Blitzscaling

 Blitzscaling 

 Author: Reid Hoffman and Chris Yeh

Preview: 

How did Companies like Apple, Google, Amazon, Facebook, etc., become so big? Starting modestly, all these companies followed an ultimately successful strategy of achieving massive scale in double quick time. Successful scale-up in a short period helped these organizations to become dominant market leaders. This is a book which explains when companies should adopt a "blitzscaling" about the approach and how to successfully tackle the problems that come with it. 

About the Author(s) 

Reid Hoffman is an investor, entrepreneur, and author. He was the co-founder of LinkedIn and PayPal and is currently a partner at Greylock Partners, a venture capital firm. Along with authoring a couple of other books, he also hosts a popular podcast Masters of Scale. Chris Yeh is an MBA from Harvard University and an angel investor. He also co-authored The Alliance, with Reid Hoffman. 

  

Learn how to achieve phenomenal business growth 

Nokia in 2007 was the world's most valuable handset maker with a market cap of nearly 100 billion dollars. Even till 2010, it shipped the highest number of phones it had ever shipped at 104 million. But with the introduction of the iPhone in 2008, and the proliferation of Android phones, led by Samsung, by 2012, it became a laggard behind Apple and Samsung. Though Nokia was sold to Microsoft for 7 billion dollars in 2013, its phone business could never recover and was eventually sold by Microsoft for a sum of 350 million dollars. 

On the other hand, Facebook, which started as a small social network for Ivy league college students, successfully transformed into an internet behemoth with over 2 billion users across the world, in just 14 years. Google burst on to the scene in the late '90s and in less than a decade, established itself as one of the premier internet Companies in the world. Amazon, another company which was founded in the mid-'90s, and had been losing money for years, now finds itself in a position of unassailable supremacy. How did these new age companies achieve explosive growth? Well, one thing which is common to all these companies and several other successful ones, is Blitzscaling. 

In this quid, you will learn: 

1)    What Blitzscaling is  

2)    Why it's riskier to be cautious than bold 

3)    What the growth factors and growth limiters are for a business that wants to blitzscale 

4)    Airbnb's initial market estimate for its service was merely 30 million USD 

 

When the market opportunity is big enough, the price of being slow can be far higher than the price of being wrong (market size) 

A 2014 Mckinsey report was titled "Grow fast or die slow". This report which analysed data from more than 3000 internet and software companies indicates that rapid growth is a critical factor in financial success. If the prize is big enough, it is a rational strategy to go all out even when doing so presents large risks. The term blitzscaling comes from the German Blitzkrieg strategy in WW II. The Germans abandoned the conventional approach of advancing along with securing supply and retreat lines and adopted the fast-moving offensive strategy which prioritised speed and accepted risks like running out of ammunition and fuel which could lead to defeat to surprise and overwhelm opponents. 

In this internet age, several businesses find themselves in markets which are characterised by a winner take all or a winner take most result. When a market is there for the taking, the strategies which work in established markets do not work. The "prudent" approach of making informed decisions and taking measured and affordable risks doesn’t work. Why? Because this strategy focuses on efficiency and accuracy rather than speed, and when a market is up for grabs, speed is the most important criteria, not efficiencies. 

Thus, since it is critical to achieve scale in a market where the payoffs are skewed towards the eventual leader, it is imperative to achieve this scale at an exponential rate. If you manage to scale fast enough and take pole position in the market, the inefficiencies won't matter, if you cannot scale fast enough and lose, efficiencies don’t matter anyway. So, get there faster is the mantra.  

The idea is not to grow at a "healthy" rate of 20-25% annually, but blitzscale exponentially in a way which corresponds to hockey stick curves rather than simple linear growth.  

Blitzscaling prioritises speed over efficiency in an uncertain environment 

In 1996, Amazon had 5 million dollars in revenue and about 150 employees. In just 3 years, it's revenue had increased by more than 300 times, and the number of employees had ballooned to more than 7500. Surely, such kind of growth cannot be explained in terms of traditional growth curves which focus on efficiencies and healthy growth.  

Blitzscaling involves focusing on speed at the cost of efficiencies when the environment is uncertain. This may include ignoring irate customers, ignoring minor issues in a product, burning capital fast, scaling up in employees, adopting an aggressive and sometimes what's considered to be wasteful strategies.  It typically requires significant amounts of capital to fuel growth, and to many people, it may look like wasteful expenditure. However, it is not so, since Companies which need to blitzscale operate in markets where the payoffs are highly skewed towards the winner. This growth strategy requires not just guts on the part of the entrepreneur, but also an environment where such risks are financed, both financially and in terms of human capital.   

Take the example of Uber. Why is Uber okay with losing massive amounts of money in new markets? The answer is that it is in the blitzscaling phase. Supported by its war chest of billions of dollars, Uber's priority is to achieve the first scaler advantage as quickly as possible across as many geographies as possible. Hence, it doesn’t matter to Uber if their prices in new markets are rock bottom compared to local competitors, its priority is scale, and for that, it embraces speed over capital efficiency. 

  

 

Market size is the most important factor to consider when blitzscaling and the business should aim at maximizing it. 

Back when Brian Chesky was trying to raise funds for Airbnb, he met investor Sam Altman, who told him that his pitch was perfect except for the mentioned 30-million-dollar market size. Altman told Chesky to make it 30 billion dollars and argued that the numbers and assumptions suggested this to be the case.  

The risk of blitzscaling makes sense only in markets which are big enough to allow you to become massive at an exponential pace. Hence, eliminate ideas which serve a small market early on.  

Often, the mathematics of venture capital results in the selection of only those businesses which have a potential to be multi-billion dollars in sales. This is because a typical VC fund needs to return about 3 times its investment in a 7-10-year period. Since most funds lose money or just about make enough to break even due to the high failure rate of start-ups, they must invest in those Companies that have the potential of giving outsized returns; otherwise, they might as well invest in stable blue-chip stocks! 

When making initial estimates of a market, things like the expansion of a market, and effects on related markets is often overlooked. Sometimes, due to innovative offerings, the market becomes much larger than initially estimated. For example, in the case of Uber, Ashwath Damodaran relying on more traditional methods, estimated Uber's market value to be about USD 6 billion based on Uber's assumption and target to win about 10% of the taxi market. However, the market size has expanded tremendously due to a low-cost offering which is easy to access. So, the real valuation of Uber is multiple times that of what Damodaran had estimated. 

Besides expanding the existing market, a business may also make significant inroads into adjacent markets. For example, Amazon, which started off as the world's largest bookstore, now sells almost everything under the sun, and book sales represent a small percentage of its overall sales. 

Businesses must figure out their distribution strategy to scale successfully 

If you have a great product which solves a real pain point of customers, how do you get them to use it? Distribution is the key when trying to achieve massive scale. Businesses must solve their unique problems of distribution if they are to scale successfully. Distribution can be the difference between a successful company with a good product and a not so successful one with a great product! 

With the growth in mobile penetration and the focus on distribution through Google Play and App Store, product discovery is even more challenging than before since traditional SEO techniques don’t work that well anymore. Users mostly look for specific things on these stores rather than exploring and discovering new things. This has resulted in more innovation in enabling product discovery and distribution on a large scale. 

Early in their life, start-ups can rarely afford to pour financial capital on acquiring users. However, this can be done by cleverly leveraging network effects and virality. Paypal achieved high user growth by leveraging eBay's platform which already had millions of registered users by adding a pay with PayPal button for sellers automatically. Later they also leveraged virality by monetarily incentivizing users to refer their friends, who in turn were also incentivized. While this was a costly strategy, it was still much cheaper than other more conventional customer acquisition strategies. 

Facebook was able to go viral organically as well as leverage network effects simultaneously by allowing users to invite other users as well as rolling out the product on college campuses to leverage the existing student networks. 

High gross margin is another factor which can enable high growth 

Gross margins are quite simply the sales minus the cost of goods sold.  Some people may think that in the startup world, revenues, or user adoption are the only relevant metrics of success. However, the Gross Margins play an essential role in deciding attractiveness for investors as well as indicate the inherent capability of the company to fund its growth. High gross margins mean a higher amount of money available for growth. Thus, not all revenue is created equal. Out of two companies which generate the same amount of revenue, the Company which makes higher gross margins will generally be more attractive to investors, as well as be more capable of funding its own growth. 

High margin easily lends itself to technology businesses. Companies like Facebook (87% Gross Margin), Linkedin(86% Gross Margin), Google (61% Gross Margin) and several others are high margin businesses which have either generate enough cash or can attract enough capital to achieve scale and continue their dominance. 

 

Network effects can facilitate exponential growth and make a business sticky 

The age of the internet has brought on unprecedented "connectedness. The power of the networks is vital for achieving long-term dominance.  

Imagine how hard would it be for a new social network to make a dent in Facebook's user base. Facebook has more than 2 billion users on its platform. Practically every-one in three people in the world is on Facebook. If a new social network came about, where would it get its users from? Facebook is tremendously valuable and holds an almost unassailable lead because of its users. The point of being on Facebook is that your friends are also on it. The tremendous advantage that the network effect has is that each additional user increases the value of the platform or the product just a little bit. Hence, the more users, the better and the more valuable it is to all users. 

Sometimes network effects can come about in indirect ways. For example, The adoption of Android OS as a standard by a vast majority of mobile phone manufacturers results in massive scale development of apps to be used on Android Phones, which in turn leads to making the Android OS more valuable than it was before. Airbnb becomes more valuable to its users as more hosts and travelers join its platform. Additional travelers make it more valuable for the hosts, and more hosts make it more valuable for travelers. A double-sided network effect! 

 

You need to achieve product/market fit and address issues with operational scalability before blitzscaling 

Product/Market fit serves as validation of your solution to a customer problem. This has to be achieved and seen in the context of a good and sizeable market.  Better the fit, better the growth prospects. However, often, the initial product is either not good enough, or needs several iterations or sometimes even pivots to achieve a form which the market wants.  

Paypal pivoted several times before it achieved product/market fit. The thing is that its easier for technology Companies to iterate a product or even to completely change course than it is for businesses that deal with physical products. 

Even when the product/market fit is achieved, challenges of operational scalability can make or break the business. Friendster, the social network before Myspace, acquired millions of users in a short period and was touted as the next big thing before it was quickly overtaken by Myspace (which was later overtaken by Facebook), another player in that category. Friendster quite simply didn’t have the infrastructure to support millions of users at that time, and as the loading times for user profiles increased to about 40 seconds, Myspace emerged to take its place as it was much faster! 

There are well-proven business models which Companies can adopt and adapt to make money 

Being digital is massively helpful for scaling. Selling physical goods can present an inherent limitation in scaling. On the other hand, if one sells digital goods, for example, a new character in a game, or a new digital theme, there is no additional cost.   

Software can easily be scaled up or "replicated" at practically no additional cost. Software also helps in scaling up and driving physical businesses. The biggest Companies today are all tech companies which are either driven by software or sell software in some form.  

Platforms can also become great businesses. If a platform manages to become an industry standard or the defacto distribution avenue, it can make massive amounts of money. The iTunes store which is the exclusive platform content distribution on Apple devices takes a 30% cut from any type of sale on it.  

When a product lends itself to an advertising model, it can be profitable even when offered for free. Facebook, for example, is free for all users, but still makes a lot of money by targeted advertising. A successful variation of the free model is the freemium model. When products do not inherently support an advertising-led model, then a freemium model can work.  Dropbox or Google, for example, give away a certain amount of free storage and then charge money for additional storage. I 

The good old marketplace model also serves as a great business model. While it may be difficult at first to find enough parties and counterparties in a marketplace, once the critical mass is achieved, a double-sided network effect can make this model a boon for businesses. Revenue is made similar to the platform model, by taking a cut. Successful examples include eBay and Airbnb. 

SaaS, or software as a service lends itself perfectly to the subscription model. AWS, Amazon's web and cloud services company runs on a subscription model. Users need to pay as they go at regular monthly intervals to avail cloud and web services. Another example is Netflix. Such a model facilitates the stability of cash flows and the predictability of revenues.  

The Newsfeed model, successfully deployed by Facebook and Twitter, works on targeted advertising inside the feed.  

Keep in mind that merely adopting or tweaking these business models is not an indicator of success; however, most companies which have successfully blitzscaled and become super successful businesses have used these principles to design their businesses. 

 

Final Summary 

Exponential scaling in an uncertain environment when the payoffs are heavily skewed in favor of the winner is in many scenarios, the most optimal strategy. It requires substantial financial and human capital to adopt this strategy. While to blitzscale or not is a strategic decision which an entrepreneur must take, this book provides a broad framework and a set of principles which can guide an entrepreneur if he or she chooses to Blitzscale. 

 

Standout Section: 

Part V: The Broader Landscape of Blitzscaling: This section discusses the larger landscape in which blitzscaling has been employed. The example of the fashion retailer ZARA, which enjoys high gross margins of nearly 57%, has been elucidated with great insight. It will help make clear that blitzscaling, while it lends itself more readily to technology companies, can also be used by other types of businesses. While this section is not a part of this quid (an inevitable consequence of editing and keeping things aligned with the central arguments), it is a great read.