What do the most successful entrepreneurs have in common? People like Jeff Bezos and Mark Zuckerberg have demonstrated the ability to turn an idea into a large, publicly-traded company -- and keep that company growing. In my recent book, Startup Cities, I dub such exceptional CEOs Marathoners. Less accomplished, but still great, are another group of leaders -- Sprinters -- who turn an idea into a large company and then sell it.
Both types of leaders share the ability to scale -- meaning that they can match the features of their first product to the unmet needs of a large group of customers. And from there, these leaders can build a business with $100 million or more in revenue.
How do you know when it's time to scale? And why do startups fail to scale?For answers on May 31 I interviewed Harvard Business School's Tom Eisenmann who is its Howard H. Stevenson Professor of Business Administration.
When is it time to scale?
Eisenmann cited HBS professor Howard Stevenson's definition of entrepreneurship: "the pursuit of opportunity beyond the resources controlled." As Eisenmann explained, "You don't scale until you achieve product/market fit which makes it clear how you will create value for customers, employees, and investors. Once you've validated the business model, you attract the resources you need to scale."
Eisenmann proposed two creative ways to think about when it's time to scale and how a leader knows it's time to accelerate. As he said, "It's a super-saturated solution and when you're ready to scale, you drop the crystal in and you get a mass of crystals. To scale, you need to acquire, organize, coordinate and manage more resources. So many things can go wrong."
How does a leader know it's time to drop the crystal into the solution? He replied, "We use the RAWI [Ready, Able, Willing, and Impelled] test.
- Ready means product/market fit -- if you took the product away from customers would they come after you? Is there a core set of customers who will keep using it and refer other people to your company? Do you see clearly how you'll make money? If you scale, is your total addressable market large enough?"
- Able: What resources will you need? Which do you have? Which can you get? Can you coordinate them?
- Willing: Does the founder want to go fast, get rich, achieve the mission, take risks, make the necessary work/family tradeoffs?
- Impelled: Are the strategy and market structure favorable? Will the company benefit from network effects? Can the company lock in customers and keep the first mover advantage? Can the company grow without waking up the sleeping giant? Can the company maintain ongoing cultural excellence without placing limits on its growth?"
More often than not, startups fail to scale. Indeed, Eisenmann pointed out that former HBS professor, Noam Wasserman, calculated that 60% of founders do not make it to their company's Series D round of financing.
Here are four of Eisenmann's scaling failure modes.
1. Failure to grow efficiently outside the core market
If a startup has saturated demand among its first group of customers, it may choose to target a new customer group in order to sustain its growth.
But that presents a danger that the startup will spend more on marketing to bring in those new customers but the new customers won't recommend the company's product to friends and co-workers. More specifically, the lifetime value of the customer will drop while the cost of acquiring the customer goes up.
As its growth rate slows and it burns through more cash, it may not be able to raise more -- leading to the startup's demise
2. Failure to withstand retaliation from a large competitor
Another scaling failure mode is what Eisenmann calls "The Empire Strikes Back." As he explained, "When People Express was flying discount routes between Newark and Buffalo, it was under incumbents' radar. But when it started flying from LaGuardia to O'Hare, United started a price war."
This seems to have been a problem for Snapchat parent company, Snap, which suffered a growth slowdown when Facebook was able to replicate its Stories feature in six months.
3. Failure to deliver promised results -- and lying to cover it up
Silicon Valley is rife with the idea of faking it until you make it. Sometimes that faking steps over the line between what's legal and what's not.
Eisenmann refers to this as the "slippery slope" -- which denotes companies like Zenefits, Theranos, and DeLorean which skirted legal and ethical boundaries in an effort to overcome barriers to growth.
For a great example of slippery slope, you ought to read Bad Blood by John Carreyrou, the Wall Street Journal reporter who uncovered the lies and reality distortion field that enabled Theranos to raise some $900 million in capital to finance what is now a worthless company.
Taking the first step on the slippery slope always ends badly.
4. Failure to beat impossible odds
Another reason companies fail to scale is that they are betting on "cascading miracles" which have a low probability of actually falling into place as desired. As he said, "John Malone, CEO of TCI, was trying to introduce digital technology, and raise huge sums of capital, among other significant challenges. The probability of each of them might have been 80%, 90%, and 80% but if one of them went to zero, the entire thing would fail."
This is what happened to Better Place, the failed Israeli startup that depended on forming partnerships with automobile companies, getting a government subsidy, the price of oil remaining high, and consumers being willing to pay, explained Eisenmann.
If you can avoid these four scaling failure modes, your odds for startup success will improve.