The uncanny profit valley
One goal of artificial intelligence engineers is to build robots who seem human. It’s natural to assume that as machines become more similar to us, they also become more likeable, a useful trait if they’re to be our companions.
This is in fact what happens, up to a point. At that point, we start to find them creepy, for reasons that aren’t certain. But as they become even more lifelike, our revulsion dissipates. This strange zone where things ought to be getting better but in fact seem to be getting worse has been called the “uncanny valley”.
The profits of self-funded companies sometimes have a similar valley. In the beginning, when there’s no infrastructure or employees — it’s just you, running around doing everything yourself by hand — most of your gross profit drops straight to the bottom line. If you’re selling something that people want, your sales will increase, and your bank account might start swelling. This will continue until you hit the limit of what a single person can accomplish on their own.
You may decide to expand. You employ staff to replace your own hours. You pay professional contractors to cover some ancillary functions. You upgrade your infrastructure to accommodate larger load. You increase advertising spend to catch more and bigger fish. You become subject to government regulations from which you were previously exempt.
You need not do all this at once, of course. You could grow incrementally. But it may make sense to blitz now, either because you want to remove yourself from the day-to-day operation to focus on growing the business, or because you want to capture the market before competitors gain ground. There are also some kinds of spending that can’t be done piecemeal, like renting a larger property.
In any case, if you spend to grow, you’ll end up in a profits valley. Its depth will depend on how much you spend, but you can’t avoid it altogether. While it may appear to the world that you’re doing better than ever — and in a sense, you are — both you and your company are poorer. You’re poorer because your gross profit now has to exceed your higher fixed costs before you see any net profit. This means that, all else being equal, your sales need to keep rising. If your bet on the market for your product doesn’t pay off, you may get stuck in this strange place where you’re now losing money or making much less than you did before, although you have more customers and higher revenue.
Since the market for most products and services isn’t very large, many businesses that enter this valley won’t make it to the other side. They end up bigger than they were before — more staff, more assets, more revenue — but not much richer, if at all. Perhaps the founders have more free time; this is nothing to scoff at. But they also have to captain a much larger ship and crew, with all the headaches that that entails. The trade-off may not be worth it.
Bigger isn’t necessarily better. As long as you love what you do and other people are willing to buy what you sell, you may in fact be no better off expanding. The reality is that most businesses won’t be large, and many of the middling ones probably made more money when they were smaller.
