Categories: Growing & Complex BusinessesUncategorized

Why it’s time to stop thinking about scaling

In 2000, the TV show Sex and the City featured its main character Carrie Bradshaw enjoying a cupcake from Magnolia Bakery, a real bakery in Manhattan. This started a nationwide cupcake craze that gave birth to other chains like Sprinkles, Georgetown Cupcake, and the now-defunct Crumbs Bake Shop.

Though Crumbs went bankrupt in 2014, they were the star of the cupcake scene, opening hundreds of stores from LA to NYC in the span of 8 years. Shares of their stock reached $16 at its peak and Crumbs expanded rapidly with a plan to dominate the global cupcake market. When owners talk about scaling their business, they usually mean increasing profits and revenues at any cost, when they should be thinking about sustainable growth, as not to implode under the weight of overexpansion.

The problem was Crumbs overreached by expanding too soon, too fast. On top of spending too much on high real estate costs, it also failed to keep up with a changing market. It was focused only on increasing sales of its products—expensive, extravagant cupcakes.

After the recession hit in 2008, consumers who had once indulged in the calorie-rich desserts for $5 a piece were no longer willing to spend on such frivolities. Meanwhile, health-conscious food habits were raising the demand for vegan and gluten-free baked goods.

Businesses like Sprinkles tapped into the changing landscape by offering other dessert options such as ice cream and cookies, in addition to a selection of vegan and gluten-free products, Crumbs failed to foresee that consumers were willing to forego delicious but expensive cupcakes in favor of more affordable, lifestyle friendly treats.

Ultimately, Crumbs didn’t have a solid plan for sustainability. Their scaling strategy backfired, causing their untimely demise.

Today, news outlets are full of stories of rapid scaling coming out of the tech world. One minute you’ve never heard of the company, and by next year, they’re everywhere. This can put pressure on businesses to scale fast even when they’re not ready. Companies are preparing to launch on public stock exchanges despite never having been profitable.

Racking up millions in losses in the name of rapid scaling can work for startups with a viable path to profitability, but growth for its own sake isn’t always a sustainable strategy, especially if your business hasn’t found product-market fit. Paul Graham, the venture capitalist of Silicon Valley’s leading incubator Y Combinator, even calls for startups to specifically do things that don’t scale until they find product-market fit.

This might include building a product that satisfies each individual user, or intentionally focusing on a narrow segment of the market. Examples include the way Facebook first started as a platform for Mark Zuckerberg and his Harvard circle, and or how Airbnb’s founders went door-to-door in New York to recruit users and test their product. Once you please your first customers, you know you have something people actually want—after that, it’s off to the races.

Some companies, particularly software startups, use a growth at any cost strategy to capture enough market share and become profitable through economies of scale. They suffer through years of losses until they dominate a category and have profitable unit costs.

Scaling is not a bad idea in and of itself. The important thing is to recognize whether it’s the right focus for your business at a specific point in time, and how much effort to dedicate to it. Here are some factors to consider when deciding how to grow your business.

Growing vs scaling

The term ‘scaling’ in the business context is relatively new and continuing to evolve. Here’s Merriam Webster’s definition:

Scale: To grow or expand in a proportional and usually profitable way.

Although the word might mean slightly different things to different companies, a business that scales is one that can grow while maintaining the same or reduced ratio of operational costs to expenses with increased overall profits.

This means that the business is following a sustainable model so that it doesn’t run out of cash while expanding its operations. You can grow your company in several ways–hiring more employees, opening up new locations, launching new products, etc. Naturally, this requires more capital. But when you’re scaling, that capital doesn’t come at the expense of profits because your profits are growing proportionally to accommodate the increased spending.

By contrast, business growth is a broader term that encompasses different tactics including organic growth and inorganic growth. Growth is often measured by increased revenue based on different factors like the number of customers, sales, or size of the company. However, just because business is growing doesn’t necessarily mean that it’s sustainable. The company might be expanding its operations while its profits stagnate, as was the case for Crumbs.

Tech companies using a Software-as-a-Service (SaaS) model can scale much faster than businesses with physical inventory or retail locations because their products are digital and can be reproduced and distributed cheaply, unlike physical products. There aren’t any shipping fees, warehouse leases, or inventory costs to contend with.

In some tech markets, the first to scale and capture market share wins, as evidenced by the races between Uber and Lyft, or Google’s and Yahoo’s search engines. Reid Hoffman, the founder of LinkedIn, recently published a book called Blitzscaling, which refers to chasing speed over other factors like quality or efficiency. Because a few companies have seen success with this type of “growth at any cost” mentality, it’s now prevalent upon entrepreneurs. This type of growth, or scale, is not sustainable.

You can see why for some businesses like Crumbs Bake Shop, a low margins, low-cost scaling strategy could be a problem. A product like Uber has massive potential for expansion because easy, affordable, transportation is something everyone would use if it existed today. Driver onboarding and user acquisition for ridesharing are fast and cheap, as the company isn’t paying for vehicle costs in most cases. A market-domination plan focused on scaling makes sense.

But a specialty shop selling one type of dessert takes longer to gain the loyalty of a mass market. Their mistake was overestimating the popularity of cupcakes, and not recognizing it for the passing trend it was.

When businesses focus on scaling at all costs, they can overlook other important aspects that contribute to business growth, such as customer satisfaction, cash flow, and product-market fit. It’s a strategy that works for some, but not all.

Growing slowly is better than scaling too fast

Scott Nash, the founder of Maryland-based MOM’s Organic Market, describes his business as a cross between Trader Joe’s and Whole Foods. But at just 19 stores, mostly located in D.C., Maryland, and Virginia, its scale is much more modest.

Nash founded his business in 1987; the slow pace of growth is deliberate on his part. For the first three years, he operated out of his mother’s garage. Over a decade later, he had three stores. During that time, he studied the successful strategies of companies like Trader Joe’s and Apple.

These first ten years of learning were vital to the eventual success of the business that now brings in over $200 million in sales each year with 1,000 employees. Going against the standard short-term, quarter-based business strategies, Nash focused on long-term sustainable growth.

Thanks to this deliberate approach, MOM’s Organic Market now has a loyal following of customers who want healthy produce. Additionally, Nash is a leading voice in the organic food market–recently he challenged the practice of setting arbitrary food expiration dates, calling it wasteful.

According to the Startup Genome Report by Compass, premature scaling is the cause of failure for 74% of internet startups, while 93% of startups that scale prematurely never pass the $100k/month revenue point.

Assuming you’re in it for the long haul, slow business growth might serve you better if you take compounding growth into account. An annual growth rate of 14.5% might not sound too impressive at first, but 50% growth in revenue over a three-year period does. The two things are one and the same—if you grow 14.5% a year, you’ll achieve a 50% growth rate after three years.

The lesson here is that scaling shouldn’t be your top focus if you haven’t yet found product-market fit or optimized operations. If you haven’t nailed your niche, defined what your customers want, and figured out exactly how and why your product offers the perfect solution for their needs, scaling up can lead to disaster.

Even if your customers tell you that they love the product, that doesn’t mean you have a great product that specifically addresses a problem in the market. Make sure your product will continue to resonate with consumers because there’s a constant need for it, rather than rely on customers who may rave about it once. MOM’s Organic Market did extensive research on the market before it started to scale, setting up the foundation for its steady success.

Be real about your market size

Making sure you know your customers matters. With few exceptions, like Google and Facebook, there’s a market size limiting the number of customers you can reach.

For example, let’s say you run an outdoor sports retail business, and you’re consistently attracting outdoor sports enthusiasts and converting them into repeat customers. You experience rapid growth in the first few years of business.

But then, you start to stagnate. You’re no longer acquiring new customers at the same rate as before because you’ve simply reached the threshold of people who’d be interested in your products.

At this stage, if you’re still focusing on scaling alone, you might be bound for trouble. The same growth strategy won’t work because you’re not going to acquire customers at the same rate or cost as before. Now is the time to adjust to a sustainable growth strategy.

Focus on gauging and creating demand before worrying about scaling

A McKinsey study on business growth found that many successful companies use one or a combination of the following ways to achieve sustainable growth:

  • Moving into adjacent markets: A company that sells outdoor sports equipment could acquire or build a relevant product like GoPro, which is relevant for many sports enthusiasts.
  • Building an ecosystem around their core product: If outdoor sports equipment is the primary product, a service that matches professional athletes with amateur buyers for recommendations could be one supplementary product.

Using these strategies, successful companies showed a fundamental understanding of their customers, which helped them find other avenues to increase revenue without acquiring new customers.

Simply by making the brand or product more useful, these companies generated more revenue from their existing customer base. And while this may require some upfront investigation, the time and capital invested pays off. The study found that reducing margins didn’t affect businesses as much as revenue growth unless they were already past the $4 billion annual revenue mark.

While it’s important to keep improving processes to decrease costs, a business that keeps customers satisfied makes much more of a difference in the long run.

Whether you’re launching a new product line or a brand new business, scaling before you’ve properly established market demand can lead to detrimental consequences. While you’re thinking about how to acquire a boatload of customers, you may be better off doing things that don’t scale to confirm product-market fit or to test a change in market tastes.

Final thoughts

Only you and your team know if you’re ready to scale the business. If you’re already experiencing steady growth, nailed down your niche, and are experiencing a steady demand for the product, scaling up might be the best way to go.

On the other hand, if you’re worried about market expansion, hiring aligned team members, or stalled customer acquisition, investing in other sustainable growth strategies could serve you better. Even if you’ve already taken some steps to scale your business, slowing down to address these warning signs can help you avoid bigger problems down the road. You can always pick up the pace later when the time is right.

Loni Klara

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