Why choosing “non-scalable business” over “scalable business” isn’t always a bad idea

Recently, I’ve e-mailed +1000 VCs and PEs about an opportunity to invest. More than 40% replied with, something equivalent to, “we believe in this company, but we focus solely on scalable software companies”.

Most investors are trying to bet on the next Google or Facebook, completely overlooking the fact that there can be only “so many” tech giants. The responses of all these VC-firms made me realise once again that we, as humans in 2020, might be focusing too much on the scalable and disregarding the non-scalable.

In this post, I will explain why we should be careful in always preferring scalable businesses (particularly, software) over non-scalable business. This post is also very personal; it shares my personal story and explains why my co-founders and I have decided to change the direction of our company.

Scalable vs. Non-scalable

Let us start by making a clear distinction between what is scalable and what is non-scalable. Because, being a popular buzzword, “scalable” is often misused to describe a company’s potential to grow in market share, revenue, profit etc. Similarly, the term “non-scalable” is often misused for companies that have exhausted their growth.

Nassim Nicholas Taleb makes a clear and simple distinction between the scalable and the non-scalable in the Black Swan. Let’s apply his distinction to the realm of business. It will help to make the rest of my story fall in place.

Scalable businesses are, for instance, in the domain of:

  • Software
  • Music
  • Books

With scalable businesses, output (revenue) is NOT directly related to input (resources). i.e. as an author, you can sell 10 or 10,000 books. Your input remains the same but your output (book sales) can differ enormously. Your output doesn’t face headwind in scalable business.

Non-scalable businesses are, for instance, in the domain of:

  • Consulting
  • Engineering
  • Hairdressing

With non-scalable businesses, output (revenue) is directly related to input (resources). i.e. as an engineer, you cannot sell your services beyond a certain point because you simply cannot be present at multiple clients at the same time. As your output (revenue) increases your input (cost, time) will increase as well. Your output is subject to gravity in non-scalable business. It does face headwind.

Land of the giants (and ants)

We see a vivid winner-takes-all effect in the scalable business domain. A handful of winners take the majority share and the rest is shared by a lot – as in thousands – of losers. To illustrate how extreme this ‘power rule’ is, consider the following stats:

Almost 70% of global digital ad spending goes to Facebook, Google & Amazon. The remaining 30% is shared by the other 500.000 companies/media outlets offering digital ads.

and

Roughly 2 Million books get published globally each year. Of which barely 2% sells more than 5,000 copies. Within this 2%, the numbers get even more skewed; just consider that J.K. Rowling has sold more than 500 million copies worldwide and her books are still among the 10 most sold books year-to-year.

So, to wrap up; convincing your investors that your business will be extremely profitable when it captures just 1% of X multi-billion market is always a bad idea. There are no equal divisions in the scalable business domain. Frankly, stating that you need just 1% of X market is a huge red flag for investors (it should be, if they know what they are doing). Find your niche. You’d rather be the king of a village than the mayor of a city.

Blinded by scalability

Over-romanticizing scalability comes at huge costs. Especially, when you are an investor trying to invest in great companies. Let me illustrate my point by comparing 2 cases: eyevestor and SEKK. Both clients of my company fundmeup (we fill investment funnels).

Eyevestor: a B2B software platform making it easy to digitise, sell and trade shares in private companies.

In the beginning of January, we have successfully filled eyevestor’s investment funnel (€250.000) within one week.

SEKK: A webshop and offline store delivering fresh products from farmers straight to consumers.

We have been working to fill SEKK’s investment funnel (€500.000) for more than 3 months.

I am not implying that one investment opportunity is more interesting than the other. I think both eyevestor and SEKK are great opportunities; we work on skin-in-the-game agreements with both companies. But, I find it rather remarkable that we had informal investors rushing into the eyevestor investment round while, in the meantime, for SEKK we are negotiating for months.

Especially if you consider that SEKK makes +€80.000 monthly revenue, has a Customer Acquisition Cost (CAC) of €20, a customer Life Time Value (LTV) of €913 and is growing at an insane pace. A no-brainer if you ask me (don’t worry this is not “shilling” I have also invested in SEKK myself).

That being said, It might be time to shed some light on our decision to not opt for the scalable model in the domain of finance.

When we decided NOT to opt for the “scalable model”

A lot is happening in corporate finance in recent years. On a global scale, we are removing boundaries, democratizing access to investment opportunities and making finance, in general, more convenient for everyone.

Especially, in the domain of community-driven finance a lot is happening. Crowdfunding has grown by double digits each year since its introduction earlier this century. The crypto-era (2017–2018) has shown the strength of large communities and the involvement of retail investors leading to 10$ billion and 11.4$ billion funded each year, respectively.

At fundmeup, we find these trends super interesting because we see how they can help entrepreneurs to finance their dreams while engaging their companies’ communities. Initially, we thought we would build a platform that unlocks these values for entrepreneurs. We were convinced the only way our company could build substantial success was by “being scalable” or by “being molded into software”.

In retrospect, these attempts were more driven by the “scalable narrative” than by grounded arguments. We explored various routes and made different plans on how to build the most prominent platform for community-driven finance.

But why? Why would we try to naively jump in the ultra-scalable domain of software platforms and assume we will turn out to be the winner?

There are currently more than 70 platforms for community-driven finance in the Netherlands alone. Eventually, only 3 of them are going to be successful. In fact, following the power rules of software, only a handful globally are going to be SUPER successful, while the rest will share the crumbles.

Driven by my father’s only advice “where the action isn’t, that’s where the action is” I aligned with my co-founders who also felt a dislike for the long and tough battle ahead to become the most prominent platform. We opted to go for a traditional fundraise-service model instead.

This move enabled us to be versatile in servicing our clients and to focus on our core competence; marketing for fundraising.

In this model we are ‘platform-agnostic’, which means we can work with any company and any platform. Instead of fighting the other platforms in order to become the most dominant solution we are now helping ALL platforms (not discriminating) directly and indirectly. Directly by making sure their clients fill their funnels quickly and indirectly by generating new platform users through our services.

When everybody is looking for gold, sell a shovel.

I cannot tell you what the best time is to opt for a scalable business model (I guess no one can). But, I can tell you what is NOT the best time. Because I see this happening everywhere. When multiple e-commerce cowboys are having a rat-race in a new market, you’ll probably be better off providing logistics fulfillment services instead of joining in the gold-rush. When too many players are pushing digital marketing tools, you might better sell digital marketing training. etc etc..

You know who was the big winner when the national alcohol prohibition in the United States ended in 1933? It wasn’t Bacardi or Captain Morgan. It was the producer of corks. Of corks… Everybody went looking for gold and the cork-producer sold very good shovels.

However, make sure you keep some exposure to the scalable while adding your “non-scalable value”. While running the agency model, we are flirting with the scalable by trying to validate scalable business models in an approach similar to throwing random darts at the dart-board. I don’t know when we will hit the center (and if we ever will), but I am sure to let you know when we do.

In the meantime, we are happily delivering real value to our customers in our own calm ocean.

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