Growth is hard, scaling is harder.
Navigating the uncertain terrain of scaling up.
More than three-quarters of start-ups fail to scale. Why? Scaling is hard.
Many businesses fall into the trap of believing that what got them this far will continue to bring success. The challenge for many is still operating the way they did as a start-up, while growing in size and complexity. They confuse growth for scale.
Growth vs scale
While growth is increasing top-line at any costs, scale shifts the focus to growing revenue at a much greater rate than costs – increasing profit margins for the business. Successful scaling begins codifying the work to better exploit economies of scale and scope so that each new customer accrues revenue while only incurring marginal costs.
Figure 1 - Scaling focuses on both revenue and costs to grow profitably
Many new ventures, especially those backed by Venture Capital, focus on growth in the early years. Often meaning they will lose money. That is not unexpected for an early-stage venture, but for companies to endure in the long-run they need to scale profitably in order to succeed.
So why is this delineation important? Let’s take WeWork as an example. At its 2019 peak, the fabled coworking venture had a $47 billion valuation. It had raised billions from investors, its memberships had grown ten-fold and revenues had continued to double year-on-year. But over the same period expenses continued to rise. In the 6 months prior to its 2019 IPO attempt, WeWork had expenses of almost $3 billion on $1.5 billion revenue, leading to deepening losses and ultimately a failed IPO. While WeWork achieved exponential growth, it had failed to do it profitably - it had failed to scale.
Challenges of scaling
Very few start-ups scale. Of those who have achieved product market fit and at least series B funding, less than a quarter succeed in scaling[1]. The remainder either sustain themselves but cannot scale, are absorbed through M&A, or fall victim to the “valley of death” and cease to exist.
The “valley of death” or “death valley curve” refers to the period between a start-up venture receiving funding and beginning to generate positive cashflows. During this period, it can be difficult for companies to raise additional funding since their business model has not yet been proven. Overcoming the valley of death is a pivotal milestone, as the venture has survived the start-up phase and is now ready to scale.
Contrary to popular wisdom, the most challenging period is not start-up, but scale-up. As an early stage start-up, there is relatively little at stake, the team is small and focused on the finding product market fit and a little funding goes a long way. But when you scale, everything is amplified. Complexity grows with every new market, customer and employee. New systems and infrastructure are needed and costs have a tendency to blow out.
Scaling encounters new challenges. While no two ventures are the same, some of the challenges include: exhaustion of the addressable market, not addressing changing customer needs, lack of clarity and focus on the business model and pathway to profitability, erosion of accountability and continuing to rely on manual processes and effort. This can result in entering a market before it’s understood, increasing costs unnecessarily and making too many assumptions about the future - negatively impacting chances of success.
Readying for scale
To help improve the chances of success, scaling requires a rethink of the key drivers of growth and the underlying organisation that makes it happen. It requires a clear strategy and business model, delivered by high performing teams, codified through efficient processes and systems, with enough funding to fuel the growth.
(1) Strategy & business model – pathway to profitability
Having a great product and service is not enough. Many innovative businesses don’t profit until they scale, but if the strategy and business model is fundamentally flawed, that profit won’t materialise. Scaling should start with a differentiated strategy and clear pathway to profitability.
Strategy refers to the choices through which the venture will compete in the marketplace. It should make clear who your company is to its market – and who you are not – relative to competitors. It is not about selling a vague opportunity but combining a clear view of the addressable market and unique value proposition with a robust plan of action as to how it can be exploited.
Start by asking: who are our target customers, is the market big enough for scale, what are we offering and is it distinct enough from competitors while still being repeatable enough to scale? Then proceed with a robust plan of action, setting goals and objectives and the investments required to build capability, and prioritising work to advance the position. When scaling into new geographies or markets this process should be repeated. Determining what the product is, for who and which channels to reach them may differ depending on the market. What worked in one may not have universal appeal in others.
Business model is a strategic choice within the strategy around how an organisation creates and captures value. Successful scaling requires a business model that increases revenue while reducing the variable unit costs. If the business model anticipates creating long term value, the early losses can be justified as investment in growth. Over time, and with improved unit economics, these losses should take care of themselves. However, if there is no clear pathway to profitability, the business model is flawed.
Take Groupon, the internet coupon site. After a successful IPO in 2011, Groupon grew revenue rapidly, exceeding $2.5B in 2013. However, in the same period the share price tanked. The challenge was that Groupon was not profitable- the business model was flawed. High cost of sales and customer acquisition costs, with low customer retention resulted in unsustainable unit economics.
Before scaling, business leaders should test whether their strategy and business model assumptions make sense at scale. The strategy should be clear on who the target customers are and how the venture will win in the target market. The business model needs to be clear on the underlying economic logic of how value can be delivered to those customers at an appropriate cost as to be profitable.
This is not static exercise but should be reviewed as a periodic planning process. It involves evaluating market competitiveness, analysing challenges and opportunities, establishing goals and objectives, and prioritising investments and initiatives needed to enhance capabilities and advance the company's position. By doing so, the scaling venture can stay adaptable to market changes while keeping the broader business goals in mind. It is the business planning equivalent of the scientific method – start with a hypothesis and goals, test the assumptions in action and revise when necessary.
Key Takeaways
Start with a growth strategy and clear pathway to profitability
Understand your addressable market and your positioning relative to competitors
Design a business model that grows revenue at a faster rate than costs
Have a clear pathway to profitability
Periodically review and adjust along the way
(2) People - Build capability, not just capacity
Scale is difficult without the right people. It is easy to misconstrue organisation building as an act of replication, merely increasing capacity of what you are already doing. However, rinse and repeat is not the pathway to scale. Scale requires a rethink of the key capabilities required to deliver the strategy and business model and making conscious decisions on whether to hire or outsource.
When scaling, there is typically a shift from generalist-based hiring to specialist roles. As an early stage venture you need “jack of all trades” to develop strategies, products, systems and processes from the ground up. To scale, these roles narrow and develop into teams of people with specific roles and responsibilities, all held together through culture.
This means getting bigger – and requires new hierarchies and governance mechanisms to allow for more distributed accountability, moving from founder driven decision making to a scalable system of leadership. A scalable system of leadership enables delegation and distribution of decision making throughout the organisation, allowing leadership at all levels to make decisions aligned with the company’s vision and goals.
In this shift, founders and management teams need to know that they can’t do everything themselves. Instead, they should focus on core capabilities of the business where they can add value, and bring in new layers of management or outsource where they need support. Outsourcing can be an effective way to bolster specialist skills, providing access to instant expertise, flexibility and in many cases cost efficiencies. Consultants can also help to fill capability gaps, with the additional benefit of an outside in perspective and fresh ideas.
Culture is the intangible glue that holds a scaling venture together. When it comes to scaling, one of the biggest hurdles is figuring out how to maintain the same successful culture that made the business thrive in the first place. While it may seem like an art more than a science, there are ways to codify the essence of the company's culture. By defining a clear vision, mission and purpose, identifying core values, and establishing big-picture priorities, a company can ensure that all employees are working towards the same goals and upholding the same culture. So, remember to take the time to cultivate the intangible but invaluable culture that will drive your venture forward.
Figure 2 - codify culture through purpose, mission, vision and values
Key Takeaways:
Rethink your organisation, don’t just replicate
Start with capabilities required to deliver the strategy and business model
Move to a scalable system of leadership with distributed accountabilities
Know when to hire vs when to outsource
Codify culture through vision, mission, purpose, values and priorities
(3) Process and Systems - Codify work to overcome complexity
As roles and teams become narrower in their focus, work begins to be codified in process and systems allowing for increased standardisation and repeatability.
Process can be considered a dirty word in early ventures, fearing that standardisation stunts creativity. However, at a certain size, companies without process become a mass of confusion. Process and systems allow for organisations to overcome the exponential complexity of growth.
To demonstrate this complexity, take the following example. As your venture grows, and you add more people (or markets or customers or products), so do the lines of interaction. Going from three to four, there may only be one more person but twice as many lines of interaction. Add some more and a group of ten has exponentially more with forty five lines. Now consider that each line may represent multiple channels (chat, call, email, web etc.) and could be considered bi-directional (both inbound and outbound) - you can see how this quickly becomes a mass of confusion.
Figure 3: Exponential growth creates exponential complexity
As complexity increases, costs begin to rise, diminishing margins. However, with the aid of process, tools and systems, these interactions can be codified. Digital self-service tools can reduce the number of human interactions and high volume, repeatable activities can be systemised and automated, driving down labour costs and decoupling growth from headcount.
The exercise of codifying work should start with a holistic framework. For customer centric organisations this could be the end-to-end customer experience blueprint. Using the experience blueprint as an example, this should start with the end-to-end customer experience, before mapping the capabilities – people, process, systems and governance – required to deliver it.
Figure 4: Start with the customer to identify the capabilities required and magnitude of business and systems change
Just like sheet music helps an orchestra play in harmony, codifying work can increase pace and certainty, aligning teams to a common framework that connects the user experience to the business and systems capabilities required to deliver it. Overlaying pain-points and key metrics allows a scaling venture to identify constraints and opportunities with the goal of staying responsive to changing customer expectations while continuously improving performance over time.
Key takeaways:
Codify work through process and systems
Use a holistic framework to align teams to a common blueprint for the business
Take a systematic approach to identify areas of improvement
Eliminate unnecessary activities and digitise, systemise or automate high volume and repeatable tasks
(4) Funding scale - moving beyond the pitch deck
Running out of funding can be a death blow for a scaling venture. As entrepreneurs and business leaders aim to scale, they often encounter periods of illiquidity on their path to profitability - a second valley of death. This requires additional fundraising to hire new people, invest in new systems and tools, or expand into new markets.
Successful fundraising is an act of storytelling, where entrepreneurs communicate their assumptions clearly and convincingly to support their long-term vision and strategy. Where a start-up is selling a vision, a scale-up is selling an operational company. Scale-up fundraising requires more than just a pitch deck, it needs a financial model that is both defendable and convincing to investors.
The financial model should be a numerical re-creation and validation of your business model and plan, determining whether the venture can become a sustainably viable business at scale. As a start-up, you may get away with basic financials, but as you scale, the financial model's importance increases significantly. A well-constructed model can help business leaders and investors identify the key drivers of growth, unpack the unit economics and to anticipate cashflow, profitability and future funding needs. It helps a scaling venture refine their pitch to investors, showing that they have a realistic and detailed understanding of their business and what it will take to scale in the future.
Investors and financiers will typically ask for a financial plan, commonly a three to five (potentially ten) year forecast, when you fundraise. Being prepared to defend your assumptions is critical in securing funding. Defending forecasted financials can be challenging, but you can develop a logical defence, be realistic yet ambitious and provide evidence. Scenario modelling, testing assumptions through customer research and experiments, adding contingencies and sensitivity analysis are all techniques that can help to make financial forecasts defendable. Scenario modelling is best practice and allows stakeholders to be better prepared for the future helping to anticipate cashflow, profitability and funding needs under base, best and worse case assumptions.
Even with iron-clad reasoning underlying your assumptions, you will, to some extent, be wrong. Therefore, assumptions and forecasts prepared in the model are not meant to be set in stone but act as a baseline to manage actual performance against. In raising funding, this shows investors that you have a belief in your plan yet are flexible to future uncertainties and are ambitious while still being realistic.
When seeking funding, it is important to identify the right investors to engage. Finding the right investors who can provide strategic guidance and expertise to help scale is essential. While securing funding is important, it is equally important to consider the investors' focus, experience in the industry, network, and their values. Scaling ventures want to look for investors who are experienced in scaling successful companies, share their vision and can provide not just financial capital but also strategic support, access to networks and advisors, and other resources such as recruitment support that can scale the venture into an enduring success.
Key takeaways:
Create a financial model for your scale-up, validating that it is economically viable
Model scenarios to anticipate cashflow, profitability and funding needed under best, expected and worse case assumptions
Be prepared to defend your assumptions to investors
Identify and target investors who provide strategic support and expertise, not just funding
Conclusion
The scale phase is both an exciting and critical time for a new venture. It can be the difference of becoming another “post-mortem” case study or a market success story.
Contrary to popular wisdom, growth is not a reliable indication of enduring success. If a venture is to have a lasting impact on its market and endure long-term, it must find a way to accrue customers and revenue rapidly, without incurring significant costs.
This means taking deliberate steps forward to refine your strategy, build your team, codify work through systems and process, sell your scale ambitions to investors and constantly be on the lookout for new ways to establish your competitive edge. All with the goal of scale, not growth.
At Tightrope, we work with scale-ups and their private investors to unlock untapped potential and shape their next horizon of growth. Our goal is to help more start-ups scale and become enduring success stories. If you are a founder, leadership team or investor navigating the complexities of scale - we would love to talk.
Source:
[1] McKinsey Analysis of 1,762 venture backed companies that have achieved product market fit, 2019 Pitchbook – NVCA Venture Monitor.