At the start of the Christmas shopping season in early November, Toys `R' Us launched a big promotion for its Web site. For a limited time, it announced, it was offering $10 off all online purchases, along with free shipping. A sucker for a bargain, I decided to click over and pick up some gifts. A few hundred thousand other people apparently had the same idea. For three days, I was unable to access the site. The best I could get was an image of Geoffrey the Giraffe thanking me for my patience.
Toys `R' Us was having what's known as a scalability problem. Like many of its big-company brethren, it had underestimated the popularity of the Web, and the company's servers and software were unable to handle the traffic its marketers had produced. It wasn't pretty, but within a week that particular problem had been sorted out, and the firm was back in e-business.
On the Internet, if you can't scale - if you can't get really big really fast - you're nowhere. And it's not enough for just your technology to be scalable. Your entire business model has to have scalability, as well; you need to be able to quickly extend your business into new markets, horizontally or vertically. `Will it scale?' is one of the first questions venture capitalists ask.
But what remains unknown about scale on the Net is whether it provides much protection against competitors. In the industrial economy, scale not only afforded higher profit margins - by enabling you to spread your overhead costs over a larger pile of revenues - it also gave you a great defense. The bigger you got, the more expensive it became for a competitor to enter your markets. A scale advantage was one of the best barriers to new entrants you could have.
Whether size will create similar advantages on the Web is a critical question right now. We're entering a phase of consolidation in many Internet businesses, with competitors rapidly buying up one another in the hope of building and bolstering margins. The sky-high valuations of Internet companies, though, make such consolidation extraordinarily expensive. If size does not provide a barrier to competitors, a heck of a lot of money is going to be wasted.
While it's too early to know for sure the benefits that scale will or won't bring, some distinctions can be drawn. Certain Internet businesses, such as those that require lots of physical assets, resemble their industrial-era counterparts. A company like Exodus, for example, has to spend heavily to lease and build out physical space around the country in order to host its clients' servers. And last-mile delivery outfits like Webvan and Streamline.com have to buy trucks and build warehouses. For such companies, scale likely will provide a deterrent to competitors, and consolidation will pay off.
Most Internet companies, though, are built on knowledge assets rather than physical assets. For them, the benefits of size seem much less certain. It is, after all, less expensive to expand a knowledge business than an industrial business; you don't need to build factories and warehouses or buy tons of machinery or carry loads of inventory. But if it's relatively cheap for you to get big, it's equally cheap for competitors to get big, too. Newcomers with good ideas will therefore find it easier to get funding than they would have in the industrial age. The barriers to entry will remain relatively low no matter how big the incumbents get.
There's an even more fundamental problem with size. In `Unbundling the Corporation,' an article that appeared in the Harvard Business Review last year, management consultants John Hagel and Marc Singer point out that the success of creative businesses hinges on their ability to keep their talent happy. But as a company gets bigger, it inevitably becomes more bureaucratic, with more corporate functionaries, more processes and procedures, more mediocrity. In other words, it becomes everything that creative types hate. And unlike warehouses, which stay put once you build them, talent is mobile; it can walk out the door when it doesn't like the way things are going.
While scalability will continue to be critical for e-businesses, I doubt scale itself will provide much of an advantage. Companies will need to be able to expand their businesses fast, but their bigness won't ensure lasting success. Rather, once they've scaled up in one market, they'll need to immediately look for new markets in which to replicate their growth. Defense was the name of the game in the old economy. In the new one, offense is everything.