Are You Scalable?
Entrepreneur's New Year’s Guide
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Pete is a classic entrepreneur. He spent 15 years building his manufacturing firm to a R30 million outfit, before his big opportunity came to take on contracts worth R120 million, allowing him to scale to R150 million within five years. This was everything he’d worked towards. This was his retirement plan.
Five years later, instead of running a R150 million business, Pete is burnt out and broke. His company is closed and he’s lost everything. The crisis has even torn his family apart. How did this happen?
A COMMON FATE
Unfortunately, it’s a far more common story than most of us would like to admit. 70% of the top 1% of businesses (by growth potential) land up failing to scale. Sometimes, like Pete, they lose everything and close the doors.
Other times, they land up bigger, but managing a chaotic hell of their own creation: A daily sprint to survive, a never-ending treadmill of frantic hustling to keep things together, with the horizon never coming closer.
The most common reasons? Either scaling something that fundamentally is not scalable, or scaling poorly; not making the right changes at the right time.
In this article, I’ll be focusing on the first reason: Attempting to scale a business that is fundamentally not scalable — because not every business can be scaled. If your ambitions are focused on high-level growth, step one is to determine if you have the right business model to do so. Because if you don’t, that’s the first change you need to make.
Some companies scale easier than others. And some don’t scale at all. Let me illustrate with two extreme examples:
Very scalable: Dropbox makes an extra $10 for every user they add, while adding $1 of cost, and zero operational capacity. That is very scalable.
Not easily scalable: A start-up ad agency is soon faced with a growth ceiling created by the limits of the founder’s time and energy. This normally occurs somewhere between ten and 20 people.
An ad agency is not a scalable business model because growth requires top, senior creative talent. Such individuals are rare, have attractive options, and usually prefer to either work for big multinationals, or run their own businesses.
It’s therefore tough for smaller agencies to attract and retain talent without offering large chunks of equity, which can be a zero-sum game. It sometimes even works out net-negative. Unless you find a way of breaking that constraint, this is not a scalable business model.
SO, WHAT MAKES ME SCALABLE?
Building a scalable business is a bit like picking a spouse. There are a number of criteria to consider, the absence of any one of which is a deal killer, even if all other criteria are amply present.
A suitor may exceed your fantasies in every regard (looks, smarts, fun, caring, etc), but if they are also prone to parallel relationships, that’s enough to pull the plug and look elsewhere.
Just as in relationships, a number of things must come together to make your business scalable. Here are the ten most fundamental drivers of scalability grouped into three core areas: Scalable market, scalable business and scalable team.
1. Size (Total Addressable Market, or TAM): The market must be big enough to achieve your ambitions. As a rule of thumb for ambitious entrepreneurs, TAM must be at least 4X your business size goal. If you want to build a R500 million business, you need a R2 billion market.
2. Economics: It’s expensive to scale. You need to invest in great management and top talent, plus spend on infrastructure ahead of actually seeing growth. To make that sensible, it must be very profitable serving your market.
3. Growth: The market must be growing, and preferably faster than the rate of new competition.
4. Number one: Highly scalable businesses almost inevitably are number one, or will become number one in their market or niche. If you can’t lead the market, you must be able to lead a sizable niche.
5. X-Factor: Every market has a bleak outlook: More competition, lower prices, lower margins. Unless you have some fundamental reason to continue to lead the market despite competitive intensity, such as proprietary tech. It must be good enough that you can be and stay number one in your market.
6. Scalable channels to market: Some customers are just impossible to reach profitably. A scalable business has access to channels to effectively target, market to and sell to customers profitably.
7. Scalable operating model: Scalable businesses have unconstrained access to all critical materials and talent, without breaking the economic model.
8. Scalable economics: You can calculate the scalability of your economics with a simple formula: [Gross Profit per R10 million new revenue] / [new cost required to manage each R10 million new revenue (managers, systems, facilities, etc)].
Highly scalable businesses have a 2X or higher ratio. 1 to 1,2 is borderline and scaling will be like walking on glass. Most businesses have a ratio <1, which means they will lose money by scaling.
9. Scalable founders: Statistically, most founders are not scalable. They lack the experience, skills and personality profile to make the required shifts as the business scales, and to develop the organisation through its various lifecycle stages. Scalable entrepreneurs are able to:
- Build a great culture for >100 people
- Attract and build an A-Team of truly impressive senior leaders, and delegate large parts of the business to them
- Be ‘builders’ and ‘managers’ — that is, graduate from ‘entrepreneur’
- Submit their interests to the best interests of the organisation, even when it’s painful — we see this when founders step down in favour of CEOs with corporate experience
- Lead the transition of the business to a professionally managed company, introducing systems, processes and policies in a way that does not break the company’s culture.
10. Leadership team: Particularly in the most painful scale up stage — going from ten to 100 staff — the key driver of scaling well is the quality of the top team. That’s why quality of early hires is a great predictor of scalability. Leaders who can adapt and be effective in a business of ten, then 20, then 50, then 100 staff are truly remarkable, and therefore exceptional.
Not many manage this transition. These leaders can be effective in three completely different ‘modes of organisation’: The hustle (at ten people); The build (from ten to 100 people); The operate and grow modes. By implication, they are — or can grow into — executives. They can hustle. But they can also shift from a tactical focus (immediate fires and opportunities, action focus), to a strategic focus (future focus and system focus).
They are able to run operations while transcending operations, bridging the long-term strategy, the short-term strategy, operations, culture, team, and finances, and they can do that in a company of ten people, or 100 people.
Of course, you can bring in new leaders and you can replace leaders that are not scalable, but this dramatically slows the scale-up journey and can even derail it.
The result of having founders and leaders who are capable of scaling with the organisation will be the automatic development of the other key ingredients for a scalable team: Great talent, a highly engaged team, a great culture, and an effective organisation.
THE KEY TO GROWTH
If you’re following the path to scale, or investing in a scale-up, it’s important to be aware of the causality amongst the above ten factors. Typically, the main factor that drives the speed at which a business can scale is how quickly founders can delegate major areas of responsibility, so that the business can continue to make rapid progress at scale.
This in turn is driven by the ‘next level’ (non-founding) leaders, as well as the leadership abilities of the founders. The problem is that early-stage companies struggle to attract top talent, unless they find people who want to be a part of the equity-incentivised leadership team pursuing an exciting opportunity.
This type of career opportunity can usually attract top talent, despite the various reasons these individuals gravitate towards well-paid corporate roles and their own ventures. But that sort of opportunity does not typically happen by accident: It’s the function of the founders getting points 1 to 9 right.
In a nutshell, the first thing you need is an amazing team of founders who work smart to nail points 1 to 9, find and pursue an amazing opportunity, and then harness that to attract amazing talent in order to delegate effectively, so that you can scale beyond the limits of the founders’ time and energy.