Monday 28 of November, 2022
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How Startups Can Survive in an Economic Downturn

We go in-depth on the mindset required to approach an economic downturn, and the resilience needed to come out of it larger than before.

May El Habachi

This year seems to be taking an unexpected turn for startups operating in the MENA region. Although funding in H1’22 grew by 46% to reach almost $2 billion according to data platform Magnitt, startups are still grappling with rising interest rates, increased inflationary pressures, decreased purchasing power and, in some cases, devaluation. This economic uncertainty is forcing many startups to re-evaluate their business foundations to ensure that they are strong enough to withstand the current turbulent market conditions.

While startups across different sectors and stages are impacted by today’s economic environment, it seems that bigger and more established startups are the ones feeling the pinch - for now.

One doesn’t have to look very far to know that Capiter, Egypt’s B2B e-commerce platform, dissolved after raising $33 million in 2021 from regional and global investors. The startup has been struggling for some time after laying off staff and failing to make payments, and has ultimately fallen apart less than two years after it was founded.

Ayman Ismail, Founding Director at AUC Venture Labs, expects to see more startups failing in the coming period. “The problem is that globally, we’ve gotten into a mindset that fundraising is the indicator of success, not business performance,” Ismail explains. “And that is not correct. In Egypt, we’re getting the first wave of startups that have raised double digits USD investments. We did not have this before, and the reality is that many of them will fail. That’s just the nature of the industry. VCs invest in startups that are high risk, there is a high probability of failure and we are starting to see some of those failures hitting.”

Meanwhile, other notable startups have started to shrink their staff like transport startup SWVL, which recently announced that it will be cutting jobs by 32% and shutting down some transport routes only months after going public. Healthtech startup Vezeeta is also reportedly laying off 10% of its staff after raising $40 million two years ago.

News of layoffs, company failures and cutbacks are becoming widespread, particularly from companies that have raised double digits in the last 18 to 24 months, despite the region boasting higher investments so far this year. To get through these challenging times, startups are advised to make some serious changes in their business strategies, focusing more on profitability and sustainable growth, instead of ‘growth at all costs’.

No more growth at all costs

The ‘growth at all costs’ concept saw investors deploying millions in funding for startups of all sizes across different sectors, in hopes of creating high growth projections. And for a while, it worked. Some startups experienced double and even triple digits, but this level of growth is no longer sustainable in today’s economic times due to changing consumer behavior, market conditions and investor appetite.

“The concept of ‘growth at all costs’ is a certain mindset and a way of building startups that, when it succeeds, will see the startups become substantial in size and value, but require a lot of cash to be spent,” explains Ismail. “It’s usually very compatible with times of high growth and high valuation, particularly during the past three years. But the mindset is changing. There needs to be growth, but with a clear path to profitability.”

According to Ismail, investors are now focused on profitability and long-term sustainable growth. “It doesn’t need to be immediate, but I want to understand how and when profit will come,” he explains. “We’re investing and we’re going to be losing money for a while, but eventually we want to make money.”

Cut spendings

To achieve sustainable growth, many startups are curbing their spending to survive the current economic climate. elmenus, Egypt’s food delivery startup, has successfully managed to cut costs and achieve profitability in the last few months after revisiting its growth trajectories.

"I would say in less than three weeks, we took a lot of action in a very smart and specific way, so that we’ve saved up a huge amount of our costs, and we’ve gotten gross profitable with high double-digit margins in one month up from a historically negative margin,” says Amir Allam, CEO of elmenus. “We’ve actually maintained that in an increasing way for the next three months, up to the closing of August.”

“Marketing is the major cost that we’ve optimized on and by doing that we were able to figure out which users we need to spend on versus which users are costing us a lot, and are not really helping us with our growth,” he explains. “We used a lot of machine learning capabilities that we've built over the last period to direct our strategy, and this enhanced our profitability numbers overall.”

With startups being advised to cut spending and increase their runway, Allam still had to make sacrifices somewhere. “We needed to adjust our outlooks, and hence had to also do some layoffs,” he says. “It wasn’t as big as the ones announced from other companies, but it was still a very unfortunate event that we had to do.”

Positive unit economics

Focusing on growth and profitability is key, but it must also be accompanied by positive unit economics. This often means that startups need to evaluate the effectiveness of their growth efforts, understand their users and customers better, and know the ins and outs of their business to make informed decisions on future trends. Although it may be harder for startups today to have healthy unit economics, it’s necessary to build profitability.

Jordan-based cloud kitchen, Kitchefy, states that with increased inflation and decreased purchasing power, maintaining positive unit economics has become challenging lately. “Supplies are way more expensive than they were a year ago, and people are spending less,” says Marwan Abu Sakna, co-founder of Kitchefy. “So, from the consumer side, there is less demand, and from the supplier side, it’s getting more expensive. The margin of making money is therefore getting smaller.”

One way the founders managed to have healthy unit economics is by buying supplies early, securing deals, and simply stocking up. They’re also getting ready for a bridge round to tide them over until next year. “This situation is pushing startups like us to raise earlier,” says Abu Sakna. “We were planning to raise a seed round next year, but we’re doing it now to make sure we have enough runway for the next period.”

Despite the economic downturn and its impact on startups, Kitchefy founders remain optimistic about the future. “Whenever there is a downturn, there is an opportunity that follows,” says Abdullah Absi, co-founder at Kitchefy. “Afterall, Kitchefy came out of the pandemic. I believe that when startups are pressured, innovation and new ideas usually come up. If you’re a startup performing in a downturn, where markets are falling and it’s getting harder to raise, imagine in a booming economy what you could be doing.”