The valley of death curve – what is it and what does it depend on?

Most startup founders believe that their company will quickly reach the scale needed to be profitable. Unfortunately, the market is competitive, which means that the assumed margins and revenue growth rates often differ significantly from reality. The real problem is the so-called startup death valley. This term was created based on analyzes of the development path of many small companies. Understanding how the valley of death curve works will also help investors making better decisions among micro and small companies. We invite you to read!

Read: How can a young company survive in the valley of death?

What is the valley of death?

The most popular death valley is the one located in California. It is one of the worst places to live on Earth. The average annual rainfall is 50 millimeters per year, while the average air humidity is 1% (in homes it is usually several dozen percent). In 1913, a record temperature of 56,7 degrees Celsius was recorded there. As you can see, the conditions there are extreme and it is not difficult to survive there for long without large supplies of water and food. No wonder this Valley of Death has become synonymous with extremely difficult conditions to survive. In business, every start-up must go through such a "health path". This most often happens at the beginning of developing a business.

There is a moment in the life of many start-ups when the company increases operating costs, but does not yet have sufficient revenues to finance these expenses from its own operating activities. This is what companies call this key moment Venture Capital "Death Valley".

Why is there a death valley curve?

Companies do not operate in a vacuum, which is why every company has a choice:

• creating a new product and service that is not yet on the market,
• start competing in a new market.

Each of these variants is very difficult to implement. In the first case, you need to create a product that has no competitors and convince potential customers to choose this solution. It's hard to follow this path. This requires huge capital and lots of patience. Creating a new market is a task that will take years, not quarters. Additionally, you need to keep your mind in mind Plan B in case the solution turns out to be unattractive to customers.

If you start competing on an already existing market, the situation is not much better. The company must compete for customers with other enterprises that most likely have more experience and capital resources than the start-up. As a result, a fledgling company must prepare a product or service that will be better than the competition from the very beginning. The advantage may result from: quality, price, customer reception of the product (marketing campaign). All this will require large investments in team development, implementation of a marketing strategy and building a distribution channel.

In both cases, a beginning start-up must incur large development costs. Unfortunately, there is not yet enough revenue to cover operating costs. This is a very difficult period because the costs are often fixed. These are especially expenses related to renting office space and paying employees necessary to operate the company. Variable costs also constitute a significant portion and are difficult to reduce at the beginning. In the case of a market-creating company (type 1), these are expenses related to research and development. In the case of marketing, it is necessary to build a brand by both types 1 and 2 of start-ups.

The shape of the curved valley of death

As you can imagine, the period of extreme conditions for small businesses varies depending on the type of business. The longer the valley of death curve, the greater the likelihood that a company will go out of business prematurely. This is because in such a case the "cash burning" period lasts a long time. Therefore, the company must have much larger capital resources than the company operating in "short valley of death". Okay, but what does the length of such a valley mean? The most important variables include:

• level of competition in the market,
• average market margin,
• consumer behavior (e.g. high level of brand loyalty),
• ease of available substitutes,
• the company's strategy itself.

That is why it is so crucial for start-ups to carefully analyze the market in which they intend to operate. If business assumptions are too optimistic compared to reality, this may result in a rapid consumption of the liquidity buffer. Therefore, it is important for young enterprises to carefully monitor the level of their expenses. There is nothing worse for a company than scaling the costs associated with employing employees beyond measure and expecting that the increase in costs will "earn" the increase in revenues.. There is no such guarantee.

If a startup has not carefully planned for this difficult period and is not prepared to carefully monitor its expenses, it will likely struggle with liquidity problems. The longer the valley of death curve lasts, the more difficult it may be for a company to invest in growth initiatives and begin to scale its business.

Summation

The valley of death curve is a graphic interpretation of a difficult period in the life of most start-ups, i.e. from the moment of founding the company to generating stable revenues that allow you to cover the most necessary expenses. It is at this point that many companies fail because, despite a good product, they do not have enough capital to survive the difficult period. Sometimes this period may last several months, and sometimes even several years. It all depends on the industry, customer profile and how aggressive the competition is. Investors in micro and small enterprises should remember about the existence of such a situation. Too much faith in the management's stories about a "bright future" may result in huge investment losses if reality brutally verifies the business model. That is why it is so important to understand what specific industry the company operates in and what opportunities it has for further development.