Choose the Right ‘Growth Hormone’ for Your Business
How to Avoid Ruining Your Company with Rapid Growth
I would like to remind you that this is the LAST chance to download my book for free. All links will be deleted on July 15th. You can find the link at the end of this article.
The history of management as an academic discipline is filled with fads.
Business school professors and consultants have made many attempts to find the holy grail of business success. BHAGs, Business Process Reengineering, Agile, MBO, Blue Ocean Strategy, Core Competence, TQM, Disruptive Innovation, Uberization — this is far from a complete list of short-lived fads that quickly rose to prominence, only to be forgotten shortly after.
Every few years, business society creates a new idol for praying. We’ll discuss it in August. Today, I’d like to focus on one fad — business scaling.
The ability to scale up a company is believed to be a sign of the health of a business. However:
1. It is not necessarily true.
2. Even if you believe you can scale up your organization, you should assess its expanding ability properly.
Three factors determine your ability to catapult your business to new heights.
Is it lucrative to be big?
Once, someone hacked my Facebook ad account. I spent a month emailing Meta tech support. The people I talked to had names but acted like chatbots. They didn’t read my comments. They ignored my requests to pay attention to some evidence I provided.
Then, they informed me that they had restored access to my account, which was a lie, and stopped answering my messages.
They pretended like nobody was home.
It is not a story about Meta. It’s about any big company. Large sizes and personalized customer service are incompatible.
Employee engagement is at its lowest, and so is customer experience. I don’t think this is a coincidence. A disengaged employee will never be a caring customer service specialist, a sales rep or a shop assistant. And big companies always find it challenging to engage workers.
Big businesses can’t trust their workers because they have too many. They must rely on protocols and rules. Staffers who follow protocols are like trains running on tracks. They cannot deviate from their routes.
Do you want to create another customer-indifferent behemoth with zombie-like workers just ‘running on tracks’? Or do you want to create value?
The large scale has some advantages. As they say, a hippopotamus has poor eyesight, but given its size, that’s not its problem.
However, the big size doesn’t make such companies immune to failures. Dinosaurs became extinct because they were too large. Lehman Brothers, Sears, Toys “R” Us, Parmalat, Thomas Cook, GE, Boeing, and many others have their stories to tell.
Sometimes, staying small, nimble, and customer-centric is an advantage.
But even if you still want to scale up your venture, bear in mind that various industries have different scaling models.
10X black magic
The idea that a company should grow at a 10X pace came from Silicon Valley. The screenwriters of the eponymous TV series mocked the idea. But I’ve been a strategy advisor for many startups, and their founders almost always repeated the 10X mantra like zealots.
However, only a few business models are scalable by 10X.
The possible growth rate of a business depends on three factors:
1. The ratio of gross profit from new customers, or marginal gross profit, to the cost of serving them. Let’s call it “MProfit/MCost ratio.”
2. The ratio of marginal gross profit to marginal capital. Let’s call it the “MProfit/MCapital ratio.”
3. The ratio of marginal gross profit to growth in human capital, or the “MProfit/MHuman Capital ratio.”
Internet companies, SaaS businesses
Imagine a website that sells cat pics, funny ringtones, or sports stats.
If its customer base grows from 1,000 users per day to 1,100 or even 2,000 users, its direct costs of serving them will almost not increase.
Gross profit equals revenue minus the cost of acquiring the customer. The MProfit/MCost ratio is very high.
It is a perfect business model for scaling up. Of course, if you want 1,000,000 users instead of 1,000, you must increase your costs accordingly. But the cost growth rate will lag significantly behind the growth rate of gross profit.
You may also not need much additional capital to expand your business. Your MProfit/MHuman Capital ratio will also be relatively low, which is good news.
Retail
If you’re in the retail business, you can’t afford this luxury.
You can’t open a store in New York City and hope that people from Washington, DC, will often shop there. You need to open a store in Washington, too.
Walmart operates more than 4,600 stores in the US not because its leaders like the number. Amazon is an online retailer, but it also invests heavily in logistics infrastructure and warehouses to provide faster delivery.
Retailers do their best to standardize their stores, reduce costs, and leverage the economy of scale. But if, say, you need twelve workers to run a store, you must hire and train those employees. You have to pay them even before you get your first dollar of revenue. So, your MProfit/MHuman Capital ratio won’t look very attractive.
Your MProfit/MCost ratio and MProfit/MCapital ratio are lower than those in SaaS. Retail chains don’t grow 10X not because they don’t want to.
B2B industries
If you’re in a B2B business and want to expand to various regions or countries, your growth ratios will be even lower than in retail.
You need a warehouse full of goods and an office full of highly competent people in each country. A sales rep in B2B is not a cashier in retail. The MProfit/MHuman Capital ratio will be as low as it gets. The MProfit/MCost ratio and the MProfit/MCapital ratio will also be scrapping the bottom of the barrel.
If you manage to expand your business by 20–30% per year, it’s a great accomplishment.
That’s why there are few 10X-growing businesses outside Silicon Valley.
Conclusion
Not every business can or should be large. Not every company can grow like wildfire. Expanding rapidly is difficult. Expanding rapidly and staying profitable is almost impossible.
Spotify has always been a rapidly growing company, but it still struggles to stop being loss-making.
Uber was in the black for the first time in its history only in 2023. From 2016 through the first quarter of 2023, Uber has reported $30 billion in operating losses. Can you also afford this?
Every industry has particularities that affect the MProfit/MHuman Capital ratio, the MProfit/MCost ratio, and the MProfit/MCapital ratio. Don’t try to expand faster than you can.
Imagine your profit increases by 20%, 40%, or 60%. How fast will your costs, capital, and human capital grow? If they won’t grow much more slowly than gross profit, be careful with plans for a 10x expansion.
Bonus tip
Today’s bonus tip concerns gross profit. Technically, it is the difference between revenue and direct expenses.
However, this difference is determined by the volume of the value your products create for customers. The more value you offer, the higher your gross profit.
The book
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Articles I’ve read recently
Here are a few interesting articles I’ve stumbled upon recently:
Japan declares victory in ‘war’ on floppy disks
A McKinsey study that helped create widespread belief that diversity is good for profits is a lie.
Those who have a EV don’t want to buy another one in the future
Read also: Sense the world through your customers’ eyes. How to find out what your customers really want.
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