The Growth Flywheel (Part 2): How To Build And Measure Your Growth Engine
This is part two of our three-part series about why a startup needs to think of their businesses as a flywheel and how they can build their own.
In part 1, We examined the key differences between the funnel and flywheel. We highlighted why startups should rethink their ideal customer persona (ICP) as a growth channel. Then we showed how happy customers have a direct impact on business metrics as measured by the k-factor.
This part of the series will introduce ‘The Growth Flywheel’ framework to demystify the flywheel- making it easier for any startup to build their flywheel and illustrate how to measure and build momentum.
The Growth Flywheel
Brad Stone describes an early version of Amazon’s flywheel in ‘The Everything Store’- “Bezos and his lieutenants sketched their own virtuous cycle, which they believed powered their business…. Feed any part of this flywheel, they reasoned, and it should accelerate the loop.”
Recommended reading: ‘The Everything Store’ — Brad Stone
The flywheel is the growth engine of any company. It interlinks strategies, tactics, and processes to allow a company to accelerate its growth. And like any machine, all the components need to work together as a cohesive unit.
Take a car, for example. Cars have one primary objective: to transport you. Some may be more powerful, some more stylish, others faster or more comfortable than others- but they still do the same thing.
And whether you have a Honda Civic or a Ferrari 812 Superfast, every car has four main components: the engine, the drivetrain, the body, and the suspension system. All four components must exist in a car for it to even work. And each component must work in unison for the car to perform optimally.
The Growth Flywheel framework breaks down and categorizes a startup’s growth initiatives into four connected components: Demand Generation, Client Acquisition, Lifetime Value Optimization, and Retention & Referral.
Components of the Growth Flywheel
Demand Generation: All efforts to generate awareness and interest in your company and your product/service offerings.
Client Acquisition: The process of converting a potential consumer into a paying customer.
Demand generation and client acquisition are relatively straightforward and match most conventional definitions. These components focus on attracting and creating customers. Usually considered the ‘funnel’.
Lifetime Value Optimization: Strategies and channels to maximize the monetary value of each customer.
Lifetime value optimization specifically focuses on additional, new revenue from the same customer (e.g., upsells, upgrades, repurchases, and cross-sells) and not recurring revenue (like a monthly subscription).
Convincing an existing customer to buy something new from you is a different effort than keeping a customer paying you for the same service or product (i.e., a subscription to the same product)
Retention & Referral: Programs and initiatives to keep customers and enable them to advocate for your company.
Retention & referral represents one key component of the flywheel because together — they measure momentum. We’ll explore this concept in detail later.
Yes, retention directly impacts the lifetime value (LTV). However, in this framework, it’s better to separate those objectives because they are fundamentally different.
For example, you can increase the retention of a customer through LTV optimization efforts like upgrading more monthly subscriptions to annual subscriptions.
And retention does not always have an LTV objective. It can be focused on market share. For example, you may prioritize product development of your app so that you get more daily active users (DAUs) so that they do not leave your app to use a competitor.
How do you apply the flywheel concept?
The components of the flywheel are the key strategic goals and focus of a company. The initiatives are clear tactical objectives.
Your company’s unique characteristics and industry landscape will determine its strategic initiatives; and evolve as your company grows.
Every company will have different flywheels. However, The Growth Flywheel framework will give you a model to start. First, analyze your company’s initiatives relative to the four components of The Growth Flywheel framework. You should be able to identify at least one key initiative relative to each component.
Your flywheel’s primary initiatives are the most critical strategic priorities that directly drive growth — the needle movers.
Prioritize initiatives that drive more than one component of the flywheel. One of the flywheel’s core concepts is to interlink key initiatives regarding company growth components. Purposefully creating connected initiatives galvanize strategic cohesion.
For example, a freemium model can both increase demand generation and improve client acquisition. A usage-based charging model can increase both lifetime value and retention.
Startups must do an aggressive and honest audit of their business and metrics to understand where the opportunities and frictions exist. Reducing friction will improve your flywheel’s ability to build momentum.
Designing your flywheel from scratch
Start with demand generation if you’re beginning to build your startup or don’t have significant traction yet. Focus on what pain point your potential customer has that you can uniquely solve for them.
Remember, as explained in part 1 of this series, the ideal customer persona (ICP) of a flywheel is different from that of the funnel. The flywheel’s ICP is the customer you can make the happiest so that they will stay with you and tell all their friends — which means you’re aiming to find customers that will have the highest k-factor.
And to identify the ICP to optimize your demand generation efforts, you must focus on positioning.
Positioning is not just a marketing or sales strategy; positioning is a business strategy. It identifies what market segment you’re competing in and the customer expectations in that segment, which will help you develop your best go-to-market strategy.
Recommended reading: ‘Obviously Awesome’ — April Dunford
Recommended reading: ‘Delivering Happiness’ — Tony Hsieh
Re-designing your startup as a flywheel
If your startup already has some traction, start with an LTV/CAC ratio analysis and compare it to relative industry standards.
An analysis of your existing and potential customer’s lifetime value will factor in retention, upsells, expansion efforts, or lack thereof.
Then comparing your average LTV per customer to your client acquisition cost metrics will give you a breakdown of your unit economics and help identify opportunities for optimization.
Example: Amazon’s Flywheel
Jeff Bezos considers Amazon’s application of the flywheel concept “the secret sauce” to its success.
Below is a picture of Amazon’s early flywheel developed by Jeff Bezos when he worked with Jim Collins, the author of Good to Great.
As you can see, Amazon’s key initiatives drive more than one component of The Growth Flywheel components. That’s what makes it so powerful!
Again, always aim to create and prioritize strategic initiatives that drive more than one component of the flywheel.
The flywheel and momentum
“Once you fully grasp how to create flywheel momentum in your particular circumstance and apply that understanding with creative intensity and relentless discipline, you get the power of strategic compounding. Never underestimate the power of momentum, especially when it compounds over a very long time.” — Jim Collins
In part 1 of this series, we explained how the k-factor allows a flywheel to grow exponentially vs. linearly like a funnel.
As a refresher, the k-factor measures the ability and willingness of a customer to attract another customer. You can think of it as a measure of organic or word-of-mouth growth.
Revisiting our formulas from part 1 …
The funnel formula for new customer growth:
The flywheel formula for customer growth:
And now we can factor in the most vital element of the flywheel — momentum.
The compounding effects of strategic actions are what builds momentum. And the longer the compounding period, the more momentum you will build.
For example, suppose you acquire 10 new customers, and they have a k-factor of 1 (meaning each customer will help bring you, 1 additional customer). In that case, your flywheel will have 10 more customers- making your total 20 new customers instead of 10.
But what about next year?
Those same 20 customers still have a k-factor of 1, so they bring on another 20 customers! The 10 initial customers now became 40 customers! And next year, if you keep all 40, you’ll double up again to 80!
Does this concept sound familiar? Well, it is. It’s the concept of compound interest. But adapted to customer growth instead of nominal appreciation, and your k-factor represents your interest rate.
We’re also assuming n = 1 as the k-factor is calculated over a time period of t.
So, factoring time and momentum (aka. compounded growth) into our flywheel equation, our new formula is:
But that makes one huge assumption. It assumes a 100% retention rate. Which we all know is almost impossible. So how do you factor retention into the growth equation?
Back to the previous example, you bring on 10 new customers with a k-factor of 1. But now, we also factor in a 90% retention rate for each period.
Instead of 10 new additional customers, you’ll only get 9 additional customers because you only kept 9 customers out of the original 10 you brought on during the time period. So, your total number of new customers at the end of the period is only 18 instead of 20 now.
Next period, you’ll only have ~16 customers (90% of the 18 customers) that will bring you an additional 16 customers. Making your total 32 new customers vs. 40 (if you had a 100% retention rate)
Now, to reflect the impact of retention (R) in our flywheel formula, our equation becomes:
Expanded out:
This formula illustrates the impact retention and referral have on acquiring new customers by utilizing your existing customer-base as the source of new customers. The formula also highlights how incremental improvement to any part of the flywheel is compounded over time and can create momentum.
The following example assumes you deployed all of your marketing and sales budgets to acquire new customers from t-0 to t-1, and then stopped acquiring new customers via direct marketing and sales efforts. This leaves you with your existing customers as your only new customer acquisition channel.
You’ll notice right away that the funnel will lose customers over time because it does not have a retention rate of 1 (R=.9) and a k-factor of 0. But you also see how, even though the flywheel has the same retention rate, it can still achieve exponential growth.
But there’s more…
The previous example shows how you can achieve exponential growth by focusing on retention and referrals from just 1 cohort of customers.
But that’s not realistic. Companies are constantly acquiring new customers every period, and if their flywheel is in motion, those cohorts of customers will bring additional customers as well.
So to capture the full momentum of the flywheel, we need to factor in the cumulative compounding of new customers acquired directly through sales and marketing efforts (eg. Demand Generation and Customer Acquisition) from period to period.
These are the respective formulas of cumulative new customer growth over a period ( 0 to t )
Lifetime Value
The last variable of the flywheel to factor in is the lifetime value (LTV) of a customer because, well, a business needs to make money. Factoring in LTV is much simpler at this point- multiply the number of customers you project to have by their lifetime value.
Multiply the previous formula with the LTV of a customer and now you will have The Flywheel Formula.
The Growth Flywheel Formula
Summary
The flywheel is not just a buzzword. It is the only business model that is durable enough to help a startup grow. And The Growth Flywheel framework helps simplify it, so it is easier for founders and business leaders to apply.
The Growth Flywheel breaks a business down into four main components so that any startup can use it as a framework to build their flywheel.
You can not build momentum with a single grand action, but instead by the strategic compounding of progress over time. To build momentum, you must think of retention and referrals from the very beginning and make it just as important as your client acquisition strategies.
NEXT: Part 3: Make Your Startup More Efficient
We will explain how to align your company towards its core growth goal (CGG) in the next and last part of this series. We will explain why the marketing, sales, support, and product teams are the startup’s key growth teams and show you their team-specific flywheels and how to align them. Yes, there are going to be even more flywheels!
And lastly, we’ll show you how to break this down and build a startup with teams that can more effectively ‘wear multiple hats.’
