Business model scalability: applying the concept to adopt the right model

We as venture investors love highly scalable business models. ‘But what does that mean in simple terms?’ has often been the question thrown right back at me. On the other hand, I continue to interact with entrepreneurs who choose a highly scalable business model over a relatively lesser scalable business model even though the latter is clearly more effective in solving a real customer pain point (read ‘Disaster’).

The following post is an attempt to conceptually understand ‘scalability’, identify key drivers of business model scalability, provide a framework to understand the scalability of a particular business model, highlight why the venture community loves scalable models, why I personally hate business models that choose scalability over effectively solving for consumer pain point and, finally, highlight some of the drawbacks of highly scalable business models.

Business model scalability  

Conceptually, scalability is the relative ease with which a business grows. All businesses grow and hence, are scalable, having said that some business models are relatively easier to grow rather than others. I bet you have heard that an “online marketplace e-commerce model is more scalable than an inventory-led e-commerce model” or “its very hard to scale a consulting business”. I will try and explain that below but what I need your takeaway up till now to be the term ‘relative ease of growth’.

Which then leads to the question that what decides the ‘ease’ of growth? Essentially, two things –

(1) How much capital does the business model need to generate incremental growth? A t the cost of stating the obvious, ‘growth’ requires ‘investment’ – be it in the form of marketing or building infrastructure (putting up retail stores and warehouses, building a power plant, developing a website). For example, once a power plant hits stable capacity, the company needs to outlay a huge sum of capital to build another power plant to drive top line growth. Offline retail businesses need to add stores at a rapid pace to continue to drive growth. Compare this to an online marketplace like eBay – the company needs to continue to spend on marketing, improve product or add geographies with little incremental spend to grow top line (read ‘much easier than the power plant or offline retail businesses’)

(2) What kind of human resource does the business require to generate incremental growth? I would categorise human resource in two broad buckets:

  • Low cost, high productivity labour force completing commodity tasks – commodity tasks are simple tasks that a person can perform repeatedly with basic educational qualification. Given that the person repeats the task day in and day out, he/she becomes more efficient at it over a period of time. Key examples include delivery executives, pickers and packers in warehouses. As long as such a labour force is in abundance, they will be easy to find and replace and, as a consequence, have low payouts.
  • High cost, low productivity labour force completing complex tasks – complex tasks requires a person to have good educational qualification and experience. Every complex task is unique and, hence, productivity can be low given that there are little or no efficiency gains from the last task. Key examples include venture capitalists, consultants, R&D experts. Such a labour force is hard to replace easily or for that matter quickly and will have high payouts.

Keeping the above two parameters in mind, the following is my attempt to build a ‘Business Model Scalability Stack’ – this should enable businesses to better understand the relative scalability of different types of business models.