When a business model has the potential to generate growth in revenues significantly faster than its cost base, the business model is scalable. As growing revenues increases the operating margin, scalable business models have the potential for earning very high profits. The key to scalable business models is to have small Costs Of Goods Sold (COGS), and to get a demand driving revenues up.
Cost Of Goods Sold
COGS is the cost for each product or service, plus additional costs necessary to get the product into inventory and ready for sale, including shipping and handling, and is a variable cost associated with each unit sold. With low COGS, the contribution margin has the potential to increase dramatically relative to the fixed cost base, resulting in high profits. A product business with outsourced manufacturing can supply thousands of units with the same staff as it might supply hundreds of units.
A less scalable business model
When selling services per hour growth in revenues totally rely on personal output of staff, and there is a linear relationship between revenues and cost base. Growth is depending on the acquisition and retention of highly qualified people delivering the services, and those are not always that easy to find, even though there might be a high demand for the services.
A common example of a scalable business model is selling software. The development costs are high but once ready for launch, the costs for each new copy of the software is very low. When packaged and distributed in physical copies, software still has a COGS per unit.
The Internet enables zero COGS
Internet platforms with user-generated content, viral or word-of mouth marketing, and close to zero in costs for each new user has created very scalable and profitable businesses. An interesting example is Craiglist, a company generating estimated $100 M with less than 30 employees, having an operating margin of 90% . Another interesting example of scalable businesses is the rapid growth of companies producing virtual goods for online games and platforms. San-Francisco based Zynga apparently turned in 2008 revenues near $50M.
Designing a scalable business model is one thing...
It is easy to design scalable business models, especially using the Internet. It is not as easy to create demand and generate high growth in revenues. Perhaps the Internet bubble in 2000 was due to the fact that people only understood the first sentence?