Do you blitzscale?

SUPERSTAR COMPANIES CAN create powerful barriers to entry. Their success allows them to generate huge piles of cash, and that cash allows them to attract talent and buy up competitors. So how do aspiring companies break into the magic circle? The answer depends very much on the industry.

High-tech companies rely on discovering niche markets and scaling up as fast as possible. Peter Thiel, the co-founder of PayPal, points out that almost all successful startups begin by dominating a niche market. Facebook dominated social networking at Harvard University before branching out to other universities and then to social networking in general. Reid Hoffman, who at one time was PayPal’s COO, has coined the phrase “blitzscaling” to describe the road to success. The term refers to the Blitzkrieg (lightning war) that Germany pioneered in the second world war. Software allows companies to advance rapidly because the marginal costs of adding new customers is more or less zero. Globalisation has a similar effect because it lowers the barriers to entry across countries. Facebook’s old motto, “Move fast and break things”, captures the spirit of the Blitzkrieg perfectly.

Blitzscaling is necessary for both offensive and defensive reasons. Offensively, software businesses become valuable only once they have acquired lots of customers. Markets like eBay are not useful until they have both buyers and sellers. Defensively, businesses have to scale faster than their customers because the first to reach those customers often end up owning them.

Blitzscaling initially burns through a lot of cash quickly without producing much revenue. To attract people to a firm with an uncertain future, you have to generate a buzz in the tech world and offer your staff generous stock options. You also have to subordinate everything to immediate problem-solving. Mr Hoffman says that every blitzscaling organisation he has worked in seemed close to collapsing in chaos. “The thing that keeps these companies together—whether it’s PayPal, Google, eBay, Facebook, LinkedIn or Twitter—is the sense of excitement about what’s happening and the vision of a great future.”

The dangers of blitzscaling will become much clearer as technology transforms wider areas of the economy. Theranos, a company that claimed to have invented a new way of testing blood, expanded at breakneck speed before the Wall Street Journal revealed that its tests were unreliable.

There are some echoes of this strategy in the emerging world. Emerging-market companies establish a fortress in their domestic markets before invading foreign markets. Grupo Bimbo, which started out as Mexico’s biggest baked-goods company, has since become the biggest baker in the United States as well, through a combination of exporting its goods and buying bits of famous American brands such as Weston Foods and Sara Lee. Such emerging-market champions frequently advance at great speed, often buying in more sophisticated skills like branding and R&D by acquiring Western companies. For example, Lenovo, a Chinese computer company, bought IBM’s ThinkPad division in order to break into foreign markets.

Some of the brightest rising stars are emerging-market tech companies. China’s Alibaba, an e-commerce firm, raised $25 billion when it went public on the New York Stock Exchange in 2014, the largest IPO in history. Didi Chuxing, a Chinese taxi service, this summer merged with Uber, which took a 20% stake in the combined company, valued at $35 billion, after a prolonged battle.

Outside the tech industry and away from emerging markets, rising stars often sparkle by consolidating existing markets and squeezing out costs. A prime example is 3G Capital, a Brazilian-rooted company that specialises in taking over mature companies and bringing in its own managers to streamline them. It forces firms in its portfolio to justify their spending afresh every year, consolidate their product lines and trim excess brands. 3G is exceptionally stingy with its managers, making them share rooms on business trips, but also motivates them by giving them stock options. Having started off small in Brazil, it has taken over a succession of beer giants, including Anheuser Busch and SABMiller. Its acquisitions have given it control of a third of the world’s beer market and several large food companies, including Heinz, Burger King and Kraft.

Some of the world’s most successful family companies practise a gentler version of consolidation, buying up smaller family companies to add scale but allowing them to keep their names and identities. The luxury and drinks sectors excel at this. LVMH, a French luxury-goods company, has acquired a succession of other family companies such as Bulgari, Dior, Krug and Dom Perignon, as has Estée Lauder with Tommy Hilfiger, Bumble and Bumble and Jo Malone.

Correction (September 21st): An earlier version of this piece mistakenly stated that ThinkPad had been bought from Microsoft. This has been corrected. Sorry.