Introduction
Why Scale?
Want to grow big fast? Truth in advertising: what you actually want is to scale, which growing big fast by itself isn’t. For a business to be sustainable and thrive — to scale — you also need to reduce the cost of per unit sold while at the same time growing. Doing both allows you to: 1) dominate a large market before anyone else, leading to strong profitability due to weak or even no competition; 2) get rich quick.
Modern scaling typically requires huge amounts of VC financing before everyone cashes out. One of the first examples of such was Venrock’s visionary 1957 funding of Digital Equipment’s (DEC), a minicomputer hardware company based outside Boston. The reason externally financed scaling is relatively new yet now commonplace is because VCs — the usual source of funding for scaling — didn’t begin to control vast sums of money till about 2012, the year when assets under management (AUM) hit $2.6 billion. Today VC AUM totals about $1.3 trillion.
Why Not?
Before we delve further into what scaling is and how to do it, now’s the time for a disclaimer. Note that there’s also much to recommend growing slow. Niche and local markets can be quite profitable for operators who prefer to bat singles over an extended period of time rather than swing for the fences then strike out. Plus, businesses that don’t try to scale are usually self-funding. That means their owners aren’t faced with having to trade control in exchange for the financing needed to support rapid growth.
So this article is for those who dream of disruptive change on a mass scale. They yearn to join the ranks of recent successfully massy ideas like SaaS, e-commerce platforms, subscription-based services, mobile apps, digital content creation and distribution, online marketplaces, cloud computing and most recently AI, among myriads of others.
Because the cost of entry into a scalable business is so high, it pays to think hard about whether an idea shows the characteristics associated with scaling success before plunging ahead.
You’ll find those characteristics – which we describe below — to be relatively few and deceptively simple. But what’s not simple is what they demand from the entrepreneur — among other things, scrupulous research coupled with pitiless self-honesty when the news is bad. After all, if creating such a business were easy, you’d see wealthy entrepreneurs on every street corner. (For the kinds of people who succeed at this risky game, see our article Characteristics of a Successful Entrepreneur.)
Look Before You Leap
The Perils of Faulty Secondary Research
Examples:
- Your sources for data on the market’s size, propensity to buy, price sensitivity, urgency, intensity of competition, presence of product substitutions, etc. are wrong.
- You’re not selecting the right data, particularly data that might cast doubt on your idea’s viability.
- In your excitement over the potential of your idea you become blind to negative news. Or you focus heavily on data that reinforces and confirms what you hope to see. Behavioral economists are well acquainted with these phenomena.
Three cures for such problems:
- Gather data from as many independent and reliable sources as possible to confirm that – ideally — their values converge;
- Be your own devil’s advocate;
- Ask disinterested others (people with no “horse in the race”) for their interpretation of the data.
The Perils of Faulty Primary Research
When you tested the market’s appetite for your product with questionnaires, interviews, focus groups, prototypes, samples, etc., you got a big thumbs-up! (For details on how to create cheap but effective prototypes see Five Common Low-Fidelity Prototypes….) But be careful about false positives generated by samples that don’t accurately represent the market.
The antidote? Change a key variable when assembling multiple samples (like a different geography, demographic, etc.). Don’t let people who are the likeliest to buy dominate your sample (unless they truly are your market). Test, test again, and fine tune your product with every iteration.
In general, mimic as closely as possible the actual conditions of purchase. As Steve Jobs said, focus groups don’t work when you’re asking people to imagine a product they’ve never seen in the flesh before. For a quick primer on the varieties of sample bias see this MasterClass article “What is Sampling Bias?”
The Sheer Scale of It
To belabor the obvious, does your research compellingly argue that your market is huge and relatively untapped (“blue ocean”)? Example: financial services delivered via mobile phone to Africans.
Will Your Idea Provoke Unintended Consequences?
When VCs dumped thousands of electric scooters into cities – assuming correctly that ubiquitous availability was necessary to succeed — they inadvertently set off a backlash against the devices. Inoperative
scooters littered streets while reckless drivers and battery fires caused thousands of injuries, even some deaths. What followed was a rain of heavy regulations and bans that drove many start-ups out of business. Could your idea attract similar unwanted attention?
Of Economies and Dis-economies
Varieties of Economies
As we know, the sine qua non of scaling is the ability to make and deliver your product ever more cheaply as sales increase so that margins exceed 50% in short order. Examples: Any product that follows the traditional scaling model: heavy upfront investment followed by ever-lower cost per item. Think software.
But how does this happen? In addition to the fact that suppliers of raw materials pass on their own savings in volume manufacturing and shipping costs, scalers also achieve further reductions by inventing novel automated approaches, especially of formerly labor-intensive processes. Example: Using “robotic process automation” systems to compare orders with packing lists and inventory counts before paying invoices.
Varieties of Dis-economies
The opposite of scalers are people-intensive companies – businesses so reliant on the rare talents of one or more individuals that no amount of unit volume appreciably reduces item cost and may in fact increase it.
Ask yourself, as John List does in his excellent book about scalability, The Voltage Effect, whether the success of your idea is based on the scarce talents of exceptional chefs or on the quality of their ingredients. Businesses that deliver products whose major cost of goods is in the form of compensation are tough to scale.
Failure to scale can apply to leadership too. Some entrepreneurs find it difficult to delegate control, thereby becoming decision-making bottlenecks. In other cases, the entrepreneur doesn’t know how to create or find “cultural missionaries,” communication systems and incentives that transmit zeal and employee commitment to the organization or its customers. For more detail on how important strong management is to scaling enterprises, see Harvard Business School’s short blog on the topic.
In yet another version of dis-economies of scale, does your idea require using some resource whose cost per unit goes up with volume no matter what you do? For instance, the longer you run an oil well, the more it costs to extract a barrel. And in California, the more non-renewable electricity a home uses, the higher its cost per kilowatt. These “cost traps” are instances where demand outstrips fresh supply or regulation limits it. Beware reliance on limited quantities of critical ingredients.
Incoming!
Does your idea leverage multiple revenue streams? Example: U-Haul rents and sells trucks, trailers, moving materials and towing packages. For U-Haul, synergies abound in revenue derived from a central resource, its market of people who need to move stuff.
To enjoy these multiple profitable revenue streams requires a management team that experiments constantly with novel products only to prune away ruthlessly those that fail to meet expectations in short order. That’s why Amazon’s Bezos says, perhaps counter-intuitively, a constant stream of small failures represents opportunities to learn what works. It’s a commentary on how hard it can be to predict success based on some theory about how the market should respond.
Barriers
In addition to using lots of upfront money to discourage competitors from entering a market, scalers also use proprietary IP, data and step-wise dominance of local geographies until they reach national or global pre-eminence.
Conversely, for activities that do not contribute to the creation or strengthening of barriers to entry, successful scalers outsource them to save time and reduce management distractions.
Wrap-Up
Blue ocean market + clear economies of scale + perpetual product refinement, diversification and cost reductions + barriers to entry + active, alert management = a scaling enterprise.
