10 common traits of a scalable business
I was speaking with an accountant friend last week about a few of his client companies and whether they may be a fit for our fund at StartFast. As we dove further into the discussion I recognized that my friend, like most people, no matter how smart they are or how extensive their background in business is, will often prematurely jump to the conclusion that a business is scalable without really checking all of the boxes. So for all the early-stage founders, advisors, professional services providers and investors out there I thought I'd put out a short list of characteristics that in my experience I've found to be necessary for a business to actually be scalable. I would encourage all to think about how this lists applies to your current business or even better how it applies to an idea you have for a new business before you actually launch it.
Now I'm going to start with a disclaimer that this is not a comprehensive list of all things important to building a great business. We are narrowly focused on a few of the most important common traits that make a business potentially scalable. Also, in the absence of first-hand market data, many of these points are somewhat subjective. Two people may see come to two different conclusions about one of these points. Nevertheless, if you're trying to evaluate whether an opportunity you are considering pursuing, currently pursuing, or are evaluating for investment COULD BE scalable, here is a list of ten main criteria to consider.
- Is this truly a "need to have" not a "nice to have" value proposition?
- Is the novelty of the business and technology limited to one or two items?
- Is there a very specific initial target customer that is easily identifiable?
- Is the initial target market >$500M or $1B?
- Do the unit economics offer very high margins and strong cash flows?
- Is the ability to market to customers repeatable and predictable?
- Is the sales cycle cost efficient and relatively short?
- Is the ability to on-board and "service" customers highly or fully automated?
- Is there an inherent "stickiness" built in to ensure repeat customers?
- Is competition (from the eyes of the customer) minimal and do you have an advantage that will allow you to grab market share faster?
1: Is this truly a "need to have" not a "nice to have" value proposition?
This typically means you are directly solving a top 1-3 problem or need for your customer; definitely so in a B2B case. This also means your offering can deliver relatively significant value for the customer not just a minimal benefit. In the best cases your customers would describe you as truly disrupting the status quo or changing the industry. The stronger your value proposition and the higher a priority it is for your customer the easier it will be to get their attention and make the sale.
2: Is the novelty of the business and technology limited to one or two items?
Believe it or not this is actually a good thing. Too much new tends to put people off, create unnecessary friction in sales, causes confusion among customers, or creates a lot of problems satisfying other points on the list. Once the customer feels you can deliver the value proposition your goal is to minimize the number of potential objections. If you have a great product but have unnecessarily introduced a unique business model the customer is not used to, you've made your job harder not easier.
3: Is there a very specific initial target customer that is easily identifiable?
Specific meaning that you can characterize the ideal customer in very narrow terms. For an extreme example "every coffee shop" is obviously too broad for an initial target market. "every coffee shop that uses square" may still be too broad whereas "every coffee shop in Albuquerque" is too restrictive and probably not a relevant way to characterize the customer. You're looking for the right balance. The low hanging fruit. Large enough to be attractive but also specific enough that it becomes easier to satisfy the points below.
4: Is the initial target market >$500M or $1B?
This part is just pure math. Another problem with "every coffee shop in Albuquerque" is that it would also be too small of a market. If you believe in Geoffrey Moore's technology adoption curve, then only 2% of any market will be "innovators" and only 13% will be "early adopters". Compound that with typical sales conversion rates and your pricing model and suddenly you start to realize just how big of a market you really need to have a shot at building a big business.
5: Do the unit economics offer very high margins and strong cash flows?
High margins meaning 80%+ type of gross margins. This means that each customer is highly profitable based on how much it costs you to service them. Strong cash flows is more related to your ability to capture those strong gross margins easily and quickly. Time delays and payment processing are enemies to scalable businesses. This is why recurring subscription payments that simply charge a credit card or withdraw from a bank account are so valuable.
6: Is the ability to market to customers repeatable and predictable?
Repeatable meaning: you know who the customer is, how to find them, how to sell them, how to on-board them, and how to keep them in a rinse and repeat fashion. It has become something you can begin to wrap a process around and delegate in a semi-machine-like prescriptive format. (This is why point # 3 was important.) Furthermore you know there are a lot more potential customers out there you can apply this process too and can predict with reasonable accuracy based on past results, how deploying $X more to sales and marketing will lead to $Y more in revenues.
7: Is the sales cycle cost efficient and relatively short?
Cost efficient means the ratio of $Y to $X (from #6) is at least 3-4. It also means that the cost to acquire a single customer, at least in the early days of the business, isn't a stratospheric number in the $100K's or greater. It may be one day, but if that's what it takes to get customers # 1-10 you're in trouble. A relatively short sales cycle meaning relative to the size of any one customer you can acquire them quickly. For an enterprise customer short might still be measured in months where as for a consumer focused product it might be measured in minutes or seconds. This is about maximizing monthly revenue over sales cycle time. A $100K/year customer that takes 3 months to acquire is much better than a $1K/year customer that takes 1 month.
8: Is the ability to on-board and "service" customers highly or fully automated?
This is a criteria often forgot about until the company is already servicing customers. Founders can often get so hyper focused on brining cash into the business that they forget to step back and view their business from a 3rd party perspective. You may have even checked every single box until this point but then find that after you acquire a customer your entire schedule is being devoted to servicing that customer. If that's the case then I'm sorry to be the one to tell you that what you have is not a tech company but a professional services business. In fact its worse then that because you'll be charging lower product-level prices while still providing the high-cost professional service. Now apply criteria 5 and 6 to your operations. If these aren't true then you can't truly scale your company in a fast and cost efficient manner. You need to be able to provide your product or service to your customer in a highly automated manner (again relatively speaking).
9: Is there an inherent "stickiness" built in to ensure repeat customers?
This can sometimes be the largest "hidden cost" of your customers, their tendency to churn. All of your effort and money spent to market to, acquire, and service a customer is thrown out the window the moment they decide to cancel their subscription or no longer be a repeat customer. The goal is to find a way to make your product inherently sticky and constantly creating value. A few common roadblocks: a product that's only needed irregularly like tax prep, a product without any switching cost, or a product that delivers all of it's value after the first use. A great example of this working well is a company called Dashlane. They store all of your passwords under one master. To make sure all of the passwords you're storing are safe, a new, unique, and encrypted one is created for each service so that not even Dashlane can identify any one particular password. That means there are huge switching costs for canceling because you would need to do a password reset for every one of your services!
10: Is competition (from the eyes of the customer) minimal and do you have an advantage that will allow you to grab market share faster?
Notice the qualifier "from the eyes of the customer". This is because a competitor that you never actually compete for business with is not really a near-term competitor. If your customer does not view them as an alternative to your product then even if it might seem to the layman that you are competitors in reality you are probably targeting different problems or different customer segments. Making sure you are competing against very few to no true alternatives is key to scaling the business fast and cost efficiently. Furthermore, ensuring you have an advantage relative those competitors that will allow you to grab market share faster is also vital. This may be a first mover advantage or it may be growth hack as discussed in "How to outrun your competitors".
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