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“The single biggest obstacle for most organizations in scaling up AI systems is acquiring, cleaning, and integrating the right data.”
“STOP TINKERING WITH AI,” PAGE 116
Features
Harvard Business Review
January–February 2023
55
The
Overlooked Key to a
Successful Scale-Up
E N T R E P R E N E U RS H I P
AU T H O RS P H OTO G R A P H E R
SEAN LEMOINE
It’s mastering the “extrapolation” stage, when start- ups begin to focus on profitability, not just growth.
Jeffrey F. Rayport
Professor, Harvard Business School
Davide Sola
Professor, ESCP Business School
Martin Kupp
Associate professor, ESCP Business School
Harvard Business Review
January–February 2023
57
ONSIDER THE TALES
of three start-ups that seemed poised for success.
In 2012, King Digital Entertainment had established itself as a developer of popular free games on smartphones. Its user base was growing exponentially, driven by the hit game Candy Crush Saga. From mid-2012 to mid-2013 the company experienced a 12-fold increase in revenue but only a sixfold increase in costs. The result was a nearly 70-fold increase in operating income, from €10.5 million to €716 million.
SoundCloud was an online audio-sharing platform and a rival of Spotify and Apple Music. From 2012 to 2013 its user base grew 15-fold, from 10 million to 150 million registered users. However, its revenues increased less than 50%, from
€8 million to €11 million, while its operating costs grew 75%, from €16.5 million to €28.5 million.
In 2017, WeWork, a celebrated coworking venture, had raised $10 billion in equity and debt. Its top-line revenues had doubled for five consecutive years, and its membership had grown 10-fold. But over the same period, operating costs rose from $400 million to almost $2 billion, leading to significant and deepening losses.
Of these three high-flying start-ups, only King Digital Entertainment became a stable, highly profitable business.
What explains their diverging fortunes?
Drawing on an examination of dozens of rapidly growing ventures and our experience teaching courses on scaling up enterprises at our respective business schools, we’ve concluded that what made the difference was that King Digital Entertainment engaged in a developmental stage we call extrapolation, in which a company explores prof- itable growth options while exploiting economies of scale and scope. This stage isn’t part of traditional organization theory, which says that businesses are in either exploration mode or exploitation mode.
Exploration involves the search for product-market fit.
The company’s hypothesis about how it will deliver value is tested to determine whether customers have a problem to be solved or a pain point to be addressed—and are willing to pay for the company’s solution.
Exploitation begins when the fast revenue and profit growth enjoyed in the start-up stage slows and reverts to market norms. In this phase the company aims to strengthen its competitive advantage by fine-tuning the business model and strives to achieve incremental long-term growth and stable profits.
ABOUT THE ART
Sean Lemoine’s photos capture scenes at LDRS (Large Dangerous Rocket Ships), an event for rocket enthusiasts held in the Mojave Desert.
I D E A I N B R I E F
THE INSIGHT
In an often-overlooked stage of growth—
extrapolation—successful start-ups en- sure that each new customer brings in additional revenue and incurs only mar- ginal cost—the key to lasting, profitable growth. During this phase firms turn product-market fit into profit-market fit.
THE TAKEAWAY
To keep scaling up, a start-up or a new enterprise initiative must have a host of resources in place—such as a proven mon- etization approach, a strategy to exploit network effects, and robust capital resources. It must also be managed as an “ambi- dextrous” organization—capable of exploring new businesses while exploiting its existing core business—and systematically remove internal business-model constraints on growth.
THE CHALLENGE Many start-ups and new corpo- rate ventures that grow very fast never sustain profitability and hence scalability.
E N T R E P R E N E U RS H I P
Harvard Business Review
January–February 2023
59
These two stages are well-known—start-ups often begin with a bang, and a few seem to emerge as stable giants.
But in our view extrapolation is the often-overlooked but critical phase between exploring many opportunities and exploiting one.
During this stage start-ups pursue two goals. The first is to confirm the extent to which product-market fit shows that there is demand for the company’s offering. The second is to achieve what we call profit-market fit—to demonstrate not only that the venture can ramp up revenue rapidly but that every new customer brings in additional revenue and incurs only marginal cost—the key to profitable growth.
King Digital Entertainment, SoundCloud, and WeWork all proved the value of their offerings by achieving impressive growth in numbers of customers and theoretically were positioned for market dominance. But King alone was able to turn its top-line growth into comparable profit growth during the extrapolation phase. Each new smartphone user who downloaded the Candy Crush Saga app brought in revenue that went almost directly to the bottom line. SoundCloud, in contrast, never managed to develop a scalable and profitable way to monetize the enormous consumer audience it had built. WeWork’s problem, aside from the well-known contro- versies surrounding its ill-fated initial public offering, was failing to establish an increasingly profitable business model to support its global network of coworking spaces.
What is the key to successful extrapolation? It demands new ways of thinking about strategy, operations, financing, and speed. It also requires approaches to organizational structure, culture, and talent that are distinct from those of the other two phases. Start-up and enterprise leaders alike must consciously treat extrapolation as a specific stage in the development of any new venture or new-to-market offer.