As startup businesses make the transition to early stage and then the rapid growth phase, assuming they are executing their business plan effectively, scaling the business becomes of paramount importance.
Understanding the differences between growing a business and scaling a business can help entrepreneurs drive their companies to successful exits.
Generating revenues is obviously fundamental to building a successful business, regardless of product, service, industry, geographic focus, and the like. But growing revenues alone will not create the highly desirable business that can generate premium multiples upon exit.
To do this, entrepreneurs must scale.
An example of growing revenues would be signing up a new customer, or increasing sales to an existing customer. While top-line revenues would increase, there will likely be increased expenses that accompany those increased revenues.
For example, the company may need to hire additional personnel to service the new account or growing relationship. There may be increased inventory management requirements for personnel, software, delivery, etc.
If expenses increase at the same pace as revenues, the dollar profits of the business may increase, but margins will not. While revenue growth is certainly important, driving increases in operating efficiencies, that in turn result in improving margins, is the essence of scaling a business.
How Do We Scale a Business?
First and foremost, the entrepreneur must want to scale the business. Although this might sound silly, there are many entrepreneurs who are satisfied with their company growing to a certain size and have no desire to exit.
If this is the case, assuming the entrepreneur does not have investors who expect a successful exit, there are still good reasons to focus on efficiency, even if the ultimate goal is not to scale the business. Greater efficiency can result in greater net profits for a given level of revenue, so a focus on efficient operations is still of value.
For those entrepreneurs who do want to scale their business to build to a successful exit, there are some basic steps, regardless of business type, industry, product or service, etc., that we can take to achieve scalability.
Many early stage businesses do not invest in software to streamline operations, but instead have personnel who perform many functions manually. This is inefficient and is almost always a barrier to scaling.
While the implementation of software packages to automate business operations is industry- and company-specific, there are almost always opportunities to incorporate software into virtually any business.
Probably the most obvious area of application, regardless of business type, is within the various accounting functions of the business. One key area where the use of software is highly effective at improving efficiencies is within the inventory management functions of a product-based business.
Often companies have employees manually ordering, receiving, counting, inputting, moving from raw materials to work-in-process and then to finished goods, invoicing, building out orders and shipping. There are numerous applications of software tools within this chain of activities that offer tremendous opportunities for using software to gain efficiencies.
Additionally, there are software tools for automating manufacturing, IT processes, manufacturing and a whole host of other activities, depending on the business. Entrepreneurs should actively seek opportunities to use software to replace manual employee functions to automate as many repetitive processes as possible.
While there is an up-front cost for the software, it is rare that this investment does not generate meaningful improvement in efficiencies, which translate to scalability.
Outsourcing functions can be a fantastic way to reduce costs and thereby improve efficiencies. Manufacturing, IT, payroll, HR and many other functions can be far less expensive if they are outsourced, especially for early stage companies experiencing rapid growth.
Keep in mind that there are added, indirect costs associated with many of these functions because, as operations grow, new employees must be found, hired, trained and managed, new facilities and supporting infrastructure — office space, computers, phone systems, parking, etc., and must be added, benefits and taxes must be paid.
All of these duties can consume, distract and frustrate key employees and managers, including the entrepreneur, which reduces efficiencies and negatively impacts scalability. By outsourcing these functions, the entrepreneur can avoid these pitfalls and keep his or her team focused on driving company success.
Stick With What You Know
Often businesses that enjoy early success will expand into new, unrelated, noncomplementary products or services. Sometimes this can work, but more often these forays into uncharted territory result in spreading the team too thin and blurring the focus of the business on its core operations.
A business experiencing rapid growth must remain laser focused on its core operations, products and/or services to promote effective scaling. Obviously, there is a fine line between expansion of the product/service offering that is beneficial to the growth and scalability of the business, and those products or services that can derail success.
Entrepreneurs who are aware of the possible pitfalls of watering down their team’s focus can differentiate between adding products or services that are complementary and scalable versus those that will divert critical resources away from the core operations of the business that foster scalability.
There are countless examples of companies that wandered far afield and paid a heavy price. Ford’s introduction of the Edsel is a prime example — a fiasco that nearly killed the company. Vigilance, especially during the early stages of development, can help the entrepreneur avoid making these mistakes.
While not all businesses have products or services that offer opportunities for generating recurring revenue, to the extent that a company can find these opportunities, recurring revenues are highly desirable, not only because they help drive scalability, but also because investors (recognizing the positive impact recurring revenues can have on valuation) place a significant premium on business models that offer recurring revenues.
Service-based businesses, or businesses that sell products that can be married to some type of service, are perfect platforms for recurring revenues.
Probably the best and most familiar example of this is the SaaS model, or Software-as-a-Service. Selling monthly software subscriptions, especially cloud-based applications, is a hugely scalable operating model.
One of my recent projects offered a software-based monitoring service that was coupled to a sensor network in which the monitoring was fully automated and customers paid a monthly or annual monitoring fee. This is a fantastic way to scale revenues because, assuming the company maintains the customer relationship, that recurring monitoring revenue will continue in perpetuity with virtually no additional costs.
To the extent that entrepreneurs can find ways to generate recurring revenues, the opportunity for growing revenues without increasing costs — or at least with a slower pace of cost increases relative to revenue growth — is the essence of scaling a business.
In this article I have discussed a few of the ways entrepreneurs can increase efficiencies to scale their businesses. There are many other ways to accomplish this, many of which are company- or industry-specific. The most important takeaway is that entrepreneurs should continuously look for opportunities to scale by improving efficiencies within each operating segment of their businesses.
Part of the strategic plan should be a periodic review of all operations to identify new opportunities for increasing efficiencies, and employees should be incentivized and rewarded for finding find ways to improve efficiencies.
The most direct path to a successful exit with a strong valuation is scaling the business. Entrepreneurs who focus on efficiencies and thereby on scaling the business demonstrate to investors that they understand how to maximize the company’s valuation, which will not only help entrepreneurs secure funding, but will also place the business in a position to exit as early in the development of the business as possible.