The Scale Fallacy (and How I Learned the Value of Success That Was Steady, Not Spectacular)
The following is an excerpt from Jonathan Siegel’s new book, The San Francisco Fallacy.
“There’s no value in services, because they don’t scale.”
Startup culture says that success must be scalable: growth should be “exponential”; distribution should be “viral.” This makes services the poor cousin in the startup world.
Services businesses don’t tell the story of spectacular success that VCs and the media want. By definition, they are limited in scale to the number of personnel. Services are not a quick way to fame, glory, and riches.
But services can be a crucial facilitator of startup success. They can be the bedrock on which a founder’s career is built. And, though they may never make you a billionaire, they can bring great rewards nonetheless: they can bring you into creative, corporate, and social spaces to which you’d never otherwise have had access.
The Scale Fallacy convinces would-be founders to focus on digital products that scale. But focusing on the services they could sell would make many of them more successful more quickly, and that might give them a platform on which to later build a scalable startup.
How I learned the value of success that was steady, not spectacular
As I struggled through my early career, lurching from startup failure to failure, I had a safety net that caught me and helped me rebound each time. It ensured my failure never wiped me out, that I had a team of colleagues to support me, and that I had a regular income. It gave me access to the executives and boardrooms of leading companies and insight into changes in the market and technology.
This safety net was a consultancy.
Even as I relentlessly pursued the founder dream, I was never afraid to dial for dollars. From the age of fourteen, I consistently sold my services. I started out helping friends’ parents buy their first PCs and then graduated to providing tech installation and maintenance services to local businesses. After college, alongside running a startup games studio, I founded a consultancy to trade on the skills of my team. Unusual for the times, we had core technical skills. We were willing to work on other people’s projects on the side and so quickly found ourselves in demand as consultants.
This was the era of the Idea Fallacy: many of those projects were nothing more than an idea; their promoters placed little to no emphasis on execution and often had no technical skills—despite being supposed “tech startups.”
One such startup was ForewardLinks.com. They proposed to build a website to schedule tee times at golf courses and raised $5 million dollars. They hired us to build it, which we duly did.
But there was a slight problem: few golf courses in those days had Internet connections. ForwardLinks.com tanked soon after.
As we learned from our own failures, as well as those of others, and took on board the coding language Ruby and the agile development process, we became a team of consultant-innovators, building new products for other people to bring to market.
The era changed. The sector learned (so it thought) from the excesses of the dot-com bubble, follies such as pets.com, Webvan, and, on a smaller scale, ForwardLinks.com. Investors saw the fallacy of the exclusive emphasis on ideas and sought to place new emphasis on the tech. They came to us for that expertise.
But, for most, there was still a crucial piece missing: bringing the product to market.
“Will it scale?” a client would ask as we talked them through the development process.
“What scale do you need?” I’d ask.
“A million users a day.”
We could build that without difficulty. But they were usually lucky to get a hundred users a day. Those clients were focusing on the product, as if that were the hard part of the development process. I learned from watching them fail that going to market was the hard part.
One such project was a piece of mobile phone software for going to Disney World. We built it rich with beautiful detail, such as graphics of tiny roller coasters on a map. But the client hadn’t tested the market…
It turned out that the market didn’t exist. Disney owned the relevant intellectual property and wasn’t about to share it. So our beautiful piece of software went straight in the bin.
Watching client after client repeat these mistakes, I started to change the way we built products for clients. I would make them do a “mini” project—a rough prototype, a kind of minimum viable product—in order to get feedback early. This insight would become crucial to my own subsequent startup success.
What is the scale fallacy?
Consultancy is the unsexy part of business. There are hundreds of best-selling books about how to make a business succeed, not so many about how to help other people make theirs succeed.
Startups have a classical narrative arc: they start small, aim high, and either succeed heroically or fail in the face of insurmountable odds. Consultancies help other businesses do business—that’s not so obvious, or dramatic, a story.
I never intended to be a consultant, or to own and run a consultancy. But without the consultancy, I would likely never have had the success I’ve had as an entrepreneur. Consultancy provided me with an invaluable bedrock for my own projects and an unbeatable learning ground.
As well as teaching me product development and market-testing skills, consultancy taught me about managing people.
In the startup environment, your “customer” (i.e., the person you most need to satisfy) is often your investor. Real customers are often a long way down the line. But in consultancy, you’re dealing immediately with real customers, and you have to keep them happy.
Startups tend to be driven by the shared passion of a small group of founders, who are willing to push themselves to burn out in pursuit of their project. By definition, that’s not sustainable.
They’re driven by passion to the exclusion of pragmatism. That can only take you so far. It may take you to the cusp of success, but it can rarely manage that success to the best effect. When people burn out, they lose perspective. They make bad decisions. Teams tear themselves apart.
Then, when a startup enters the consolidation phase, the leadership commonly overreacts to the earlier chaos and becomes overly cautious. Original team members grow disillusioned. The company loses its spark.
I tried to combine the best of both worlds in our consultancy: the intimacy, collegiality, and creative fire of a startup with the sustainability and family-friendly environment of a more stable company. Using the company as a development lab for my own projects (and those of other team members) helped keep everyone stimulated and the atmosphere creative and supportive.
Consultancies aren’t immune to the business cycle, but they can have an intrinsic countercyclical thrust. In a boom, you can scale up, but only as quickly as you can hire. In a bust, you can cut your margins and cut staff, responding immediately to the changing market rather than relying on economic forecasts. One of the virtues of consultancies is that they can do well in a downturn by helping the larger companies around them downsize, streamline, cut costs, and gain efficiency.
Services business are good businesses. But, till recently, if you asked a typical VC to fund your professional services agency or consultancy, you’d get a resounding “no.” Services businesses don’t scale, which is why a VC typically won’t invest.
Services businesses don’t scale because they are based on manpower: to double your revenue, you need to double the hours worked. Unless there is unused capacity, that means doubling the size of your team. And that’s just to achieve 2x growth. But in the tech world, scaling often means aiming for 10x or even 100x growth because the marginal cost for making extra copies of a digital product is insignificant.
VCs are looking for many multiples of growth to make a return on the multiple businesses they’ll invest in that fail. They’re not interested in slow but steady growth; they want boom, and they’ll risk bust (for the individual startup) to get it. (That’s just another reason why investor interest is not a good guide of the potential of your startup.)
So VCs won’t be interested if your startup doesn’t scale, and neither will the media and neither will the public. This is because the American dream isn’t a fantasy of steady, incremental growth—it’s a dream of celebrity, stardom, and riches.
If you’re prepared to put the dream on hold and take a cold look at your prospects, you’ll realize that there are significant advantages to creating a services business—one that doesn’t scale.
You’ll see money on day one, instead of working towards a future payday – which may never come.
You’ll learn about the cutting edge of what customers are demanding (and developing).
And this combination of revenue to play with and a sense of what is in demand can provide the perfect ingredients with which to subsequently create a successful scalable product business.
Jonathan Siegel is the founder of RightCart, RightSignature, and RightScale, the chairman and founder of Xenon Ventures, and the author of The San Francisco Fallacy.