The Fine Line Between Scaling Up . . .or Not (Part 3)
Have you seen the movie Grand Canyon, starring Danny Glover, Kevin Kline, Steve Martin plus a host of great supporting cast members? It is a movie with a clear message: there is a fine line between rich/poor, love/hate, marriage/divorce, success/failure. I thought about the movie as I wrote this final post about scaling up, because there is a fine line between a company that can (and does) scale up and one that can’t (or could but doesn’t).
That fine line often has to do with whether a business model benefits from economies of scale as it grows. You can easily identify business models that just don’t scale up. One example is the so-called “expert model,” where the growth of the business is far too dependent on the special knowledge or skills of one person, but its scaling-up would require that one person to serve thousands of customers personally. It isn’t possible. Another example is the “venue model,” where the business is limited by the confines of a physical space, yet isn’t suited for franchising.
Take a look at the key takeaways:
Suppose that expert-driven business developed a reliable, consistent method for translating the mind/experience of the expert to others through intensive training. It might be able to grow fairly well because theoretically, it could serve X additional customers at Y price over Z time, with X being the growth variable. If they had 10 people just as good as the original expert, they could grow by 10x. But the unit profit would be flat because the price of the service and the cost of providing the service would be in lock-step. That is growth, but it is not scaling.
The point of all of this is that if you are contemplating scaling up, you must account for that fine line between sustainable competitive advantage or dwindling competitive advantage. Furthermore, you must account for the fine line between marginal economies of scale versus expanding economies of scale. Most business simply do not enjoy either. In Grand Canyon, this is portrayed early in the film as the camera pans back and forth between kids playing basketball on an inner-city court and the Lakers playing at the old Los Angeles Forum. Physically, these players were only a few miles apart. But in reality, they were millions of miles apart. Maybe one kid in one hundred thousand could play college ball. Maybe one in five thousand of those will ever play professionally. Scaling up is like that.
Remember, scaling up is brutally difficult. Few make it. Most fail even if they manage to cultivate the internal and external mindsets required for scaling-up. They fail because their X-factor isn’t sustainably strong enough vis-a-vis the competition or because they have not created a metric for growth that generates increasing unit profits as they grow. As I wrote in my last post, Verne Harnish intimates that to be truly scalable your X-factor must establish a sustainable 10x competitive advantage, then define a metric allowing you to measure how profits increase as you scale-up.
- X-factor = All the improvements you bring to customers compared to the incumbent competition TIMES your “sustainability factor”
I don’t think Mr. Harnish actually simplifies the X-factor this much, so I’m doing it here, for your benefit.
Being able to sustain your competitive advantage (with patents, trade secrets, key relationships, etc.) for 5 years might be a sustainability factor of 2. Being able to lock in your advantage for 10 years for sure might be a sustainability advantage of 3 or even 4. In other words, if you can lock in your competitive advantage for 10 years FOR SURE (such as a web of patents that CANNOT be breached and is yet broad enough to control the market — very difficult to prove) then your actual advantage in the market doesn’t have to be as large.
I’m most comfortable with a sustainability factor of 2 in most cases because it is so hard to control an advantage for 10 years. How hard is it? Think for example of how Google (through buying Android) combined with Samsung was able to attack Apple’s iPhone advantage, even though Apple had innumerable patents. To quote Steve Jobs:
“I will spend my last dying breath if I need to, and I will spend every penny of Apple’s $40 billion in the bank, to right this wrong,” Jobs said. “I’m going to destroy Android because it’s a stolen product. I’m willing to go thermonuclear war on this.” Steve Jobs speaking, according to Walter Isaacson’s biography Steve Jobs
The results of his threat are there for all to see. Apple thrives yes, but so does Google and Samsung.
I discussed some of the challenges of a sustainable competitive advantage in my last post. In this post, I want to explore how to define your metric, the way to move towards that Big Hairy Audacious Goal of a massive scaling-up.
First, you must identify your key metric for growth. In a franchise, it might be additional stores. In a retail store, it might be profit per square foot. In a technology products company, it might be profit per unit sold. Whatever that key metric is, your initial job is to identify it.
Next, you must develop a formula for that metric that gets you to that X-Factor of 10. Let’s say your metric is profit per product category. Suppose there are 10 currently identifiable product categories in your market. Your formula needs to identify what profit per category you must achieve in order to reach your X-Factor of 10. As I’ve said, perhaps the single greatest way to accomplish this is through a sustainable competitive advantage due to innovation, efficiency and the blanket protection of patents.
Finally, you’ll have to test your assumptions frequently as conditions change, perhaps adjusting them or even rethinking them completely. This kind of work requires in-depth analysis. Real “hard-core,” data-driven assessment based on carefully crafted assumptions you then continue to hone over time, assessing new data, creating new predictive models. Scaling is an iterative process, one you have to continually undertake while you’re running the business and ensuring that your brand promise is uniformly embraced internally as well as externally. That’s one reason scaling is so difficult.
For our purposes, your key decision point is whether to tell investors you’re going to scale up, if so to what level, or whether you do not plan to scale-up. If your decision is to scale-up, I recommend putting significant time into developing, testing, honing your X-factor to see if it really stands up to that 10x competitive advantage. If you think it does, create your BHAG which tells you the extent to which you plan to scale-up over what time period, as well as how you plan to do it –that key metric you’ll use to see if you’re succeeding. Get that flat, best as you can with the information available to you. Then find a mentor to test it on, someone experienced in business growth or an investor with that kind of experience. Consider working with George and me in the Entrepreneur$ Boot Camp. Just do what you can to get a second or third opinion.
Truly experienced mentors can spot early on whether your business, your mindset, your X factor and your BHAG metrics are likely to scale to the level you are predicting, over the time period you are predicting, with the profits you are predicting. Don’t try to do it alone, even if you have previous business experience. Remember, you aren’t likely to white-wash the issue of scaling with investors. They know better. They know it’s a fine line between success or failure in business, even more of a fine line when it comes to successfully scaling-up. Don’t lose sight of your primary goal with investors: generating then sustaining trust. From there, so much is possible, even a massive scaling-up in your future. Without investor trust, you’ll never know.
Key Takeaways: Scaling up can be brutally difficult. Investors know this. If you determine to put forth a plan for scaling-up to investors, be sure you can speak clearly about how you’ll develop the internal and external mindsets necessary for consistently fulfilling on your brand promise. Then you’ll need to show investors that you’ve thought through what it will take to get there: a really terrific X factor. Be honest about your X factor. It really must be a product of all the improvements you bring to the customer (such as novel benefits, better service, better price) TIMES how sustainable that competitive advantage is. Be able to defend your metrics through research, backed by input from mentors with experience. Never lose sight of your over-arching goal with investors: generating and sustaining trust. A poor or not-well-thought-out scaling strategy will kill trust, so don’t try to fool them. It’s better to eschew scaling-up and go for moderate growth than it is to say you’re going to do it without a solid case such as Verne Harnish’s Scaling Up method: Seven Strata of Strategy.
Summary of Key Takeaways:
- Scaling up is brutally difficult
- Investors know it
- Internal and external mindset is key
- Mindset includes your X-factor
- Make your X-factor at least = 10
- X factor = All the improvements you bring to the market TIMES your sustainability factor