Big Bet Versus Scale Businesses

There are industries which are focused on creating a blockbuster. Movie studios, video game companies, and venture funds are all examples of industries that rely on outsized returns on a few properties to generate a majority of their profits. While looking for each “blockbuster” losses are generated on bets that don’t pan out.

On the other hand, there are the companies that focus on selling millions of units and getting a little bit of money from every sale. Examples for this type of business include clothing, retail, and running ads on a website. These are all ideas where money is made based on the idea of scale or reach. By getting a small amount from as many people as possible, the goal is to receive enough nickels and dimes from everyone to make a fortune.

Each side has its own pros and cons. For a blockbuster industry, it’s important to accept that you’ll most likely be losing money on a majority of deals. For venture funds, I’ve heard numbers ranging from half to80%, which can be hard to swallow for many. However, when that blockbuster finally hits, the rewards are otherworldly.

On the other hand, if you’re a scale business you can rest easy knowing that you’re making money on every unit sold. However, you’ll never get that 10X return that can be common in a blockbuster industry. In addition, you’ll be at the risk of being commoditized. Abstraction is the way of the world, and it is especially true in retail. From Sears came Walmart, and now we have Amazon. Notice newspapers: the money is falling out of the industry because the internet does what they do better.

I’m not sure which option I prefer. Each is optimized for it’s specific field; predicting what startup will generate those 10x returns is neigh impossible, thus it’s built on making lots of bets. Trying to find a series of small yet profitable investments doesn’t fit with how the business is run. Similarly, there are some clothing companies that focus on making outsized returns ¹ but clothing and style often aren’t defensible. Is buying a four hundred dollar shirt worth it when I can buy a similar shirt for a tenth of the cost? The type of business follows the incentives of the industry.

It’s also important to realize what type of company you’re currently in, and optimize accordingly. If you’re in a scale based business, focus on decreasing price to increase revenue. Meanwhile, if you’re in a blockbuster business, focus on finding the blockbuster. Don’t hang out in the middle, scoot to either side of the bell curve.