I received the following question from rathin and thought that this a good question which cannot be answered in a short comment.

Hi Rohit,
Can you elaborate more on “Business scability”…Rakesh JhunJhunwala emphasises on that…
Can you also give one practical example of a company??

Rakesh Jhunjhunwala empahsizes the term ‘business scalability’ a lot in his interviews and presentations. Let me try to give my understanding of of the term

I think business scalability should be analysed based on two key factors

  1. Market opportunity – How big is the addressable market, the company is trying to target
  2. Business model – How scalable is the business model in its ability to tap the above opportunity profitably

Let me expand further on the above two points via some examples

Lets take the example of Bharti or any other similar telecom company.

Market opportunity – The market opportunity is case of telecom is huge. Telecom services are still far below international level and even after years of hyper growth, there is still a large untapped market. Market opportunity is easier to identify and one can compare the indian market with other markets to get a sense of it. However the fallacy by most analysts is to take a direct linear estimation. For ex: for argument sake US consumes 20 Kg of choclate per capita per annum. India’s per capita consumption is say 100 gm. so the market opportunity is 200 times that of US.

This is a very simplistic approach and should be taken with a pinch of salt. There are far more variables involved in evaluating market opportunity and a range of values for most products and services should be considered.

Business model – This is far more complex to analyse. This is where the genius of investors such as Rakesh jhunjhunwala is apparent. They are able to evaluate the business model far in advance and are able to judge if the business model of the company can scale profitably.

For ex: In case of telecom, there is a huge upfront investment in the infrastructure, license, setting up the marketing infrastructure etc. However once these investments are done, incremental cost of gaining a Rupee of revenue is low. Such business models are far more scalable

To get technical – The marginal cost remains steady or reduces in scalable models. Such companies get more profitable as they grow.

In contrast lets look at IT companies. It is apparent that the market opportunity is large. However the business model is not as scalable as Telecom. Here the relationship of revenue and cost is at best linear. In some case there may be a disadvantage to the scale. As the company grows larger, you need to manage more employees, have more layers and there are other costs involved in managing such large organizations. The top tier IT companies now have 100000 employees . A 10% CAGR growth for next 10 years , which is not a high assumption , would take the employee strength to 1 million plus. So you are talking of model which is not as scalable as Telecom

Lets take an extreme example of a roadside eatry. The addressable market is big. However the business model is not scalable as the eatry can only serve limited geography and may be limited by the competency of its owner and the employees running it. However if the owner can develop a franchise and start licensing it, then the model is scalable. Alternatively if the owner can brand its product then it is scalable to a certain extent

Among the two factors discussed above, I think the more crucial aspect is the scalability of the business model and how competent would the management be in tapping the external opportunity.

Next post: How does scalability impact valuations ?

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