Growth opportunities: How to scale your service business

Growth isn’t always easy. Here are the key factors that impact scalability, and how to navigate the complexities of expanding your service business effectively.

how to scale your service business

Reid Hoffman is a legendary figure in entrepreneurship and startups. As a member of the Paypal Mafia, a co-founder of LinkedIn, a successful venture capitalist, and an advisor to many high-growth startups, he’s a prominent icon in Silicon Valley.

In his book, Blitzscaling, Hoffman discusses when and why companies should ‘grow at all cost’. He coins the term ‘Blitzscaling’ – “prioritising speed over efficiency in the face of uncertainty”.

Hoffman presents the core factors businesses should consider when going for ‘’hyper-growth’’. He explores tactics used by companies in their quest for world domination – companies like Facebook, Airbnb, Amazon, Tencent, Oracle and Apple.

It’s a fantastic book, and Hoffman does a great job at distilling his wisdom into a set of principles a startup needs to adopt the ‘Blitzscale’ mentality.

My only issue with it is that its advice only applies to a specific type of business – scalable tech companies, which represent a tiny fraction of businesses globally.

If your business isn’t the sort of hyper-growth, wannabe unicorn, ‘grow-at-all-costs’ software-focused company typically found in Silicon Valley, then Huffman’s advice might not be applicable to you.

However, what the book does do well is help founders understand what scaling means, and how it varies across different business models.

Scale is sexy

‘Scale’ is a buzzword often used by founders, but it’s important to contextualise what scaling means for your business. Not all business models are suited for rapid scaling.

In this blog, I’ll explain why scaling can be challenging from an operational finance perspective. We’ll explore the different types of growth presented by Hoffman and analyse the unit economics relevant to your business model.

Brace yourself for lots of pretty graphs.

What the heck is Blitzscaling?

Reid Hoffman describes the four overarching categories of growth that every company experiences, in one form or another. Understanding these, including Blitzscaling, can help you determine the right strategy for your business.

The four types of growth:

1) Classic Startup growth. This is a controlled growth phase where your early-stage business is hustling to find the elusive ‘product/market fit’. It’s like building an airplane that has already been thrown off a cliff. Most founders in this phase are grinding it out to discover what works.

2) Classic Scale-up Growth. In this phase, a company has a solid understanding of its product and distribution channels and takes a measured approach to efficiently growing the business.

As an accountant, I’m favourably biased towards this form of growth because it involves efficient capital allocation – investing in projects where the ROI exceeds the cost of capital. In simpler terms, if I invest $X in this growth campaign, I know with confidence it will yield $Y in return. 

This is the most common form of growth when trying to maximise value in a proven, stable market.

3) Fastscaling. This means you’re willing to sacrifice efficiency for the sake of growth. I like to call this ‘vanity growth’ (haha).

It’s applicable to companies that forgo ROI considerations and focus on strategic objectives like taking market share or hitting revenue milestones to meet investor expectations and satisfy founder egos. In this scenario, if I invest $X, I don’t care about the yield as long as it results in more revenue.

4) Blitzscaling. This is a special form of ‘all or nothing’ growth, which underpins Hoffman’s entire thesis. You forget about efficiency and embrace gut-wrenching aggressive speed and uncertainty in your quest for world domination. In other words, I don’t care how much money we burn, because if we don’t burn it, we will lose. All that matters is winning.

Blitzscaling: Is your business model right for it?

Blitzscaling is not for every business. It’s reserved for specific types of business models, which we’ll explore shortly. Here are the characteristics that define a Blitzscaling business model.

The four growth factors critical for Blitzscaling 

1) Large market size

This might sound obvious, but to build a massive company, you need a massive market. Without a large enough market, achieving exponential growth is impossible.

2) Distribution

As the saying goes, “a good product with great distribution will almost always beat a great product with poor distribution”. Blitzscaling companies can achieve distribution at scale in two general ways:

  • Leveraging existing networks: Tapping into existing networks to distribute their products. For example, Airbnb leveraged Craigslist to reach a wider audience in its early days.
  • Virality: This occurs when users of a product bring in more users, creating a chain reaction of growth. Each new user invites more users, creating a viral loop.

3) High Gross Margins

High gross margins are powerful because they allow more profit to be reinvested into growth and expansion. Most technology businesses enjoy enviable, high gross profit margins, often upwards of 70% to 80%. What’s also important to note is that the cost of duplicating software is almost zero, making it highly scalable. (I will come back to this point.)

4) Network Effects

Network effects occur when a product or service gains additional value as more people use it. The classic example is social networks: Facebook wouldn’t be very fun if you were the only user. Network effects are powerful because they make the platform more valuable and useful as more people join.

The two growth limiters

On the other hand, Hoffman highlights two characteristics that can limit growth. 

1) Lack of product/market fit

Without product/market fit – a product that satisfies a strong market demand – you don’t have a viable business. This is the fundamental requirement for any company looking to grow.

2) Operational scalability

Having a scalable business model is critical for blitzscaling. While having an in-demand product is important, being able to deliver that product to your end users with minimal friction is another challenge entirely. Tesla is a great example of a company whose growth has been hindered by infrastructure limitations.

Categorising growth cateristics

Growth characteristics can be placed into two overarching buckets:

  • Outward-facing challenges: These include product, sales and marketing-related issues
  • Inward-facing challenges: These include operational, finance and product management issues.

Let’s focus on the inward-facing characteristics of growth – high gross margins and operational scalability. 

The gross profit economics of growth

Gross profit is the profit made at the level of individual products. In other words, it’s the profit after all direct costs are deducted from the sales revenue.

Measuring gross profit is important because it shows the profit margin you’re making on your products and services, ensuring you have enough remaining profit to reinvest back into your business.

The formula is straightforward:

GROSS PROFIT = SALES – DIRECT COSTS

High gross profit margins are essential for scaling companies. If you don’t get this crucial ingredient right, there’s a high chance of ‘growing broke’.

Growing broke means that the costs associated with growth outstrip the viability of your business model. To prevent this, it’s critical to model both the financial and operational scalability of your business.

Breaking down direct costs

Direct Costs, also known as Cost of Goods Sold (COGS) or Cost of Sales, are the expenses directly attributed to the production of your product and service. This includes the costs of the materials, direct labour, software hosting, and shipping.

Direct costs can be further categorised into Variable and Fixed Costs.

  • Variable costs: These are expenses that increase directly in relation to your sales volume. Examples include the costs of your product and all associated shipping and logistics expenses (assuming you’re an inventory-based business).
  • Fixed costs: These are expenses that remain constant regardless of your sales volume.  Examples include direct labour costs (in a service-based business), software hosting (for a software business), and most other consistent expenses.

It’s important to differentiate between your fixed and variable costs as it plays an important role in scaling up your company.

Why software businesses scale so well

Software businesses typically have high gross profit margins, ranging around 70-80%. They scale exceptionally well from a unit economics perspective because they have close to zero incremental costs.

This means it costs almost nothing from a direct costs perspective to service more customers. For example, selling one software subscription versus selling 200 subscriptions has little impact on the hosting bill you pay to AWS each month.

Since the direct costs of software businesses are fixed with minimal incremental costs, gross profit margins actually improve with scale.

There’s a reason why they call it ‘hockey stick growth’.


Operational scalability

Software businesses can scale beautifully from an operational perspective because the product is a digital asset. These businesses are not entirely reliant on human capital, as customers depend on the product itself.

The result is that many valuable software companies have relatively few employees compared to their revenue and gross profit. For example, WhatsApp – up until its sale to Facebook – had grown to 500 million monthly active users, with just 43 employees. Pretty crazy.

These operational and financial characteristics make software companies ideal for scaling. They are attractive operating business models for investors because they benefit from both operational and financial scalability.

Scale for ‘traditional’ businesses

So, if you don’t own and operate a software business, what does that mean for you?

Within the context of scale, let’s compare the software business model to a couple of more ‘traditional’ business models. The two most common models are:

  • Inventory-based businesses (etail/ecommerce)
  • Professional services/Consulting

Inventory-based businesses sell physical products, as opposed to intangible goods or services. Think of your typical ecommerce business, fashion retailer, or health supplements company.

Gross profit margins for these businesses typically range from 40% to 60%, fluctuating primarily due to production costs, fulfillment and warehousing costs.

Inventory-based businesses have a high level of variable costs compared to fixed direct costs. This means direct costs will grow in relative proportion to revenue. But with scale, it’s not uncommon for the cost per unit to reduce as products become cheaper to produce in larger quantities. In other words, they can benefit from economies of scale.

Inventory-based businesses can also scale well by outsourcing fulfillment to 3PL (third party logistics) providers. It’s common for ecommerce businesses to employ only product and sales and marketing specialists, while outsourcing the remaining functions.

The result is a low fixed overhead with scalable operations, creating high-leveraged teams.

Then there are professional services. The key difference between professional services business models and software or product-based businesses is that their product is people. They rely heavily on human capital to deliver their services.

Gross profit margins for service-based businesses range between 50% to 70%. The direct costs include the wages of the ‘technicians’ servicing your customers. While wages are technically fixed costs, they act like variable costs because you need more staff as revenue increases.

Accordingly, the incremental cost of growth is high. Gross profit margins will grow in the same proportion as revenue, whether you’re a 10-person company or a 100-person company. Humans don’t scale like software.

Additionally, a firm’s ability to grow is constrained by the capacity of employees to service customers, often measured in billable hours.

You’re limited by the ability to find, train and onboard technicians to continue servicing customers as revenue grows.

This requires disciplined attention to capacity management – the art of perfectly matching human capital to workload.

Capacity management can make or break your service-based business, especially if you’re aiming for exponential growth. 

Excess capacity erodes your gross profit margins due to higher direct costs relative to revenue – you have people sitting idle with no work to do. Conversely, insufficient capacity risks losing revenue because your customers are not being serviced adequately.

It’s a balancing act that demands strict attention to both your hiring economics (a repeatable process to hire employees) and growth economics (a repeatable process to generate sales).

Capacity management to growth

Gross profit impact:

Capacity management to growth financials

The challenges of scaling service-based businesses

Operational scalability is particularly challenging for service-based business. As they depend heavily on human capital, they need to hire a large number of people. As team sizes grow, layers of management become necessary – often consisting of personnel who are not directly generating revenue. Consider the infrastructure needed to manage a team of 7 people versus a team of 30.

You require middle management to oversee capacity and workflow, HR personnel, and other support staff. These roles are essential for servicing the internal needs of the business, allowing  revenue-generating staff to focus on their work. 

Revenue per employee, measured as total sales divided by headcount, can decline as you hire non-revenue generating staff for operational infrastructure, directly impacting profitability.

Additionally, service-based businesses contend with a high percentage of fixed direct costs. If revenue tapers off, you’re left with payroll obligations that directly affect your profit and cash flow. This is why consulting firms often expand and contract abruptly in response to market conditions.

Overall, there are arguably little to no ‘economies of scale’ to be gained with operating a service-based business model.

A rational founder might ask themselves why they should even bother scaling a traditional service business, because the benefits of scaling are limited. 

Instead, there are sweet spots in team size that traditional service-based business models can aim for to optimise their revenue-generating team members while maintaining an efficient operational structure. I’ll explore this in a separate post.

In summary

The term ‘scale’ is often used by founders and entrepreneurs, but it’s crucial to contextualise what ‘scale’ means for your specific business. Are you aiming to be the next Amazon, or do you want to be the best at what you do in your local area?

Understanding the unit economics of your business model is critical to avoid the risk of ‘growing broke’.

At SBO, we’ve looked under the hood of over 500 businesses from an operational finance perspective. Through this extensive analysis, we’ve identified patterns that distinguish highly profitable, efficient businesses from those that struggle to break even each month.

The greatest businesses share one thing in common: they translate their growth strategy into numbers. This helps them understand how their decision to scale impacts profitability and cash flow.

We offer a service to help founders contextualise growth and translate it into a financial model. If you’re serious about growing your business and need visibility into how your strategy translates into numbers, request a call to set up a free 1-hour consultation with one of our financial advisors.

Don’t leave your growth to chance. Build a business that lasts.

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