Getting to Scale: Cost versus Disaster

Getting to Scale: Cost versus Disaster

Understanding how operations can either propel or torpedo your growth plans.

Every startup has a skeleton — the operational infrastructure that lies within. The only question is whether it will be a source of strength and stability that propels the organization to new heights, or a constant distraction from the core mission that torpedoes growth plans.

This is the fourth in a series of articles that explores how to successfully develop a start-up’s operational infrastructure. By closely evaluating several key themes, I will identify the start-up’s needs and differentiate them from established organizations. As any successful founder will tell you, the right infrastructure should not only be able to quickly help you achieve scale, but it should also be able to pivot with you when the need arises.

In this article, we explore the concept of achieving scale. As we begin, it is important to recognize that scale is not a static state. Rather, scale is achieved when the firm can profitability deliver its products and services to its full client audience. If you lack the capacity to service your full customer set, you have not achieved scale (even if you are operating profitably). The key is to be thinking about rightsizing your output capacity to customer demand. By defining scale as the intersection of customer demand, production capacity, and profitability, you will enable your operational infrastructure to pivot as the inputs change.?

Successful entrepreneurs will define the process of achieving scales as a cost of doing business — not as an objective onto itself. I am a regular consumer of the podcast Masters of Scale: Rapid Response, hosted by Bob Safian (a sister podcast of Masters of Scale with Reid Hoffman). Distributed by WaitWhat, this production delves into many common themes that affect aspiring entrepreneurs. I find Bob’s folksy interview style both entertaining and educational. In a recent episode, Bob spoke with Michael Seibel of Y Combinator, the legendary start-up incubator. Michael noted that, “The number one killer of start-ups is company building. Founders are 10x more afraid of scaling too late than scaling too early. Scaling too late is not normally fatal; it can be painful, it can be difficult, but not likely fatal. Scaling too early is almost always fatal.” The process of scaling turns from a cost of doing business into a disaster when the linkage between cost and scale is severed.

Defining Scale — What size should you be?

Your firm’s scale is dependent on its product set, target market, and cost structure. It can be thought of as production capacity over a set time horizon. Bigger is not better if you outstrip demand. The scale you are pursuing is relevant to your currently foreseeable circumstances, not the ones that might develop many years into the future.

That being said, entrepreneurs need to futurecast; they need to see the world as it will become rather than what it currently is. Foresight is essential, but projecting too far can be fatal. Continuously scaling at a measured pace — as the demand arrives on the horizon — is far better than overextending and threatening your survivability. You need the right idea at the right time. A failed company with the right long-term vision and wrong timing is just as failed as the company with the wrong vision.

Don’t guess when attempting to determine your optimal scale; do the work to understand it. Eric Ries, in The Lean Startup, does a wonderful job of defining the path would-be entrepreneurs can take to validate their product market fit through experimenting, low batch sizes, and fast learning. Shipping a minimal viable product, collecting feedback, adjusting, and repeating will quickly and clearly convert the process of guessing into forecasting. Far too many charismatic entrepreneurs convince themselves and their early supporters of an idea’s validity without seeking direct feedback.

Achieving Scale — The Actions

There are fundamentally only three methods to expand scale: hire, outsource, and automate. Every successful firm will need to undertake a mix of all three. ?Your optimal combination will depend on a wide array of variables, including cashflows, costs, availability of expertise, timeframe, bottlenecks, stage of development, opportunity set, etc. Successful scaling creates capacity while at the same time remaining mindful to not outpace demand and ensuring that expenses do not outrun financial resources.

Getting to scale normally starts with a core team of strategic hires. Successful founders realize they need to broaden their skillset by bringing in additional expertise, flexibility, and depth. The first ten hires (the firm’s cultural ambassadors) need to be first principal thinkers who relentlessly ask the questions “Why?” and “How can I help?”. This group provides the building blocks from which each subsequent level of scale can be developed.

Once assembled, the core team can begin to consider the tradeoffs between hiring and outsourcing. In my experience, the decision to outsource is driven by the confluence of four inputs: the cost to outsource, the cost to NOT outsource, the availability of expertise, and the ancillary benefits of being associated with the outsourced service provider. The first criteria is absolute (can you afford it?), while the others attempt to maximize the potential benefits.

The opportunity cost of NOT outsourcing is important to understand. Mission-critical long-term objectives will fall prey to immediate fires. Any low cost, highly specialized, firm essential activities (payroll, bookkeeping, desktop support, website hosting, email, etc.) should be candidates for outsourcing as soon as reasonably possible. Removing these day-to-day distractions will allow the leadership team to focus on driving the core mission to success.

Certain functions will be difficult, if not impossible, to outsource economically due to the lack of available expertise. These functions need to be satisfied via hires (or training) and should be prioritized. Often times, ?they will directly relate to the competitive advantage the firm is looking to develop or a bottleneck the firm needs to avoid.

The final component of the outsource decision — one that is often overlooked — is the ancillary benefits that accrue by aligning your firm with an industry leader. This advantage comes into sharper focus as capital-raising becomes more central to the firm’s success. Prospective capital providers undertake due diligence before each new funding round. High quality industry leaders hired as outsourced service providers will reduce both the actual and perceived operational risk of the firm. This less tangible benefit can make the difference between securing funding and floundering.??

Automation is the third alternative available to achieve scale. Its success is grounded in the tasks that are selected to be automated and its implementation. Each prospective automation task needs to be well defined, repetitive, and static. In my experience, automation is best undertaken in an incremental and continuous process. Automating step one will add clarity to step two, step three, and step four. This clarity will make these subsequent steps more likely to be automation candidates in the future.

However, not everything that can be automated should be. The goal is to reach scale by improving the organization’s throughput. Automation is the tool, not the objective. Elon Musk, the founder of Tesla and SpaceX, provides important insight here as he was attempting to reach scale with Tesla. “There are some things that are very well-suited to manual operation and some things that are very well-suited to automated operation — and the two should not be confused,” Musk said during one of the company’s earlier earnings calls (Q1 2018).

Implementing the automation process is also essential to its success. When done properly, it will impact individuals within the firm in three ways – reduce mindless repetitive tasks, transition to exception processing, and expand the user’s opportunity set for advancement. All too often, the impact of automation implementation on the individual is overlooked and under communicated; creating a positive feedback loop between the individual impacted and the automation process will empower employees to propose subsequent activities to automate. When automation drives employee motivation, you create a scale flywheel which can propel the firm to new heights.

Achieving Scale — The Pitfalls

The road to achieving scale also includes challenges. The core team needs to recognize the hurdles and take them on directly. Anything swept under the rug at this point can grow to threaten the firm’s survival.

Employees need management — Every hire should understand how they fit within the organization and the opportunity set that lies ahead. Each team member should be an active participant in their own career path.?

Outsourcing needs oversight — Each outsourced activity needs an internal resource that is committed to its success.

Automation needs expertise — Automation is great until it isn’t. Do not think of automation as a one-time investment; it is a continuous process. Many steps along the journey will generate headaches or growing pains, but over time the cumulative benefits will far outweigh these inconveniences. The firm needs to ensure the cumulative learning from automation is internalized and grown.

Change needs communication — Getting to scale requires change. Change causes uncertainty. Uncertainty is mitigated by communication. You cannot communicate too often or too clearly.

Achieving Scale – The Goal

The goal is simple: enough capacity to profitably service your customers. The key is to remember that the definition of scale is dynamic. Optimal scale changes as your customers and products expand and contract. Your objective is to evaluate market conditions, improve processes, reduce bottlenecks, and repeat. The goal is not to “achieve” scale, but rather to constantly better align scale.

Additional articles in the series include:

• The Skeleton in every Start-ups Closet
• Clients: Who are they? What do they know? What do they not-know?
• Compliance as a Competitive Advantage: Dos and don’ts
• Capital Raising: Build a Shared Vision
• Culture: Buid or Accept