Compound interest is the eighth wonder of the world. He who understands it, earns it … he who doesn’t … pays it. – Albert Einstein
In business, and particular in the world of startups, we like to refer to our growth as a percentage. “We’re showing double-digit monthly growth.”, or “We’ve grown 150% since last year”. Have you ever stopped to think about why a relative metric like percentage is so frequently used over an absolute one? The actual growth is the same whichever form is used to communicate it, so why do we so often lean towards the relative framing? I’m sure there are many reasons for this, but I think in the world of startups there are two main ones.
The first is that it will often sound more impressive, particularly when you’re a small early stage company with small revenue numbers. Imagine standing in front of a bunch of investors and telling them “Our revenues have grown 800% since this time last year”; it sounds pretty impressive. Now compare that to standing in front of those same investors and saying “Our revenues have grown from $100 last year to $800 this year”; definitely less impressive.
I think the second reason we lean on this is that it more strongly suggests some sense of future predictiveness. We’re trying to imbue our company in people’s imaginations with a sense exponential growth, defined by the following formula:
By saying that we grew by 5% monthly what we’re suggesting is that our growth rate is 1.05, a positive value (a growth rate over 1 is positive growth). From the above formula it’s easy to see that as ‘t’ increases (as time continues to pass), clearly our business growth will reflect this graph:
As anyone who’s actually tried to scale a business can tell you, that graph doesn’t come for free. There are certain ‘engines of growth’ (to borrow a concept out of Lean Startup) that do exhibit exponential characteristics. The best known one is a viral engine of growth, where for each user on your system they naturally bring more than one additional user. Unfortunately truly viral businesses are rare, especially for any service or product that isn’t free.
Instead, for most of us in order to achieve that exponential growth engine we need to find a way to make our customer acquisition channels actually scale exponentially.
Let’s walk through an example. Say you have a new startup that’s made a great e-mail client. You’ve been struggling along for a while, and then you get covered on LifeHacker. All the sudden your growth rate takes off and your customer base triples in one month. You plug your new 200% growth rate into your financial projections, and start looking at brochures for lamborghini’s. But (isn’t there always a but) there’s a problem. That 200% growth rate isn’t exponential. The top of funnel traffic you get through LifeHacker isn’t going to continue to scale. At best it will remain linear.
To put some numbers to this let’s say your initial customer base was 100, and that article brought you 200 customers in that first month. That gives you your 200% growth rate for that month. The problem is the next month you now have an existing customer base of 300, and will still grow by only 200 (best case). That works out to only a 66% growth rate. The month after that it’s only 40%, and so on until your churn rate catches up to you and your business stops growing completely (a topic for another blog post). Your business growth will instead reflect a logarithmic curve, which looks something more like this:
The upshot of this rant is that it’s dangerous to think about your growth in relative terms if the engine of growth for your business isn’t actually a relative function of your current size. If growth rate will be 200 users whether you have 10 users or 1000, then your growth rate is neither 2000% nor 20%. It’s 200 users.
If you have a business model that doesn’t have inherently exponential characteristics its critical that you instead think of absolute terms, or a year down the road you’ll find your growth has stalled completely, and it will be too late to fix it. Better yet, find a way to scale customer acquisition and revenue growth in a way that truly is relative to the current size of your business, and then you really can talk about your 20% growth.