How Businesses Grow
Scaling Strategy by The Family
By Nicolas Colin (Co-Founder & Director) | The Family
This article is part of a The Family series exploring business strategy in the 21st century. Sign up for my weekly newsletter to make sure you’re up-to-date on how businesses thrive in the Digital Age.
To better understand the rules of business strategy in the digital world, it is useful to realize what it took to scale up a company in the past. In the 20th century, launching a new venture required both creating a product and making it known to prospective investors, employees, and customers. New ventures had to take many risks at the same time: R&D, marketing, distribution.
In practice, fortunately, public spending (in academic research or via research tax credits) covered the cost of some research and enabled technology companies to get to the development phase faster, thus offsetting a substantial part of the early stage technological risk. It reduced the need for seed capital, which often came from an individual investor or from an existing company’s free cash flow. Just look at how Joe MacMillan, in Halt & Catch Fire, hacks Cardiff Electric to get hold of its cash flow and create a portable computer.
At the next stage, the weight of R&D reduced to zero, and all risk was now on another front: marketing and distribution. That was because the product had to be completely designed and developed before it ever reached the market (as seen when MacMillan strikes a deal with a retail store chain only after the product is ready). Therefore the stake was finding a market for the product. In the traditional economy, private investors were reassured by a product they could see (for instance at the COMDEX computer exhibition) and a market study that somehow concluded that it would be a success. Based on that kind of reassurance, they could agree to allocate capital to finance marketing and distribution.
If the initial marketing and distribution efforts were successful, the company finally reached product/market fit… and a new challenge: growing into a dominant position. This was usually the time to do an IPO (remember, in the traditional economy, companies had their IPO quite early in their history). The company then went through different phases, attracting different kinds of investors: first, those who made money with capital gains on growth stocks; then the ones who demanded dividends from income stocks. It finally reached a dominant market position.
Once a 20th-century company was dominant, its scale was large enough to keep competition at a distance. Broadcast advertising, preferably through mass media, made it possible to keep the customers under control. Moreover, the company could use its operations and influence to raise a barrier to entry that alleviated competitive pressure and delayed any need to implement radical innovation. This is how it kept R&D at a low level: by not letting the market reach the stage where high technology research would be the only way to survive.
R&D might have been on the rise at that point, but it was still below the 50% threshold: all the company needed was to implement efficiency innovation (thus liberating capital and making more money for its shareholders) or sustaining innovation (shipping slightly improved products that helped keep competitors at a distance). At this point, the only danger was a competitor willing to bear a higher level of technological risk and break down the barrier to entry with a radically innovative product, such as was seen with Japanese car manufacturers entering the American markets in the 1970s.
At every point in this (somewhat simplistic) history, few outside investors were willing to cover a high (relative) level of R&D: the first stage was partially financed by the state; the intermediate stages were marked by a much higher level of risk on the marketing & distribution front; at the latest stage, efficiency and sustainment (both moderately difficult technological challenges) were financed by free cash-flow.
Many executives and consultants have been trained in that 20th-century framework for scaling a business. The reason for the traditional companies’ unprecedented weakness in a more digital economy is that many things in that framework are in fact obsolete:
- technology is so abundant and cheap that research and development at the earliest stages matters even less than before;
- it has become so easy to show customers a minimum viable product that product/market fit now comes much earlier in a company’s history;
- once a company reaches a dominant position, increasing returns become so powerful that marketing and distribution are not that big of a risk;
- at the later stages, barriers to entry are lower on digital markets, hence dominant tech companies have to keep on innovating instead of living off their rent.
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