Startups are getting cheaper to build, but more expensive to grow

Photo credit: Max Pixel.

Startups should be getting cheaper to build. After all, the industry’s created several waves of innovation that support this across multiple layers in the stack:

• Open source software instead of paid developer tools
• AWS instead of your own data center
• Per-click ads instead of Superbowl commercials
• Off-the-shelf SaaS tools versus building your own
• App stores for efficient global distribution

Not only do a number of these trends make building new products cheap, they also, in many cases, drive the costs down to zero. If we zoom just into AWS/cloud computing, you’ll see how a massive amount of competition is leading to significantly lower costs—some vendors are even giving away their services pro bono. According to The Economist:

As cloud providers rush to build new data centres, and battle for market share, businesses are finding that the cost of putting their computing and data storage into the online cloud is getting ever cheaper. In the past three years prices are down by around a quarter, according to Citigroup, a bank; and further significant falls look all but inevitable. Some providers, such as Microsoft, have started providing their services free to startups, in the hope of turning them into paying customers as they grow.

However, this is opposite of what’s happening. Startups are raising and burning more capital to get to their Series As. It might be cheap to build the first version of your app, but getting traction is an entirely different story. Compared to a decade ago, it’s getting more expensive to get traction now, and at the same time, growth is getting harder from intensive competition, consolidation, and saturation.

Why costs are rising

There are two underlying reasons for the increasing costs: the salary/compensation for your team and the shifting of growth toward paid acquisition. While the former is obvious (especially to those paying rent in San Francisco), the second is more nuanced since it’s driven by a number of industry trends.

As we’ve said, growth is getting harder. And as a result, companies building new products are evolving their strategies away from traditional channels like virality, SEO, and organic to paid acquisition to scale. Even though traction is difficult to achieve in today’s climate, venture capital abound for those who hit a solid growth curve. This means that companies have an advantage when they execute well and have a natural product/channel match for paid acquisition channel. (Think high LTVs, lack of ad competition, being good at fundraising.)

What’s happening

As a result of this pivot toward paid acquisition to scale, we see four trends that go along with rising costs:

1. Startups are raising more money to get traction.
2. Companies are trying paid marketing earlier.
3. There’s an increase in emphasis on paid referral programs rather than virality.
4. Companies are going for deeper monetization in order to open up paid channels.

Let’s look at each of these trends.

1. Startups are raising more money to get to traction

More focus on paid acquisition means startups need to raise more money so they can raise money only when they can prove their traction. We’re seeing more companies raising more money to get more traction before they raise, and when they do take the new round, it’s often to fund bigger and more expensive paid acquisition efforts.

Conclusion