13 Conference Report #techonomy13

Beyond Scale-up: Growing Software Companies Into Billion Dollar Giants

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  • (All photos by Asa Mathat)

    (All photos by Asa Mathat)

  • Techonomy 2013 - Tucson, AZ
Speaker

Kara Sprague
Principal, McKinsey & Company


Software is no longer designated to a single industry—it has become embedded in the processes of every company going forward.  How, then, does a company achieve scale and sustained high growth in a time where creating a company can require only a week?  What are the phases seen in high growth companies, and what traits do they share?

Read the full transcript below. (Transcript by Realtime Transcription.)

Sprague:  I’m going to share with you today some highlights from the work that we’ve been doing recently looking at growth in software and online services.

But first some context. Why does this matter? Why is this important? Why am I talking about it? This matters because if you believe, as we do, every company going forward will have to be a software company to thrive in some way. We’ve talked a lot about innovation and disruption. Well, much of that is happening in software and online services.

And finally as we think about leaders, as important as it’s going to be for them to understand the impact and potential of technology on the demand side, it will be equally important for them to understand the dynamics on the supply side.

So what did we find? I’m going to take us through four findings. First, and this is not a surprise, growth rate matters and it matters a lot. What was a surprise to us was how much it actually matters.

So, first, when we looked at companies that were growing greater than 60 percent when they were achieving $100 million in revenue, they returned five times greater returns to their shareholders than companies that were even growing at 20 to 60 percent.

A second thing we looked at was how important revenue growth is relative to margin. So when we looked at companies, for example, that grew from less than 20 percent to greater than 20 percent, they achieved 2x the market cap impact than companies that improved their EBITDA from less than 10 percent to greater than 10 percent. And we also looked at what happens when you stall, because 85 percent of companies, after they reach $100 million in revenue, stalled their growth and never returned to their prior rates. Well, 30 percent of those can actually reignite it at some point in the future.

And then finally what happens when you decelerate? It’s actually far more painful to decelerate than it is to accelerate, in fact, by 2x. So companies that decelerate had a 2x impact on their enterprise value than companies that were able to accelerate their growth by the same amount. So growth is super important.

I’m going to talk a little bit about this 5x return just so you can get a little sense of the depth. So we looked at three segments of companies that achieved 100 million in revenue. The first one we called the accelerators, and these are guys that are growing at greater than 60 percent when they reached 100 million in revenue. That was about 10 percent of our sample. When we looked at them three years later they returned 20 percent return to their shareholders.

The next thing that we looked at we called growers, and these are the guys that were growing between 20 and 60 percent. Again, these guys were about 30 percent of our total sample, and we looked at the return to shareholders, it was at 4 percent. So there’s that 5x I was talking about. It’s the 4 to 20 percent. And, finally, the last segment, this was the large majority of the companies we looked at. We called them stallers, and they weren’t actually stalled. They were still growing but at less than 20 percent, 60 percent of our total sample size, and when they returned to shareholders three years later it was negative 18 percent.

The second key finding from our research is that sustaining this growth is very, very hard. When you actually look at companies, and we took a database of companies that went as far back to 1980, there were about 3,000 companies in that database, only 28 percent of those guys reached $100 million in revenue. And then it got even more difficult. Twelve percent of those that reached $100 million in revenue ever made it to a billion. Then 18 percent of those made it on to $4 billion. In fact, when you look at the number of $4-billion software companies today, there’s only 17 of them.

So what enables sustained high growth? We can boil it down to five things. The first thing is the market. You’ve got to pick the right market, ideally one that has what we call limitless potential, meaning there’s millions of potential customers that you can monetize.

Second important factor is the monetization model. Your market doesn’t mean much if you’re not actually monetizing that limitless potential, which means you want a monetization model that’s going to scale with the market. The third important factor is rapid adoption. Rather than going after the big white elephants or the huge reference stories, we found many successful companies found a grounds full of support by going after smaller companies and more rapid broad adoption. Next one was stealth. Stealth is important because in an age when almost anybody can set up their own company within a week, it’s very important that you’re ahead of your competition and you stay there. And then the final one is around incentives. This means putting in place a team and the right compensation philosophy that motivates them not just for IPO, but to scale the business beyond.

Our last finding here is about the different phases of growth and what happens in those different phases. So there’s three that we identified. The first is what I would call a prelude. This is where you have the spoke solutions, meaning every customer wants something slightly different. You don’t really have a business model that scales. Once you figure out something that a lot of customers want and you have some commonality amongst them and you get an offer that truly does scale and the business model defined, that’s what we would call Act 1, and Act 1 companies are typically pre‑IPO. And then finally we define Act 2 as when a company moves on to a second offer that has to scale. This is typically after they IPO.

Now, within Act 1, when looking at a bunch of case studies, what we found is there’s four archetypes for success. First there’s the pioneers. These guys are guys that go out there and define a new market and take it over. Second are the revolutionaries. These are ones that go after a defined market, but what they do is they totally disrupt the business model and revolutionize the market that they play in. The third was specialized standard setters. So these are identifying markets where there’s a need of a standard and they can monetize that standard. And then lastly was the product innovators. And these are companies that identify a market where there’s already a known solution, but they make a better solution and therefore capture the gains from that.

Now, when you transition to Act 1 to Act 2, much of the stuff that makes you successful in Act 1 might not be the stuff that makes you successful in Act 2. In fact, as we looked at this over many companies in terms in how they grew, you see those that went from $100 million to $1 billion. You see several that fall out because they stall or they go out of business. There’s others that get acquired by larger companies, but eventually the ones that make it to Act 2 looked different.

So we’ve got rocket ships there. Those are folks that have mastered a specific kind of business model and specific kind of market and they continue to ride that all the way. We’ve got our adjacency buyers, so folks that say, “Well, my initial market is kind of sputtering out, but there’s something next door that looks really interesting, so I’m going to go into that.” And then finally there’s re‑inventors, and re‑inventors are the ones that start over from scratch and pioneer or revolutionize a new market.

So in summary, four findings. First is that growth is super, super important, more important than we thought. Second, sustaining growth is really, really hard and not many people can do it. Third, there are enablers to sustaining growth, and there’s a proven formula for doing it. And, finally, the phases of growth matter, and what gets you successful in one act is not going to keep you successful in the next.

Thank you.

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