The Search for Scalability

The investors dream business is predominately focused on one word in the end — scalability. If you hear it uttered once, you will hear it uttered at least a thousand times more. Many of you may be asking right now, what exactly is a scalable business? Well, essentially a “perfect” scalable business is one which can achieve huge revenue growth with little additional investment capital required. It’s a business whose revenue model is not constricted by factors such as manufacturing outputs or human capital considerations — it’s one where the revenue (y-axis) vs. cost (x-axis) graph looks much like a vertical line sloping on a 89 degree angle. The cost of each dollar invested is far outweighed by the revenue per dollar returned so the overall incremental cost is reducing as the business expands. To put it simply, a scalable business is one where revenue is exponentially increasing as a function of time.

Of course, such a “perfect” business is never truly possible in real life — this is half the battle. People are needed to run business (damn those humans), markets are different, risks in each market are different, market share is different, brand power and intellectual property considerations are all different. All these factors play into the battle of finding companies which are working towards a highly scalable model, and companies which investors want to focus their funds on. Of course, even taking investment capital suggests — at least in the beginning — that the business is not a truly scalable one, since the investment infers that cost per dollar invested is already outweighing return. Of course, a longer term growth return projection may set this initial failing straight — but applying the narrow definition stated above — it’s an observation that is still true.

So what are some scalable businesses? To start, it’s important to state from the outset — humans are not scalable.

Yep, that rights — any business which solely relies on humans is not scalable. Businesses restricted by human capital and output volume as a function of time do not scale. For example, a legal firm is inherently unscalable — lawyers have lengthy skill development (education), time is limited to a maximum of 24 hours per day which means revenue restrictions, billing time per day fluctuates and most importantly — there is a ceiling limit on what clients will pay for legal advice. Even the best lawyers can only charge so much — as people and businesses — the customers — are themselves limited by cost constraints and will go to the next best lawyer who charges slightly less. This is a perfect example of the inability of an entire industry to be scalable businesses because it is fundamentally restricted by revenue as a function of time — that is, revenue per hour hits a limit.

“OK Then” you are thinking, “well, what is scalable?” Well, practically any industry that is not solely reliant on those pesky humans. Take the Internet for example.

Internet businesses can be hugely scalable because the market available online is not restricted, for example, by jurisdiction. You can purchase a domain name and any person in the world can access this domain name. Sure, they might not even know that something exists at the domain name you have purchased — but it doesn’t limit them accessing it. On the flip side, legal advice is restricted by jurisdiction as laws are different in every country. So Internet businesses have the potential to be hugely — not infinitely — scalable. Of course, a lot depends on the nature of the Internet business and the degree to which it exists entirely online. Business which are built and rely entirely on software are not restricted in anyway by manufacturing output for example — since software can be distributed and replicated an infinite number of times. In comparison, Internet businesses which rely on the processing of physical goods are restricted since they rely on channel, production and distribution partners to assist them with the delivery of the customers order.

This is why a lot of “new age” business are moving online because it entirely removes the need for physical distribution locations — which have heavy costs of staffing, leases, safety, insurance, internal shop fitting and all the rest. It all comes down to the revenue as a function of time. The faster the revenue as a function of time, the more scalable the business — conversely, business which are restricted by such an equation are either not scalable or no longer have the same degree of scalability. If you own a business, you need to look at your revenue drivers and try and establish the highest revenue areas as a function of time and then focus — or promote these more — since it is probable that these are the areas of your business that will increase profit in the long run.

Of course, importantly — this article is not in anyway suggesting that businesses which are not scalable have no chance at being successful — that is a ridiculous proposition. It is merely pointing to the establishment of businesses which are scalable and have a “higher chance” at being able to generate huge revenue quickly as a function of time. Any business can generate huge revenue — but typically they do not fall into the high revenue businesses as a function of time. The key is too look for businesses which can produce $2 or $3 or $100 per second and have no ceiling limit on what this rate can scale too.

No business can do this forever, but the ones that consistently maintain high levels of revenue as a function of time are the ones to watch.