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It all comes down to the burn rate

The importance of operational expenditure within early dotcom businesses

Within this episode, we explore the importance of operational expenditure within early dot-com businesses, particularly after the downturn that followed the dot-com bubble’s peak in early 2000. In doing this, we follow the concept of burn rate through our email archive to show how this measure of operational expenditure became central to AuroraTec (a pseudonym) and its post-bubble strategy.

What is a burn rate?

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New millennium, new realities

The run-up to “Y2K” had seen extraordinary stock performance by dot-com companies in markets like the NASDAQ, which were taken as a key indicator of the industry’s performance. However, following a sharp decline in the spring of 2000, the performance of listed dot-com stocks had entered a steady downward trend, with investors selling up their stocks. While there was still a general sense of optimism about the future of such enterprises, the venture funders who invested in pre-listed start-ups were taking a notably more conservative (or "bearish") view of any new and continued investment in technology and internet start-ups.

NASDAQ at close

Glum stockbrokers react to the NASDAQ crash. Credit: Getty Images (c/o The Wall Street Journal).

Burn rate makes the agenda

These new, leaner market conditions, required start-up companies like AuroraTec to seriously consider operational issues, which were becoming increasingly important investment issues for the more conservatively minded investors. At the same time, these businesses also need to continue the initial development and marketing of their products, a generally expensive period in a business’s growth. Thus, on a Thursday evening in August 2000, AuroraTec’s CEO and founder clicked ‘send’ on an email to the board. It contained a brief summary for the next month’s meeting and rattled off in shorthand the various items for discussion, along with who would cover what. Towards the end of his message – behind updates on issues like sales, marketing, and engineering, were the words burn rate.

The headcount takes a hit

While AuroraTec weathered the initial crash fairly well, by June 2001, things were really not looking so good. Not only was Ravi having to respond to criticism from some of the board about internal ‘teamwork’ and ‘focus’ issues within the company but he was also having to make some difficult decisions to reduce the company’s burn rate. The “action plan” he set out to management primarily involved widespread headcount reductions and an almost exclusive focus on issues of an administrative and financial nature.

Burn rate beyond AuroraTec

Similar issues became increasingly critical for many dot-com companies in 2001, and AuroraTec was not alone in tackling its burn rate with heavy job cuts. Confidence in the dot-com economy had evaporated and investors were reluctant to continue funding high-cost, low revenue ventures. All too often over the past two years, start-ups had been allowed to grow exponentially, based on investor optimism, but with little realistic hope of matching their oversized operations and marketing budget with actual sales income.

Just the day after Ravi shared his action plan with the board, another AuroraTec exec shared an email conversation with an external contact from another dot-com. Both businesses recognized the need to bring down the burn rate as a priority, and extensive reductions within their respective firms were in effect. In both cases, they needed to reduce how much cash they were spending, and the quickest way to do this was to reduce the number of employees they were paying.

Close to home

Unfortunately for Jane, the changes took on a more personal significance when she found out that she too was to be a casualty of the cost reductions.

Pushing back on the lean approach

Even after the first round of downsizing cuts, the pressure was still on AuroraTec to again reduce its burn rate. Thus, in a planned presentation to the board, Ravi proposed they plan to reduce its burn rate from $2.3 million per month to $1.8 million and combine this with a quarterly sales target of $2.4 million. On seeing a draft of the presentation, not everyone was convinced, with one founder/manager in particular voicing concern about the realities of both the sales and burn rate targets.

Time for a change

Nonetheless, by September, the board had decided that more drastic action was needed, instructing Ravi to focus on the internal operations of the business, rather than the external interests like new business and funding opportunities. Number 1 on his list of priorities was bringing the burn rate down to a level that would ensure they would survive the downturn they were currently experiencing. While he did not tell his teams as much, the figure he had in mind here was $1 million per month, so way below the $1.8 million target his colleagues had been failing to realize.

A matter of do or die

A week later, Ravi started providing weekly updates to the team, in which he reported on the response to burn rate-related downsizing. He assessed the response as mixed, acknowledging the grief that some employees felt, but also believing that there was an acceptance that such actions were consistent with the bust conditions of the market.

Cautiously positive news for investors

While even the most profitable businesses want to avoid unnecessarily high burn rates, it was becoming especially relevant to venture-funded businesses that were common in the early dot-com economy. The extraordinary growth and expenditures of these companies were often accompanied by little or no earnings, and while this was ok in the boom, funders, analysts, and lenders were becoming increasingly interested in how long such a company could survive at a given burn rate.

A typical boardroom scene from the early 2000s. Credit: iTechVision

While AuroraTec still had limited actual sales revenues to back up the investments from funders, its heavy cost-cutting efforts in the months before had at least enabled it to show investors that they were serious about running a lean operation that matched the economic climate and its own sales revenue performance.

In fact, having a burn rate below $1million would become something of strapline for the company’s executives to use with investors, to be cited along with its other achievements like blue-chip clients, steady growth figures, and technical developments. A New Year letter to investors sent out in January 2002, even made a point to note that “with monthly burn rate below $1 million, we have enough cash cushion to last another 18 months in the unlikely condition of continued adverse economic climate forcing little or no growth in revenue.”

A path back to glory

Also with the New Year, came a change in leadership for AuroraTec. This change was actively supported by Ravi, who had already tried to leave the company’s internal operations to other founders and placed an actively sales-oriented CEO with “downsizing experience” at the helm of the company. While the company’s management had shown initial resistance to the board’s choice, it was eventually seen as their best chance of increasing sales and growing (rather than downsizing) the business again.

Continuing to count the costs

Although Ravi had stepped out of the CEO’s chair, he was still on AuroraTec’s board and continued to push burn rate as the organization’s key strategic consideration. Even when the new CEO, Paul Jacobs, was negotiating new deals, Ravi was keen to know how the burn rate would be affected. In this way, burn rate was becoming more than just a response to the current situation (i.e., the fact they had been spending too much), and was becoming part of how the company assessed future business decisions.

New CEO, old issue

As Paul settled into his new role, it became increasingly clear that burn rate control was to remain part of the business’ ongoing strategy, and something they would actively push when selling their venture to potential investors. While the market was still interested in the ‘next big thing’, there was an acknowledgment that this needed to come with a level of conservatism in relation to cost and realism in relation to sales. Perhaps this is why, in addition to noting how well received the company’s aggressive approach to cost control was, Paul also enthused about actually having a “real customer”.

It all comes down to the burn rate

As for Ravi, he was happy to take a step back from the business, knowing that he was leaving it in the hands of someone who shared his priorities of controlling burn rate and that the company itself was in the sort of shape he wanted it to be in. In fact, within his standard copy/paste text used when letting contacts know of the change in leadership, Ravi was sure to point out the low burn rate.

Want to read more about the burn rate and dot-com business?

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Read about the spectacular fall of “Boo.com” in The Capstone Encyclopaedia of Business (2013)