The benefits of scale

(mellow music) - So we've picked our mountain, we've sized it up. We understand the base of competition, the terrain of how customers choose who they work with and we've figured out how we're going to build unique capabilities to serve our customers in a way that no other company can. That's what an aligned strategy is about. But it's really important to also understand the role that scale plays in being effective in a market. As it turns out, most of the profits, most of the value goes to market leaders, but it really depends on the role that scale has in defining winners and losers. So we're going to take a moment to understand how to think about scale. And as it turns out, there is a relationship in every market between how big you are and how effective you are. And we're going to draw that in a chart. So, I want you to imagine that the higher you are on this chart, the more effective your product is with your customers, the more successful your business can run. And as you go from left to right, that's the size of your business. And each market has a different relationship in these two factors. I'm going to start with a very small scale example, which is restaurants. If you want to open a restaurant you can be quite successful with one location, with a small footprint, and you can build a loyal following and a pretty good business. As you add more locations, there are some benefits, maybe people know you a little bit better but you don't get your rent less expensively. You still have to hire your team and your food might be a little bit better so you can learn. But buying large scale only plays a small role in who gets to win in the restaurant industry. And so, there's a very modest relationship between the role of scale and the way that companies succeed. Now, I'm going to compare that to a very different industry. Maybe the prime example of a scale business, which is semiconductors. Creating the chips that power all of the computing in the world is a huge challenge that companies face, and there are four companies that win in that market. You've got AMD, Intel, TSMC and Nvidia. Now, if you want to just start small as a semiconductor company, you can't even play in the game. And the reason is in order to be effective you need to build a fab. And the cost of a modern fab to make chips might be north of $10 billion. So, at the low end of scale you're basically creating no value. It isn't until you get really big that you can be effective. And maybe the semiconductor experts in the world can you know, know whether once you get bigger and bigger and bigger beyond that point, whether there are advantages. But it's an example where there is a very high barrier to entry and once you are at scale there's actually a big market to go after. I'll compare that to another example which is in marketplaces, and I'll use Uber. If Uber only had a few drivers in your city, then it actually wouldn't be that effective of a product. It might take a really long time for a car to arrive to pick you up which is a big part of the value proposition. The base of competition in ride sharing is how quickly someone comes and helps you get to where you want to go. So when they're starting small it's actually really hard to be effective as a product, but as the driver network gets bigger, the value grows until a point where it's actually not that much more helpful if there are more drivers beyond a certain point. And so you see the curve plateau. So each industry has a different dynamic in terms of the role of scale. But one of the things that's really important is you have to understand the curve that your business has in the market that you're going after. And then depending upon how important it is you need to figure out how you're going to operate to get scale effectively. And actually, there's a great book if you are interested in this topic, "Masters of Scale" by actually LinkedIn co-founder Reid Hoffman, is an excellent book to help understand how different companies thought about scaling. So I highly recommend. Also, by the way, "Quiet" by Susan Cain not related to strategy, but also a very good book. But understanding scale is really, really important to building the right strategy. So, where do scale advantages come from? There's actually three places that I want to talk about. The first is the idea of cost scale. If you're running a factory and you're making a product, the bigger your factory is the more volume you can put through it. You can probably negotiate better prices on the materials that you need to make your product. Perhaps you can run the factory more efficiently if it has more goods that you're putting through it, maybe you can buy the equipment that's more important to scaling up. And so, most businesses have this idea of a cost scale dynamic. Another example that might be a little bit further from factories is content. The reason that HBO can spend so much money to build "Game of Thrones" is because they have such a wide subscriber base to spread that cost over, they get to amortize that cost on a user basis that's actually much more modest. So one, understanding cost scale is really important. Another good example though of scale benefits is what I'll call innovation scale. The bigger you are, typically you can get more benefits from solving a problem. Tesla is a great example of this. The reason they're able to invest so much into making electric vehicles more effective is because they can spread it across a business so that every problem that they solve gives them more benefit to their customers. Now, not all problems benefit from spending more against them, but a lot do and understanding whether that's the case in your industry is really effective. And then finally, and perhaps the most popularized example of a scale benefit is network effects. Like Uber, there are lots of examples of businesses where the bigger you get, the more valuable your product becomes to people that use it. That happens in community products, that happens in marketplace products. And usually there's an inflection point where product really becomes valuable if you hit a certain scale. And then there might be a point at which beyond which it's actually not that much more helpful as we saw in the case of Uber and their curve. So, I want to make sure that as you think about the mountain that you're going to pursue that you understand the role that scale plays so that you can operate effectively and establish market leadership.