The concept of an easily "scaleable" business is intuitively easy to understand - it is one that can expand quickly. But it is easier to define by comparison to not-easily-scaleable businesses.
A business can be very profitable without being easily capable of high growth. Take a speciality restaurant, for instance. It takes years to train people to cook at Michelin Star standards. So it's much more difficult to scale than a burger-joint, which can be franchised in a week.
Most businesses are scaleable. But the degree of difficulty varies. In manufacturing, it is a question of finding additional commoditised resources.
An auto manufacturer or a cement factory must source capital and cater for higher raw material costs and higher wage bills when expanding capacity. These are commodities.
A consultancy or services business (financial, legal, software, or otherwise) has more difficult HR issues. A consultancy may be able to grow for a while by billing at higher rates and improving productivity via technology-induction. But eventually growth can only be sustained by the addition of skilled manpower. A shop-floor technician takes three-six months to train. A consultant needs six-seven years of college and relevant work experience.
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A software products business or a game can be very easily scaled, at least initially. If a program written by one person or a small team takes off, it can sell a million copies almost as easily as it sells a thousand.
Media and entertainment businesses often have similar highly-scaleable characteristics. A movie or a song can be delivered to larger audiences without much incremental effort.
A hit doesn't cost any more to make or deliver than a flop and it generates multiples more revenue. A newspaper with higher circulation or a programme with higher TRP can charge disproportionately high ad-rates.
In some businesses, the initial scale must be very large. A telecom network for example, must create as much capacity as it can, right at the beginning. That way, as and when traffic climbs, the returns are higher and there are no capacity constraints. It costs little more to maintain a network with 10 lakh users compared to a network with only 10,000 users.
There are some interesting characteristics associated with scaling. Where scaling is commoditised, businesses have relatively low and predictable margins. Branding makes a difference for sure. But all manufacturers of detergent, of cement and of cars will tend to have roughly similar margins to their peers. So will banks, retailers and software service providers.
Highly scaleable businesses on the other hand can have wildly varying returns and tend to be inherently winner-take-all in characteristics. Microsoft dominates the home PC environment, Google dominates Web advertising; the differences in marketshare and profitability between no:1 and no:2 in such businesses is usually vast.
That's because a highly scaleable business can gain volume quickly and unpredictably at near-zero marginal cost. Let's say an unknown singer features on Oprah Winfrey - within 24 hours, there could be a million downloads.
Supply is very elastic and expands instantaneously to meet rising demand. But if a cement manufacturer wants extra marketshare, it must first invest in extra capacity. Supply cannot expand instantly.
This difference implies that investors need to be much more selective (and luckier!) in highly-scaleable businesses. If you think for example, that the cement industry will do well, you can adopt a shotgun approach and buy every listed company. All the shares will travel in the same direction.
If you dabble in media or in entertainment shares, selectivity is more necessary. The dominant businesses will generate much better returns than the also-rans and indeed, the profits will often come at the expense of weaker players. Shares in these industries often move in diametrically opposite directions.
Individual business characteristics are far more important in highly-scaleable businesses. The overall industry trend is more important in the case of commodity-scaleable businesses.
Until fairly recently, India didn't have any listed businesses of the highly-scaleable type. That changed with the spate of media and entertainment IPOs in the past few years. It will change further as India develops a software products industry and a bigger profile in the games market.
I suspect however that investment styles will not change quite so readily. The investments in media have been quite indiscriminate, for example and returns have been very lumpy. This could well be a recurrent pattern as more highly-scaleable businesses come to the market.