4 Sources of Sustainable Growth and 3 Engines of Growth for Startups

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4 Sources of Sustainable Growth and 3 Engines of Growth for Startups

In the illuminating book of "The Lean Startup," the author Eric Ries put forth four sources of sustainable growth and three engines of growth for startups.

Four Sources of Sustainable Growth

First of all, sustainable growth needs to be differentiated from sales surges generated by one-time activities, such as a single advertisement or a publicity stunt that could jump-start growth but without long-term effect. Sustainable growth is distinguished by one simple rule: The actions of past customers create new customers. This can be achieved in four ways:

1. Word of mouth: Satisfied customers talk with family and friends about their enthusiasm for the product and naturally give rise to a level of growth.
2. As a side effect of product usage: Certain products such as luxury ones drive awareness of fashion or status in people who see the product being used; or viral products like Paypal automatically influence non-users—those who receive funds from Paypal users.
3. Through funded advertising: Businesses pay for advertising to attract new customers. For this source of growth to be sustainable, the advertising must be paid for out of revenue on a long-term basis and the cost of acquiring new customers must be less than the revenue generated by them.
4. Through repeat purchase or use: Some products are designed for repeat purchase, through either a subscription plan (a cable company) or voluntary repurchases (groceries).

These sources of sustainable growth power feedback loops that Ries calls "engines of growth". The faster the engines turn, the faster the company grows. He argues there are 3 such engines.

Three Engines of Growth

Each of these "engines of growth" should be designed to give startups a small set of pertinent metrics to focus on in order to gain validated learning and long term growth.

1. THE STICKY ENGINE OF GROWTH: Businesses using the sticky engine of growth rely on having a high customer retention rate. They have an expectation that once a customer starts using their product, he will continue to do so. A good example is that mobile phone service subscribers usually "stick" to the same service provider. Companies relying on the sticky engine of growth must carefully track their churn rate that is defined as the fraction of customers in any period who fail to remain engaged with the company's product.
   
   The rules that govern the sticky engine of growth are pretty simple: if the rate of new customer acquisition exceeds the churn rate, the product will grow. The speed of growth is determined by the rate of compounding, which is simply the natural growth rate minus the churn rate. Like a bank account with compounding interest, the higher the rate of compounding is, the more rapid the company's growth can become.
   
   The way to find growth is to focus on making existing customers to "stick" to the product, thus improving customer retention rate. For example, the company could get more and better listings or send messages to their customers about limited-time sales or special offers.
2. THE VIRAL ENGINE OF GROWTH: Online social networks and Tupperware are examples of products for which customers do the major part of marketing work. Awareness of the product spreads rapidly from person to person as a natural side effect of normal product use. For example, Tupperware customers are not only the users but also the representatives of the products—they earn commissions by selling the product to their friends and neighbors.
   
   The viral engine is powered by a quantifiable feedback loop that's called the viral loop, and its speed is determined by a single mathematical term called the viral coefficient that measures how many new customers will use a product as a consequence of each new customer who signs up. The higher this coefficient is, the faster the product will spread. For example, a viral loop with a coefficient that is greater than 1.0 will grow exponentially, because each person who signs up will bring, on average, more than one other person with him.
   
   Companies that rely on the viral engine of growth must focus on increasing the viral coefficient more than anything else because any tiny change in this number will cause dramatic changes in their future growth. Consequently, many viral products do not charge customers directly but depend on indirect revenue sources such as advertising to minimize the friction that discourages customers from signing up and recruiting their friends.
3. THE PAID ENGINE OF GROWTH: Companies using the paid engine of growth increase their growth rate in one of two ways: increase the revenue from customers or drive down the cost of acquiring new customers. The paid engine of growth works when customers are willing to pay more for the product than what the company pays to reach them by, e.g., paid advertising, or outbound sales force, etc.
   
   Each customer pays a certain amount of money for the product over his "customer lifetime." After deducting variable costs, this amount of revenue is usually called the customer lifetime value (LTV) that can be invested in growth by acquiring new customers. When LTV exceeds the cost of new customer acquisition (CPA—Cost Per Acquisition), the product will grow. The difference between the LTV and the CPA determines how fast the paid engine of growth will turn (this is called the marginal profit).
   
   Over time, the CPA of any source of customer acquisition will tend to be bid up by competition. Thus, the ability of a company to grow in the long term by using the paid engine requires a differentiated ability to monetize a certain set of customers. In other words, the company needs to target a specific group of customers that it has the ability or can build up the ability to serve better than its competitors.

Technically, more than one engine of growth can operate in a business at the same time. For example, there is no reason why a product cannot have both high margins and high retention. However, successful startups usually focus on only one engine of growth at a time, specializing in everything that is required to maximize the profit; companies attempting to deploy all three engines tend to cause a lot of confusion as it's quite complicated to model all these effects simultaneously.

Source: Ries, E. (2011). The Lean Startup: How Today's Entrepreneurs Use Continuous Innovation to Create Radically Successful Businesses. The Crown Publishing Group.