Most early-stage companies are finding that reaching profitability has become critical in their quest to find financial investors. Gone are the days when investors were satisfied to fund losses while businesses matured and experimented to find their footing. There are sector exceptions like many of the AI platform developers, but the general investor sentiment is a return to fundamentals and insistence on positive EBITDA. In fact, many investors simply will not look at a company if it is EBITDA negative, no matter how solid the concept is.
Today, we blame everything on AI, and this evolution is a reflection of at least two AI influences. AI has disrupted many elements of the tech industry, and in particular it has introduced uncertainty in pricing, gross margins, and operating costs. The result is a return to fundamentals for evaluating the economics of emerging businesses. Investors want to ensure that the unit economics will result in an acceptable and predictable gross margin, and they want to know that the business is operating in a capital efficient manner to create profitability with meaningful growth?
The second AI influence is a bit less obvious. The pace of innovation has dramatically increased as AI is accelerating the engineering process required to create new capabilities, and simultaneously it is democratizing engineering so that almost anyone can build a new application in no time. I recently attended a presentation where one of the speakers announced that his company had stopped buying enterprise software. He claimed that on their own they could easily create whatever custom applications they needed. He implied that ‘do it yourself’ was more cost effective and more likely to meet their unique needs. This is a very extreme position, and doubtful if it is true, but it highlights the tenuous nature of investing in an application software business. The heightened risk that a company’s application will be obsolete before there is an opportunity to build a valuable business is forcing financial investors to become less risk tolerant. The business has to make economic sense before an investor will risk funding its growth. We used to say that ‘positive EBITDA will set you free,’ meaning that once a company reaches positive cash flow and/or profitability, the pressure shifts from survival to strategic success. Today, positive EBITDA is only the starting point.
The mantra that this focus on profitability is creating is a mindset to do more with less; much less. AI is making the product development cycle more efficient, and is streamlining all areas of business. One firm proudly announced that it had terminated its entire digital demand-gen department and replaced it with AI tools that were generating much more targeted traffic and leads at a fraction of the cost. This type of transformation is happening across the operational landscape.
CEOs and leadership teams are taking up the ‘do more with less’ battle cry, but often it is just that, a pronouncement without any real guidance to the team about how to do better, not just do less. We are seeing a mini-generational variance between companies that came into existence more than five years ago compared with companies that were born in the current age of AI. Five year old companies are broadly still early-stage businesses, but they formed in the time before the AI explosion, and staffed up in traditional ways. These are the businesses that are being forced to change their ways and downsize their costs to race to positive EBITDA on a new and faster trajectory than they were originally tracking. Too often, leadership has difficulty acknowledging just how much bloat is in the business, and just how much smaller it will need to be, and how fast it will need to get there. Like trying to lose body weight, we reach plateaus, and our body wants to return to its earlier weight as if it has a mind of its own that is resisting the concept of losing weight. Businesses built in one operational model resist shifting to a new operational model.
Management often tries to reduce costs incrementally without fundamentally redesigning the business. They try to cut as much as they think is possible while still performing all of the same tasks and getting the same work done. Cuts are never quite deep enough because management is asking the wrong questions. Instead of asking how much cost can we remove, they need to ask how the business can operate completely differently, leveraging all of the new AI tools available.
To run faster, farther and more capital efficiently, businesses need to commit to change. They have to ask how doing business differently can increase the pace and raise the quality of what everyone does. They need to reimagine the business to spend less time in meetings, but get the information in a different and more efficient manner. They need to rethink how they build and deliver products and services. In short, they need to question everything. It requires a commitment to introduce new standards and processes that will streamline work across the board. There is an old saying “lead, follow, or get out of the way,” which has to be the watchword for CEOs and management teams. Challenge the creativity of the team to find new paths forward for the business. Lead by insisting on fundamental redesign, not just incremental cost savings.