Growing to Scale
It’s about time to have the concepts of growth and scale addressed. Both of these are positive things to see in a business that you are investing in or building yourself. But what actually is the difference? Which one is better?
Growth was, and is, the original way to build a business. Whether it is growth in revenue, profit, or any other metric, business people would always seek growth, and still do. Growth means the addition of resources at the same pace that revenue increases. Or in other words, when you grow a company, you do it at some sort of cost. There is an equal an opposite reaction to each action taken as Isaac Newton put it. For example, if a rail company wants to grow their revenue by providing more shipments, they’ve got to increase the staff for the additional routes, maybe purchase or manufacture more rail cars, or any other number of costs. But the addition of these costs would be equal to the revenue that they bring. Another great example is simple consumer products. In order to sell another widget a business must produce another widget, which comes at a constant cost (assuming no economies of scale). So, sure, the company is making more money but the aren’t increasing their profit margins. This is a concept that many business people are comfortable with. There is nothing wrong with it. But what if there was a way to increase revenue at a faster, or larger, pace than attribute costs increase. This is scaling.
For years, scaling, and the ability to scale, has been the holy grail of so many businesses. When revenue grows and the costs that are required to grow that revenue increase at a smaller rate, this is called scaling and is a totally attractive feature in an investment; more money for less expenditure? Of course. I’d definitely take that. Sometimes this situation comes as a result of “economies of scale” in the production process: widgets are made at a cheaper rate as the volume increases. So – A business sells more widgets, increasing revenue, but costs increase at a slower race. Voila! You have scale. Revenue is added at an exponential rate while costs are added at an incremental rate.
Scale has become a very attractive and common feature in businesses since the increasing use of the technology. Technology acts as a developmental factor in capital deepening and marginal production of capital. With increased technology machinery can be better and faster, processes can be improved and quickened, and even inputs can be adjusted to be more cost effective. However, the most influential form of technology that has made scalability possible is the Internet and computers. As a result, scalability has become so drastic that a company can increase revenue without ANY additional increase in costs. A great example of this is cloud-based software that is sold as a service (SaaS). A company can produce and manufacture one piece of software, only once, and sell subscriptions over and over and over, increasing revenue but keeping costs at bay. Now, this is a very crude and quick & dirty example, the premise stays the same.
So, now that you we understand the difference, which one is better? It’s very clear and easy to say that scaling is significantly better than growth on the surface. But companies that have stable growth, a long runway and future, and a competitive advantage to protect their business and the economics of their growth shouldn’t be discounted as lesser. We must be prudent as investors to investigate all facets of a firm’s revenue model in order to ensure that we really aren’t missing out on a great opportunity.