Editor’s note:
Author: Zhu Xiao Hu, managing director of GSR Ventures, whose investment in ride-hailing company Didi Chuxing, bike-sharing startup Ofo and food delivery service provider Ele.me earned him the nickname “Unicorn Hunter”. KrASIA.com has been authorized to publish.
The destiny of a startup is affected by numerous factors, such as its financing activities, management decision from entrepreneurs and market trend. Zhu thinks there are six commonly made mistakes that entrepreneurs should avoid.
The first one to mention, according to Zhu, is getting financed too easily. Unlike how people ordinarily frame it, Zhu thinks getting financed easily does not always lead to a good result.
Sometimes startups get financed easily because its business model is easy to comprehend and thus easy to copy. More often than not, entrepreneurs may also hold a false sense of confidence and make reckless spending.
That is why entrepreneurs need to come up with really creative business models and be cautious about every spending.
Secondly, betting on seemingly unscalable niches or projects beyond the startups’ competence would lead to a failure.
This is Part 1 of a 3-Part Series.
Link to the Part 2.
Why is it that some startup, though popular among VC firms in the early stage, ended up falling through? This must be a question haunting many investors.
Entrepreneur’s mindset may have played a factor, but apart from that, I see six problems that failed startup share.
1. Getting financed too easily
Startups that get financed easily often have simple and straightforward business models. They may be easy to operate, but are also readily replicable.
More often than not, a business model that’s easily understood involves little more than moving a traditional business from offline to online. Such models stand no chance against revolutionary startups that bring disruption to traditional industries by making full use of the benefits of the internet.
Therefore, aspiring entrepreneurs should ask themselves such questions: Can the model bring substantial change to the status quo? What is the likelihood of a competitor emerging with a better model?
On the other hand, startups with real potential are usually undervalued for having chosen a path rarely taken.
A case in point is the travel information search engine Qunar. The company’s founder Zhuang Chenchao practically approached all investment firms out there back then, yet no one believed there was room for another travel-focused platform when the market was already dominated by Baidu and Ctrip.
No one except us. The only term sheet Qunar signed then was with our company.
Didi is another example. Many investors had doubts about Didi’s decision to start with taxis instead of private cars as Uber did in the U.S. DiDi met with 20 fund companies and saw its cash flow run dry before landing an investor.
Likewise, when Momo, a location-based instant messaging app, sought financing, investors (including me) were still coming to terms with the shock of witnessing the social networking platform 51.com, despite having already amassed 100 million users, losing the battle to Tencent’s instant messaging app QQ in half a year. Social networking among strangers seemed a far-fetched idea back then.
Besides business models, the ease in securing investment has an impact on entrepreneurs’ mentality as well, which in turn plays a factor in a startup’s success.
Getting financed too easily may lead the founders of startups to overestimate themselves. They may take the funding for granted and start to throw money around, the biggest mistake a startup could make.
The companies that have thrived over the past 15 years in China’s internet industry all went through a difficult and painful process before raising their first funding round. They became successful, because their founders, well aware of the difficulty of financing, spent every penny cautiously.
They didn’t expect to acquire large numbers of users overnight. Offering subsidies to users was never an option, because they knew that they risked letting users down once subsidies end and to win them back, they might have to spend ten times or more as much as they did originally.
Instead, they chose to test their products among, say, a few thousand or ten thousand users first to collect feedback and user behavior data before scaling up.
Successful companies like Didi and Inke (a live-streaming app) tend to rely on word-of-mouth marketing rather than subsidies to acquire users in the early stage. In fact, users that must be acquired with subsidies are not part of a company’s target market in the first place.
I believe no investors would like to see companies use their money to subsidize users instead of in more worthwhile areas. Neither Didi nor Ele.me (food delivery app) offered subsidies extensively before the C round.
Of course, investors do recognize one type of subsidies—those offered to drive competitors out of the market. That was the strategy Didi used for its chauffeur and car-pooling business.
2. Betting on seemingly unscalable niches or projects beyond the startups’ competence
It is not uncommon for the entrepreneurs to be given a colder shoulder while raising capital for their startups. Among all the factors that could result in the startups’ failure to raise capital, starting off with too small a niche is also one of them.
Unable to make sense of the startups’ projects, the VCs, invariably, turn their heads away.
In retrospect, though, many internet startups in China have succeeded by betting on small niches in the beginning in the last 15 years. Qunar, for instance, started off by aggregating ticket offers from airlines and Didi with its taxi-hailing business.
The small niches oftentimes can’t deliver fat profit as expected by the internet giants like BAT, so it is quite logical that they would shrug them off. For big projects, however, the startups often hit the roadblocks at the very beginning, i.e. locating the core area to zero in on. As a result, those giants will naturally become the dominants.
The fact is evidenced in the much talked about artificial intelligence (AI) world. Currently, a large proportion of the territories in the AI world are claimed by the giants. This means that the startups which are also in the race could only work in this area on a “to Business” basis.
In this case, the room for growth is limited. So it is almost unlikely that those startups will evolve into companies worth tens of billions dollars, at best hundreds of millions or billions of dollars.
Nonetheless, this doesn’t necessarily mean that all small niches hold no prospect for success. A good entry point into the market enables the startups to branch out into more areas in the future.
When Didi initially rolled out its taxi-hailing services, the taxi drivers could only make ￥5,000 or ￥6,000 (around $770 to $923) a month even when they had been working over ten hours each day, making it hard for Didi to skim profits from those taxi drivers.
However, on the basis of taxi-hailing services, DiDi launched its private car-hailing services. This has helped Didi boost its profit, though the state of its taxi-hailing services still remains very much the same.
A startup had better focus on an existing market in its early days.
Some entrepreneurs set out with big ambitions like educating customers. Well, this couldn’t be more wrong. As small startups, they often lack the resources and experience for such aggressive goals.
Ele.me succeeded, but, it didn’t start off by building its own food brands from scratch. Instead, it worked its way upwards by bringing on board existing small restaurants. Only when it retained enough number of users did it embark on expanding its market share.
The VCs are often reluctant to invest in the startups that started off with the niche market which lacking scalability.
The Babytree in Wuhan that focuses on parenting falls into this category. Its app, which is designed for parents to save and organize their children’s photos, registers a remarkable retention rate, which had shot up to 24% in six months alone since its launch. But we didn’t invest in it as it shows little scalability.
