Scale as Competitive Advantage: When Scale is your ultimate weapon, and How to use it

Note: Republishing this post I shared on the Medium paid subscription a few years ago. This was originally written in August 2015.

Scale As Competitive Advantage

In some industries, scale is a distinct advantage and a clear competitive advantage. In others, scale creates unnecessary overhead and fragility that leads to larger companies being continually beaten by smaller competitors.

Company size and industry structure determine scale strategy

To understand the impact of scale, look at the dynamics of your industry. If the largest companies enjoy the best margins and profits and continue to grow, massive scale is a competitive advantage. We’ll take a look at some examples in the retail and manufacturing space.

For highly fragmented industries like Home Services, the little company wins every time. In that case, being small and staying that way is a sustainable competitive advantage.

Wal-Mart: Scale as Purchasing Power

Sam Walton is one of the masters of scale. He’s simply the greatest retailer of all time, and his book, Made in America is the story of him building one solitary grocery store in Bentonville, Arkansas into a worldwide retail empire.

The book is the story of the scaling process — he talks about the role of technology and the foundations he laid for growth. There are great passages about the organizational structure that allowed for quick and effective growth:

The bigger we get as a company, the more important it becomes for us to shift responsibility and authority toward the front lines, toward that department manager who is stocking the shelves and talking to the customer.

They keep focused on the details that formed their foundation:

The bigger Wal-Mart gets, the more essential it is that we think small. Because that’s exactly how we have become a huge corporation — by not acting like one.

Actually, that’s not the only way they became a large corporation. One of the most brilliant aspects of Wal-Mart’s early strategy was to grow by expanding into small midwestern markets. They didn’t go to the large city markets where K-Mart and the other retailer were competing fiercely with each other.

Instead, they pursued scale by choosing fights they knew they could win. Wal-mart opened in small towns with no competition, and easily built up scale. They understood that scale is a competitive advantage in the retail sector. As they became larger, they got better prices through bulk discounts with vendors, and could offer deeper discounts with larger margins.

This scale advantage kept them in the lead as they took on competitors in larger markets, and it’s kept them in the lead as the largest retailer in the world.

Intel: Economies of Scale in Production

Andy Grove, President and CEO of Intel, came to understand this well as the computing transitioned into a horizontal, commoditized industry. He writes about this in his book about inflection points (crises) in business, called Only the Paranoid Survive:

The fundamental implication of this model was — and is — that the player with the largest share of a horizontal layer is the one who wins. As this realization sunk in at intel, it reinforced our belief in the significance of compatibility with all of the rest of the horizontal layers and provided further encouragement for our drive toward high volume and low cost in our microprocessor business: toward improving our scale and scope.

This is one of the most basic concepts of economics: Economies of Scale. The more you produce of something, the better you get at producing it — efficiency increases and costs decrease as production volume goes up.

Swiped from a dude named Ken Szulczyk via Google Images

That means that the largest company in this type of industry will have the best competitive advantage — the lowest costs and best production system.

Operating in these industries as the little guy is not likely to be fun. The best chance of survival is to create a new value proposition other than cost (very hard in a commoditized market), offer incredible differentiated service, or find niche application and cater specifically to that demographic.

Small Scale as Competitive Advantage

Spending the past few years working in the world of Home Service businesses at Zaarly, I’ve come to appreciate that this industry has Diseconomies of Scale.

This big long paper has the research and details, but you can get the idea just from the abstract:

Industries specializing in repair services frequently display significant negative correlations between price and quality. Further, possible signaling mechanisms, such as the size of a firm’s Yellow Pages advertisement, or a firm’s status as a member of a nationwide chain, do not function as indicators of higher quality in this data set.

The larger these companies get, the worse the cost structure (overhead for offices, advertising, support staff.) Typically, that means higher prices and worse service for customers.

Businesses that are just one or two guys and a truck will under-charge and outperform bigger companies every time. In these industries, the way to win is to stay small, and keep costs low and service high.

Zero Scale as Competitive Advantage

Being a certain size (tiny) may preclude you from certain strategies — and that can be a good thing. Acknowleding your current scale enables you to craft a strategy around your advantages. It forces you to play to your strengths, working within the constraints that you have.

Do Things That Don’t Scale

This lesson comes from the most commonly-cited essay on Scale in the startup world, written by Paul Graham: Do Things That Don’t Scale. It was suggested by Roger L. Cauvin, Preet Anand, and Aaron Wolfson.

For those building something from nothing, PG’s words are gospel:

A[nother] reason founders don’t focus enough on individual customers is that they worry it won’t scale. But when founders of larval startups worry about this, I point out that in their current state they have nothing to lose. Maybe if they go out of their way to make existing users super happy, they’ll one day have too many to do so much for.

That would be a great problem to have.

See if you can make it happen.

And incidentally, when it does, you’ll find that delighting customers scales better than you expected. Partly because you can usually find ways to make anything scale more than you would have predicted, and partly because delighting customers will by then have permeated your culture.

I have never once seen a startup lured down a blind alley by trying too hard to make their initial users happy.

The odds of long-term success for new companies is so small, that it makes no sense to optimize for anything other than survival. That usually means doing something unscalable, manual, and uncommon.

The need to do something unscalably laborious to get started is so nearly universal that it might be a good idea to stop thinking of startup ideas as scalars. Instead we should try thinking of them as pairs of what you’re going to build, plus the unscalable thing(s) you’re going to do initially to get the company going.

When you have no scale, that is your advantage. You are so desperate for each individual customer that you can overwhelm them with attention, service and appreciation. This turns out to be a pretty good strategy.