A1What is scalability?

Scalability describes how easy it is to expand a business model and grow its revenue significantly, without equally increasing its cost base. Relative to its fixed cost base, revenue has the potential to increase exponentially and therefore, scalable businesses offer more profitability and huge growth opportunities.

Over the long-term, a scalable business model is optimally designed to provide increased profitability without a linear relationship between cost and revenue. For a business owner, this means that you do not have to spend much more money in order to bring in a lot more revenue. For example, software falls in this category because selling more products does not necessitate much more expense. By contrast, service businesses are not typically considered scalable models because they rely on the personal output of staff (costs) in order to increase revenues. While there is nothing wrong with starting a successful accounting practice, your revenue growth will be limited by time and staffing resources.

Scalability is one of the most important factors for entrepreneurs considering starting a new business or hoping to take a current business to the next level. Successful business growth depends on a scalable business model that will increase profits over time, by growing revenue while avoiding cost increases.

Keeping this low-cost, high-profit goal in mind, consider how the business model will affect the bottom line when you expand your offerings.

The 2 questions sentencing a business to “death”:

  1. Does business output always require increased input in order to grow?
  2. Does the business need to hire more employees any time revenue must increase?

 Linear growth can be slow and expensive.

Did you answer “yes” to the questions above? Then your business model may not be scalable in a way that yields greater efficiency and profitability over time.

Take a step back: Businesses can grow without scalability, but they won’t achieve the increased profit margins of nonlinear growth models.

For example, if a business requires hiring more employees every time revenue must increase, the business model may not disconnect revenue growth from cost growth. Expansion for OLD-FASHIONED BUISNESSES means increasing costs to support the additional revenue.

Businesses tend to increase costs even before revenue growth – because employees are feeling “weighed down”!

Scalability Criteria according to Christian Mayuad (Verticom Group):

Scalability Criteria #1:

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For a business to be scalable, the incremental costs must be decreasing – ideally approaching zero. This means that the cost of making each incremental Rand in revenue must be going down.

This is essentially the financial criteria, and is what people usually mean by scalable. In my mind this is a necessary, but insufficient, criteria to be a truly scalable business.

Nothing is infinitely scalable. So, scalability must be defined relative to market size and market share projections. A company only needs to be scalable for anticipated revenue. But any enterprise can grow to a point where it becomes non-scalable. At any point in time, a company is only scalable to a certain revenue volume, beyond which each incremental revenue Rand begins to cost more. Once a company reaches that point, the scalability of the enterprise must be addressed directly – through investment in operations, new technologies, new distribution, etc.

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Furthermore, relative scalability is also a source of competitive market advantage. A company which is more scalable relative to its competitors will continue to outperform its competitors until something alters their relative scalability.

Scalability Criteria #2:

To me, criteria #2 is the real key to understanding “scalability” – but, as with criteria #1, it is also a necessary, but insufficient, criteria.

For a business to be scalable, the business must be able to grow – even if you throw mediocre resources at it (Both in terms of people and money – i.e. it must still be able to flourish with dumb people and dumb money).

An important point for entrepreneurs is this: If your business requires smart, talented, hard-driving management, sophisticated investors or customers to grow, it is, by definition, NOT SCALABLE! If a company’s long-term requirements include any “super-humans” or “super-heroes” (including management, customers, employees, investors etc.), then it is NOT SCALABLE!

If mere mortals can’t run it – IT DOES NOT SCALE!

My Personal Rule is “The bigger the key man insurance policy, the less scalable the business.”   In fact, I believe the mere existence of key-man insurance is a red flag that the business isn’t scalable. All of this is ultimately related to the KISS principle (“Keep It Simple Stupid”), or, as I like to say: “Complex businesses MUST become simple before they can scale.” 

The General von Moltke Management Value Matrix

German Field Marshall, General von Moltke, had a very simple, but elegant, conceptual framework which underlined his approach to leadership and management. He classified all individuals on only two dimensions – intelligence and drive – which he considered key independent variables. According to General von Moltke, people are either smart or stupid, and they are either active or lazy.

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What often surprises observers is the relative value General von Moltke assigned to these four categories of people. Although most people would automatically assume that the “Smart Actives” would be the most prized – it was actually the “Smart Lazies” that are the most valuable. The von Moltke logic is as follows:

  1. Smart Lazies” are your command centre generals. They are the most valuable because they are the most strategic minded – they figure out the easiest way to accomplish any objective.
  2. Smart Actives” are your battlefield generals. They can think quickly on their feet and recognise and exploit opportunities as they arise on the fields of battle.
  3. Stupid Lazies” are your rank and file troops. They don’t second guess their commanders and just follow orders to the letter.
  4. “Actively Stupid” are the most dangerous. They must be kept out of all operations at all costs because their presence constantly undermines the mission. They don’t follow orders to the letter and make many mistakes as they actively pursue their own agenda, which may be at cross-purposes to the mission.

If we adapt the General von Moltke Matrix to the life-cycle of companies, this means:

  1. The “Smart Lazies” Discover Value – these are typically the founders of a company.
  2. The “Smart Actives” Capture Value – these are typically the professional managers of the company during its growth phase.
  3. The “Stupid Lazies” Maintain Value – these are the staff and administration which handle the day-to-day management chores of an operating entity.  Basically, the “Stupid Lazies” inherit the value created by the labours of the “Smart Actives”.
  4. The “Actively Stupid” Destroy Value– these are the elements that can spring up like cancer within an organisation and create a drag on company performance that can only be cured through radical removal from the organisation.

Long-term sustainability is part of scalability: While Heroic Efforts are Heroic – if Heroic Efforts are required, then the business is Not Sustainable and therefore Not Scalable. This follows from our von Moltke Analysis.

The “Smart Actives”:

1) Are brought in to “heroically” capture market share.

2) Eventually get bored when the war is won and routine of governance sets in.

3) Move on to lead new battles at other companies.

4) Leave the “Stupid Lazies” behind to govern.

So, if the “Stupid Lazy” leave-behind management can’t govern what has been captured by the “Smart Actives”, then the business isn’t sustainable or scalable.

6 Universal steps to scalability

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  1. “Productise” your service

It is rare that an item is 100% a good or 100% a service. It is usually a mixture of both. Take this scenario for example; you purchase cough syrup at your local drug store. While it may not sound like you are purchasing a service, consider the cashier bagging the merchandise for you, taking your credit card, and even the store stocking the cough syrup in the most convenient place. The same is true with services: there is always a product element of a service.

  1. Make it uniform

If you want a service that is scalable, it must be uniform. Uniformity means something can be easily repeated and duplicated. You want your service to be something that is repeatable so the customer encounters the same outstanding service every time. Uniformity will make the service seem more reliable and thus more attractive to the customer. Something that is uniform will not require you to personally service the client since you are turning the service into something routine.

  1. Make it basic

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The simpler your service is, the easier it can be repeated and duplicated. Furthermore, the chances are that if the service is simpler, there will be less skill required to perform the service, also making it easier to train employees.

If making a service more basic is difficult, consider dividing the service into its fundamental parts. Then, delegate these simpler parts according to the position and skill sets of your employees.

EXERCISE: Think about the service you render – can it be broken down into components that are really basic and easy to follow?

  1. Make it binary (yes/no)

Making a service technical (almost mechanical) will make it easier to automate, outsource or delegate. Something that requires creativity or judgement will require experience and talent. This makes it difficult to repeat and scale, so make these types of services more technical by turning creative or judgement elements into systems if you can.

A lot of what a successful business person does is based on their creativity, experience and professional judgment. A lot of this stems from the fact that we see ourselves as professionals and technicians – specialists in our chosen fields. The problem with this is that it is impossible to scale – there are only so many hours in the day. To scale any technical service, you need to be able to boil down the individual judgement decisions to simple yes/no or ‘binary’ questions.

  1. Make it transportable & automate as much as possible

If the work can be done remotely (e.g. not performed face-to-face), it can be completed by anyone (or anything) qualified for the job.

Automation is almost always better than delegating or outsourcing. If your service is uniform and transportable enough where it can be automated, you have even greater profit margin and scaling potential. Look for the opportunity to automate any part of the service if possible.

–       What more can we automate?

–       Are we really mining all the potential of the systems we pay for?

  1. Step aside

Now that you have structures and systems in place to ensure that the service you offer is scalable, step back to ensure that it can grow without you. Allow others to manage the day to day affairs of the scalable services you offer, this way you won’t be tied down to managing more and more as the service grows.

Final thoughts

In my opinion, the scaling of old-fashioned businesses is going to begin with management scaling their own time. Here are some questions you should consider:

  • How does your office look? Remove the clutter and open your mind.
  • Stop trying to be everything to everyone – people will exploit this.
  • Prioritise
  • E-MAIL HOUR: Allocate one hour in the afternoon (and one in the morning if you have to) to attend to e-mails – it is not necessary to answer all your clients immediately.
  • Reverse the thought process of “pouring people onto our problem” – should you continue with this trend, you can forget about scaling.
  • STOP complaining about “stupid lazies” – they will be the ones we need to use in scaling the business.
  • Identify “stupid actives” – GET RID OF THEM.
  • Ensure you use every time-saving tool available (become more tech-savvy, if needed).
  • Accept the fact this will be a process – get a clear structure going and develop our people accordingly.

This article is a general information sheet and should not be used or relied upon as professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your financial adviser for specific and detailed advice.  Errors and omissions excepted (E&OE)