Replication Costs and Business Model Scalability

One of the things I like to think about when evaluating a business model is the cost of scaling it. For example, if a company is in the business of manufacturing and selling widgets, to grow sales it would need to produce more widgets and then sell them. A cost is associated with each additional widget sold. To produce and store more widgets, it would need to incur costs to increase production and warehousing capacity. These investments likely must occur before the number of widgets sold can increase. The widget company has high replication costs, which impacts the scalability of its business model (unless it has unlimited cash).

Conversely, if a company is a software-as-a-service (SaaS) business, it’s selling a software product that’s delivered digitally over the internet. Incremental sales don’t require producing more software. People can just buy the existing software at will. The software company can increase sales without incurring replication costs (for simplicity, I’m ignoring costs for R&D, sales, marketing, etc.). In an ideal world (which business isn’t), the software company has low, very low, or nonexistent replication costs, which means the business model is highly scalable.

Businesses with low replication costs and the potential for infinite scalability are intriguing. As I evaluate business models through this lens, businesses that don’t appear attractive on the surface become interesting opportunities, especially if their product or solution could be distributed digitally.