Using Porter's 5 Forces to determine what makes businesses scalable

Source: ChatGPT

Porter's 5 Forces is a framework used to analyze a market and evaluate it's competitiveness. (Investopedia)

They include:

1. Power of buyers

2. Power of suppliers

3. Threat of new entrants

4. Threat of substitutes

5. Rivalry amongst competitors

With that in the back of my head, I considered what makes a business scalable, and found myself coming to three drivers, using a "back of the envelope" approach:

1. Feasible unit economics

2. Economic value creation

3. A sustainable competitive positioning, in an attractive market

Diving into each of those one by one:

1. Feasible Unit Economics

Business Model (Operations)

• Viable volume targets, at realistic price points, to satisfy break-even thresholds and profit expectations.

• Repeatable processes

• Limit in operational bottlenecks

Revenue

• Incremental revenue gets easier to produce (network effects, sticky customers, repeat buyers etc.)

Costs

• Diminishing marginal costs per unit. I.e., costs (can eventually) stay (relatively) fixed, as volume scales; or there's an ability to negotiate variable costs lower as scale increases.

2. Economic value creation

There needs to be value, demand and utility.

3. A sustainable competitive positioning, in an attractive market

Taking those one at a time,

• Sustainable competitive positioning - a defendable competitive advantage (moat); and unique capabilities, essential to output, that are difficult to imitate.

• in an attractive market - Structural tailwinds, with a total addressable market that is big enough and growing

These would allow for a strong negotiating position with buyers and suppliers, as well as head starts and tools to defend against new entrants, substitutes and competitive rivalry.

ClassPass, a short case study

With some (unusual) time on my side, I looked for ways to explore the city I recently moved to. But in a way where I can leverage the situation, into more of a two-for-one-special type of scenario. I came across ClassPass, a subscription-based service/ platform, that allowed me to try out a bunch of different classes, and be working on wellness, fitness, social and a little bit of adventure (makes trying out something new, easy).

Reflecting on that value creation, made me empathize with the core importance of utility and demand. I could see why people would want this, the problem it solves and why it's useful.

They have a strong competitive positioning, as online marketplaces tend to benefit from the network effects that come from achieving scale first (First Movers Advantage). Thinking through the lens of Amazon and Uber, network effects were such that establishing a strategic position as the "go to" place to purchase, incentivizes vendors to "come to the party" with the lure of visibility, and the opportunity to connect with consumers, where they already are. Meeting consumers "where they already are" is of strategic importance. I also discussed this in a previous article, (LINK) where we saw Nike's shift back to brick and mortar distribution after overcommitting to D2C. And the decision to do so, being guided by meeting consumers "where they already are". On the consumer side of the equation, there is a benefit from optionality and a competitive offering. The effect of this strategic positioning offers an example of a defendable competitive advantage and essential capabilities (scale) that are difficult to imitate.

With wellness on the rise, there is a strong and growing consumer demand story to tell, especially in a lifestyle city like Vancouver (I just started using it and, I'm a fan). These are structural tailwinds, in an attractive market with willing buyers.

Being a software company tends to present favorable unit economics. Data accumulation allows for a head start in providing a more streamlined and personalized experience, through UI updates and customer analytics. With the correct execution, these effects tend to compound and make incremental revenue easier to produce. And with most of the costs occurring upfront (building the software), costs tend to stay relatively fixed, as sales volume increases (don't have to build a new factory, deal with physical inventory at scale etc.).

As I experimented with something new and applied my framework in real time, ClassPass became a useful case study. It prompted a broader question: what truly matters as businesses scale - and what criteria I use to form a humble opinion (that's not investment advice) on the systems that create environments for businesses to scale durably.