The Economics of Startups

Background

A startup is a young company with a unique business idea that is in its first stage of operation. Startups typically begin as sole proprietorships or partnerships that aim to solve an existing market problem. 

Entrepreneurship is highly encouraged worldwide, and as people try to become the next Apple, startups have begun to alter the economy in a major way. Since 2017 over 20,000 new startups were established worldwide and since 2012 there has been a 1400% increase in funding for advanced manufacturing startups.

We must remember that before Apple became a tech juggernaut and Google became the world's most popular search engine, they were both at one point startups. The sheer potential of a small company turning into something big is what drives investment into startups. However, for every success, there are dozens of failures. In 2017, worldwide, the failure rate of startups was 90%.

Startups can also exit without failing by being acquired. Acquisition is when a larger company buys a startup. Usually, the core team of founders gets a large chunk of the deal. Acquisition has become a major part of startup culture, as most founders aim to get acquired by a larger company so they can earn a pretty penny. On average, for a startup to get acquired, it takes a startup 6.5 years.

Current Scenario of Startups

The COVID-19 pandemic has pushed around 41% of startups into the “red zone” this implies that they have only around three months of cash runway left. In such a situation, fundraising becomes nearly impossible. Since the beginning of the pandemic, startups have had to terminate a large percentage of their full-time employees due to a sharp decline in revenue generated. Operation scales have also been substantially reduced in an attempt to cut down on expenses (cost-cutting) like premises and electricity. Compared to other industries, Tech and IT startups have continued to operate.

38% of startups have not received assistance and do not expect to be helped by policy relief measures related to the crisis. At the same time, 16% are not currently supported but expect to be helped by a policy measure soon. Whilst the remaining 46% of startups are currently receiving assistance.

Although startups have taken a toll over the short run due to the pandemic, startups play a very important role in the economy in the long run, both at the micro and macro level. Let's take a look at how.

The Microeconomics Of Startups

Most startups aim to be disruptive. That means they try to create a new market entirely by their innovative products which completely disrupts an existing market - pushing the leading firms out. Therefore, in a way, the aim of a startup is to create a new market and monopolize. The marked success of a startup is when it establishes a monopoly in its market - or at least takes a large chunk of the market share.

However, most of the time that is not the case. Unless the startup can come up with something so innovative that it attracts hordes of investors and publicity (like Apple), it is ultimately a small player in a large market. Therefore, startups have to react to the demand of consumers. As price-takers, startups have to compete with not only other startups but bigger and well-established companies. Smaller companies have to operate within the price set by the market and also have to deal with taxation, regulatory laws, and compliance laws. This makes it increasingly difficult for startups to flourish in an economy.

In a modern regulated economy, becoming a monopoly is almost impossible for any company because of government intervention and judicial control. Hence, due to massive competition and government regulations,  most startups find it difficult to succeed in their goal. 

The Macroeconomics Of Startups

Startups are affected by and affect all three concerns of macroeconomics- National Output, Employment, and Inflation substantially. 

Startups contribute heavily to national output, be it in the form of technological advancements or production gains. Older startup companies tend to invest in Research and Development while younger startup companies prefer investing in cutting-edge, state-of-the-art technology to solve the market problem they are tackling. 

Entrepreneurship has been considered the fuel of the job-creation engine. Though starting small, startups aim to expand into Unicorns (companies with a valuation of over 1 billion dollars). With company expansions, the creation of employment - not only labor but also skilled workforces - is a given due to the increased demand for human skills within the organization. Contrary to the popular belief of manufacturing companies being the highest employers, tech companies have the most demand for human capital - especially skilled workforces. 

Inflation makes business challenging. It decreases profit margins, hence making expansion harder, affects consumer behavior drastically by reducing their purchasing powers, increases costs of management, and causes a decline in financial support in the form of funds and grants. Inflation has positive impacts as well. It allows the startups to raise the prices of their goods and services to keep up with the overall market. An essential step for a startup to take is to do a thorough financial analysis to understand risks to manage funds effectively. The firm may also choose to opt for alternative suppliers to minimize production costs to maintain profit margins. It is also important for entrepreneurs to keep in mind the paradox of thrifts so that they do not end up affecting aggregate demand and hence, economic growth. 

Conclusion

Ultimately, startups are the life source of a healthy private sector. Every open economy needs new companies to enter the market so competition, employment, and growth can be maintained, and startups are the best way to achieve that. 

Written by Rayandev Sen and Zoyah Virani; edited by Alidar Kuatbekov