Repeatable and scalable: the two keys to convincing an investor

We have heard this question a thousand times: what is it that convinces investors to place their money in one business or another? In other words, what do entrepreneurs need to work hard on in order to convince investors?

In fact, the answer is quite simple. There are two fundamental factors in any decision taken by an investor: repeatability and scalability. Business models which offer both are very likely to find favour with investors.

A business model is said to be repeatable when it is able to generate recurring sales effortlessly.
A business model is said to be scalable when it can increase sales and profits without incurring a proportionate increase in costs.

But we mustn’t go too fast. Let’s look at an example of this.

I want to set up a business which, let’s say, sells customised computers. This would involve both a product and a service, because although I do sell the computers, I do so after speaking to my customers and offering them the computer configurations which best meet their needs. That is the business which I want to set up, and I’m going to design a first business model to see how profitable it is (and also how interesting it is for potential investors).

FIRST VERSION OF THE BUSINESS MODEL
At first, I had thought that the process could be the following:
1- I would have a door-to-door sales team who would talk to potential customers, aiming to sit down with them to discuss their computing requirements. Based on those discussions, I would then devise the best possible computer configuration for each of them.
2- Orders received by the sales team would be sent to our factory.
3- The factory would receive an order, find or order the necessary parts, assemble them, and then send the product to the home-delivery department.
4- The home-delivery department would receive the computer and send it to the customer.
5- The accounts department would be responsible for issuing the invoice and collecting payment from the customer.

It was as simple as that ‒ and that was my business model. But wait a moment … imagine that you are a potential investor who is considering investing money in this future business…does it look like repeatable business?

No, it doesn’t, because it wouldn’t be. Why? Because every time I wanted to make a sale I would have to make the same effort again: the salesperson would have to try to contact the potential customer, make one or more appointments, prepare the order, send it to the factory, where it would have to be assembled, dispatched, invoiced …and the whole process would be repeated every time a sale was made. This requires so much effort that people call it a “heroic sale”. No-one in their right mind is going to invest a single penny in an enterprise with such unrepeatable business. I shall have to reconsider my model.

SECOND VERSION OF THE MODEL
I’m going to try to change the model to make the business more repeatable. I shall replace the sales team with a website through which people will be able to buy the computers.
The process would be as follows:
1- In the website there would be a form containing questions for potential customers, whose answers would ultimately lead them to order the product.
2- The order would automatically be sent to the factory.
3- The factory would receive an order, find or order the necessary parts, assemble them, and then send the product to the home-delivery department.
4- The home-delivery department would receive the computer and send it to the customer.
5- The accounts department would be responsible for issuing the invoice and collecting payment from the customer.

As a result of this simple change I wouldn’t need to make such an effort to sell a computer. I could divert my efforts to publicising my website so that potential customers consulted it and then used it to prepare their orders. They could do that once, or they could do it a thousand times, but for me the amount of work would be the same, and I would not need to make any additional effort to get the number of orders that I want. My business model is now much more repeatable than it was. And through making only one change!

But let’s put ourselves once again in the investor’s shoes. Do you think that now, with business that is more repeatable, the probability of success has increased? Without doubt, it has increased. But we are still far from a high probability of receiving an investor’s support. Why? Because this business model, even in its repeatable version, is not scalable. What does that mean? It means that although each time my sales increase I don’t need to multiply my efforts (because the sales are repeatable), my costs do increase ‒ almost in proportion to the increase in sales. Why is this? It is because every time a computer is sold, every time an ordered is processed, there is additional work in the factory. So if I sell 10 computers per week, a single factory with 10 employees may be sufficient, but if sales increase to the point where I sell 100 computers, that single factory with its 10 employees will not be sufficient, and I will have to open additional factories or enlarge the one that I have (which will necessitate a big investment). I will also have to employ more people, and this will increase my variable costs, my cost per product. So sooner or later I shall be faced with the dilemma of wanting to grow, but not too much, of wanting to sell more, but not much more ‒ I wouldn’t want things to get out of control. With more sales, more cost, almost in the same proportion… there’s no prospect of business there! And investors know that. My model is not scalable…yet.

THIRD VERSION OF THE MODEL
I’m going to make one more change, to try to make the business more scalable. The change will be a simple one: instead of proposing many options in customisation (I had originally thought of offering 50 different configuration options), I’m now going to reduce them to 20. What will I achieve by so doing? Have a look at the process.
1- In the website there will be a simplified form which, instead of offering 50 options, will only offer 20, from which customers will choose theirs and issue their orders.
2- The order will automatically be sent to the factory.
3- The factory will receive the order, but now, as there are far fewer combinations, the resulting pre-prepared computer models (or at least the most common of the 20 possible combinations)can be held in readiness, to streamline the process. The work at the factory will usually be confined to packing the consignment and passing it to the delivery department.
4- The delivery department will receive the computer and will send it to the customer. It goes without saying that this delivery will be effected in a shorter time, as the time for assembly will have been reduced.
5- The accounts department will be responsible for issuing the invoice and collecting payment from the customer.

Now, my model is for business that is scalable. If sales increase, the amount of work to be done in the factory will not increase in the same proportion, nor will the costs. If, instead of selling 10 computers per week, I start selling 100, there will not be a 1000% increase in work and costs ‒ there will not even be a tenfold increase.

SO WHERE’S THE CATCH?
An important detail will certainly have been noticed. In the process of making our business more repeatable and more scalable, we have lost something. First, we have lost that direct, human contact with our customers, that opportunity to sell an advisory service and to make our expert knowledge available to them. Replacing a team of salespeople with a website put paid to that. And secondly, we have lost in terms of the level of customisation. Instead of 50 different combinations, we are now offering only 20. The change, which was made to streamline and ease the assembly processes, also put paid to that. So it seems that, by making these changes, we have lost what seemed to be our hallmark: customisation and advice. That is true. Sometimes, in order to make a business more profitable, we have to relinquish some of that business’s characteristics. But don’t forget that it is also true that the initial business model, which was so genuine and so firmly based on customisation and advice, was not viable, repeatable or scalable, so, in the end, it was not attractive for investors, without whom there would be no business of any kind.

We should therefore never forget to test our business model to see how repeatable and scalable it is. You now know that the more your business has these two characteristics, the more chance it will have of being successful, and the greater will be the probability of attracting the attention of investors.

[salto]

Marc Ambit – Consultant and teacher at TBS Barcelona Campus

Tags: business model|entrepreneurship|startup