Today we're going to a little deeper and talk about the concepts of growth, leverage and scale in your business. What are they? When is growth good, and when can it pose some risks (yes, it can!)? What is leverage and how do you use it in your business? And we've all heard of "scaling" a business but what does that mean exactly and how do you know if your business is scalable?
Leave us a comment with your experiences and let us know if this episode has been helpful for you!
Pamela: Hey everybody it's Pamela
Tracy: And this is Tracy
Pamela: And we are here to discuss How Business Really Works.
Tracy: Today our topic is growth, leverage, and scale. Do you know the difference and how they affect the profitability of your business?
Pamela: So Tracy, what are the differences between growth, leverage, and scale?
Tracy: So growth is when revenue increases but the cost to create that revenue increases at the same percentage. So for example, let’s say you have a business doing one hundred thousand dollars a year and it costs you fifty thousand dollars a year to produce that. You’ve got fifty thousand in profits. Well if you grow evenly then you are going to get to the point that let’s say you are doing a million dollars a year in revenue. It’s going to cost you five hundred thousand dollars a year to produce that revenue and your profits are going to be five hundred thousand dollars a year.
Now everybody would love that, right? I would love to go from making fifty thousand dollars a year to making five hundred thousand dollars a year.
Pamela: Yes definitely. It’s a good problem to have.
Tracy: But the problem with that kind of growth is sometimes you can actually go broke. We’ll explain that in a minute.
Now leverage is the use of a tool or system to make work possible, faster or more profitable. So, Pamela what’s an example of leverage?
Pamela: Example of leverage would be money. You know you have money you need to put in your business to make it go and make it grow. So that’s a very basic example. A technology example would be a platform such as WordPress that you run your website on. You choose this platform and you create your website on the platform. But the WordPress platform is the thing that enables you to create your site and grow it.
[Time – 2:00]
Tracy: Yeah and the nice thing about it is it also produces scale.
Tracy: Now scale is when revenues increase but the cost to produce those revenues stays at the exact same level or only increases at a lower percentage. So using our previous example, you’ve got one hundred thousand in revenue. It’s costing you fifty thousand to create it. You’re profiting fifty thousand. As you scale, you’re going to go to that million dollar revenue, but maybe the cost of producing that only went up to two hundred thousand dollars. So all of a sudden now we’ve got that eight hundred thousand dollar profit.
So in this case, your profit margin increased because you have scale.
Tracy: Now, in using Pamela’s example of your WordPress site. Why does a WordPress site scale? Because it doesn’t matter is a WordPress site is receiving hundred visitors, a thousand visitors, ten thousand visitors. As long as your hosting package can handle the volume,…
Pamela: I was going to say as long as your hosting is good.
Tracy: … your WordPress site is going to expand exponentially without more costs involved.
Pamela: Another great example of scale is an eBook. Like the eBook that I have mentioned on previous episodes. Many people have written eBooks for Kindle. I can publish it once on the Kindle platform and millions of people could download it. I should be so lucky, but millions of people could potentially download it without affecting any input from me. So if I sell one copy or one million copies, I still put the same amount of work into it, so the profit margins can grow exponentially for me the more copies I sell, because my costs aren’t increasing.
Tracy: True. Even though you are paying Amazon a commission, it the same commission every time.
[Time – 4:00]
Pamela: Yes that’s true. That’s right the commission doesn’t go up with the number of copies you sell.
Tracy: Actually I think sometimes it comes down.
Pamela: Oh interesting okay.
Tracy: But, it’s nice because; do the work once, have the expense of doing the work once, sell an enumerable number of copies. So anything that is I guess digital, such as software, if you create themes for websites, plugins, any of that kind of stuff is just…
Pamela: Even short eBooks. You don’t even have to have a full-length eBook, just these PDFs I see people selling for ninety-nine cents. I’ve bought a few, some cooking ones over Christmas. Recipes that I wanted to try and they were ninety-nine cents. Real easy, very cheap. I bet they made a lot of money on those because a lot of people will buy at that price.
Tracy: Yeah, software, even platforms. You take like a Facebook is a huge example but you take some of your simpler things like Feedly. I use Feedly a lot. Hootsuite, any of these quote unquote tools that you use in your everyday life, it doesn’t matter how many more clients they take one. Their only real expense in taking on those extra clients is really bandwidth.
Tracy: So they created that product, that software one time and those expenses don’t really go up. The only thing that goes up is the cost of delivering those products. So that is a very scalable business.
Now, what are some businesses that really aren’t scalable?
[Time – 5:45]
Pamela: We were talking about the example of a carpet cleaning business. Now you can grow that business, but does it have scale of the kind that we just described? No, it doesn’t. And the reason it doesn’t is because say my carpet cleaning business serves one hundred people perfectly with the number of employees and the amount of equipment that I currently have. And those a hundred customers are just very satisfied with the service I am providing, so word of mouth is spreading and now more customers are coming through the door to have their carpets cleaned.
Well for the next one hundred customers I get in the door, I have to add equipment and possibly add employees, probably add employees actually. So my costs, my input, the cost that I am putting into the business, in order to serve those extra one hundred employees (should be customers) are going up at the same time my customer base is going up. So yes, I’m growing, but it’s not scale. It’s growing in a linear fashion where my inputs are tracking with the output.
Tracy: And actually, you know, in a way, your example kind of reminds me a little bit more of manufacturing, because to me manufacturing is a business that’s got a major scalability issue.
Pamela: That’s true.
Tracy: It scales for short periods of time, but then it hits that wall. And when it hits that wall that’s when you can go bankrupt. So, the faster you grow, sometimes the easier it is to hit the point of bankruptcy if you are in a business that can’t scale exponentially. So for example, with your example, that expenditure of more equipment, more employees, and that, has to be made really before that next one hundred customers. It has to be made with only an extra ten or twenty. And then you’ve got some scale because you’ve got some room to grow up to that one hundred. Then we hit a wall again and we have to put a front outlay of capital to get it going.
Now capital can be leverage, because I spent the money to create more capacity. But if you’ve not been managing your finances well and you’ve not been managing your cash flow well and your demand is highly rapid, the demand can sometimes outpace your ability to fund that demand.
Pamela: That’s right.
[Time – 8:10]
Tracy: And you’ve heard all these stories about “they grew so fast they went bankrupt”. And that’s how that happens. And you’ll see that in manufacturing where they are working twenty-four hours a day, running three shifts. The machines are going, going, going. The demand is there for more output and it physically cannot be done. And all of a sudden a manufacturer has to come up with the ability to lay out capital for a hundred thousand dollar piece of manufacturing equipment.
So if you're; we’re not saying those are bad business models. We’re saying if you have that business model, you need to understand scale; you need to understand growth patterns and you need to know how to manage your cash flow and your growth. Sometimes you have to throttle your growth back purposefully so that you don’t go bankrupt.
Pamela: And understand that, in my carpet cleaning example, those extra hundred customers are not guaranteed. You may be projecting those, and your projects may or may not be accurate, depending on what you are basing them on. But, that future revenue is never actually guaranteed. You’re betting and it might be a safe bet, but it’s not a sure thing. So those customers may not come through for whatever reason. Maybe we hit a bubble in the economy just when you bought that equipment and people don’t want to spend extra money on things like carpet cleaning.
Tracy: That’s true. I mean you could be a whiz at analytics. You could know how to analyze the potential, but there’s always things you can’t control such as another competitor coming into the market. Such as one of your employees doing something that just screws your reputation royally and you have to have the time to recover from that.
[Time – 9:53]
So although you can look at prior sales, you can look at demand, and you can look at all these things and justify that there needs to be the next expenditure of capital to increase your productivity and your scalability, you also have to make those with a little bit of a; I hate to use the word pessimistic, but you got to have that touch of…
Pamela: Well with some caution.
Tracy: Yeah, caution. You have to go “but what if?” What if another competitor opened up? What if something really went wrong? What’s my timetable to recover?
You know the nice thing about it is if you got a great reputation, one screw up by one employee is not going to kill you. It’s just going to take you a while to soothe everybody’s feathers and keep moving on. We all know that somebody will say something negative about you faster than they will say something positive.
Pamela: That’s true.
Tracy: So anytime something like that happens it’s a blip on the radar that you have to actively handle and fix, but keep those things in mind. I don’t want to say expect them. I don’t want to say be pessimistic. Always be optimistic but judge.
Pamela: Well there’s that saying that goes hope for the best but prepare for the worst.
Pamela: That is sound business practice.
Tracy: Alright, so we’ve kind of described leverage, scale, and growth. Now, what are some of the signs in your business that’s just sitting there blinking at you like a big red light going “you need to leverage”?
Pamela: Yeah, how do I know when I need to create more leverage and there are a bunch of signs that we want you to be aware of. So the first thing is if you are doing the same activity over and over if you are constantly adding new inventory to your e-commerce store.
[Time – 11:53]
Tracy: Well if you find that you as the business owner are doing the same thing over and over and over again. Then it is time to create a system. Instead of it being your knowledge and your brain power, your skills. You need to document that, create a training program and hand that off to somebody else. You don’t need to be doing the same thing.
You are the most skilled, the most talented person in this business. You’re the dreamer, the believer, the visionary, so you need to be spending your time on growing that business, making sure there’s leverage in your business, figuring out how to set your business up where it can scale. You don’t need to be the person that is doing this task repetitively.
Pamela: Right, the repetitive work you could easily set up a system for or train someone else to do.
Tracy: Right so a system is a tool of leverage.
Pamela: That’s correct, yeah.
Tracy: So other tools of leverage: money, money, money, money. We all love money, right? But there’s this four letter word that goes along with money that everyone hates, it’s called debt. And I’ll admit, personally debt is a horrible thing. You should never be in debt personally. But debt is a fantastic tool for business.
You take the manufacturing example I gave just a minute ago. The ability to borrow that hundred thousand dollars to buy that new piece of equipment at a low-interest rate usually makes a lot more sense than taking it out of your capital.
Now, you have to know, you have to measure at what rate will my production go up to pay for this piece of equipment. How long will take me to pay for this piece of equipment? What will my costs of that debt be over that time period? And will it be profitable for me to take on the debt rather than using my own cash?
[Time – 13:58]
Tracy: And in today’s market, most of the time debt is profitable. But you only take on debt when there is known revenue to pay the debt. You don’t take on debt because “I want to start a business”.
Pamela: And we’re not talking personal debt.
Pamela & Tracy: We’re talking business debt.
Pamela: Difference, big difference. Personal debt: bad. Business debt: good or can be good anyway. If you know, like Tracy said: if you know how to properly handle it and have a plan to repay it, and you’ve got the revenue to repay it. So yeah, debt is definitely a type of leverage.
Tracy: Well here’s an example of why debt personally is bad, debt business is good. Debt personally; you might be able to afford the payments out of your current income, but guess what? You just took away from a lot of other things to do that. You got rid of your expendable cash that you can use for entertainment, anything you want to do, putting away for savings, whatever. It’s now gone to servicing debt.
In business when you take on debt, you don’t take on debt that you are going to pay for with current revenue. You take on debt that is going to create new streams of revenue that will pay that debt.
Pamela: So personal debt is really just sucking your reserves and your income with no return on it really and business debt is something that you can, as we say, leverage to actually build more in the future.
So the next sign that you need to create leverage is if your business won’t make money in your absence. It’s time to create some leverage for your business.
Tracy: And this again goes back to systems, technology, machinery, these are all tools for leverage.
Pamela: It’s a big problem with consulting. Because you know I do consulting. Freelance right now and I’ve done consulting as a full-time consultant in the past and basically, if I’m not on the job working there is no income. That’s just the way it is in a consulting firm.
[Time – 16:03]
Tracy: True. And that’s why a lot of consulting firms, they are agencies and if your agency was properly set up, no one person could affect revenue. On other words, the work that Pamela would be doing would be so well documented that if Pamela suddenly comes down with the flu and is just sick beyond sick and can’t even raise her head up off the pillow someone else can pick up all of Pamela’s data and continue on for that client. That’s a system. There is a system of documentation. There is a system of training within that agency where any; well let’s not say, anyone, because obviously the secretary would not know how to be a consultant, but any of the consultants in that agency has the training to pick up where Pamela stops. Pamela stops on Tuesday afternoon; someone else with a few hours of review can pick up on Wednesday morning and continue her work. That is a system.
So understand very closely how important systems are for your business. There is a great acronym for system. It stands for saves you stress, time, energy and money. Remember that. A system is the most important thing you can have in your business. It saves you stress, time, energy and money.
I need to get a t-shirt with that on it. So you’ll find as you follow us that I am a; I have a major love affair with systems.
Pamela: Yes she does.
Tracy: I systematize everything. I tell Pamela all the time that if we are going to run a successful business; if I drop dead tomorrow, there are enough systems in place that she knows how to pick up and do the work I do or hire somebody to come in really quickly and take over. It should not be a blip on the radar.
[Time – 18:03]
Tracy: Really a well scaled, well-systematized business even the CEO’s absence will not affect the ongoing revenues and movement of the business.
Pamela: Alright just to recap the sign number two that you need to create some leverage in your business is if in your absence you stop making money.
Pamela: So point number three: your revenue has plateaued; time to create more leverage.
Tracy: Yeah and that kind of goes back to the carpet cleaning example.
Pamela: Yeah exactly, yeah.
Tracy: We have reached our maximum capacity. Our people, our equipment, nothing can produce more. We are flat-lined. We can only earn this one amount of money.
So at that point, you’ve got to come up with leverage. Whether it’s a capital expenditure, whether it’s the use of some; well, let me clarify here, the use of your own money really isn’t technically leverage. You need to be using someone else’s money to make money. That’s leverage.
Pamela: Hey Tracy can I borrow a thousand dollars?
Tracy: Sure Pamela, I love giving my money away.
Pamela: I’m going to create some leverage out of it.
Tracy: So whether it’s to go borrow the money and take on the debt because we know the revenue will be there to service that debt. And even using your own money to buy machinery or buy technology, if it can create significant scale, then that is leverage also.
It’s interesting you can grow without leverage or scale, but you can’t have scale without leverage.
Tracy: So, alright, what is the other sign that you need to leverage?
Pamela: Well if I am putting my heart and soul, all of my blood sweat and tears into this business and I’m still feeling stressed and I don’t have time to get all the things done that I need to get done to service the business, then it’s time to create more leverage.
[Time – 20:03]
Tracy: Yes, and I hit this wall quite frequently.
Pamela: I think it’s a common problem.
Tracy: It really is a common problem. There’s so many opportunities in front of you as a business owner, you can’t do it all. You’ll hear every successful business owner tell you that, you can’t do it all. We’ve done an episode on the fact that
Pamela & Tracy: you can’t do it all.
Tracy: You have to have to have people around you. You have to build a team. And I know it’s scary if you like a startup. It’s like oh those are major expenses. I want to keep my expenses as low as possible. But you have to be able to judge when the stress level gets to the point that you become less productive, when there’s opportunities out there you’re having to pass up because there’s just not enough hours in the day, it makes sense to bring on that person, so that you can take advantage of those other opportunities.
Now, I hear this all the time: “It just takes so long to find a good person and to train them that I might as well just do it myself.” Well, you know what that tells me? You don’t have a system for finding good people. You haven’t created a training system that allows you to train people without your direct one on one involvement. When you’re doing a task that you do over and over and over again, start documenting it, record it, do a screen share, write down every detail of what you do. Put it in a document, put it in a video, put it in some way that you can hand this off to somebody and they can do it.
Great test of whether you’ve done that correctly is to get your kid or your spouse or best friend or whatever, to attempt to do this job. See where they get hung up, that’s where you know you need to fix your training material because the nice thing about it is when you do hire someone, you’re going to hire someone with some skills and some knowledge in this area. So if someone who doesn’t, you know your kid, your husband, your friend, finds an inability to continue on and you’ve fixed that, then you’re never going to have to work with that person that you bring in as an employee that you’re paying. They will self-train.
[Time – 22:16]
Okay, there is one warning we want to give you about systems. They’re not a bureaucracy. A system is supposed to allow you to work more efficiently, to make more profits in the same about of time. It is not the be all, end all, one answer on how to handle anything. You need to assemble a team that can work within a system but has the judgment and the ability to know that when this scenario doesn’t perfectly one hundred percent fit the system, I know how to judge, I know how to maneuver, I know how to still solve the problem and help the client.
Pamela: Right, you need to give your employees or your contractors enough leeway and trust them to make sound decisions in the absence of a perfect fit within your system.
Tracy: Yeah the systems there for guidance, the systems there for efficiency. The system is not the one answer.
Okay Pam, so now we’ve gone overgrowth. We’ve gone over leverage. What it is and the signs you need it. So now let’s discuss scale a little bit more in depth. Is there signs that you know you have scale or don’t have scale?
Pamela: Yes there are certain signs that you have scale or can scale your business or should be scaling your business that we’ve identified for you to keep an eye out for in your situation and the first one is: How much unused capacity is there in your business?
And capacity could mean any number of things, depending upon the specific thing you are talking about. It could be technology, it could be human capacity, etc. but you need to measure it to tell how much capacity you have and how much there is unused.
[Time – 24:01]
Tracy: Yeah and we talked previously about you know a WordPress or a digital product that has unlimited scale.
Tracy: It’s only limited a lot of time by the platform it’s delivered on.
Tracy: So as you will notice as we discuss scale and sometimes there is unlimited scale, which is something you should always be looking for an opportunity in your business. But then the most important thing as a business owner is you look at, I can scale but then I am going to reach a wall. How do I make sure I don’t ever reach that wall? How do I keep applying the ability to scale into my business?
Now one of my biggest pet peeves and I just laugh my ass off because how big of an idiot can you be, when you have this great website. You’ve used WordPress. You know it can handle a large number of people but your hosting can’t. And I see this all the time on Shark Tank. These people go on Shark Tank and they know months in advance what their air date is, they know whether they got a deal or not, they know how the sharks reacted and what the probability is that people are going to have an interest in this and yet their episode airs and boom, their site goes down because of too much traffic. Now I’m sorry…
Pamela: They didn’t plan ahead for that capacity.
Tracy: They didn’t and you know as a business owner you have to think of all these things. Is the scale available? You know it was alright when the first person did that but when person after person after person after person comes on this TV show and makes the same stupid mistake. I’m sorry, pick up the phone, call your hosting come and go “Hey, I’m going to be on Shark Tank on this date. My traffic is probably going to quadruple. It could be a hundred, tens of thousands, hundreds of thousands, a million people in a twenty-four hour period. Are you going to be able to handle that for me? What’s it going to cost? What do I need to do? Yes, I’m not going to maintain this. I need this bandwidth for a short period of time. Can you do this for me?”
[Time – 26:05]
Pamela: And there’s actually an easy way to do this yourself without having to call hosting company if you are just getting set up. You can get on AWS, Amazon Web Services. Get an account with them and host your site there and set your; you go into your panel where all your control panel is and you can set it up to where it automatically scales however many servers you need based upon your traffic. So it will react almost in real time to the traffic that is coming into your website. It will scale up your capacity when it’s high. It will scale it back down when it’s low so you’re only using and paying for the capacity that you use and you don’t even have to get on the phone with your hosting company because AWS does it all for you.
I’m a fan of AWS. You know, I ‘m not formally affiliated with them. I just think it’s a great technology solution to that problem.
Tracy: Capacity should be elastic. And you as a business owner should always be taking capacity into consideration in all your business decisions. The ability to scale, the ability to be flexible, the ability for your business to be elastic, to increase and decrease in production is vital to the success of your business.
Pamela: So to recap this episode, we have talked about growth and defined what it is. We talked about leverage, defined what that is as well as scale and how these things work in your business. How they differ from each other and how you should be using them. The different tools and systems that you can put into place that will help you move your business forward using leverage and using scale and achieving growth as well.
So we have a question of the day for you.
Tracy: Yes, we would like to know if scale is a consideration. Is it something you think about when you are making your business decisions?
Pamela: And if you haven’t thought about it until now, has this episode prompted you to start thinking about those things when you are going through your business operations?
Tracy: Yes, so if you’re watching this video, leave us a comment below. And if you are listening on the podcast, head on over to how business really works dot com and chat us up there. There’s plenty of places you’ll find where you can leave us a comment or get in touch with us.
Pamela: Please like and share this video. If you are listening on iTunes, we would love it if you would leave us a review. That will really help us get the word out about our podcast and help people like you grow their businesses. So please like and share and engage with us and we’ll see you next time.