Optimize for Growth while Adding Gates

Twice in the past week the topic of startups optimizing for growth at all costs came up. Pre-pandemic, there was more emphasis on the Rule of 40 save for certain white-hot sectors. With the Rule of 40, the general idea is to calibrate the trade-offs between the top-line growth rate of the business and the corresponding profitability (free cash flow margins, typically). Growth rate, as a percentage, was combined with profitability (or lack thereof) as a percentage, and the two were added together into a score with the goal of being 40, or higher. Well, that went out the window with the dramatic increase in valuations for high growth companies brought on by the reduction in interest rates, growth in demand for private investments, and the belief that tech markets are even larger than previously predicted.

So, if growth matters more than capital-efficient growth, should you care at all about other metrics? Yes, absolutely. The trick is to care more about the most important metrics (e.g. net dollar retention), and gate the slide of the standard metrics (e.g. cost of customer acquisition). Eventually, the market will revert back to an emphasis on more measured growth, but you never know when that is going to happen.

Let’s say before you were focused on the cost of customer acquisition relative to the lifetime value of the customer (CAC/LTV). Traditionally, a cost to acquire a customer that represented one to two years of revenue was fine (e.g. customer pays $10,000/year for five years, excellent if it was $10,000 to acquire that customer). Now, as sales and marketing ramps up to grow faster, the cost of customer acquisition is likely to go up dramatically, making the CAC/LTV ratio weaker. What to do?

Set a gate that you won’t go above or below. Find something that is more aggressive but don’t let it get so out of control that you can’t get back to more capital-efficient growth relatively quickly if the markets were to change.

Continuing with the CAC/LTV example, if before your cost of customer acquisition was $10,000, make the lifetime value more aggressive by factoring general growth of the account (ideally net dollar retention above 100%), ability to raise prices (inflation is here, with a vengeance), and the introduction of new products to upsell/cross sell down the road. Because of these three variables, you could argue for a substantially higher lifetime value of the customer. Now, increase the cost of customer acquisition a corresponding amount, say double, and you get a gate at $20,000 to acquire a customer. Now, you’ll spend $20,000 to acquire a customer, but nothing more. This makes the sales and marketing spend much more aggressive, but it’s also inline with with the focus on growth while assuming more good things will happen in the future.

Optimize for maximum growth while still setting gates that can’t be crossed on standard metrics. This growth with guard rails approach allows for more flexibility and agility as the world changes, and change is the only constant.

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