The Law of Sustainable Growth

Source: http://www.linkedin.com/today/post/article/20121015181612-2157554-the-law-of-sustainable-growth



I recently had two startups seek my advice on the same day. As types of businesses, they could not have been more different. The first is developing a marketplace to help traders of collectibles connect with one another. These people are hard- core fans of movies, anime, or comics who strive to put together complete collections of toys and other promotional merchandise related to the characters they love. The startup aspires to compete with online marketplaces such as eBay as well as physical marketplaces attached to conventions and other gatherings of fans.
The second startup sells database software to enterprise customers. They have a next-generation database technology that can supplement or replace offerings from large companies such as Oracle, IBM, and SAP. Their customers are chief information officers (CIOs), IT managers, and engineers in some of the world’s largest organizations. These are long-lead-time sales that require salespeople, sales engineering, installation support, and maintenance contracts.
You could be forgiven for thinking these two companies have absolutely nothing in common, yet both came to me with the exact same problem. Each one had early customers and promising early revenue. They had validated and invalidated many hypotheses in their business models and were executing against their product road maps successfully. Their customers had provided a healthy mix of positive feedback and suggestions for improvements. Both companies had used their early success to raise money from outside investors.
The problem was that neither company was growing. Both CEOs brought me identical- looking graphs showing that their early growth had fl atlined. They could not understand why.They were acutely aware of the need to show progress to their employees and investors and came to me because they wanted advice on how to jump-start their growth. Should they invest in more advertising or marketing programs? Should they focus on product quality or new features? Should they try to improve conversion rates or pricing?
As it turns out, both companies share a deep similarity in the way their businesses grow— and therefore a similar confusion about what to do. Both are using the same engine of growth.
The engine of growth is the mechanism that startups use to achieve sustainable growth. I use the word sustainable to exclude all one-time activities that generate a surge of customers but have no long-term impact, such as a single advertisement or a publicity stunt that might be used to jump-start growth but could not sustain that growth for the long term.
Sustainable growth is characterized by one simple rule:

New customers come from the actions of past customers.

There are four primary ways past customers drive sustainable growth:

1. Word of mouth. Embedded in most products is a natural level of growth that is caused by satisfied customers’ enthusiasm for the product. For example, when I bought my first TiVo DVR, I couldn’t stop telling my friends and family about it. Pretty soon, my entire family was using one

2. As a side effect of product usage. Fashion or status, such as luxury goods products, drive awareness of themselves whenever they are used. When you see someone dressed in the latest clothes or driving a certain car, you may be influenced to buy that product. This is also true of so-called viral products such as Facebook and PayPal. When a customer sends money to a friend using PayPal, the friend is exposed automatically to the PayPal product.

3. Through funded advertising. Most businesses employ advertising to entice new customers to use their products. For this to be a source of sustainable growth, the advertising must be paid for out of revenue, not one-time sources such as investment capital. As long as the cost of acquiring a new customer (the so- called marginal cost) is less than the revenue that customer generates (the marginal revenue), the excess (the marginal profit) can be used to acquire more customers. The more marginal profit, the faster the growth.

4. Through repeat purchase or use. Some products are designed to be purchased repeatedly either through a subscription plan (a cable company) or through voluntary repurchases (groceries or lightbulbs). By contrast, many products and services are intentionally designed as one- time events, such as wedding planning.

These sources of sustainable growth power feedback loops that I have termed engines of growth. Each is like a combustion engine, turning over and over. The faster the loop turns, the faster the company will grow. Each engine has an intrinsic set of metrics that determine how fast a company can grow when using it.
This leaves a large amount of variety in terms of which numbers one should measure. In fact, one of the most expensive forms of potential waste for a startup isspending time arguing about how to prioritize new development once it has a product on the market. At any time, the company could invest its energy in finding new customers, servicing existing customers better, improving overall quality, or driving down costs. In my experience, the discussions about these kinds of priority decisions can consume a substantial fraction of the company’s time.
Engines of growth are designed to give startups a relatively small set of metrics on which to focus their energies. As one of my mentors, the venture capital investor Shawn Carolan, put it, “Startups don’t starve; they drown.” There are always a zillion new ideas about how to make the product better floating around, but the hard truth is that most of those ideas make a difference only at the margins. They are mere optimizations. Startups have to focus on the big experiments that lead to validated learning. The engines of growth framework helps them stay focused on the metrics that matter.