Technology start-ups must look beyond scale

For years, anyone seeking a role model for successful businesses could look to the world of tech and fintech. Companies such as “buy now, pay later” pioneer Klarna — once Europe’s most valuable private tech company — commanded vast valuations, with investors funnelling money into their growth.

But as inflation rises fast and the macroeconomic environment sours, unprofitable companies with an emphasis on simply building consumer numbers are looking increasingly exposed. Klarna’s valuation fell from $46bn to less than $7bn in a funding round this summer.

For business students who have come of age in a time of “disrupters”, the lessons should be clear. The age of easy money is over, and growth at all costs is no longer a mantra that makes sense. The tech companies that dominate the future have to be built on sustainable foundations.

The need to look beyond traditional ways of doing things partially reflects trends that predate the pandemic — a growing realisation that an emphasis on simply scaling up is insufficient.

“Traditionally, venture capital has been geared towards revenue growth,” says Nalin Patel, Europe, Middle East and Africa lead analyst for private capital at data provider PitchBook. “It’s been about increasing to a vast scale to become an outlier and dominate an industry.”

That model has been deployed across tech companies, ranging from payments to food and grocery delivery, where a plethora of businesses have been battling each other for years — a contest intensified by the pandemic.

But that approach has led to oversaturation in the market. While individual restaurants may have deals with specific food delivery companies, there is little to distinguish between the latter businesses.

“There is some good in that it could drive costs down for customers,” Patel adds. “But the question marks remain whether it’s just a duplication of effort. It’s a low-margin business, and you have to ask whether, if there was a consolidation or just a few players, ultimately those companies are more likely to be successful.”

The same has been true in buy now, pay later, a popular form of short-term credit. While there are a variety of players with nuances between their services, they are all fighting for the same customers — and in many cases, the same space on retailers’ checkout pages.

The key to the successful companies of the future, says Patel, lies in innovation. “It’s about focusing on something unique, rather than something that’s there to just grow, and add to a broader landscape.”

Investors have become increasingly risk-averse in the face of rising inflation. Even those venture capital groups once willing to part with substantial sums now want companies to prove that they have a path to profitability.

Aman Behzad, founder and managing partner at fintech advisory firm Royal Park Partners, says the companies best positioned for future success combine two attributes from different generations of technology.

“First, [it is] those with rock-solid fundamentals and long-term vision,” he says. Big Tech leaders such as Apple and Microsoft have proved successful by prioritising products that solve clear problems, while building value for their shareholders in the long term.

“Second, the culture of management style of post-2010 ‘tech darlings’ is of equal importance,” Behzad adds. Treating top talent well and having the ability to drive change within organisations helps businesses retain the best people and continue building strong products.

He says that tech companies often focus on one of these facets over the other, leading either to a focus on solving short-term problems or outdated corporate working practices — but “the best businesses don’t have to compromise”.

Investors want companies to prove that they have a path to profitability

Sectors that have shown some of the most promise in this regard are business-to-business software and infrastructure providers, says Behzad. He sees companies such as British cloud-banking business Thought Machine or smart payment card provider Pleo combining long-term business fundamentals with the culture of modern start-ups.

“By narrowly focusing on best-in-class products and services providing business value, they don’t need to chase market trends or integrate buzzword features, as other firms of their generation sometimes do,” he adds.

Patel agrees that B2B companies are better suited in some ways to falling consumer spending and the rising cost of living around the world. “Consumer-facing companies are driven by spending, which can go up and down depending on how the economy and employment is doing,” he says, “while B2B can be a recurring business model.”

He points to the $160mn funding round by London-based Thought Machine that doubled its valuation to $2.7bn in May. Among the investors were banks such as Morgan Stanley, JPMorgan and Lloyds Banking Group.

“Big banks are riddled with legacy IT infrastructure issues — it leads to all sorts of inefficiencies,” Patel says. “B2B software companies can be really core to their clients’ activities.”

While students may not be familiar with these brands as “sexy” household names, that is no bad thing, says Behzad. “Visibility is not the mark of success — revenue, model, and where your customers come from is what matters. Business cases should be based in the here and now, not in addressing the needs of a hypothetical market that doesn’t exist yet.”