Finding the right path to profitability in Southeast Asia’s digital landscape

In recent years, the startup business landscape has experienced a challenging time, a so-called “tech winter,” a period when startups are facing a tougher fundraising climate and persistent inflation. This phenomenon has prompted startups to pivot towards building more sustainable business models focused on driving profitability. 

Profitability as the first and foremost goal for startups? 

In response to this challenging environment, investor sentiment certainly seems to be shifting. There is a growing expectation that startups’ key focus is growth but eventually need to become profitable, and investors are increasingly seeking out companies with strong financial fundamentals. However, the question remains: should profitability become the main goal for startups and investors? 

Understanding profitability is crucial. In general, profitability is the ultimate goal for any business. It encompasses various stages, with each stage revealing valuable insights. Here is how East Ventures views the path to profitability:  

• Contribution margin: In the early phase, startups focus on achieving a positive contribution margin. This metric reveals whether the revenue generated from selling a single unit (after accounting for variable costs like materials and direct labor) is enough to cover its variable costs. A positive contribution margin signifies that the core business model is viable and has the potential to be profitable. This metric can be elaborated into different levels (see the table).
• Profitability at transaction Level: As the company scales, the focus shifts to profitability at the transaction level. Here, the revenue from each transaction (sale) needs to exceed all variable costs, including commissions, shipping, and customer service. This ensures profitability on a per-unit basis, regardless of fixed costs like rent and salaries.
• Positive EBITDA or profitability at EBITDA: Reaching a positive EBITDA (earnings before interest, taxes, depreciation, and amortization) is a significant milestone for startups. EBITDA represents a company’s operating profit, excluding non-cash expenses like depreciation and amortization and financing costs like interest and taxes. A positive EBITDA also becomes a strong early indicator of future financial sustainability and a key metric for investors to evaluate high-growth startups.
• Profitable at net profit line: Reaching this level is where all expenses, including non-operating expenses, are covered, resulting in a positive net profit. This becomes increasingly important when a startup matures and the founders start deciding on their exit strategy.

Early-stage startup strategies for profitability 

We recognize a one-size-fits-all approach to profitability does not work.  Startups at each stage have unique applications and strategies for their path to profitability. While financial health is a priority, early-stage companies should not solely focus on profitability from the get-go.

At East Ventures, we prioritize a founder-driven thesis, especially for seed-stage startups. We believe that good products are built by good people who address big markets. Hence, we understand they need time to achieve positive EBITDA. 

A core focus from the beginning should be to build a strong product that solves a big enough problem statement, such that the market will pay for the ‘painkiller’. Part of the process of building a strong product is convincing customers to use your product, leveraging technology to disrupt traditional business models, and achieving product market fit. 

After achieving product market fit, early-stage startups should then focus on building a sustainable business model, with positive unit economics. This means each product or service generates enough revenue to cover its variable costs, without relying heavily on discounts or subsidies. 

This focus on customer willingness to pay at a fair price validates market demand and a strong value proposition. In essence, building a foundation on sustainable unit economics is crucial for long-term success. 

Our strategy is clear: We provide early-stage startups with the runway they need to achieve product-market fit while also demanding a well-defined plan for achieving positive unit economics. We go beyond simply supporting big dreams; we help them translate them into actionable steps to build sustainable businesses. This approach underscores East Ventures’ commitment to fostering innovation that thrives, even amidst economic headwinds.  

A good example of this is ESQA, a direct-to-consumer (D2C) cosmetics brand in our portfolio. ESQA bootstrapped for over four years before securing investment from us in 2020. This period of self-funding allowed the founders to refine their product and market positioning without external pressure. 

This focus on unit economics helped them achieve profitability within just two years. With our investment, the founders are able to enhance their strengths and adapt to market changes to build a solid foundation for growth.

The digital revolution in Southeast Asia also has empowered D2C companies to leverage an online-first approach. This strategy allows them to understand and engage with customers through digital platforms and analytics, significantly accelerating business traction compared to traditional offline-first brands. 

The digital revolution has given other early-stage D2C brands in our portfolio the ability to build a positive contribution margin business quickly. For example, Compawnion, a pet food company in our portfolio, was able to build a strong online community and expand its brand presence rapidly. 

This has helped them secure partnerships with retailers and expand through over 200 distribution points today. Similarly, BASE, a D2C skincare brand, used online data to develop products based on customer feedback, accelerating product development compared to traditional methods.

Our support extends beyond D2C companies to B2B platforms like Chickin, a poultry-focused startup, IOT SaaS startup McEasy, Bababos, a manufacturing supply chain platform, and Rekosistem, a circular economy waste-management startup. These companies have achieved positive unit economics even while achieving significant growth, giving them the foundation to grow and expand further. 

Key strategies for growth-stage companies in achieving profitability

East Ventures has always backed growth-stage startups with strong business fundamentals and a clear path to profitability. Within our growth-stage portfolio, more than half of our companies are profitable or will reach profitability within six months.  

With these startups, we work alongside founders to ensure their business model and growth strategy lays the groundwork for future financial sustainability.

Profit is essentially revenue minus variable and fixed costs,  we will explore a few examples below where we worked with our invested growth-stage companies to achieve profitability. 

• Operations optimization and productivity improvement

Operations optimization and productivity improvement is one area where many growth stage companies. It can come in the form of improving productivity or reduction in manpower requirements through the adoption of technology or automation solutions such as generative AI. 

One example within our portfolio is waresix, one of the largest logistics platforms in Southeast Asia, where they implemented generative AI to automate internal processes around logistics route planning and processing requests from customers. This has allowed them to service a higher volume of requests without needing to increase headcount.

• Cash flow or working capital management

Cash flow or working capital management is key in the journey of getting to profitability, despite not having a direct impact. Having a healthy working capital and short cash conversion cycles, are signs of strong financial strength.

Praktis, a supply chain platform provider in Indonesia, managed to reduce their working capital requirements through renegotiation of payment terms with their suppliers and customers. At the same time, they increased the coverage of their product offerings to their customers, thus improving margins and increasing stickiness in their customer relationships. 

While not all startups can get to this position from the get-go, it is important for them to leverage working relationships and trust built up over time to negotiate for better payment terms, more flexible agreements with partners, and many more. This allows the startups to grow more efficiently.

In summary, focus is key for startups in their profitability journey. They need to identify areas of opportunity and prioritize initiatives that have the most impact. Having clear goals and regular milestone reviews helps startups track their progress and also assess the effectiveness of the initiatives. It also enables us as investors to provide assistance at every stage along the way through sharing industry best practices, introducing relevant business partners, providing additional funding, and others.

If you are a startup founder, send us your pitch here.

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This article is crafted by the East Ventures Investment team.