The New Scale

I should save this for my cliche of the week, but its Tuesday and I can't wait to blog this until tomorrow.

One of the most overused cliches in the venture business is the word scale.

"It doesn't scale"

"They've reached scale"

"We are having scaling problems"

"There are economies of scale"

Etc, etc.  You get the point.

We all look for scale because scale is what generates returns.

In the old world anyway.

As Jeff Jarvis points out in a great post, scale doesn't mean what it used to anymore.

You cannot collect all the pieces of a marketplace in a centralized way and control all of it.  The technology won't allow that to happen.  You can't "get to scale" that way.

You must be open to others owning pieces of the equation.  You must let the users get the value of scale however the choose to create that scale.  You must facilitate the creation of virtual scale.

We had two conversations in the office yesterday that are good examples of this.

First, we were discussing the online news business with a newspaper executive.  He mentioned the the AP is considering pulling out of Google news if Google doesn't pay for AP's content.  After getting off of that call, we all agreed that the Google news reader won't suffer too much if AP's stories aren't part of Google news.  There are so many sources of news these days that Google news will still be a viable service with our without AP.  AP's scale is the wrong kind of scale.  Google's is the right kind.

Second, we were talking about financial markets.  For as long as there have been markets, there have been centers where all the participants need to get together and trade.  Call them exchanges, hubs, or trading pits.  It doesn't matter really what they are called.  They've been a critical piece of every market that has existed.  Soon that won't be the case.  Plenty of trades get done one to one these days because technology makes that happen.  There is still a need for some kind of centralized clearinghouse that provides price discovery and liquidity.  But technology will provide that to the market participants and everyone will be trading one to one with tools that create a "virtual marketplace".  The kind of scale that exchanges provide is the wrong kind of scale.  Bloomberg's is the right kind.  And even Bloomberg faces the possibility that its kind of scale will be the wrong kind soon as new technologies emerge to replace it.

So think carefully about the word scale when you use it next time.  Is it the right kind of scale you want to create?  If you go about creating the old kind of scale, you'll spend a lot of money and end up with some really bad economics.  Just watch what is going to happen to the AP.

Comments

[Keshava]

I know that the term has been over-used recently, but isn't this more of the "long-tail" phenomenon? It just seems like "scale" is no longer the volume of the hits, but rather the number of niches you can reach without additional overhead. AP might have one VC article a day, but my bloglines feeds me over 30 from various blogs. Therefore, for me, the value of scale of my blogroll is higher, even though it only takes 10 people blogging, over the 3000 reporters AP has.

[another.vc]

most simply what we usually mean by "scale" is high operating leverage. meaning, high gross margins after initial investment in R&D. in traditional software businesses, you invest plenty of money up front to build an interesting product, then you sell copies at 95% gross margins. that scales nicely.

in a traditional professional services model, every additional dollar you sell requires an additional unit of headcount (person-hours). that business doensn't "scale" well.

that's usually what scale means around our shop. some of the other examples fred gives here just don't make much sense. the AP's business scales beautifully. they pay a writer a meager salary to cover an interesting story, then they reprint and syndicate it, electronically and otherwise, thousands of times -- this is true of all content businesses with any significant audience/channel potential once those channels are set up.

what's described here in the AP/Google case is a low switching cost for google due to the wide variety of near-perfect substitutes for the AP's news coverage available for free or close to it.

but i wouldn't say the AP's business doesn't "scale" -- it's just increasingly competitive.

[Mike Sanders]

Fred

Are you forgetting about the risk assumption function of the centralized Clearing Houses/Exchanges? For Institutional Trades there is less need for this function, but when the little guy is involved, you need the middleman. And I doubt an EBay like model would transfer to stock transactions - certainly not in the SEC's eyes.

[Jarrett Collins]

Don't forget that before you can "scale" you have to get "traction." I know this is a tangent to your cliche, but can someone please tell me what traction is? If I hear one more presentation in which an entrepreneur tells me about all the traction his company has, I may attempt to jump out one of our office's non-opening windows. (One hint: traction appears to be inversely correlated to actual revenues...)

[Bill Erickson]

To further your point of scaling financial markets, according to a recent CNBC poll 83% of people think the NYSE should eliminate floor specialists and go all electronic. Here's a link to the article and poll: http://moneycentral.msn.com/content/CNBCTV/Promos/P114795.asp?ShowResults=1&HasVotedTwice=

[Ann]

For financial markets, there are times when they need some sort of middle-man or screener. A good example is IPO auctions - the type of auction that Google used has been tried in many countries over the last couple of decades. They sound great - just toss the shares out there and let them find their own market. But in practice, they've been risky and haven't functioned well, largely because no one is managing the process.

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