SCALE and the Principle of "A Basket with Holes": What needs to be prepared for a startup to scale?
When having discussions with founders of early-stage startups, I asked them about the reason for fundraising, and lots of them answered that they would like to scale up their businesses right after fundraising. When I was a newcomer to the Venture Capital world, to be honest, I was obsessed with this reason. Scaling is a thing that not only founders but also investors would love to see because it shows the great possibility of growth for startups. But the truth is not all startups are ready for scaling. Rushing to raise capital and rushing to scale can cause startups to die young. According to a report by Startup Genome, which surveyed more than 3200 global startups, showed that over 70% of startups fail due to Premature Scaling-also is known as Scale when "not yet ripe enough". In this blog, I would like to share my perspective as a VC, who invests in early-stage startups, about Scale and the risks of premature scaling with the principle of "a basket with holes", and what startups need to prepare to be ready for Scale.
What is the real definition of Scale?
Scaling is a concept commonly understood as the activity of expanding the business, increasing the number of users, in order to increase revenue, when there is the addition of necessary resources such as finance, people, technology. However, the concept of Scale is sometimes misunderstood or only understood one part of its nature that is focused on growth, but without really focusing on the effectiveness of the cost of resources in exchange for growth.
In fact, the ideal way to define the concept of Scale is that revenue increases due to business expansion, without adding too many resources. It is ideal because it has a certain degree of difficulty and complexity that depends a lot on each type of business. For example, with an asset-light SaaS model like Zoom, when serving 1 customer, with 1000 customers, with 1 million, or 10 million customers, Zoom doesn't have to proportionally increase its resources. On the other hand, with asset-heavy e-Commerce models like Amazon or Tiki who owns warehouses, to sell more products, they need to work with more suppliers, and need to prepare more capacity for storage and operational costs,... Each business model has its own difficulties on management and operation that combines many different internal and external resources, so in order to scale-up effectively, startups need to optimize their operations by standardizing and automation, thereby saving resources effectively while ensuring revenue continuously increases.
Principle: A Basket with Holes
"A Basket with Holes" is a metaphor for a startup to scale when it is not yet mature enough. It shows that the startup can not keep customers staying to use and pay for products or services. In this case, there are customers but they just come and go, a very wasteful way.
It is not difficult for us to find a lot of startups in Vietnam, easily fall into the trap of "A Basket with Holes", when are busy chasing top-line revenue growth, paying fees to get more users, without really focusing on core values of the product development for more sustainable growth.
Here are some common examples of startups that fall into this trap:
1/ Startups pay a lot of money to run ads to get more customers to use their products or rush to mass media campaigns, while product development is not good enough, in accordance with the needs and expectations of the target users. This will lead to, the startup gets a large number of users "flowing in" the first time, but they like customers, who come to your restaurant, then find out the food and service is not good enough, they will leave and never come back for a second time. It is a fact that running ads is very "addictive" in nature, once too rely on it, startups will always have to use this channel to continue acquiring users, and to continue gaining revenue from those "one-time users".
2/ The startup lacks focus, falls into the mass expansion of new product lines to increase new revenue streams. A familiar saying in Vietnam that, "One job is nice and nine is bad" is quite true in this case. While a product is not "ripe" - mature enough, the expansion of new product lines and all of them are not ripe enough, making it impossible to exploit all the profits from each product. This leaves startups pushed into the trap of "always creating new things", chasing new users, and of course, they will be "one-time" users who come and leave forever. This trap will create the mistaken idea that the startup is growing, as there are many new products launched, but each product does not have enough depth, maturity, and good enough to sustain customers and Increase profit per customer.
3/ The startup doesn't have the optimization and operating standards needed for user growth. This greatly affects the customer experience and satisfaction. When the startup expands customers, from serving 100 customers at a time, to serving 100,000 customers at the same time, it requires the startup to have the prior preparation of the operating team and the operating process. Standardization and optimization are needed to ensure a consistent and good customer experience. Otherwise, it will cause a "break" in the customer experience. When customers are not satisfied with your products or services, meaning startups will not see them coming back for a second time. Worst of all, startups have spent a lot of effort and cost to get a large number of users but do not get enough profit to make up for that cost, it causes even more losses and even further from profitability.
What needs to be prepared for a startup to scale?
Based on the true definition of Scale, to avoid falling into the above-mentioned trap of " A Basket of Holes", we can find a formula to figure out how Start-up can be prepared for Scale-up, as shown below :
Scale-up= Product Market Fit + Profitable Growth Model + Scalable Operation
That means startups need to verify products that are suitable for the market (Product Market Fit: PMF), need to find a growth model that can generate sustainable profits and create a scalable operating process.
PMF products are:
when customers come to you in the most organic way, not dependent much on paid advertising channels.
when interested customers register to use your services or products, with a high sign-up rate.
when a customer pays for your service with a high conversion rate, from a free trial to a paid real one.
when customers return to use with a high retention rate, and use your product regularly with the number of users by day (Daily Active User), by week (Weekly Active User)and by month (Monthly Active User) ),...are big. Along with that, when there is a low Churn rate - customers leave out of products.
when a customer wants to recommend your product to their friends and family with a high Net Promoter Score (NPS) survey score.
The highs and lows of the above indicators will indicate the Strength-Weakness of the PMF. Different products, in different markets, with different business models will have different reference indicators. However, the mutual mission of startups is to listen to the voice of users, to make continuous adjustments and improvements, so that the products can achieve the above indicators as best as possible.
When the founders can make users become the "Co-founder" of their startups, they are the ones who actually use, directly give feedback, and make suggestions on the products to meet their real needs. When products most closely reflect the voice and needs of customers, products will get closer to PMF.
After achieving PMF, startups will need to find an efficient growth model that generates profits increasing along with the number of users. In this case, the Unit Economic will be carefully calculated to make the Customer Acquisition Cost (CAC) low, and create a profit per customer in the product's cycle (Life Time Value: LTV) is high enough, to get Unit Economic positive, delivering sustainable profits for startups. As mentioned in the PMF section above, products need to be reached to customers in the most organic way without relying too much on expensive advertising channels to maintain CAC low. For example, diversifying channels to reach customers, by building a community of target users, building user-oriented content, or strengthening SEO search, ... On the other hand, to create incremental LTV, startups need to convince users to stay longer with products, encourage them to use and then pay more by up-selling and cross-selling.
Ultimately, startups need to build teams and processes ready for expansion. At this stage, startups will recruit more people. The risky thing here is, given the pressure to scale quickly, startups tend to be rush to hire lots of people, and lots of them are not really the right fit for the company. Moreover, startups tend not to have enough time to train new employees. Also, startups will not be able to standardize the process to ensure the quality of products and services consistent and good enough, when opening the door to welcome many customers at the same time. Therefore, startups need to have the best preparation of the above to be more ready to scale the businesses.
Start-up wants to scale-up. And VCs - venture capitalists like us, always support startups that want to scale, need to call for capital to scale. Hopefully, through this blog, it would be great to kindly remind startups that before scaling, startups need to prepare the necessary things to be able to achieve successful scaling. At Genesia Ventures, we also stand side by side with our founders on the journey of preparation those things for scales, such as supporting startups to build scalable teams, finding strategic partners to develop PMF products and customer base,... We acknowledge that startup is a long and nonstop journey, to be able to achieve scale, to move towards sustainable growth, to bring the most value to its customers on the larger scale. Therefore, it is required that founders and teams need to carefully prepare the most necessary things for the above, and it is also very necessary to have patient and supportive investors walk alongside them together heading to scale.