Growth Rates: Defining Growth
Intuitively, it seems like defining growth should be simple. Given a metric like Revenue, it should be as easy as calculating how much higher revenue is today than it was in the past:
With this simple approach, the Growth Rate is the percentage change in revenue from one month to the next. If we were to chart our Revenue over time, the growth rate would simply be the rate of change between each data point. Take for example the following chart of revenue over time for a sample company:
The growth rate for this company, based on our simple formula, would be a straight line of 10% per month.
However, the straightforward chart above can tell many different stories if we look below the surface, as such a simple growth rate can hide many things. What if your prices changed? What about customers you gained and lost during the month? For example, consider the two charts below, where the Old Customer Revenue reflects the revenue from all customers who were customers before the beginning of each month and New Customer Revenue reflects the new revenue attained in that single month.
In Example A, the business is steadily growing with a healthy clip of new customers in addition to existing customers. In Example B the business is losing customers fast, but hiding it behind the rapid addition of new customers! Both examples would result in the same growth rate using our simple formula (the top of the area chart in both cases).
This confusion between new and old customers is an important problem with growth rates that needs to be resolved. Retail stores have this problem in abundance, as the opening of new locations can easily offset declining sales in old locations. As a result, retail stores have their growth rate measured using a metric known as “same-store sales” which only measures growth in stores open at least one year. This separates the true growth of sales from the rate of new openings.
You can modify your growth rate calculation similarly and isolate the growth of existing and new business by taking your churn rate into account. All you need to do is subtract it from our original formulation of growth rate from above:
As we discussed last week, your churn rate might actually be negative in which case it increases your growth rate!
This new growth rate formulation might be a better measure of our business, as it clearly tells us how well we are growing in terms of retained customer value. However, there are still challenges with this approach:
- Short months. Some months have more days (31) than others (28 or 30) which means a longer time to generate revenue. As a result, February may always look like a slow growth month! Weeks can be shorter due to holidays as well, making our growth rate move around more than it should.
- Metric components. Understanding the drivers of growth can be as important as the growth rate itself. Your ability to breakdown your growth rate into components is directly tied to how you calculate that growth rate.
Just like with churn, there is no magic formula for growth rate and you will need to decide for yourself how best to measure growth in your business. What we have covered so far should be enough to get you started on defining growth for your business and finding a way to calculate it accordingly.
Tomorrow we’ll take this a step further by thinking about how growth rates themselves change over time when we cover compound growth rates.
Quote of the Day: “Man is not what he thinks he is, he is what he hides.” ― André Malraux