Wednesday, 2024 May 29

6 Fatal Mistakes in Starting a Startup, the VC Behind Didi & Ofo Explains with Classical Examples (Part 2)

Editor’s note:

Author: Zhu Xiao Hu, managing director of GSR Ventures, whose investment in ride-hailing company Didi Chuxing, bike-sharing startup Ofo and food delivery service provider earned him the nickname “Unicorn Hunter”. has been authorized to publish.

The destiny of a startup is affected by numerous factors, such as its financing activities, management decision from entrepreneurs and market trend. 

In Part 1 of the feature, Zhu points out 2 commonly made mistakes in starting a startup: getting financed too easily and betting on unscalable niches or projects beyond startups’ competence.

In this part, Zhu explains:

  1. CEOs should base their updates and strategies on retention data, rather than the growth in the number of users.
  2. A penetration rate above 20% is a major turning point for any markets. Startups should be careful when pioneering an immature market.

This is Part 2 of a 3-Part Series.

Link to the Part 1.

3. Fast growth but low retention rates

Photo by Igor Ovsyannykov on Unsplash.

Some may be unimpressed by a retention rate of 24%, but the thing is, while day 1 retention rates can be easily manipulated, it’s hard to fabricate figures for retention over longer periods of time, for example, 30 days.

I believe few apps in China are able to achieve a retention rate of 24% over a period of six months. In fact, a retention rate of 10% is good enough for a six-month period and 20% is remarkable.

Most internet companies have to spend money to acquire core users. It’s also what VC firms want companies to do with their investment (not in the form of direct subsidies though), but what I care about most is not the growth in the number of users acquired, but whether the users stick around in the long term.

As a rule, retention rates tend to fall notably in the first two months, to around 40% to 50% at the end of the second month.

In this sense, six months is a good measurement period because that’s how long it usually takes for retention rates to level off.

Some apps saw retention rise again after the initial fall. The retention rate of Didi, for example, picked up as the number of its drivers increased and riding experience improved. Such companies often have the potential to reach a market size worth $1 million.

I attach great importance to user retention when determining whether a startup is worth investing in. It was the question I asked 80% of the CEOs I met. If they told me that they had to check with their COOs, then chances are the companies were not what I was looking for.

As far as I’m concerned, user retention, rather than the growth in the number of users, is the one indicator CEOs must monitor closely as it’s the best way to tell how the market is responding, say, to your product updates or business strategies.

Wise CEOs would base their updates and strategies on retention data. It’s fine that their retention rates are low at first, as what investors care about is whether they have the capacity to achieve high retention in the long term.

4. Chasing after the investment buzz indiscriminately while turning a blind eye to the rationale behind

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Many entrepreneurs have a tendency to gamble on the areas heated up by VCs, while, in most cases, they fail to grasp the rationale behind the investment buzz.

People often use the following indicator to identify if an area has entered its prime investment period: the startups in this area being able to complete series A, B, and C financing rounds in as short as 12 months.

If not so, making a leap into that area would simply be a bad decision. Well, this makes sense. Speed matters a great deal for startups in the early days. For this reason, the startups should concentrate on honing their core advantages to the maximum impact.

The fact is, the investment buzz is not at all groundless. It has its rationale behind. A major telling sign is 20% market penetration.

The internet giants in China, i.e. BAT, were all birthed in 1999 or 2000, when China’s internet industry was just budding. In 2005 or 2006, the second-tier internet companies in China, including travel information provider, local information website and, sprouted one after another, taking China’s internet industry to the next level.

Photo by Kyle Johnston on Unsplash.

The reason why so many internet companies debuted in 2005 or 2006 is rather simple. That is the penetration rate of PC internet had climbed to 20%.

A penetration rate above 20% is a major turning point for any markets, and it also adds to the likelihood of success for startups.

The same development pattern can also be observed in the mobile internet industry.

In 2007, Apple introduced to the world its 1st generation iPhone, which ushered in the mobile internet era. The leading mobile internet companies in China today were founded successively in 2011 or 2012, which is also the time when the penetration rate of mobile internet in China had jumped to 20%.

In recent years, AR and VR have made much news. Yet, they still haven’t found their way into the mainstream.

The penetration rate of AR and VR has barely made 1% even among the technophiles and early adopters. Well, the fact is a market penetration below 10% is way not compelling enough to rope in VCs, who usually deem 15% penetration rate as a prerequisite for moving ahead with their investments.

Photo by Billetto Editorial on Unsplash.

The startups, too, shouldn’t consider diving into an area before its market penetration has hit 5% to 10%. Judging from that, it is still too early for the startups to jump on the AR and VR trend now that the penetration rate is still below 1%.

My advice? The startups shouldn’t charge into any area mindlessly before the data suggests doing so. In the business world, the early birds usually don’t catch the “worm”, but failure.

Even the startups manage to survive to the prime investment period, they will often be squeezed to the edge by the giants. For example, many companies entered into the taxi-hailing business before Didi. Still, they had to give way, because their mindset simply couldn’t adapt to the game played by the new rule.

36Kr Global Contributors
36Kr Global Contributors
The tech ecosystem is roaring. Unicorns valued at billions of dollars have emerged worldwide, while venture capital and strategic investors are constantly on the lookout for the next big thing. 36Kr Global is committed to establishing ties between global stakeholders and providing the most vital information about China’s tech scene and capital markets.

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