Growth Rates: What are Compound Growth Rates?

This is part 3 of our series on Growth Rates, previous segments are available in our archives.

Yesterday we covered how to think about growth rates from one month to the next (and is similarly applicable to days or weeks). However, a growth rate is typically considered over much longer periods of time because of how much variability there might be in your growth.

To show why this is important, let’s cover the example of a company that is steadily growing revenue by $1,000 every month (and that the churn rate is 0 each month). Their total revenue chart is a simple straight line and shows a consistently growing business:
Example of linear, not compound growth

However,the growth rate, as seen in the next chart, is decreasing over time!

Example of linear, not compound growth

This is because $1,000 slowly becomes a smaller and smaller percentage of overall revenue as the company grows. Eventually, if the company reaches $1M in revenue per month the $1,000 they add in a month will be only 0.1% growth!

To have a consistent growth rate of 10% month over month means you are actually generating compound growth, meaning that you are growing faster every month. The same company, starting from the same initial revenue of $1,000, with a consistent 50% growth rate, would see their total revenue grow as follows:

Example of compound growth

In order to maintain a growth rate over time, you need to grow fast the bigger you get. This is a hidden trap with companies who set growth rate targets into the future – the farther into the future you target a specific growth rate over time, the harder it will be to maintain.

 

Tomorrow we’ll cover another complication to growth rates and predictions, which happens when your business grows at different rates depending on the time of year.
Quote of the Day: Anyone who believes exponential growth can go on forever in a finite world is either a madman or an economist.” – Attributed to Kenneth Boulding in United States Congress