Pre-mature scaling is a large cause of start-up failure and it's important to understand there is a transitionary stage before scaling to avoid failure or stagnation.
It's no surprise that many ambitious entrepreneurs and CEOs with some early success in their ventures are jumping at the bit to start scaling. I certainly was with my own start up. Yet 'premature scaling' is cited as one of the biggest causes of failure in new ventures.
With all the confusion around scaling and scale ups, it's sometimes difficult to get a precise handle on when to begin scaling or rather, when to take more risk and invest in the kind of growth that is associated with scaling.
The allusive hockey stick growth is supposedly driven from finding 'product-market fit', which is cited as the main pre-condition to scaling up. However there is a transitionary stage before scaling and after a level of product market fit is found, that is important. And you can save yourself a whole lot of risk, money and future anxiety to first validate whether you are ready to scale.
I received an email just this week a very well regarded investment fund that touched upon just these questions. The investor is all in on Quantum computing and was previously looking to raise their next fund, which they labelled 'growth stage'. Only to wind this back a later to 'late-early stage' fund for some reason, signalling the ventures were perhaps not ready for scale level funding and risk.
Whatever the label, I've learnt there are a few basic principles you as the entrepreneur or CEO can run through like a checklist to understand if the timing is right to start investing in scaling and to potentially avoid the kind of disappointing results from scaling pre-maturely.
Growing and scaling are not the same thing
Your business may have been growing in customers and sales for a number of quarters or years, but it may not be 'scalable'. Scaling refers to a period of time, usually a number of years, in your business' life when growth is at its peak and it is growing both rapidly and efficiently. Whether it is a manufacturing, software or a services business, a growing business might be growing in sales, revenue or even cashflow. But it may also require the same (or worse ...more) investment and costs to generate each new dollar of sales. Whereas a scaling business grows rapidly and efficiently at the same time, reducing the unit cost or incremental investment to generate the next $1 of sales. In this way, as you grow, the returns to scale and margins or profit grow exponentially, not just linearly.
Scrutinise your business model
Very few businesses scale exponentially on auto-pilot or even at all after five years. In fact the vast majority of businesses who survive the first five years in business will just survive and many will never exceed $1 mill in sales.
Research does indicate that if the business has not experienced high sales growth >30% within the first two or three years in business, then it's highly unlikely it ever will.
This is because planning for scale begins early and it is intrinsically linked to business model. You will likely need to scrutinise and work on improving the scalability of your business model to unlock scale. To start, get an understanding of how efficient your business model is today and the trendline. Some questions you should be able to have answers to are for example:
Is you per unit economics (per unit cost is required to deliver $1 of sales) transparent and known to you?
Is your per unit economics accurately measured and tracked regularly?
Are you making margin at a unit economics level? i.e. per unit costs to deliver 1 customer less than your sales revenue per customer? Or unit costs to deliver $1 of revenue less than $1.
What are the trends over time? Are your per unit costs decreasing and revenue increasing or the other way around?
Are you accurately measuring the unit cost to deliver the product as well as to acquire the customers or sell?
If you have a project or services component in your business, is the effort and time to deliver each type of project accurately measured and consistent? If not, why not?
The best thing about this exercise prior to scaling is it gives you a deep understanding of the economics of your business model. It tells you if you were to invest big bucks in growth to 10x or 20x your sales tomorrow, whether you would actually be able to generate increasing returns to scale or require more capital to invest as growth is linear.
Have you found your niche?
I co-founded a business that offered a software platform to shopping centres. In software platforms, a lot of the costs are in headcount for developers and commercial staff. The beauty of software platforms (which is why venture capital investors favour them) is technology enables delivery of the product or service to many more customers (10x, 100x, even 1000x,) without significant additional development costs, so the margins on a per customer basis are really high - almost >70-80% at scale. Enviable margins I know!
Shopping centres were a great market, but there were not enough of them in our region to reach the scale we were aiming for. However if we were able to capture a market beyond our region, and dominate it, we would have a suitably valuable company. An alternative choice for us was to target another adjacent industry - large, multi-brand retailers. So we tested this and what we learnt that while they had similar needs, the top 'jobs to be done' were actually different. Shopping centres 'top job' is to drive traffic to the mall and stores for their tenants. While retailers 'top job' at that moment of time, when it came to digital is to sell online. This meant we needed to invest in more development and build different features and this complexity limited our ability to scale efficiently.
If your business is already serving multiple different customers and looking to scale efficiently and globally, it's a good idea to run a simple exercise to identify your BEST customer and their top jobs to be done. By best customer I mean, most profitable customers where you have potential to deliver 110% against their top jobs and needs all of the time.
The best customer cohort both need you the most and value (read profit) you the most. Who you can build a differential strategy with greater marketing effectiveness and easily win versus competition or anyone else competing in the broader market.
So run an exercise to understand your profitability on a customer, industry and/or customer cohort level. Define the top jobs to be done per cohort. Then ask yourself, can we reach our scaling goals if we only focus our marketing and develop our products to deliver to 100% of these customer's needs. If the answer is yes, ditch the other customers and scale with these customers globally like these Hidden Champions have done.
Find your biggest constraint
Ask yourself "if I were to 10x or 100x my sales / customers tomorrow, what is my biggest constraint?"
Most CEOs or entrepreneurs know deep down what their biggest constraint is. Likelihood is you will have more than one constraint. List them all down. It's possible that there is an order or relationship to the constraints.
Back to our start-up software platform. Our biggest constraint (apart from never having enough working capital to grow as fast as we would like - another story) was our services offering and our customer mobile app. We would sell our platform on a subscription model, however we secured a large upfront fee from customers who would pay for project deployment and a branded application specific to their shopping centre or mall. Not unusual for software providers. The constraint was we could only deliver one enterprise customer with our current resources at a time. In order to run multiple customer projects concurrently we would have to add tech resources. Not very scalable.
Examining the constraint we worked out we could 'turn on' the back-end platform in 2 hours for a customer, but the front end mobile application and project management of all that took 12 weeks! With some brainstorming we solved this in three ways.
Outsourcing the build to development partners (based in lower cost countries like Vietnam and the Philippines) who could do just as good a job but for half the price tag, leaving us a nice margin.
Process innovation in the form of automation to speed up the time (man hours effort) to deliver the initial mobile app from 12 weeks to say less than 2 weeks. That at least was a 6x improvement.
Change in business model whereby we simply dropped the front end application from our offering, which may mean letting go of the upfront cashflow as well.
We executed 1 and 2 of the solutions above and that worked for a few years. However ultimately we knew to properly scale we had to 'ween' our customers (and ourselves) off the app and upfront fees, and focus on the back-end platform in order to scale 10x, 100x efficiently.
Start an exercise with your team to identify your biggest constraints and the first domino that leads to this constraint.
Examine your options with your team - some are short term fixes, others may be more longer term.
Set up a lean and focused team implementing solutions to remove the constraints to scale in your business. Be it through technology, standardisation, outsourcing, process innovation or changes to your business model.
Secure your cashflow and runway
Most start-ups and small business run lean. In other words, where every possible resource is run a maximum capacity. However, before you start scaling you will likely need to build some 'slack' into your business starting with a cash runway to invest in growth.
There are a number of sources of funds for growth - reinvesting profit (plough-back), bank loans and credit lines, grants, angel investors, venture capital or PE funds, - all with different types of financing arrangements, pros and cons depending on your business. There are even new alternative or hybrid types of funding such as venture financing and factoring.
You want to be confident in the predictability of your business model ahead of taking on risk from any sizeable investment in growth.
Once you take on growth capital, expectations regarding your growth path and patterns will be set with the financier. So predictability regarding how $1 of investment flows through your company and returns new sales growth is important to know. You may find your profit is growing but your cashflow is not and in fact you are 'growing broke'!
If you are not yet profitable, what level of investment will get you to profitability or the next value inflection point. If you are having challenges visualising how cash flows through your business and where you focus financially should be to maximise valuations, there are smart people who can help you to do this and various software packages for building scenarios.
One such software that has helped many Scaling Up companies is Cashflow Story. From 12 data points (3 years of quarterly data), Cashflow Story makes it easy to depict how cashflows through you business today and where you should focus to improve your cash and working capital position in order to reach the growth in profit and valuations you are looking for. Such transparency is useful ahead of negotiating positive funding arrangement with financiers and setting expectations from the outset.
Once your cash runway is secure you can invest in building capacity - be it resources or talent needed to manage and accelerate growth.
Ongoing, having a clear picture of which financial levers such as price, cogs, margin, accounts receivables, payables, working capital needs will drive the business and valuation growth.
Communicate and get everyone in the team aligned regarding priorities to reach your chasflow drivers and valuation uplift goals.
Final words...
Pre-mature scaling is a large cause of start-up failure and it's important to understand there is a transitionary stage before scaling to avoid failure or stagnation.
In addition to learning to repeatedly sell and finding product market fit, Entrepreneurs and CEOs should be aware that scaling and growing are not the same thing. Scaling is a process some businesses undertake that leads to both high and efficient growth.
Ahead of investing in scaling, gather data and measure the efficiency of the current business model. Look for ways to unlock scalability starting with removing their biggest constraints.
Further, understand how cash flows through the business and how each dollar invested has potential to maximise cash flow and grow valuations.
