Economics Isn’t Esoteric for Startups
I recently attended a board meeting where one of the topics was the Federal Reserve’s interest rate policies. We discussed how the Fed is very much focused on controlling inflation, and are far less concerned about avoiding a recession.
Naturally, our discussion extended to what the Federal Reserve’s policy setting will mean for startups. One particular area of concern among these Board members is how the Fed’s policies may impact minimum viable products (MVPs), product launches, sales activities, annual contract value (ACV), etc. For example, when the Fed raises interest rates, that increases the incentives for startups’ customers and prospects to save and reduces the incentives to consume, which – depending on the industry – may lead to a reduction in purchasing activity.
Economics, Federal Reserve policy, or the financial markets in general are bound to come up at one time or another in startup Board rooms and exec team meetings. Company leaders will opine on topics such as interest rates and inflation trends, public company and startup valuations, the impact of a U.S. economic slowdown, the definition of a recession, or food and heating oil prices here at home, in Europe, and elsewhere around the world.
It is reassuring that Board members of companies in the U.S. and abroad are thinking about economics, and financial markets locally, nationally, and internationally. But today’s workers care far more about their livelihoods. Their worries are more immediate, centering on things such as the direct impact of economic and financial conditions on their families, home life, pocketbooks, and the businesses where they work.
Put another way, company leaders tend to focus on macroeconomics while workers zoom in on microeconomics.
The field of economics includes many concepts that can help startup founders, executive leadership teams (ELTs), and workers. Familiarity with these concepts can help all of these startup participants to understand their macroeconomic situations, yet still manage their businesses effectively at the microeconomic level.
For example, the concept of disruption is a critical one to understand. Disruption and disruptive innovation occur when a startup with meager resources is able to successfully challenge an “incumbent” or established business.
A startup’s raison d'être, valuation, sustainability and ability to secure financing is directly and indirectly related to this concept. In addition, when a startup challenges an incumbent vendor or technology, several other key economic concepts come into play. These include: market share, comparative advantage, differentiation, sunk and opportunity costs, vertical versus horizontal product and GTM specialization and integration, etc. Important economic concepts such as these must be at the forefront of any startup’s strategy and planning, and be integrated into its tactical activities.
All of these concepts and economic behaviors are totally in the control of startup founders, executives and employees. It is for this reason that I have three recommendations:
1. Understand the economic concepts (listed above). Oxford University Press has the always reliable Dictionary of Economics and online, The Economist has a compendium of economic terms. There’s Wikipedia and other sources. There’s also the Wall Street Journal and Financial Times. Take advantage of these resources.
2. Apply concepts of economics to your funding pitches and company meetings. Macroeconomics, microeconomics, and economic policies can be really helpful topics when describing the underpinnings of your strategies. They can add great clarity, for example, to your GTM or revenue model and, ultimately, ACV. But use them selectively. (You don’t want to drone on while your audience falls asleep during a town hall meeting, or for them to confuse you with a tweed jacket-clad econometrician.)
3. Once you internalize these concepts, focus on your work or projects. Let them augment your arguments and positions, not dominate them.
Here are ten specific areas where startups can use economics concepts:
Conducting risk analysis for financing, forecasts, board discussions, etc.
Developing business models; licensing or subscription models; go-to-market (GTM) models, etc.
Determining product and/or service pricing. Specifically, derive a unit economics model to determine if your product is overpriced or undervalued. More broadly, unit economics can be used to calculate sustainability standards.
Building pro forma and manufacturing, sales, marketing forecasts, operating expense analyses and budgets.
Planning product and service offerings – including especially MVP and MVC. (See below)
Establishing key performance metrics – better known as “KPIs” – and objectives and key results – better known as “OKRs”, and other metrics. In particular, payback period and margins (CAC) and long-term margin contributions (LTV) are two KPIs that have an economic foundation.
Managing the planning of the sales, marketing, and product marketing functions.
Handling infrastructure and operations planning.
Creating transfer pricing models, understanding currency impacts and global distribution models.
Board-level situation analyses (e.g., executive session presentations and discussions).
These are 10 areas in which startups can use fundamental concepts of economics. When leveraged effectively, they can make great contributions to any startup’s success. They can help you and your team to beat the competition, gain market share, rapidly realize EBITDA, get properly financed and realize a great exit. It is for this reason that CEOs, CFOs and ELTs should embrace and take the lead in educating all startup personnel about economic concepts.
I want to thank Manuel Hoffmann, PhD at HBS for his pre-release review of this blog post.