Why Your Business Shouldn’t Scale

In the deep heart of the City of London, a few steps from the Bank of England, there is a small coffee shop. It is so small that it occupies just the narthex of St Mary Woolnoth church. Like Roman encampments, large food chains surround this tiny outpost. Like the village of Asterix and Obelix, it proudly refuses to be conquered.

I have my macchiato there every day, and I am not the only one. The shop survives not because of the donations received from the church but because of the endless stream of clients that pick this place for their daily caffeine shot.

It is so popular that I often have to queue. I use this opportunity to observe the other customers and sometimes exchange a few words. Besides the occasional tourists, they (we) all work in the financial or legal sectors. They (we) believe in the capitalistic model, in the efficient use of resources and in a pie that keeps getting bigger so that everybody can get a bigger slice. They (we) invest our money and the money of our clients in enterprises that can scale, replicating their success across the global market.

The nearest cost-efficient and scalable Starbucks is probably 15 meters away from the church. They (we) don’t go there to get a coffee. They (we), instead, prefer the tiny shop owned and operated by the same person, with no IPO in sight and no marketing office.

I wonder if this apparent inconsistency reveals something deeper about ourselves and the world we live in.

Tribalism

The first reason why our behavior differs from our theoretical economic preferences is rooted in evolution. Until very recently, human beings have been living in small communities with strong and deep personal ties among their individuals. We are wired to seek and create such connections in the economic domain as well, because personal liability has always been the best remedy to prevent frauds and keep a high level of quality (for a non-naive interpretation of Hammurabi’s Code, please read the dedicated chapter in Skin in the Game by Nassim Taleb).

Big brands and franchises inherently lack this sort of bond with their customers because they are de-personalized. The reason for their (apparent) success lies precisely in offering a standard level of service, whose quality and characteristics don’t depend on the people working in that specific branch or shop. A McDonald cheeseburger in Chicago will be the same as one in Shanghai.

Standard quality as a key ingredient of success is one of those beliefs that everybody agrees on until we start examinining our actions in the real world. No one values the identical paintings produced by a robot painter higher than those produced by a human painter. But this is also true for artisanal coffee mugs versus mass-produced coffee mugs. In addition, the idea of standardization as a value clashes with our everyday life, where variations are frequent and often desirable (e.g., in our diet, in our work, in our social life). Standardization and uniformity are not human and don’t appeal to human beings.

However, it is interesting to see how de-personalization and a standard quality of service are prominent features in a well-received business plan. A company that leverages processes and workflows instead of its people is deemed more resilient and, more importantly, its business is easier to scale.

Fragility

Scalability means growth. The business can — and should — expand its operations, conquer new markets and increase its customer base. Preferably at a very fast pace.

If we look at similar behaviors in nature, we find only one example: the cancer cells.

Everything else does grow, but a) often at an irregular pace, based on the available resources and b) it stops at some point during the vital cycle.

Companies are fictional entities, and we often assume that laws of nature don’t apply to them. In doing so, we forget that economic science is, at best, an imperfect observation of reality. Instead of looking at our mathematical models with skepticism, we blame the world for not conforming to the results of our spreadsheets.

The modern company needs to grow, often at the expense of its financial stability. For reasons that will be discussed in the next section, making financial losses to acquire a bigger market share is almost always considered wiser than having solid and positive cash flow. Making a business idea profitable has somehow run out of fashion these days.

The other argument against growth at all costs is that it increases the fragility of the entire business. When the environment changes, the biggest animals are always the first to go into extinction. The same applies to companies and business.

A big entity will always be slower to adapt, innovate and respond to changes especially if it uses a centralized model of governance. The longer the distance between the CEO and the client-facing personnel, the higher the chance of an untimely response. It may not appeal to everyone, but in the metaphorical battle for market survival, it is better to be the a mouse rather than a dinosaur.

Tipping the scale

We have seen how scalability and endless growth do not really appeal to humans and how they could reduce the survival chances of the business. Therefore, one would expect such entities to have already disappeared from the market.

There are three main reasons why this has not happened in a consistent way

a) Conflicts of interest. The need for endless growth starts with the early stage investors. Startups need to grow quickly and massively so that venture capitalists can build a compelling story for the market and the retail investors before landing an IPO. Early investors have no interest in running the company.Their main target is to get a very high ROI on the money they funnel to the business. As human beings, we are naturally impressed by size and we feel reassured by a good narrative in a world full of uncertainty; it is easier to pump up the evaluation of a loss-making behemoth compared to a small profitable family business. It is not by chance that privately owned startups with over 1 billion dollar evaluation are called unicorns, a mythical creature many talked about but whose existence no one has been able to prove yet.

In many instances, this is just a risk transfer exercise from the early investors to the general market and not necessarily the best business decision the company founders should make. Because of this selection bias which is driven by conflicts of interest, we infer the wrong cause-effect relationship in terms of successful businesses. What we think is that scalable businesses are funded because they are successful but what we should think instead is that scalable businesses are successful because they are funded.

b) Lobbying. A certain degree of market regulation is unavoidable and desirable. However, once the rules are human-made, they can always be tweaked. As someone once said, laws are applied to enemies but only interpreted as regards to friends.

Size matters during the legislative process and huge sums of money are spent persuading government officials to enact certain regulations that will benefit the general public (and incidentally the lobbyist’s employer) or to repeal other regulations that would harm the general public (and incidentally the lobbyist’s employer). Tax benefits, bailouts and artificial barriers to entry distort the natural selection process of the market, leaving us with companies better at doing politics than at doing business.

c) Advertising. Every big company has an enormous marketing office. This may appear counterintuitive as we would expect that a small company should spend more to have their brand recognized while the other ones would have their global scale and capillarity do the larger part of this job for them.

Why a big company has to spend proportionally more on advertising compared to a small company is unclear until the true nature of this type of advertising is understood.

Traditionally, those who work in the advertising sector describe their activity as a way to inform the public about a product capable of satisfying the pre-existing customers’ needs. This is certainly true, but it only describes part of why advertising is so important in the modern economy. The constant exposure to specific content is, in fact, capable of generating the demand for a product leveraging e.g. the effect of the availability heuristic. This is why we find increasingly more attractive the people we see every day. Exposure also creates a feeling of trust and familiarity so that when we are faced with an uncertain decision between two products, we often go with the already known brand, only because we have repeatedly heard that name before.

Big companies need to spend more on advertising because that is what drives their business. We can appreciate here another cause-effect inversion. The business doesn’t advertise because it is successful, it is successful because it advertises.

Artisanal entrepreneurship

I wanted to write this small piece not to denounce the dire conditions of our modern society but to celebrate the unsung heroes of our economy.

Being an entrepreneur is incredibly risky, and those that run small businesses risk even more. They put not just their money but their soul too in their enterprises. In addition to defying the odds of any economic activities, they also need to face the often unfair competition from bigger companies. I have never read a business case describing the story of how a corner shop owner can sustain his or her family of four, even if this achievement seems pretty remarkable considering the obstacles they need to face.

We are conditioned to think that a successful business can only be big and global, even if we quite often prefer the small and local ones (given the choice). To those already running a small business, a big thank you for holding on, and a small piece of advice — fully embrace technology. It will not change why you do what you do, but it is necessary if you want to have a chance of keep doing it. To those thinking about starting a business, don’t be put off if your idea is unlikely to take you to the Fortune 500 list. There is something inebriating in seeing a customer walking through the door of your shop or order a product from your website. They are not just buying from you but, to an extent, they are also buying into you. Purchasing something from a small business is just another way of saying “Hey, I like what you are doing and I like you.” This would be an irrelevant line in a scalable business plan, but not everything that counts can be counted.

Still learning how to write. Lover of used digital photography equipment https://www.instagram.com/camera_flips/

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