working for non technical people. It's really hard to get motivated to work for someone who has no clue what you actually do. Great technical minds don't want to work with someone who will just tell them to make the website fast. They want to partner with someone who really understands the challenges of building high performance software. Now, the good news is that it's pretty easy to learn to code these days. So even if you have a business background, you should be able to study up and learn the basics in a few months. And if you're building a piece of software, I promise it will be a great investment. But what if your company isn't primarily focused on software development? Who? Well, then you probably don't need to learn to code, but you still need to make sure your founding team has the skills required to deliver a high quality product. Clearly, software development wasn't an issue for Theranos. What they needed was some sort of major breakthrough in biology and microfluidics. Most people agree that we're still decades away from this type of technology, but when it arrives, you can be sure that the team that figures it out will have deep technical expertise in how biological systems work. So you've made sure that the world actually needs your product, that it's possible to build your product, and and that you have the team with the skills to deliver that product. Now what? Well, you need to answer the level two question. Do people want to buy your product? Tons of talented entrepreneurs will spend months building the next great product, only to launch it and get zero signups on their landing page. Avoid this situation at all costs. It's demoralizing and a huge waste of time. The faster you can get your product built, the faster you can get it in the hands of real users and start getting feedback. That's a big part of why it's so important to have the technical skills to build your product directly within the founding team. Outsourcing product development will slow you down and add an extra layer of complexity to your product iteration cycles. You want to be able to add a new feature to your product and then go get feedback from your users immediately. And as soon as your users give you their opinions, you need to incorporate that into the next release immediately. So how can you conclusively prove that people want to buy your product? Well, you can ask them to pay for it. Lots of entrepreneurs start by asking friends, family and professional connections to test new products. If you. It can be hard to get honest feedback from people you know though. So this is where broader test marketing can be helpful. Sharing a demo of what you're building to popular sites like Hacker News, Reddit, or Product Hunt. Can be a great way to start testing your product with people you don't know. And it's important to understand the difference between a user and a customer since they aren't always the same person. For example, Facebook is a free service to users. The customers are advertisers who want to reach those specific users. If you're building a business where the user and the customer are different, and it will be very important to validate that everyone likes what you're building. After all, there are tons of websites out there with lots of users who can't attract advertisers because they feature objectionable content. I've spent months building projects I thought would be successful, only to launch them and completely flop. Some companies spend years making this mistake though. The short form video app Quibi was in development for years before going live on the App Store. Even though they had spent over a billion dollars developing the platform, platform and content, no one wanted to pay for it. The Quibi team offered a free trial, but pretty much everyone who tried the app wound up canceling as soon as the trial ended. It was a disappointing outcome for everyone involved, and it highlighted the importance of validating demand for your product. So build your product quickly, adding only the few features you need to prove the concept, and then get it in the hands of real customers. As soon as you have clear evidence that customers are willing to pay for your product, you'll have a much easier easier time raising money, hiring employees and scaling your business. But getting customers to pay for your product is only half the battle. Plenty of entrepreneurs build a product and establish a customer base, only to run headfirst into the level three milestone. Profitability the entire point of any business is to generate a profit, but a shocking amount of companies never figure out how to do it. Now, to be fair, I'm really talking about gross profit here, which is just revenue minus costs. Completely normal for high growth companies not to make net profits for years, but that's a completely different metric. Let me explain. Gross profit describes how much money a business makes from just delivering their product to customers. It's just how much money the customer pays minus how much it costs to produce that particular product. For software companies, gross profits are typically very high since servers don't cost very much to run. But the gross profits of grocery stores are usually extremely low since the food they sell to customers is expensive. So you need to really investigate how much your product costs since this will be a critical factor in determining if you can make a positive gross profit selling your product. This might seem obvious, but you'd be surprised at how many startups get this wrong. They assume that they can undercut the competition and then magically reduce their costs in the long term. Sometimes there really is a path to reduced costs through automation or scale economies. Your startup might be paying a lot right now, but you might be able to swap in robots down the line or build a larger manufacturing plant that can produce products very cheaply. It does happen, but often the business model is just fundamentally flawed and there's no path towards profitability. Just look at what happened in MoviePass. The idea was simple. Get people to pay for a subscription and then let them go see unlimited movies in theaters whenever they want. People loved MoviePass. The product worked perfectly, and customers were definitely willing to pay the monthly subscription fee. So MoviePass had cleared the first two hurdles. But getting to gross profitability was another issue entirely. See, every time a MoviePass customer swiped their membership card at a theater, MoviePass would have to pay for the ticket. And MoviePass customers loved watching movies. The hope was that theaters would be willing to charge lower prices. Or maybe MoviePass customers wouldn't see so many movies. But that never happened. Instead, the cost of each MoviePass customer exceeded the revenue they were bringing in, so the company was never able to generate a gross profit. It was a tough situation for MoviePass, and the company eventually had to file for bankruptcy since they just couldn't find a profitable business model even though they had built a product that customers loved. None of that mattered since they were losing so much money. So always be honest with yourself and your investors. Is there really a path to making reliable gross profit profits? Any company can attract customers by selling something at an unsustainably low price. But if they can't turn things around quickly, bankruptcy is inevitable. But let's assume that you found a profitable business, every customer you bring in generates more revenue than cost, and you're in a good financial position. Well, now you have a new how can you grow your business? You might have a few customers coming in organically, but very few companies wind up growing organically forever. Eventually, every company builds a sales and marketing organization. Even though you might not see a lot of marketing for products like Google Search, there's still a large organization dedicated to getting advertisers to pay for Google Ads. Building a profitable marketing machine is key to advancing past level four, and this is one of the trickiest things to do at scale. When you get to this stage, two terms will start to rule your life. Lifetime value and customer acquisition cost. Lifetime value or LTV is the total amount of gross profit generated by a customer. Basically, it's just how much profit you actually take home from the average customer. Now, a big ticket item like a fancy car might generate thousands of dollars in lifetime value almost immediately. On the flip side, a free to play game might only generate a few dollars of ltv, with most of it coming from a small portion of the user base. Remember, LTV is an average figure, so some companies will have tons of customers using a product for free and then make most of their profits from just a few big whales. Regardless, this lifetime value figure determines how much you can spend to acquire a new customer. If your LTV is $100, then paying a customer acquisition cost or CAC of less than $100 will mean that you're growing profitably. And this is where it gets really tricky. See, finding new customers isn't always easy. Easy, you might need to test out several different marketing channels before you find one that really works effectively. And then, even after you're running ads and getting customers to buy, you need to make sure that your customer acquisition costs stay lower than your lifetime value as you scale. And this is where a lot of businesses run into trouble. They've built a product that people are willing to buy at a profitable price, but they just can't find scalable marketing channels. Plenty of young businesses will start running ads on Facebook and see good results for the first few months. But then slowly, as they start spending more and more money, the customer acquisition costs start to rise. Eventually, that marketing channel isn't profitable anymore, and the startup needs to find a new way to reach customers. It can lead to a really tough situation, like what happened with Blue Apron. Shortly after they went public, even though their meal delivery kit business had grown significantly, they just couldn't acquire new customers cheaply enough to keep growing. Part of the problem was that customers wouldn't stick around long enough to generate a high lifetime value. Shipping food is expensive, so it's not like Blue Apron was making big profits on every box they shipped. The margins are thin now. Slim margins aren't that big of a deal if the customers are sticking around for a long time. But that just wasn't happening when customers stopped ordering after just one or two months, the lifetime value would drop, meaning that the marketing team couldn't spend as much to acquire new customers. So the reason that you see so many YouTube ads for VPNs is that those companies have lifetime values that are high enough to pay for tons of ads. If you sign up for a VPN you're very likely to just keep using it for years. And it doesn't cost a lot to provide that service. Unlike shipping a box of food, all the VPN company needs to do is keep a server online. Building a profitable marketing engine is hard, but not impossible. I've been able to get past level four twice in my entrepreneurial career, and it's unlocked millions of dollars in revenue every time we crack the code. But I've never been able to break through to level five. See, once you have a growing business, everything starts revolving around scale. How big is the market that you're going after and how quickly can you capture it? And this is where the really big growth stage investors start getting involved. When you're just working on building a product, you might be able to raise a million dollars in seed money. Once you have paying customers and a viable marketing strategy, you might be able to raise $10 million in venture funding. But everything changes once you can prove that bigger investments will lead to higher returns for investors. A big problem for many companies is running out of places to invest profitably. They develop one great product, figure out the marketing plan, and then start growing really quickly. But over time, they start saturating the market and need to find new opportunities. If a company can find good uses of capital, they can keep growing. But if they can't, they'll quickly stall out. For example, in 2012, Facebook bought Instagram for $1 billion. They just made $26 billion from Instagram last year. That's an incredible return on investment, and it's something that larger companies need to get really good at if they want to be around for the long term. On the flip side, it can be useful to look at Peloton. In 2020, the stock started climbing quickly as people ordered more and more exercise bikes. Peloton was perfectly positioned to take advantage of the new trend of working out at home. But they ran into a problem. Basically, everyone who was going to buy a Peloton bought one in 2020. They had delivered a great product, found a good price point for it, and professionalized their marketing efforts. But they hit a ceiling. It's always a bit silly to say I could have done it better, but I do think they could have avoided this situation by acquiring acquiring some of the other fitness brands. While their stock was so highly valued, Strava could have helped them expand to outdoor fitness. Whoop would have enabled better health monitoring. Tonal would let them offer strength training. And Hydro's rowing machine seems like a logical extension from stationary bikes. All of those Companies are worth less than $8 billion in total. Meanwhile, Peloton was worth 60 billion at its peak. It's hard to say if that strategy would have worked out for them. But Peloton has fallen in value to just $8 billion today. So clearly shareholders aren't optimistic about them scaling any further. When you're a public company, you need to be able to consistently find new areas for growth. It's an incredibly challenging task, but that's why these companies are worth billions. But there's an entirely separate class of companies that are essentially untouchable. They are the megacorporations that have achieved startup nirvana and broken through the sixth and final hurdle of business success. They've created a platform. Every startup loves to say that they're building a platform. It's a super trendy buzzword. And to be fair, some entrepreneurs really are building platforms. But these things take time to actually develop. Microsoft is the classic example of a platform business. And Bill Gates has outlined exactly how he thinks about building platforms. Bill says that you're only really a platform if the value of the ecosystem on top of the platform is is larger than the company that owns the platform. What that means in practice is that you're enabling entirely new businesses to develop on top of what you've built. And if you add up all the value that those businesses create, it's larger than the underlying company. That's certainly true for Microsoft Windows, which has enabled entire industries to flourish. Everything from accounting software to video games is built on top of Windows. But Microsoft isn't the only platform company out there. Every major tech company has figured out a way to conquer level six and become a platform. Apple has the iPhone and Mac platform. Amazon has built a platform for independent merchants. And tons of businesses have been built on top of Google Search, Google apps, and even YouTube. So regardless of where you are in these six stages of business growth, just stay focused on getting to the next level. And if you'd like to learn about how Shopify grew from a tiny snowboarding website into a multi billion dollar e commerce platform, just watch this video next. Thanks for watching.