Growth and Underinvestment: Aligning Performance and Resources

Start-ups are confronted with a particularly tricky issue: when and by how much to build up production or service capacity. In its early stage, the priority of a start-up is customer and product development. Without a concrete product and a concrete customer, it’s risky to divert scarce financial and management resources to production capacity. On the other hand, once the product is developed and some customer wants to buy it, then production capacity needs to be in place to deliver. This high uncertainty if and when demand starts to grow results in a behavior pattern called growth and underinvestment. While demand grows, the capacity to deliver lags behind. Typically, if capacity is insufficient to meet demand properly, this results in a growing backlog or decreasing quality. Either way, customer satisfaction deteriorates, resulting in shrinking demand. Because of shrinking demand, there is now more than enough capacity. The difference between revenues and expenditure results in a negative cash flow. By the same token, when the backlog shrinks, quality might improve. If the start-up survives its financial crisis and is still in business, then demand grows again, but not all lost customers will come back. This dynamics is shown in Fig. 14.1.