Wednesday, November 30, 2011

Don't be cheap, be frugal

Number 8 in Paul Graham's essay Startups in 13 Sentences is "Spend Little. I can't emphasize enough how important it is for a startup to be cheap." It's a good essay, and even more interesting to watch as he writes and corrects it. But he is wrong on about #8. Cheapness is always bad, frugality is good. It may seem like minor semantics, but from someone as influential as Paul Graham it makes a difference.

To be cheap is to be stingy or miserly [1]. A cheap person is unwilling to spend money to their own detriment [2]. They are incapable of making smart financial decision because of an irrational fear of spending money. Being cheap is being penny-wise, pound-foolish. It's short-term profit leading to long-term losses. Cheapness is what destroyed the American automotive industry.

Frugality is "prudent or economical in the use of consumable resources such as food, time or money, and avoiding waste, lavishness or extravagance. In behavioral science, frugality has been defined as the tendency to acquire goods and services in a restrained manner, and resourceful use of already owned economic goods and services, to achieve a longer term goal." [3]

Numbers 5 and 6, "Better to make a few users love you than a lot ambivalent" and "Offer surprisingly good customer service," are not possible for a cheap person, those things cost time and money. A frugal person will understand that the extra money is required to achieve the long-term goal.

As an example let us consider what it takes to host a startup's web service. A cheap person will insist that the site can be hosted on GoDaddy for $6/month. Any rational person knows that's not possible, the site will go down with the first PR push. A person capable of making rational financial decisions will know that the company cannot survive on shared hosting, so they will suggest spending $60/month on load-balanced cloud servers or VPSs. That's 10x more money, no way a cheap person is going to spend that. Sure it's a trivial amount of money that could saved by not going to Starbucks everyday, but that kind of rational thought doesn't occur in cheap people. A frugal person will take the rational thought a step further to realize the engineering cost of operating their own cloud servers isn't worth it at a small scale. The fugal person will suggest spending $120/month on Heroku so they can better use their engineering resources on their core business. That kind of intelligent spending is incomprehensible to a cheap person, even though they could save that much money by bringing lunch from home and not buying $10 salads every day.

The issue compounds itself over time. Eventually the cheap person will cave to reality and peer pressure. But they are not accustomed to making wise financial decisions, so they overreact. To replace the failing GoDaddy hosting they might buy physical servers, maybe even rent space in a data center. Once the shock of spending that money hits them the fear will kick-in. They will then be too cheap to pay for the Operations staff required to manage the physical servers in the data center. The new servers will fail and the cycle of being cheap followed by wasting money will continue.

Cheapness is akin to a metal disorder symptom like hoarding. If you have someone who demonstrates an ingrained cheapness, they need to be removed from the process of making financial decisions. If you are a normal, rational person trying to achieve Ramen Profitability, don't strive to be cheap, be frugal instead.