Startup businesses ought to grow in size and complexity. The expression of the business founders’ passion to meet a need in the marketplace, it should in theory grow as big as possible to meet that need. Unfortunately, for most startups scaling up often leads to failure and is a leading cause of startups not succeeding within the first 10 years.
Why do startups fail when they want to scale up? Is there something they fail to understand or miss noticing about the way they scale up? I think the best way to understand this is to examine it from the standpoint of the Value Chain.
The Value Chain is the sum total of the activities performed by a business in order to deliver a valuable product/service to the customer. The Value Chain is about creating value for the customer and the business. When the Value Chain is efficient and effective, it confers to the business a competitive advantage when there is a good fit between what is created and what the customer wants.
When there isn’t a good fit, that may be because the focus of the business is not on the customer, and the customer is not really wanting the product/service that is being created. If at that point the business starts to scale, the scaling up is premature and therefore will fail. What is needed is for the business to have a dialogue with the customer to explore what a good fit is.
Next we consider the Value Chain. Assuming that there is a reasonable fit between the value created and the customer, the business would be profitable if it is well optimized and efficient. If it is not, the profit margin would be thin, and the business barely breaks even. The profits do not quite cover costs adequately as one would wish.
One would have thought that this is not ideal for scaling unless there are economies of scale. But I have seen entrepreneurs scale up at this point, perhaps under the assumption that increased sales will cover cost. However while profits do increase, so also do costs unless the Value Chain is optimized to achieve cost reduction. The scaling is thus premature unless there is an analysis of the Value Chain to determine that it is profitable, and the strategic direction is aligned with the business environment.
The Value Chain is a concept developed by the strategist Michael Porter, to explain competitive advantage. It is composed of the following: inbound logistics, operations, outbound logistics, marketing and sales, after-sale services. The idea of the Value Chain is to add value so that it results in higher prices and/or lower costs and therefore greater profitability.
The activities described above are known as the Primary Activities of the Value Chain. These are value drivers as they add value to products/service. To enable the primary activities to be performed seamlessly, you need
Support Activities which would include procurement, technology, human
resource and infrastructure. These are the cost drivers. Support activities especially with regard to technology (think machines to produce your
products/services), staff strength and infrastructure including physical spaces can be implemented at different levels. If possible, such support activities should be outsourced largely because of the high cost structure nowadays. The business must be operating at or near full capacity before you consider the need to scale up. That is to say that you are bursting at the seams and you really need to increase your capacity.
Yet I have again seen entrepreneurs scale up prematurely by increasing their support activities such as staff recruitment, office space etc in anticipation of increased demand that is forthcoming. In doing so you are burning your dollars fast. The anticipated inflow of sales may not be forthcoming, and you will most likely crash. Use support activities like painkillers to relieve pain, not like vitamins to prevent future problems.
I have mentioned a few times that scaling up is sometimes premature. I have observed that often this is due to pressure from investor(s) inpatient to see results. Entrepreneurs are then forced to show the investors that something is actually happening by doing what is more visible. While scaling up is the right thing to do, the wrong timing can lead to extravagant waste that a business can ill afford.
Next if your margins are thin, perhaps you should examine your value chain processes to see whether there is waste and redundancy. Try to achieve a lean operation for that will improve your margin significantly. Do a Value Chain Analysis to see where inefficiency lies and optimize it and
achieve a seamless operational efficiency with less idle time between processes.
This is particularly important if scaling up is achieve by means of digital transformation. Sure digitalization can lead to significant cost reduction and increased revenue. But if this is implemented without paying attention to operational processes, it can be piecemeal and uncoordinated and the implementation in different departments or subunits may be in strategic misalignment with each other.
Rather if digitalization is pursued as a means of scaling up without any prior value chain analysis sometimes what happened is that the business may ended up with 2 systems running side by side, the old and the new in parallel, thereby increasing cost.
Scaling up and digitalization are both change processes that requirement management. A lack of leadership directions and organizational silos are the kind of issues that will sabotage your attempts at negotiating the change. You need to ensure that your organization is internally aligned with
regard to strategic direction and in turn the organization must be aligned externally to the realities of the competitive landscape of your business.
So scaling up especially when you are taking the digital transformation route requires both planning and engagement with all stakeholders to ensure that what you are embarking on will be reasonably successful. For that you need to look at the following that will impact the outcome.
1) There is a need to build systems. Most entrepreneurs started off as an one-man-operated(OMO) concern. Thee owner is procurer, involved in the operational processes, marketing and after-sales service all at once. As you develop, you need to delegate and to create specialized functions that are well co-ordinated, staffed by different people who are specialists in what they do. When you have an organization that is organized on systemic
lines and functioning seamlessly, scaling up is also relatively painless.
2) Leadership is needed to change, and we had said that scaling up is change. As the leader, you need to keep your focus on your strategic direction. As you decide on different change options, your strategic direction will inform you as to how and what to choose. And as your
organization grows, and different people tend to pull it in different directions, you have to rein in these impulses and direct the energies of everyone to work together to achieve the goals and targets set by your strategic direction. Leadership is simply engaging the stakeholders so that all would work together to achieve common goals.
3) Review your marketing strategy to ensure a good product/customer fit. Remember such a fit changes with time so it is an ongoing process. Engage your customers and allow them to shape your decisions. This partnership with customers will ensure your business stay relevant.
Lastly, keep an eye on the financials. These undergird and support your entire value chain. Talk with your accountant to ensure that you track the right indices to make sure that your costs are kept under control, and that your prices your customers pay will give you a return on your investments.
That will keep you and investors happy in the long run.
Most importantly, do not neglect to do a strategic analysis of your Value Chain. Tools such as SWOT, 5 Forces, PESTEL at the very least should be employed to flesh out your priorities and strategic direction. This would ensure your digitalization is on target and does not fall flat, especially since
digitalization involves the investment of substantial funds. Your return on invested capital (ROIC) must be something you put a priority on.