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Why You Need To Know The Difference Between Growth vs Scale

Most business owners want to grow their businesses. However, unless you’re hoping to build the next industry giant. Growth by itself is not a smart business objective.

Like when you were a kid marking your height on the lounge room wall. You’d get way too excited when you grew a tiny amount. Imagine if you were allowed to pick how tall you grew. We’d all be walking around 8 feet tall. The same way 8-foot humans don’t function well, most companies are better off small.

Wall Street lives and dies by growth metrics such as top-line revenue, number of stores, number of territories, etc and silicon valley is dangerously following suit. Making it easy to believe that’s what you should be doing as well.

You can find countless articles warning about the perils of growing for growth’s sake. Like this one, this one and this one.

Gary Vaynerchuck (Founder of VaynerX Group) is continually warning his audience about falling into the growth trap.

I think too many business owners are focused on growth like revenue and headcount, vs scale, like providing value and generating free cash flow.

Advertising revenue, stores, and staff numbers are great branding plays and makes a company look like it’s doing better than what it is. But those numbers don’t necessarily translate into a sustainable, successful venture.

Growth means adding resources at the same rate that you’re adding revenue. For example, a company that gains a customer hires more people to service them. Adding revenue at the same rate, they are adding more costs.

A graph showing costs increasing at the same rate as revenue
A graph to show revenue vs costs linear progression for companies focused on growth

Growth companies often incur more than $1 of additional costs for each $1 of revenue generated.

On the other hand, to scale you need to add revenue at a rapid rate while adding costs at an incremental rate.

A graph showing revenue increasing faster than costs
A graph to show revenue vs costs linear progression for companies focused on scale

Growth vs Scale Is The Difference Between Sustainable & Un-sustainable Companies

Here’s how it plays out when a startup only focuses on growth.

They go out and raise a bunch of money based on a business plan.

The investors want to see ‘growth,’ so they put pressure on the founders to focus on acquiring new users and growing top-line revenue.

The company starts pouring money into user acquisition, new leads, social media followers, and sales.

So far, so good.

The first couple of capital raises will follow this pattern. If the product is half decent and offers a new opportunity to consumers, initial user growth and audience growth will be relatively easy.

However, once all the low hanging fruit has been picked, the cost of user acquisition will start to increase, audience growth will slow down, investors start getting scratchy.

At some point in time, the cost of customer acquisition outpaces customer lifetime value. Growth becomes unsustainable and the company can no longer raise money at previous valuations. The startup enters a death spiral and dies.

That’s a simplified version of events, but a general pattern many startups follow.

Exceptions To The Rule

There are a few exceptions. Focusing on growth can lead to a successful sustainable company. These companies are the ones that become industry unicorns.

Such as Facebook, Shopify, Netflix, etc.

For a company to become a unicorn, they need to meet at least two of the following factors.

1. Economies of scale: When a company’s average cost per customer decreases with each additional customer. Software like Microsoft, Android, or Google products are good examples of this.

2. Network effect: When a company’s product increases in value as each new customer is acquired. Think of social networks.

3. High switching costs: When customers find it expensive, painful or challenging to switch to a competitor and thus become a referrer to their company of choice. Think Apple or Amazon.

Reid Hoffman (co-founder of LinkedIn) likes to neatly wrap all of these types of companies into what he calls platforms.

Platforms create a feedback loop. As demand for the platform increases, the cost of providing the platform per user decreases. Giving them more budget to spend on functionality & features – which increases the value of the platform per user – In turn, demand for the platform further increases.

Choose Scale Instead

For the rest of us, the better alternative is scale.

Graph to show revenue vs costs linear progression for companies focused on scale
Graph to show revenue vs costs linear progression for companies focused on scale

When a company ‘scales,’ it increases revenue faster than costs, which produces cash flow and a sustainable business model.

Increase Your Customer LTV

Here’s why this works at my gym which should illustrate the difference between growth and scale.

We have a range of different products and services we can sell to our members but instead of trying to provide and sell them everything at once.

We ‘walk’ our members up our value ladder (See below).

This starts with a free trial – the free trial is our first product; after completing a free trial we hope people will become gym members. Then we try to progress our gym members to a ‘tribe membership’ and finally our ‘wellbeing membership.’

Each step our members take up our value ladder increases their lifetime value.

Due to the gym’s size, we can only serve a maximum of 500 members. The problem is, if all 500 members are gym members, we’d make no money.

Dunedin is saturated with gyms. The cost of acquiring a new member is very high and continually increasing. Eventually, the cost of acquisition for each gym member will outweigh the LTV of gym members, hence we need to progress them up the value ladder to scale.

Not every member is going to end up on our well-being membership. Maybe only 5% will, but each well-being member is worth 6x more than a standard gym member.

Be Strategic With Your Costs (spend on scale, not growth)

If our costs to operate the gym increased proportionately with revenue (Growth), we’d just be treading water. We might be better off with 50 members in a small studio than 500 members in a large facility.

We need to make sure that our cost structure increases marginally compared to revenue.

There are a few ways we do this.

We incentivise staff with performance bonuses rather than salary increases. As our member base and revenue grows, our staff costs will increase marginally.

We’ve based our business model on our fixed costs. What does this mean? We have several fixed expenses such as our lease, insurance, rates, etc. that won’t change no matter how many members we have. So we’re trying to grow revenue within the same fixed cost structure – rather than continually upgrading to bigger and ‘prettier’ facilities.

We’ve invested in equipment, layout, and a business structure that will provide our members with the same quality of service as our membership base grows. Leveraging automation with software is the trick here. We try to make the gym run as much like a machine as possible.

Nurture Organic Growth

We invest more resources into serving our current members than we do acquiring new ones.

Our members are our tribe. We try to create a space and community that our members want to introduce to their tribes.

This has taken us a while to develop. COVID threw a few spanners in the works. We had to cut services and reduce our cost base, which was detrimental to our members’ experience, and we paid the price for that.

Now that we’re back on track, we’re seeing many old members returning to us after testing different waters and bringing mates with them. Close to 50% of new members are now referred to us by current or previous members.

Don’t Scale Too Early

So what’s early. I think you’ve got to create a product or service that people love and find a viable business model to support it first.

I look at it like this. You can build a business by investing heavily in advertising and paid acquisition, or you can build your business by investing heavily in its product and business model.

You can focus on growth and hope that you’ve created something people want, or you can create something you know people want, then let the product or service do the hard work for you.

Unless you’re building your industry’s next unicorn platform, focusing on finding a scalable business model is a safer bet.

If you’re bootstrapping, then scaling is your only choice.

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