Pros and Cons of Scalable Business Models

Scalable business models are the latest buzzword in entrepreneurial circles all across the world. Most new-age founders aspire to make their businesses more scalable. However, scalability has to be built into a business before it actually exists. It is for this reason, that the decision to scale or not becomes strategic and something that founders must work towards in the early stages of the business. In order to make a correct decision, entrepreneurs have to be aware of the various pros and cons that scalability has to offer.

This article will provide a detailed explanation of the pros and cons of scalable business models.

Why Do Investors Prefer Scalable Business Models?

Investors’ preference for scalable business models is well known across the globe. However, this preference is not without any reason. A scalable business model provides investors with some very specific advantages. Some of these advantages have been mentioned below:

  • Larger Investments are Possible: Venture capital and angel investors are very concerned about their ability to make the best possible use of a successful business model in a short period of time. The venture capital business model is based on making many investments, only a few of which, turn out to be successful. Venture capitalists face a lot of failures. However, when they do find a winning investment, they want to make the most of it since it is expected to make up for all the losses from the failures as well.

    A scalable business model allows investors to pump in large amounts of capital within a short span of time after they have validated the workings of the model. Venture capital funds are time-bound. Hence, if they have a five-year horizon and if it takes them two years to find a winner, they would want to deploy as much money in the project as possible so that they are in a position to exit the investment at a high valuation when the fund is about to mature.

  • Shorter Payback Period: Scalable business models are generally asset-light. This means that they do not have a very high payback period. Hence, investors can not only deploy their capital faster in such businesses but they can also recover it very quickly.

    This shorter payback period means that the investors, as well as the founders, are likely to have more cash available at the end of the investment cycle which will allow them to scale the business even more. Scalable business models have a self-perpetuating cycle which allows them to reach even more scale till the market has been saturated.

  • Capturing Market Share: A scalable business model allows investors and founders to quickly take their product offerings to a large number of people within a short span of time. This can be very advantageous to any investor. This is because the scalability of the business does not allow the competitors any time to respond.

    Hence, as soon as a business model has been validated, investors and founders can start capturing market share. This gives the start-up company a high brand recall. This first-mover advantage is crucial to the success of the business in the later stages.

  • Resilience: Another huge advantage of having a scalable business model is the fact that it makes the business resilient. Scalability allows the business model to increase or decrease the number of users within a short period of time. Hence, such business models have a higher degree of cost control compared to usual businesses. This cost control makes these businesses more equipped to deal with a period of recession in the external market.

Disadvantages of Scalable Business Models

Scalable business models also tend to have some important disadvantages. Most founders decide to overlook the disadvantages since the model provides many benefits. However, it is important to know the details of the disadvantages before making the final decision.

  • Drop in Quality: It is important to note that when businesses scale up at a very high pace, consumer quality ends up suffering. This is equally true for online businesses. Customers have frequently mentioned a marked reduction in the quality of their customer experience when a company is trying to scale up too quickly.

  • Low Barriers to Entry: It is also important to note that if a business is scalable, it means that there are low barriers to entry in place. This can be considered to be a competitive disadvantage to any large business.

    Industries, where scalable business models are prevalent, are prone to increased competition which often leads to price wars and finally leads to decreased profitability in the long run.

  • Structural Design: Another important point to be noted is that scalability has to be built from the roots of the business. It is a permanent feature of the business since it cannot be changed midway. A lot of times investors do not have the experience or knowledge to structure their business in the best possible way when it comes to building scalable business models.

  • Obsession With Scaling: Even though scalability is inherently a good thing, it can quickly turn into an obsession whereby the entire business ends up being focused on scalability. Scalability should be the result of a successful business model. It should not be the reason behind the existence of the business.

The bottom line is that scalability is a very important characteristic in modern business. Even though it does have some disadvantages, the advantages offered are vastly greater. As a result, scalability is preferred by a lot of investor groups.

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