There’s no lack of sensational success stories in today’s startup culture. But when you really look at the stars of the startup world, it becomes apparent that we’ve begun attributing hype to success—not sustained growth and business fundamentals. Brands like WeWork, SoundCloud, and Jawbone all failed to capitalize on their growth potential and went belly-up. As it turns out, this is the norm for many startups. According to growth expert Bo Parfet, startups focus too much time on the bottom line during the scale-up phase, assuming their existing business model will continue to turn a profit as they grow. And they devote too little time to developing a sustainable growth model by engaging in a process called extrapolation.
Bo Parfet is Chief Growth Officer at DLP Capital, a real estate solutions provider, and he is the founder/CEO of Denali Venture Philanthropy. DVP seeks out and funds startups that aim to make a difference in the world. This has provided Parfet with unmatched experience managing growth for companies of all sizes and in a variety of market conditions. Having worked with many promising startups, Parfet has realized that failure often results from skipping a critical step during the scale-up phase.
What Is the Scale-up Phase?
The scale-up phase of a startup’s life is a bit like its adolescence. It’s the growth stage between the frenetic childhood of a startup, when customers and profits surge, and its adulthood, when it grows into a mature company with long-term targets, tested processes, and a permanent organizational structure.
The scale-up phase usually involves:
- Finding a product-market fit.
- Expanding the customer base.
- Developing new sources of revenue.
- Optimizing processes to lower costs.
But according to Bo Parfet, this process excludes a critical step. To achieve sustainable growth, companies must reevaluate and potentially reconstruct their business model to reduce variable unit costs and fixed costs while still boosting revenue. This process is called extrapolation.
Extrapolation: The Missing Link to Start-up Growth
Extrapolation is a rigorous auditing phase determining a company’s path to sustainable growth. Instead of simply ramping up sales and marketing, which is what most consider scaling, extrapolation takes a step back and examines the implications of each sale as the company grows.
Bo Parfet says that traditional scale-ups optimize the product-market fit, but extrapolation determines the profit-market fit. What that means is that it demonstrates how each new customer will bring in net gains and incur marginal costs during the scale-up phase and beyond.
WeWork is an example of what happens when extrapolation is ignored. The company “scaled” by opening locations around the globe but realized too late that its operating expenses far outweighed its profitability at scale. Because the company didn’t extrapolate, it scaled itself to death.
The Extrapolation Process
How does a company determine its growth potential—and predict drying revenue streams—by engaging in extrapolation? Bo Parfet suggests the following five steps.
- Define your growth goals: Where do you see your business in 5 years? Ten years? Write down your specific growth goals and ask yourself if you currently have the means to achieve them. Next, determine what you need to achieve those goals and the costs incurred.
- Identify assumptions about your business model: You may have to deconstruct your business model to grow. In order to do that successfully, you’ve first got to dismantle assumptions about how your model functions. Boil your model down to its absolute necessities and leave everything else open to change.
- Locate barriers to growth: What will prevent you from achieving your long-term growth goals? If you identify these barriers now, you can remove them before they become potentially disastrous. For example, you may realize that the current geographical market in which you operate is too small to remain profitable after market saturation.
- Develop strategies to overcome growth barriers: Brainstorm strategies to work around growth barriers and develop a plan to implement them before growth stagnates. This may require drastic changes to your business model.
- Reassess to identify new barriers: Once changes have been made to remove certain barriers, you can’t assume that your road is now barrier-free. The altered path may contain new barriers that arose as a consequence of removing others. This is why Bo Parfet suggests removing one barrier at a time (i.e., making small alterations to your business model) and then returning to step one of the extrapolation processes.
Why Don’t More Start-ups Perform Extrapolation?
It’s no surprise that most startups fail. Most don’t have a good enough product offering or strong enough leadership to break into the market. What’s more puzzling is why so many startups with proven product-market fit fail to scale. They have the funding and the staff, so why don’t they extrapolate?
The primary reason is that extrapolation is slow and resource-heavy. Bo Parfet says that extrapolation takes between 1-3 years to complete successfully. This is a problem for up-and-coming businesses, as even successful startups are faced with huge pressure to maintain momentum and grow fast. According to the founders of the failed startup Wantful, anything less than hyper-growth won’t attract the late-stage funding needed for survival. Unfortunately, this creates a dilemma in which companies must choose between failing now and potentially failing later.
Nevertheless, extrapolation is essential. It may seem like a lengthy process, but remember that it occurs during (and as a part of) the scale-up phase. But this begs the question: How do you extrapolate while maintaining sufficient growth?
Maintaining Growth Momentum During Extrapolation
According to Harvard Business School senior lecturer Jeffrey Rayport and growth expert Bo Parfet, businesses that pass the fire test of scaling up must be “ambidextrous.” This term originally referred to a person who can use their right and left hands with equal effectiveness. In this case, it refers to companies that can reinvent and refine themselves (through extrapolation) while still executing their current core business strategy.
Ambidextrous companies mustn’t be micromanaged. They must remain flexible in order to adapt to current market trends, grow sales, and extrapolate. Successful startups accomplish this by breaking large teams into small, autonomous groups. Smaller teams led by qualified managers are able to alter their business model and adapt to market conditions without getting bogged down by the overarching organization. This increases the agility of a startup exponentially, allowing teams to extrapolate their processes according to their needs and incorporate current and long-term growth strategies into their day-to-day.