It makes sense to be stupid in business. Here’s my proof.

Did you know that it is possible to fund a company on the wake of the business wave that you create on your own, while burning through the cash that you don’t have at all, and still survive in the end, finishing up in a company that garners respect and admiration by everyone?

The above written ludicrousness is not something I have invented, but is a model of what I have witnessed. And at that, I have seen this dynamic in a few companies, not just a single one. Sounds crazy? It is.

Let me show you the model. A company enters a market that already exists. The company has no advantages over the other players in the industry, on the contrary, in most aspects the company is in a detrimental position. Yet the company has nothing to lose, and that, dear reader, is the key advantage.

So, what does such a company do?

Easy. It decreases the price. It under-prices the competition.

What happens? The company quickly gains a few customers. It serves them and if the service is ok, more customers appear. The system starts moving. The problem that the company has is not demand, there are always customers for lower priced products, but the quality of service. Yet the company does not have enough money to pay for the service to the customers since the price is too low to pay for the cost of the service. But, here’s the key, the company does not find it is lacking cash because more and more customers are pouring into the business and the new customers start paying for the service of the customers that were there before them. The wave appears.

Too complicated? Don’t worry. I’ll repeat the story by using numbers now.

The competition is selling something at 100$. The purchasing cost to them is 80$, while it costs them 15$ to service the customers. They make 5$ on each product sold. They cannot price something at 95$, unless they risk losses, so what they do is ignore under-pricing in the first instance and later ask suppliers for protection, which is not legal, but it happens every day.

Our company sells the same thing at 95$. The purchasing cost to us is 90$, our service cost is 10$. We make a loss of 5$ with each sale. But we don’t see the loss, because we don’t have the experience, our accounting is not fast enough, and most of all, the sales is rising so fast that our economics still works out, there’s always enough cash in the bank.

How come?

Let us say that our company sells 100 products in month 1, and 120 products in month 2. That is 9.500$ cash in the company from month 1 and 11.400$ from month 2. The costs in month 1 are 10.000$ and 12.000$ in month 2. The loss is 1.100$ in just two months. Yet the costs created in month 1 only need to be paid for in month 2. So in month 2, there’s 11.400$ cash in and 10.000$ cash out, a plus of 1.400$ in the bank. In the next month the sales increase by 20% again rising to 144 products, bringing in 13.680$, while the cash out is 12.000$, giving the company another 1.360$ in the bank. There’s now 2.760$ money in the bank.

It works, you see! It’s a wave and our company is surfing it. But it’s a very dangerous wave, because when the growth slows down all hell breaks loose.

Actually it is possible to work out how much growth is needed in such a case in order for the story to continue. The case above requires 5,3% month-to-month growth to keep it going. This translates to 85% yearly growth, or about 20x growth in just 5 years. On one hand everything is fine, there’s money in the bank. However there’s a bull in the china shop. The accumulated losses in five years time are roughly 200.000$. It’s a figure that sooner or later raises suspicions. People get scared. This will crash! Of course, it’s a tsunami.

As soon as panic breaks out, it does, believe me, damage control mode is turned on. If the company is lucky enough than it managed to grow big enough to become the “too big to fail” problem that the suppliers and the market want to help solve. In such cases the prices are raised to normal on-par levels with competition, costs within company are slashed and all sorts of organising appears. The growth is over, but what remains is a big company.

Nice, don’t you think?

Now you see. It’s not always the smart who win in business (and in life), but the the ones stupid and brave enough to just do it.