The Growth Flywheel (Part 1): Why Flywheels Are Better Than Funnels
This article aims to help founders and business leaders understand the fatal errors of thinking of their startup as a funnel, and why it will likely kill their company.
We’ll break down the fundamental differences between the funnel and flywheel so that you can see why a funnel will fail at achieving the most important thing for a startup — building momentum.
Companies have based their business strategies around the funnel since the beginning of time, and it used to work very well. But not anymore. Customer acquisition costs (CAC) have increased across the board in all industries as consumer behaviors have become more complex. There is now less friction in the buying process, heightened competition, and easier access to information, giving customers more power to engage with a company at different entry points of the purchasing journey.
76% of customers think it’s easier to take their business elsewhere, according to the 2019 SalesForce ‘State of Connected Customer’ report.
The recent failures and flops, like Casper Mattresses (CSPR) losing 80% in valuation, and unicorn-status startup, Brandless, shutting down are prime examples of why the unit economics of a funnel no longer work. Acceleration of decreasing profits is a clear indicator that something is going horribly wrong. It usually happens as the CAC (largely impacted by marketing expenses) is increasing faster than revenue growth, as cited by Casper and Brandless.
These current market conditions have highlighted some of the funnel’s fatal flaws and why startups need to think of their business models more holistically, like a flywheel.
Key differences between the funnel and flywheel model:
*The k-factor is an action-based measure of how happy your customers are. Explained later.
What is a funnel?
Let’s start by defining what we mean by a funnel. Whether people are talking about a marketing, sales, or purchase funnel — they’re all referring to the same thing: a funnel is a graphical model of customers’ journeys towards purchasing a good or service.
The funnel has some key characteristics and assumptions:
- The stages/phases are sequential.
- There is some measure of attrition from one phase/stage to the next, creating the funnel shape.
- The goal is to manage and optimize the process towards purchases.
- Customer acquisition is a linear process.
Walk into any company’s sales or marketing department, and you’ll probably hear teams talk about their funnel. And there’s a good chance you’ll see a faded poster of a 6-stage funnel taped to a wall that has different colored sections labeled Awareness, Interest, Consideration, Intent, Evaluation, and Purchase — with a customer standing at the bottom.
By design, a funnel is a linear, throughput process with a customer as the end result. They are just the output. That’s it. The customers’ journey and momentum stop there.
The simplified formula below represents a business as a funnel. New customer growth is a function of how efficient you are at spending marketing and sales dollars to acquire new customers.
The funnel equation of customer growth:
This function is becoming more unsustainable due to increasing customer acquisition costs (CAC) across all industries.
We’ll reference these formulas later as we compare them to the fundamentals of a flywheel.
What is a flywheel?
The mechanical flywheel first popularized during the Industrial Revolution with steam engines’ development, and then later with the combustion engine. The flywheel was designed to build and keep momentum going so that the engine can more efficiently transfer energy to power the vehicle.
Flywheels are not just highly energy-efficient; flywheels are energy multipliers. Flywheels store kinetic energy and then release it faster than the energy source itself — accelerating as momentum builds. The more force you can apply to a flywheel, and the more friction you can remove, the faster the flywheel spins.
The flywheel and business
Jim Collins and his team first introduced the flywheel concept as it applies to businesses in his book ‘Good to Great”. They discovered that every company that made the transition to becoming a great company got their flywheel turning.
Recommended reading: ‘Good to Great’ — Jim Collins
The flywheel is the growth engine of a company. The impacts on one component of the flywheel affect the rest of the business as a whole. The flywheel interlinks strategies, tactics, and processes to allow the company to accelerate its growth.
And there is no spectacular launch, not a crazy stroke of luck, nor a masterfully crafted marketing campaign to get your flywheel turning.
Momentum is built from the culmination of results, generated from a disciplined process — step by step, action by action, and turn by turn of the flywheel.
Why are funnels fatal for startups?
Funnels do not build momentum and are economically inefficient. And startups cannot afford either.
Startups need to build momentum with their customers as a source of growth while spending every dollar they have carefully — which is impossible if they view their company as a funnel.
There is no way for a startup to be efficient if they optimize towards a broken business model. As explained earlier, the funnel framework is incomplete because it ignores half of a business — maximizing customer value and retention.
Funnels are not the most optimal framework for acquiring new customers. Funnels are outdated because they no longer fit today’s business processes and consumer behaviors. Modern innovations have reduced the friction involved in consumption decisions by giving consumers better access to information and options.
From our previous formula:
CPL has increased as consumers are less likely to directly contact a company because there is much more readily available information. And Conv has decreased because competition has grown significantly in all industries, giving more customers more alternatives. Which all increase CAC.
Unit economics is essential for any business, but especially for startups because their business models are much more fragile. Startups, by definition, are still trying to find traction and doing it with limited resources. All costs are proportionally larger relative to a startup.
For example, your company plans to launch a $100,000 marketing campaign — maybe it is an influencer campaign with a celebrity or series of podcast ads. If you are a large Fortune 100 company, that is likely to be just a fraction of your marketing budget. That campaign does not even have to generate revenue to be still considered a success. It can be a branding, awareness, a PR move, or just an A/B test for data points.
But for a startup? That can be your entire bank account. And if it fails, your company is dead!
Recommended reading: ‘The Lean Startup’ — Eric Ries
What is the k-factor
A straightforward way to measure how a customer will help a company grow is by measuring how effective and willing they are at referring more customers.
Most people use the net promoter score (NPS) to gauge this, but that would not be accurate. The NPS score is a self-reported happiness rating. It goes without saying that happiness is subjective but more importantly, it does not measure action.
A better gauge is the k-factor. The k-factor is an action-based measure of happiness. It is a measure of a customer’s ability and willingness to attract another customer to your business. One way to think about this is that the k-factor measures organic growth.
This concept is borrowed from the medical field of epidemiology to understand how viruses spread (I know this is an unfortunate analogy right now).
So, if, on average, every one of your customers tells ten friends (i = 10) and each one of those friends has a 25% chance of becoming one of your customers too (c = .25), then your k = 2.5.
The impact of the k-factor
And happy customers are not a nice-to-have; they are a must-have.
The following formula will illustrate how the k-factor impacts your unit economics and why the flywheel is a measurably better business model than a funnel.
Back to our previous formula for new customer growth:
And now introducing the k-factor…
*we are using (1+k) instead of just k to represent total new customers including the existing customer base and not just the additional new customers as represented by the k alone.
Our new equation is:
The formula shows that keeping all else equal, a company with a positive k-factor will bring more net new customers with the same resources.
A larger k-factor will also decrease your overall CAC.
Example:
The better ICP
The first customers of a startup are almost as important as the first hires. They are the first real data points a startup has about its customers and product-market fit.
The critical difference between the ideal customer for a funnel and flywheel is that the customer is just a desired outcome in the funnel. In contrast, customers in a flywheel are also a key growth driver.
The traditional (funnel) view of the ideal customer persona is the theoretical representation of who will most likely buy from you.
But this is a very singular, purchase-focused view of your customer. A more holistic, growth-focused view of your customer would ask instead: who will rave to their friends about us? Which customers will help build momentum for our startup? Which customers will have a naturally higher k-factor? Which customer’s life will you improve the most?
Recommended reading: ‘The Customer Growth Officer 2.0’ — Jeanne Bliss
Target the k
Not focusing on how a customer can help you grow makes your business model inefficient — something that a startup literally cannot afford to be. As measured by one with a higher k-factor, a happier customer will decrease client acquisition costs and reduce client retention costs.
For example, an unhappy customer (e.g., a customer with the wrong expectations) will take up relatively more time for your customer success team, who will likely involve the product team to solve its needs and complaints.
And suppose they don’t resolve the customer’s issues in a timely or satisfactory manner. In that case, they will likely complain to the salesperson who sold them the product or service, which will cause them to spend valuable time to appease the unhappy customer instead of using that time to bring in new customers. Nobody wants that.
A happy customer will have the opposite effect. Happy customers take up less time and resources. And all else equal, happier customers have a higher probability of renewal or repurchase, which increases their lifetime value (LTV).
Summary
Besides directly impacting a startup’s early (if not only) revenue, a startup’s first customers significantly impact the business operations and trajectory.
Startups should think about customer retention and referrals from the very beginning when identifying their ICP. Targeting the wrong ICP will lead to false indicators of performance and strategic focus.
The flywheel model gives a startup a more holistic, customer-centric business model that better fits today’s market conditions. Ditch the funnel.
NEXT: Part 2: How to build and measure your growth engine
The next part is the meat of this series. We will introduce ‘The Growth Flywheel’ framework to help any startup build their flywheel. It breaks down all growth-focused business initiatives into four main components: Demand Generation, Client Acquisition, Lifetime Value Optimization, and Retention & Referral.
We’ll also break down the flywheel metrics even more so that you have a usable formula to measure your flywheel’s performance objectively.
