How to calculate your company’s growth rate
Whether your business is growing or not is an important fact, but understanding how fast its growing can be hard to nail down. As we saw with our investigation of churn, it can be hard to even define a simple metric like growth and even harder to calculate it. So how fast is your business growing?
Your growth rate is an important metric for allocating your resources in the future. If your business grows faster than you can handle, you may find yourself stretched too thinly. If it grows too slowly, your business might not survive. What growth means to you will influence how you calculate your growth rate and how you use that metric.
Misleading positive growth rates can represent the dark side of data, making people think your business is growing faster that reality. Sometimes that is a result of purposeful deception, and sometimes is an honest mistake based on the complexity of calculating growth. The stakes are high, as most businesses are valued as much on their growth rate as their overall profitability.
Here we’ll delve into what makes growth rates hard to define and how you can make sure your growth rate metric is reliable. Specifically we will cover:
- Part 1 — Defining Growth
- Part 2 — Compound Growth Rates
- Part 3 — Seasonal Growth
- Part 4 — Predicting Growth
Let’s get started by defining growth…
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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.
Example A:
Example B:
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.
Part 2. Compound Growth Rates
It is easy to think about growth rates from one month to the next (or 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:
However, that linear growth rate, as seen in the next chart, is decreasing over time!
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:
In order to maintain a growth rate over time, you need to increase growth faster 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.
Part 3. Seasonal Growth
In our exploration of growth rates so far, we’ve made an implicit assumption that your business would grow at roughly the same rate all year. This is not true for most businesses! Some business will grow rapidly during some months and contract during others. Take the example of an ice cream truck: during the summer months business will be brisk and grow rapidly, only to shrink in the fall and winter as the weather gets colder outside.
In highly seasonal businesses, understanding growth is even harder but also more important. It won’t be obvious from your charts whether you are growing, as evidenced by the following revenue chart for a seasonal business over two consecutive years:
We need to rethink our original assumption about growth, since in these businesses calculating growth by comparing one month to the previous month is not a good measure of growth. If you don’t believe me, this is the naive growth rate for the business in the example above in the second year:
It is hard to make much from that chart as it jumps from positive to negative growth rates and back again. All we can discern is that the summer months are bad for business, but are we growing?
We can do much better than that! Let’s compare each month to that same month from the previous year, which was the same time of year (season). You can see that below:
Our growth ranges from 20% to 30% reliably until December when it jumps significantly.
That is much more useful and something we can work with to understand how our decisions are impacting the business.
If your business is seasonal you might want to use a similar approach as it makes growth easier to understand and more relevant for your business.
Part 4. Predicting Growth
Almost immediately after you define your growth metric, you will want to project it into the future. Will you grow more quickly this year? How long will your current growth rate continue? The better you can predict your future growth, the more accurately you can allocate your resources and plan ahead.
Unfortunately, real world growth can be hard to predict. For example, given the following daily revenue data let us try and predict the revenue for each day next week:
Like most real world data there are patterns and trends hidden in this data, making extrapolation difficult. Luckily, there is an easy way to model the growth of cyclical weekly data. Instead of trying to understand the data as a whole, we can observe that the repeating cycle means we can focus on each day of the week independently. That way, way can use a technique like Linear Regression to give us a prediction for every day next week (Read more about this).
For example, if we just analyze the Mondays, the trend is actually a straight line!
By creating a separate trend for each day of the week, we can build a model for what we think revenue will be every day next week with a fairly high degree of accuracy (we could use more advanced techniques like Double Exponential Smoothing to smooth out the individual estimates):
With this projection in hand, we can calculate our future growth rates in the same way we have in previous chapters this week!
In Review: Whether your business is growing or not is an important fact, but how fast it is growing can be hard to nail down. The way you calculate and predict your growth will depend on how you define growth for your business and is a decision best made early.
Outlier monitors your business data and notifies you when unexpected changes occur. We help Marketing/Growth & Product teams drive more value from their business data. Schedule a demo today.
- Outlier was the Strata+Hadoop World 2017 Audience Award Winner.
