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Low Startup Capital Requirements: Blessing or a Curse?
Most people in the startup world know that, compared to other industries, you need very little capital to start a startup. If you want to start a restaurant, you'll probably need hundreds of thousands of dollars to buy the building, buy the equipment, hire the staff, etc., before you're profitable. Starting a startup can often be done for no more than the cost of the founder's living expenses. This might seem to be great for a founder.
However, one of the fundamental laws of economics is: there ain't no such thing as a free lunch. In a competitive market, any advantage which is freely available to all of the participants doesn't benefit any of them, because it will simply cause new people to enter the market and make things more difficult for everyone. Suppose there are two cities, A and B, and people in both have a taste for ice cream. People in A are willing to pay $1 per scoop, but people in B are willing to pay $3 per scoop. This might seem to benefit ice cream sellers in city B. However, what will happen is that ice cream sellers will move from A to B until there is no more reason to move (ie, expected profits in both cities are equal). In other words, even though prices are higher in B, so many people are selling ice cream in B that any one ice cream store will have relatively few customers, canceling out the benefits.
The same goes for the world of entrepreneurship. There are lots and lots of people who have, or can get access to, $5,000. There are many fewer people who have, or can get access to, $500,000. Hence, many more people will try to start companies in fields where the capital requirements are only $5,000, and so the market in these fields will be flooded with new entrants. The flood will continue until the difficulty of competing with all the other entrants equals the difficulty of getting $500,000 (assuming the expected reward and risk are equal).
If we look at the Internet, this is, in fact, exactly what we see. The capital requirements for starting a website (whether for profit, for fame, for the heck of it, or whatever) are so low that millions of people have done it. Someone once quipped, "Type in, ‘Find people that have sex with goats that are on fire,’ and the computer will say, ‘Specify type of goat.’" This is great for Internet users, because they can find information on practically anything, and a huge variety of applications, at no cost to them.
However, the flip side of this is that there are so many people competing for Internet traffic that you either have to be really skilled, or really lucky, or spend a ton of money on advertising, or do deals with a bigger partner, or something else extraordinary to get a decent amount of traffic. For every YouTube, Facebook, and MySpace, there are a hundred applications out there which will never have enough users to pay the founder's living expenses.
So, to everyone who would say that the low capital costs of startups are a boon for founders: you are not avoiding pain through low capital costs, but merely switching from one kind of pain to another, like a person who chooses to work for a big company for twenty years and invest the money to get rich instead of starting a company at all.
- _delirium 17y agoI agree that removing barriers to entry means more people can get in, but isn't that the point? I can see that, from the perspective of someone who would be in the market either way, more people is bad: you'd rather be one of 10 than one of 100. But what if I'm one of those 90? I'd rather be one of 100 than excluded from the market entirely. And it forces everyone to compete on innovation, rather than using market incumbency and competitive moats to keep up profits by keeping out competitors.
- apsec112 17y ago"I'd rather be one of 100 than excluded from the market entirely." No, you wouldn't; that's the whole point. Suppose that there are two options: an open market and a closed market. If it's a closed market, there's a high barrier to entry, and so only ten people are in the market. If it's an open market, anyone can join who wants to, and so there are a hundred people. However, you must not be able to benefit from joining the open market, or else more people would join and drive wages down. And, if you were one of the ten people in the closed market, you still wouldn't be any better off, because the high wages of the closed market would be counteracted by the difficulty of getting into the market (see: "medical doctor"). There ain't no such thing as a free lunch. EDIT: Your reply is potentially valid, but only if the market we're talking about is so large that opening it up will raise salaries outside of it. The startup market is only ~0.1% of the US economy, so I don't think this applies.
- _delirium 17y agoDistribution of wealth isn't necessarily the same in both situations, though, so things can really be materially better in one situation vs. the other for different sets of people. The closed-market situation leads to more divergent outcomes: you have wealthy people who are in profitable markets, and non-wealthy people who are kept out due to high barriers. Reducing market barriers makes that rigid in-v-out dichotomy harder to maintain, which is better for the people who would have been out in the closed-market situation. They can still only profit a little, but before they couldn't profit at all. Markets where capital is a requirement also tend to result in rich-get-richer effects, where you have to have money to enter profitable markets, which then make you more money. Low-barrier markets make it harder to get a return out of capital, and force people to get returns from other things, like their tech skills. (Of course, tech skills are probably correlated with wealth too, but not to the same extent that literally having piles of money is.)