Ah, the dreaded question asked by investors everywhere since the late 90’s: “Does your business scale?”. To which the correct answer is, of course, “Yes it does…”, followed by a steely glare that challenges them to prove you wrong. Failing that you should probably learn if your business is actually scalable and whether it really needs to be. 

Definition

So what is ‘scalability’ and how can you test whether your business is scalable? 

First of all, I’m going to assume that you aren’t financially sophisticated and versed in the language of accountancy (if you are, skip this bit). You need to understand a few simple terms: 

• Revenue: The money your customers pay you for your product or service.

• Cost of Sale: The cost of raw materials, labour, mailing and marketing required to sell your product or service. 

• Gross Profit: Revenue minus Cost of Sale

• Fixed Costs: All of the other costs you have to run your business like premises, management and administrative staff, insurance, professional costs etc.

• Net Profit: Gross Profit minus Fixed Costs.

Note: What’s the best way to differentiate between a Cost of Sale and a Fixed Cost? If you sold nothing your Cost of Sale would be £0 but your Fixed Cost would remain unchanged.

A business that can increase its Revenues as much as it likes without increasing its Fixed Cost at all is completely ‘Scalable’. A business that needs to increase its Fixed Costs in parallel with its Revenues is not ‘Scalable’ at all. It’s a pretty simple definition really.

Examples

The craze for ‘Scalability’ really started in the Dotcom boom when it became apparent that with a few servers and a winning idea a business could service millions of customers worldwide from one office in San Francisco. Google, Facebook, Twitter et al are all very scalable businesses. Fixed cost growth is focussed on processing capacity/efficiency and little else. These businesses are now amongst the most valuable in the world. 

However, arguably the most valuable companies (Amazon and Apple right now) are less scalable. While both have diversified substantially, their core business model is either retail (where every product sold has to be bought) or manufacturing (where every product sold has to be made). Both have high fixed costs related to the need for factories, distribution centres, plant and machinery etc. and all the people required to run them. 

For a really ‘un-scalable’ model you can look to the big accountancy firms like KPMG, PWC, EY. In these businesses their service is provided by their people. The more customers they have, the more people they need (and places for them to work). 

Do you need to be Scalable?

Put simply: If you can be scalable then be scalable. There is a good reason investors are looking for scalable businesses. 

Scalability brings higher profits (because more Revenue is converted to Net Profits as the business grows) and they are more robust (when sales volumes drop there is less risk that the business will not be able to cover Fixed Costs). 

However, don’t bin a good idea in the hunt for scalability. As Jeff Bezos and Steve Jobs proved, a good product or service can succeed whether it is scalable or not. So if your company isn’t scalable and an investor asks tell them, “Well no it isn’t but its going to succeed because…”.