Nov 17, 2015 · 4 minutes

A few weeks ago, I wrote about a gutsy decision Poshmark’s Manish Chandra made back in 2013: Slashing his marketing costs by some 80%, damn the high-growth consequences.

He’d gotten caught up in all the same paying-for-growth mania as the rest of the Valley, but noticed that as commerce companies posted impressive numbers for a while that way, eventually it topped out. Poshmark took an initial hit, but wound up growing far faster, more cost-effectively and more organically. It was a decision against raising a mega round to keep gaudy growth numbers growing. But, he argued, one that saved the company.

It was visibly unsettling for him to think about what could have happened if he hadn’t made that call. I compared it to narrowly avoiding a car crash because you weren’t paying attention and only realizing after the fact how close you may have come to death. “Exactly!” he practically screamed.

Lemme give a bunch of startups out there some advice: Do this right now. Your growth numbers will take an immediate hit, but this is the perfect time. No matter what happens you are probably worth ⅓ less than you were a few months ago. Some of the best startups created in recent years are all taking hits right now in mutual fund write downs and other negative reports on slowing growth. Remember Zenefits, aka one of the fastest growing business software companies in history?

It’s experiencing something similar to what worried Chandra. From the Journal:

Since late summer, Zenefits has frozen hiring in certain departments as sales teams have repeatedly missed targets, according to people familiar with the matter. It has cut the pay of some employees and dozens of people, including at least eight executives, have left or been fired, the people said.

Zenefits has said it aims to reach $100 million in expected annual revenue, based on its number of users, by January. A customer milestone hit in August suggested the figure had reached about $45 million by that point, according to people familiar with the matter, who say it will be difficult for the company to reach its target. 

Not a story anyone wants written following a $4.5 billion valuation that some people called the peak of the market. But it’s the best possible week from a PR perspective, because so many unicorns are looking wounded right now. It seems more the market than mismanagement.

Stalling growth will just look like something everyone is experiencing. And if employees, investors and the press get wind of the slowing growth and start to freak out, you’ll have a seemingly responsible excuse: We wanted to reduce our customer acquisition cost and run the business more conservatively.

Not every company should do this, obviously. A slowing market can be some of the best times to invest and grab share if you are in a position of strength. For instance, you could argue it makes sense for leaders in a crowded market who have a massive fundraising advantage, to continue to bleed out less-well-funded rivals.

But there’s one “truism” in the Valley that Poshmark – at least – proves is not true: It’s always a good idea to invest in growth if you are network effects business. In recent weeks, I’ve asked VCs to explain to me the concern trolling over burn rates, given they serve on the boards of and fund the companies in question. Is this seriously a case of naive entrepreneurs just wildly spending with no regard to investors’ sage advice?

One thing I keep hearing: Well, if it’s a network effects business, it makes sense to pay to acquire customers.

What?

There are two problems with that rationale: Network effects businesses are not all created equally. Poshmark is certainly a network effects business. There is a 1:1 seller to buyer ratio, which is one thing that keeps both parties so engaged. The more people who enter the system, the more everyone benefits. And yet, paying up for that was not the best way to grow, as it turned out. Chandra – in fact – argued that because of its strength as a network effect business, it shouldn’t have to pay up quite so much. It should be able to grow somewhat organically.

The other problem is that a lot of companies think they are network effects businesses, and they just aren’t. It may look like it on a whiteboard, but not on paper. Consider HomeJoy. It’s unclear that anyone really benefitted more from others joining. Retention rates were horrible, they paid too much to acquire customers, and more cleaners joining wouldn’t have done anything to change that. I guarantee there is a deck somewhere describing the network effects HomeJoy would enjoy.

Network effects is one of those dog-whistle terms entrepreneurs throw around, because a high percentage of companies worth deca-corn prices in the public markets were network effects businesses. But that, in and of itself, doesn’t mean a company will succeed – or that it justifies heavy spending to acquire users. This should be obvious, but these businesses only work if large numbers of people see value, join, and keep using it. Every social network ever attempted was a network effect business too. And thousands still failed.

...

SPONSOR MESSAGE: We handle the payments. You handle everything else. Learn more about Braintree