The ease with which some businesses scale in the new globalized and digitized economy has led to a handful of massive global companies and increased wealth inequality. Small companies can reach customers around the world. Millions of customers can instantaneously download the latest app for $1 and make overnight millions, with zero added cost per customer. The internet has made business services in one corner of the globe able to work seamlessly with customers anywhere. And global supply chains and ease of trade allow manufacturers and distributors to sell products everywhere. Scale is not always obvious but when looking at the potential of a business there are some signs to look for to evaluate the limits to growth. Here are some factors to consider when determining the scalability of a business.
The size of the market matters and the number of potential customers determine the limits to the scale of any business. A specialized business serving niche clientele will never become a massive company with a limited number of customers. Or, manufacturers of obscure products have a limited customer base. There is a very limited number of people interested in purchasing a bobsled. However, a product such as a smartphone is not even limited by the number of humans on earth since many professionals now have two. Another consideration is the regularity of the transactions. Does this business sell to a customer once or is there an ongoing relationship? Alternative revenue streams are a way to increase sales even when the potential market is completely saturated if the business has economies of scope.
Ability to Reach Customers
The global reach of winning businesses today means that location does not matter. Customers and businesses can be anywhere in the world and still be able to transact. However, there are certain businesses with regional constraints to consider. A great business that can scale easily might have geographical constraints due to shipping costs, or a service that has to be performed in person has travel limitations. Product companies, distributors, and manufacturers can technically reach customers anywhere in the world. However, if the margins on the product are so low and the cost of transporting those products cannot get passed on to customers, then even best-in-class products have limited scale, even if manufacturing capabilities are set up in other regions.
Cost of Expansion
Sometimes fixed costs don’t stay fixed. It is easy to think that a business with high operating leverage, a high fixed cost, and low variable cost, will be able to generate large profits as sales increase. Software companies have a large upfront fixed cost of programming, but the cost to sell one new copy of the software is essentially zero, so it has high operating leverage. But many companies run into production limits and require additional capital expenditures to grow beyond a point. A manufacturing plant can increase hours of operation as sales increase until it is operating 24/7/365, and then to increase production further, another entire plant has to be built. The new production is expensive and limited the ability to generate increased returns as a company grows.
A product or service is replicable if each new one is the same as the last. This concept is essential to scaling because a winning idea can only go so far if each time the idea is replicated it is different. Repeat customers would become unhappy and new customers might not get the same winning service as before. If the business is based on a process that can be standardized instead of relying on star employees, then it is scalable. That process can be taught to additional managers and employees in other locations. Any service-based company that is successful because of employees and specialized knowledge will have a hard time expanding to alternative locations. And any manufacturer that does custom work might not have a product that scales.
Ability to Evolve
Many markets and industries change so rapidly due to changes in preferences, regulations, technology, cost of capital, or ease of supply, and each time there is a major shift in one of these factors is an opportunity for competitors to take significant market share. A business has to understand which type of industry they are in and how prone this industry is to disruption. The ability of the product or service to evolve with the shifts in the market will determine the scale of the company over time. If a product only works in a fad market, it will not scale. A business that was set up to make and or distributor pagers is probably long out of business unless it was prepared to pivot and sell cell phones. Alternatively, some markets will change very little, such as lawn mowing or grocery shopping.