Note from Peter: This post originally ran in the Wall Street Journal
The issue of scaling is one of the most difficult obstacles entrepreneurs face, especially first-time founders. In order to scale smoothly and successfully, founders must know the right time to push the pedal down and accelerate a company’s growth, and have an idea of how it will impact the company, its culture and their own role. Founders who have not experienced scaling before might be surprised by how difficult it is to know when the time is right. Nearly all startup failures can be attributed to premature scaling — and it’s more of an art than a science.
There are five major factors and characteristics to consider when deciding if a company is scalable or not. Many companies will have two or three of these characteristics, but it’s not time to consider scaling unless your company has a firm hold on to at least four.
Can the founder grow into a big business CEO? Some of the most successful CEOs founded their companies and stayed on as their businesses evolved – Mark Zuckerberg, Bill Gates and Larry Ellison are great examples. It’s a strong sign of scalability when founders have the drive and ambition to become a visionary product CEO, while ensuring that the company continues to grow swiftly.
Many entrepreneurs can build a great product but are hopeless when it comes to designing and implementing a business strategy. Some founders might need a few years off to refocus.
No matter the product, if the market is not big, then forget scaling. If the market is big — like e-commerce — then the market can afford multiple scale players. Think Blue Nile, Zappos and, of course, Amazon. But if you’re just entering an industry where the companies that own the market are not scaling, then how is a new product supposed to not only compete, but also dominate and scale? The hard truth is that if you are entering a small market, scaling is nearly impossible, due to lack of opportunity for speedy core business growth. However, there is one exception to this — if your idea is big enough, create a new market.
Creating a New Market
Sometimes, entrepreneurs’ ideas are so fundamental and innovative that there is no particular market that the company fits in. This approach is not for the faint of heart or the timid — it’s an incredibly high-risk, high-reward approach to scaling that can result in huge wins, or on the other end of the spectrum, disastrous failure. When you reach the point where you are beginning to think about scaling, take a moment to truly gauge how big the product is.
Next, if you honestly believe that the product has the potential demand to create a scalable market — for example peer-to-peer payments — then you have to gauge just how big the idea is. Then, if your idea is something that has never been done before, e.g. PayPal, across the space, then you might have the makings to create your own market. And when you create a new market, you’re in luck — you’ll have an early advantage in the industry, because that you have monopolized it for the time being.
Another test for a scalable startup is whether a venture has the financial engineering to support high growth. When the CAPEX (capital expenditure) requirements are particularly high or complex, then it can become an issue threatening the life of a startup. Some, like Amazon and Tesla, have been able to overcome the requirements through massive bond offerings or government loans, respectively.
Although some have pulled it off, others have not. Just look at the dot-com crash and many of the clean-tech companies of the last five years. This is definitely something to take into account. However, high CAPEX is also a barrier to entry, meaning that once successful, a company can grow within a market without as much worry about potential competitors. Therefore, when deciding whether to scale, you have to consider: What kind of CAPEX requirements does your company have and can you address them?
Today, network effects could quite possibly be the critical factor when it comes to successfully scaling your business, whether consumer, developer or enterprise-focused. It took several decades for Coca Cola to build its brand, yet it took Pinterest just a few years to make a name for itself. Why? The answer is network effects.
Think of other companies that have been able to scale quickly and successfully — not just social companies like Facebook, Twitter, Instagram and Reddit, but also companies that have developed a tight network of users like eBay and Pinterest, among many others. This immediate and widespread connectivity between people is something that simply did not exist until recently, but it is something that all businesses must take advantage of. Not only must your customers be given the opportunity to tell others about great products, but your product/platform must indeed have “positive feedback loops” that spiral toward scale.
Word-of-mouth has always been one of the strongest marketing tactics that a company can use. It’s just that word-of-mouth has gone digital.