Which types of startups are most often profitable?

One answer: E-commerce, Chrome extensions, mobile apps, enterprise SaaS, SMB SaaS — in that order

I co-run an agency that teaches a hundred startups per year how to do growth marketing. This gives me a unique vantage point: I know which types of startups most often reach profitability.

That’s an important metric, because startups that don’t reach this milestone typically fail to raise additional funding — then die.

Here’s what we’ll learn:

  1. Companies are increasingly living and dying by ads. Because it’s the startup’s approach to customer acquisition — not its business model or market — that most determines its early-stage profitability.
  2. E-commerce companies lend themselves best to ads, and SMB SaaS the worst. Meanwhile, most startup founders in 2019 are starting SaaS companies. They’d benefit from the data we share in this post.
  3. In fact, our agency has found that every other type of business reaches profitability quicker than SMB SaaS, including mobile apps, Chrome extensions and enterprise SaaS.

Our sampling of startups isn’t as biased as startup valuation leaderboards, because we also see those that failed. That’s the key.

You can use our experience to de-risk your startup. That’s what this post explores: How to change your product roadmap to pursue a path more likely to reach profitability.

The startups that frequently reach profitability

Here’s the data my agency is referencing for this post:

  • We train 12+ venture-backed and bootstrapped startups every month. Half are Y Combinator graduates. This is how we study early-stage product-market fit trends.
  • We run ads full-time for between 20 and 30 mature companies per year. On average, each spends $2.5 million annually on paid acquisition. And, on average, each has 30 employees. Our clients include Tovala.com, PerfectKeto.com, SPYSCAPE.com, ImperfectProduce.com, Clearbit.com and Woodpath.com.
  • Our students and clients are roughly evenly distributed across D2C e-commerce, B2B, mobile apps and marketplaces.

When we try to control for founder skill and funds raised, the types of startups that first reach profitability do so in this order:

  1. E-commerce
  2. Chrome extensions
  3. Mobile apps
  4. Enterprise SaaS
  5. Small-to-medium business SaaS

On average, an e-commerce company is more likely to first reach profitability than an SMB SaaS company.

Before I explain why, let me explain how we’re differentiating startups: I use the word “type” instead of “business model” or “markets” because I’ve learned that business model and market are often not the best predictors of success. Instead, it’s your approach to customer acquisition. That’s what typically determines the likelihood of profitability.

To repeat, it’s not how your startup makes money from customers nor how big your market is, but how you acquire your customers.

That’s the first lesson from seeing hundreds of startups succeed and fail.

How customers are acquired in 2019

Why does reaching profitability quickly matter? And how is it achieved?

The answer lies in paid acquisition: running social and search ads. Nearly every startup tries them first, because most startups lack the in-house expertise to aggressively pursue customer acquisition channels beyond ads. So they put all their eggs in the ads basket.

Most deplete their funding and resources pursuing ads, and are left with little momentum to pursue the remaining channels. Then they die.

For better or worse, companies are increasingly living and dying by ads.

That’s the second lesson.

And it just so happens that e-commerce is the best fit for profitable ads. That’s why e-commerce reaches profitability — and survives — most frequently.

To put paid acquisition into the larger context of customer acquisition, here are the most common customer acquisition channels we see in 2019:

  • Social and search ads
  • Sales (mostly relevant to B2B)
  • User invites
  • Influencers (mostly relevant to B2C)
  • Blogging
  • Word-of-mouth

I reviewed our client data to rank those channels chronologically. Meaning, startups usually start by testing ads and sales, then experiment with user invites and sponsoring influencers, and so on.

This post’s focus is on paid acquisition, because it’s the catalyst for why e-commerce is on top and B2B SaaS is at the bottom. So, for those who are curious, here’s a ranking of ad channels by how frequently they’re made profitable for the 100+ companies we worked with last year:

  • Instagram
  • Facebook mobile
  • Google Search
  • Apple Search (for mobile apps)
  • Banner ad retargeting
  • Facebook desktop
  • Pinterest
  • Quora
  • Snapchat
  • YouTube video ads
  • Twitter
  • reddit
  • LinkedIn
  • Spotify

Accordingly, that’s the order in which the average startup should test ad channels. (Twitter and every channel below it are rarely made profitable today.)

E-commerce

Why do e-commerce companies lend themselves so well to profitable ads?

There are many reasons, but here are three:

E-commerce ads gets better click-through rates

The best-performing ads on Facebook and Instagram are always video ads. We often see video click-through rates outperform images by 3-5x. That improvement can make or break profitability.

And e-commerce lends itself to video much more than software. Consider how it’s hard to make a video for B2B software be eye-catching, share-worthy and interesting. (Who wants to watch a screenshare?) In contrast, a stop-motion ad showcasing your pillow next to comfy beds and couches… that tends to get views.

It’s harder to do enterprise video ads right, but Heap is an example of doing them right

People are predisposed to buy

At some point, everyone needs to buy clothing. And a pillow, and a toothbrush, and so on. When you’re selling physical staples, some people will definitely buy — if your product is compelling and competitively priced.

In short, making paid acquisition work for e-commerce is relatively easy. Your success as a business is therefore mostly determined by your margins.

That’s easier to manage than the alternative of advertising software: Most people will have no ingrained need to buy your software, so you have to sell its purpose in addition to its value. That puts a burden on your ads, website, sales team and product experience to be extremely compelling. There can’t be a weak link in that chain or it falls apart.

Meanwhile, I can half-ass a website for a premium toothbrush and get a bunch of people who need new toothbrushes to buy it. Then, I optimize to reduce my costs until the margins are interesting.

E-commerce ads tend to be more concise and more enticing

People know what a deal looks like

If I’m selling a premium mattress for $500 that normally costs $3,000, that’s self-evidently a great deal. You’re going to consider it.

And that’s the power of selling physical goods versus software: deals on physical goods resonate because people understand how those goods are normally priced. And deals continue to be a major trigger for what gets people to buy.

Compare that to software: Leads are indifferent when you claim they’re getting a deal at your arbitrary price of $500 per month. You need to prove that value through demos, trials and an amazing product.

In other words, software advertising campaigns lose a universally compelling value proposition: cost competitiveness.

All this said, e-commerce is not a Holy Grail. It’s not significantly better than the other business types. It’s just the best by some modest margin because of the realities of making paid acquisition work, and paid acquisition is where startups usually throw all their weight first.

If you’re already a RedMart customer, there’s a good chance this ad will get you to click

Chrome extensions

After e-commerce, which startup type is most likely to reach profitability? Chrome extensions.

They’re the least-discussed, most quietly successful startup type that my agency regularly sees outperform mobile and SaaS.

Chrome extensions perform well because an important quality of a customer acquisition funnel is low friction. And nothing is lower friction than tapping twice to install an extension into your browser.

There’s no user signup, no filling out forms — you just click twice to confirm.

And once it’s installed, it’s there for life. (Until you remember to delete it, which people forget to do.) That longevity is high-leverage: A Chrome extension reminds you of its presence over time. It proactively makes itself useful by interacting with the pages you visit.

In other words, Chrome extensions are the perfect Trojan horses. They unassumingly get in, then establish their presence over time. Once they prove useful — like how Honey shows you better deals as you shop — they introduce a pitch to upgrade to a paid account. Since you’ve already experienced the extension’s value, you’re receptive to that pitch.

And here’s what makes Chrome extensions suited for paid acquisition: Facebook and Instagram let you exclusively show ads to Chrome users. So you can narrowly target the people you need, making it cost-efficient to acquire extension users.

In practice, we see extension installs are often 2-5x cheaper than SaaS signups and mobile downloads.

And now you see — once again — why paid acquisition is a strong determinant of startup success. And why Chrome apps are ranked second on our list.

Clearbit Connect is a popular Chrome extension that we helped grow

Mobile apps

Mobile apps have a similar Trojan horse aspect, which is why they’re ranked third. Even in 2019, it remains cost-effective to acquire app users through social ads.

Similar to Chrome extensions, it takes just a few taps to install a mobile app and use it. The friction is similarly low. A signup form isn’t needed. In fact, many apps delay that friction until after you’ve experienced their value.

One subcategory of mobile apps we’ve seen perform particularly well is finance. When you’re helping transact a large volume of money, you can ask for a small percentage of it. That’s perceived as lower friction than billing a monthly fee for usage, and so the psychology of it is more digestible.

Those small rakes add up. Think Venmo, Cash App, sports betting and every other app that helps navigate your finances.

Enterprise SaaS

Enterprise SaaS reaches profitability when a founding team has intimate access to enterprise leads that are already motivated to work with them. Usually that’s thanks to nepotism.

Pair that with a good salesperson and you can close a few $100,000 annual deals that jumpstart your business.

Enterprise doesn’t typically lend itself to ads, but sometimes it does. If you appeal to fewer than a few thousand businesses, however, you’re likely exclusively reliant on sales. And that’s half the reason why high-cost enterprise startups are ranked low on the list: They’re unfit for most channels — from ads, to content marketing, to influencers. It’s all about sales, which leaves you without a backup if they don’t work.

The other half of the problem is that most founders don’t actually have intimate access to high-value customer leads. Even when they think they do, they often realize they don’t.

My recommendation is to have a co-founder or a lead investor who contractually commits to making high-level introductions. And be sure to audit that they really can make those intros.

SMB SaaS

We are sad to say we see low-cost SMB SaaS fail most frequently.

Why? Because neither ads nor sales typically work for them. So, you’re left with few viable customer acquisition channels.

Let’s do the math: If the average SaaS app charges $50 per month and retains a customer for five months, they make $250 per customer.

Now, if the average cost per click on a North American Facebook desktop ad is $2.50, and if the average conversion rate from ad click to SaaS signup is 10 percent, and if the average signup to paid rate is 10 percent, it costs you $250 to acquire a paying customer from Facebook.

So, you spend $250 to make $250. Factor in volatility and operating costs, and that’s clearly not sustainable. (And these numbers I’m using aren’t far off from reality.)

In short, ads rarely work for low-cost SaaS businesses. It’s why most of the ads you see on Facebook and Instagram are for physical goods (e-commerce) and services (local, retail, agency, etc.).

And that hits B2B SaaS companies hard because Facebook remains the highest-volume channel for acquisition. And it’s typically the most cost-effective. So if Facebook doesn’t work, most other social ad channels tend not to.

Also, with low-cost SaaS, you can’t justify sales labor to acquire customers either — because it’ll cost a skilled salesperson at least $250 in labor to identify, nurture and close a deal.

So, what’s the solution? Should you just abandon your B2B SaaS startup? No. Just consider adjusting both your roadmap and pricing to aim for at least $1,000 per customer in lifetime value. Hopefully much more.

That’s the third lesson.

And, to be clear, none of this is to say that a weak e-commerce idea is more likely to reach profitability than an amazing SMB SaaS idea. I’m providing averages to help you prioritize.

UsabilityHub redesigned their pricing plans to capture higher customer lifetime value, and they made sure to offer more value in exchange

Don’t overlook SaaS

The upside for SaaS (both enterprise and SMB) is that — if it succeeds — it often reaches higher revenues and greater long-term stability than e-commerce.

Why? Because e-commerce is more susceptible to fads and competition: consumer interests are fickle, and e-commerce trends quickly welcome copycat competitors. Consider how many online mattress companies there are today. They’re hurting each other’s margins.

Plus, SaaS apps tend to have better subscription lock-in rates (it’s hard to quit a tool on which your business relies), better organic referral rates (co-workers invite each other to use the tool) and often reach higher margins — especially from enterprise customers.

But, in the context of this post, SMB SaaS is the least likely to reach meaningful profitability early. From what we’ve seen, most never get enough paying users to survive.

But, when they do, they’re often more defendable than e-commerce.

That’s the fourth lesson.

What this means for your startup

Here’s what we’ve learned in this post:

  1. Ads are often the easiest way to quickly make a business profitable.
  2. Quickly making a business profitable is the greatest leading indicator of startup longevity.
  3. Not all companies can make ads profitable with equal ease.
  4. I’ve shared which kinds of businesses can do so most easily and why.

Use this knowledge when deciding which startup idea to pursue. Consider each option’s likelihood of making paid acquisition work. If, that is, you care about quickly reaching profitability. You may have a good reason not to.