Every business has two sides.
You might not know it yet, but your business will end up having two sides: one made of technology (which I call the “Southern Side”), and another made of tangible stuff and frustrating dealings with old institutions such as regulators (the “Northern Side”).
These two sides are clear opposites in many respects. For instance, the type of returns to scale they generate have a very different shape:
The Southern Side is dominated by software, hence it comes with everything good that software makes possible, including increasing returns to scale (the more you grow, the easier it is to grow further and to increase the distance between you and your competitors).
The Northern Side is about hiring more people, investing in more tangible assets, complying with more regulations. Hence it comes with diminishing returns to scale (the more you grow, the more exhausted you become, and you have to stop at some point).
That doesn’t mean it’s bad to have a Northern Side. In fact, no business can rely on software alone, and there’s a reason why every company that grows ends up building a Northern Side:
The Southern Side is about scalability, which is good. But if you start losing steam for one reason or another, soon enough competitors will catch up, race ahead, and you’ll never be able to recover your previous lead. Think: Uber stumbling in 2017 and reviving Lyft as a result.
The Northern Side is about defensibility, which is also good, if not better at a large scale! That’s because once you’ve hired more people and invested in more assets, it becomes difficult for competitors to challenge you. However, it also makes your business slower and more rigid.
Because each side has its advantages and contributes to a business’s success, I believe the strategic focus of any founder should be to analyze their business in terms of the two sides and then make sure they strike the right balance between the two. The benchmark here, as often is the case, is Amazon:
While returns are clearly diminishing on the Northern Side, the opposite trend — increasing returns — is at work on the Southern Side. For Amazon, every new warehouse costs more than the previous one, especially because it has to be located closer to the city so as to shorten delivery time (= diminishing returns). But the new customers that this warehouse will enable Amazon to serve will drive more than revenue: as they join the experience made possible by the architecture of participation on the Southern Side, they create value for Amazon through many channels: revenue, higher volumes, network effects, machine learning, and content-driven virality (= increasing returns).
Obviously the kind of balance you seek depends on the sector you’re operating in. Google long had more of a Southern Side because it was all digital content. Amazon, on the other hand, started with labor-intensive fulfillment centers on its Northern Side, which made it more difficult to scale up fast—but eventually acted as a rather high barrier to entry, protecting Amazon from the competition.
The balance between the two sides also determines which kind of investor you should talk to. Businesses that tilt toward the Northern Side have lower returns to scale but are also more easily defended, thus they’re a good fit for investors that prioritize lower risks over outsized returns. Conversely, businesses more exposed to the Southern Side have a higher probability of failure at every turn, but success also means outsized returns on invested capital—which is why most of these companies are VC-backed.
We at The Family are glad to have that discussion about what balance you should strike between the two sides as your business grows. Do apply to join our next batch!