Build a compounding vehicle

1. What compounding is

The same input, a rising output. The aim is a business that grows on its own while you go on doing the same amount of work. You put the same thing in, and over time more comes out: that is what compounding means here.

Set against leverage. Leverage happens once: a bigger return on what you put in. Compounding is itself a form of leverage. Picture push-ups: you do one and get two back; you do one more and get three back. That is compounding at work.

So almost all businesses should look for a compounding vehicle of some kind. Think of one as a flywheel, or a virtuous cycle.

Reputation is the everyday case. Doing more makes you better; being better gets people talking; their talk helps you do better still; and round it goes again.

Getting more out of each input, and aiming it at the constraint, has its own procedure: SOP 185 — Allocate resources to the constraint and use leverage.

2. The kinds of compounding vehicle

Beyond reputation, these are named, in this order.

Structural virality. The spread can be built into the structure of the thing. Take a community platform. Someone opens a community and brings 200 people into it; of those, one or two or three start communities of their own, and each of them invites 200 people in turn. Because the spread is part of how the platform works, it compounds.

Long-term stick. Say you sell 100 customers this year, 100 next year and 100 in the third year. If you kept every one of them, the business would be three times its present size in year three. Many owners work from the view that to grow, they must grow sales. That is one way to grow; the view here is that it is also the hardest, and that finding something to sell that people do not cancel is significantly more valuable. Then you could hold marketing and sales where they are and still get bigger every year, by default.

A bar to clear. Not everything people buy again makes a compounding vehicle. The view here sets the floor at 80 percent or more of it kept, and calls that the bare minimum: below it, what you have lasts a while and then stops. The period the 80 percent is counted over is not stated with the bar. Where what you sell is bought once, the places to look for a vehicle, and how to attach one, are SOP 283, section 2.

Network effects. This means a real network. Suppose you have 100 people and all of them are good. Add a hundred and first who is also good, and the whole network improves. That is a true network effect: each addition raises the value of the network. It is not the same as adding people to a services business, which, in general, will thin out the quality of its service. Facebook is the example: the more people use it, the more it is worth.

Integrations. The same can come from what you connect with. If you link up with many different vendors, and those connections add value for your customers, as with Zapier, you have a compounding vehicle.

Sales networks. These compound too. A product can be one people never stop buying, which is long-term stick. Or it can be one people do not stay with for long, because of what it is; that describes a lot of owners. Selling houses is the case: maybe, over many, many years, the same person buys or sells a house through you more than once, but that is no long-term relationship. Seen as a business, a brokerage produces through its agents: each agent is the node of production, not each house sold. So the work becomes getting those nodes in. What makes it sticky is your skill at drawing in and signing up brokers or agents, and the value each one then brings you. Mortgages reportedly work the same way.

3. A warning about what this is for

The view here is that what sections 1 and 2 describe is the way to build a really big business, and that everything else in the method just helps you make whatever you have bigger. Wealth is within reach without any of it; what you give up is becoming the best.

The warning is for anyone asking "how do I win in my market? How do I win in my category?" These vehicles are how a category is won. If all you want is to get rich, even independently wealthy, being the best is not really required. What you need is to earn more than the thing costs you to produce, and to keep doing so for long enough.

Choosing the business. Which kind of business you pick is called arguably the most important decision an owner makes. The body you are born with is not yours to choose; the business is, so pick one that keeps its customers, or work out how to attach something that does. Most true services, such as pool care, lawn care, water treatment, insurance and financial services, keep their customers. Education, consulting and done-with-you work tend not to, because at some point a choice was made to give advice rather than service: advice carries much higher margins and far less operational complexity. That trades more money today for less tomorrow. The view here is that the trade is fine, as long as you see that you made it. The limits on how big one kind of business can get are section 5 of SOP 191.

4. The three basic wheels

Some wheels need no technology, no clever thinking and no special strategy, and every business can fit them in while giving it basically no further thought. There are three:

1. Reputation referrals. If the work is good and kept up long enough, more keeps coming in. It is well worth the focus.
2. Getting people to keep buying. Every business can do this.
3. Getting people to never stop selling for you.

They are the three most basic compounding wheels, and anyone can do all three.

5. Company A and company B

How does a little restaurant turn into a big fast-casual chain? The answer is pictured with company A and company B, an exercise worked through with some of the owners.

Year	Company A	Company B
One	Sells 100 customers, loses 100	Sells 100, loses none
Two	Sells 200, loses 200	Sells 100, loses none, and still has year one's 100, so 200 in all
Three	Sells 300, loses 300	Sells 100, loses none: 300 in all

Look at company A and you would say it tripled over the period; not bad. In year three, both companies are counted as having 300 customers' revenue that year, and as making the same revenue. Yet the one you would rather own is plainly company B, which keeps its customers and sells more slowly.

Flag: how many fewer company B sold. Two readings appear. One puts B at "as third as many" customers as A. The other comes from the figures: company A needed to acquire 600 customers over the same three years, twice as many. This page does not settle which reading is right.

Why B is the better business.

• It is better to own. If it never sold another customer again, as long as you live, it would still earn you money.
• It is significantly more profitable. Acquiring the first 100 customers, set against acquiring 300, plainly costs less. On top of that, company A had to acquire 600 over the same three years, twice as many, and the extra cost of winning them comes straight out of the bottom line. The incremental three hundred that B keeps fall to its bottom line, probably out of proportion, because delivering to customers you already have is almost always significantly cheaper.
• It gets customers free. With B probably doing good work, it probably gains a decent part of every hundred through word of mouth, probably at no cost. Maybe the ones B might pay to acquire are only 50 of each hundred; a figure of 25 of each 100 also appears. The comparison then drawn is 300 customers that have to be paid for, against maybe 25, put as a tenth, with all of the difference dropping to the bottom line.

This is how you really build a compounding vehicle. The owner of a fast-casual chain puts the idea like this, in substance: if your customers truly love what you sell, they come back and buy again. How long that chain took to build is on SOP 191 — Keep the vehicle and stretch the timeline.

6. Marketing and selling alone

Many owners are trying to build their business like company A, on the idea that if they just market better, more money will follow. The answer is the one in section 3. If marketing and selling are all you learn, you can certainly earn money and certainly support yourself, and you can even reach independent wealth. You will not build anything big. It is a lesson, plainly put, that is slow to sink in for someone pretty skilled at marketing and sales.

So ask a different question: how do you build something that compounds? Reputation, together with not losing customers, is one of the key routes.

7. How it looks by type of business

Put together, the steps run in order. Find the constraint. Put leverage on it, and see whether you can hit it from several different angles. If that succeeds, you create a compounding vehicle. Everything you have — effort, money, brand, all your inputs — goes into the machine, the black box, and you want it to compound by itself. That is the flywheel.

A shop or other brick-and-mortar business. You want to reach the point where, once a store or shop is full, you no longer pay for marketing, since the shop remains at capacity. Then pricing is the only lever left there: you keep pushing the price up and stay full. Then you open another location, and do it all again.

A brokerage or other sales-driven business. The point is to be in a business where you can keep recruiting, onboarding and training, round after round, and keep activating new sales reps. Then, as long as those reps produce, you keep stacking, year over year.

Without it. You need some sort of compounding in the business. Without it, you kind of pour people in while they fall out the back door; you decide the answer is to sell to more people, and your margins keep getting squeezed.

The order. Learn enough marketing and selling to get started. Then turn your whole effort to keeping people from ever leaving, and stay on that. Sometimes solving that one problem takes years. Once it is solved, the business grows by default. You could then hold sales steady, in a way kind of like section 5's company A and company B, and B is the one to be: its growth carries on whatever happens, since the money keeps coming whether your sales hold level or stop entirely.

Flag: keep everyone, or let the front end pay its way. The order above says to turn your whole effort to keeping people from ever leaving. A second reading, given for a consulting business, holds that it is unlikely to reach true 80 or 90 percent revenue retention: treat the consulting as a cash-flow vehicle that offsets the cost of winning clients, take stakes in the best client companies, and let those grow, so the compounding happens there. This page does not settle which reading is right.

8. Where this sits

• The elements in order, and the questions that find the constraint first: SOP 184 — Find the one constraint with six questions.
• What leverage is and where to aim it: SOP 185 — Allocate resources to the constraint and use leverage.
• Holding on to customers once they have bought: SOP 133 — Run the five retention habits and expect the first-month rise; SOP 138 — Keep value above price to hold customers; SOP 139 — Onboard customers to the activation point.
• Turning a customer's mention of a friend into a real introduction: SOP 16 — Keep the referrer in the conversation when you contact their friend.
• Partners who go on selling for you as affiliates: SOP 50 — Choose an affiliate integration model.
• Paying your own team for recruits they refer, with an insurance brokerage's case: SOP 152 — Sell a second product at ten to nineteen people, section 8.

9. What this page does not decide for you

• How many fewer customers company B sold. See the flag in section 5.
• Which company's first 100 customers are set against 300. Not established on this page.
• What the 300 and the 25 compare, and what the tenth is a tenth of. Twenty-five is given per hundred, and 25 against 300 is less than a tenth. Not established on this page.
• What is stacked year over year in a sales-driven business. Not established on this page.
• How long is long enough. This page gives no figure for how long a good job must run before referrals keep coming.
• The period behind the 80 percent. Whether the bar in section 2 is counted by the month or the year: Not established on this page.
• Keep everyone, or let the front end pay its way. See the flag in section 7.

10. The checklist

Step	What to do
1	Find the constraint, put leverage on it, and see whether you can hit it from several angles
2	Look for a compounding vehicle (almost all businesses should): reputation, structural virality, long-term stick, a network effect, integrations or a sales network
3	Build in the three basic wheels: reputation referrals, people who keep buying, people who never stop selling for you
4	Learn enough marketing and selling to get started
5	Then turn your whole effort to keeping people from ever leaving; sometimes that takes years
6	In a brick-and-mortar business, once the shop is full, raise the price, then open another location and repeat
7	In a sales-driven business, keep recruiting, onboarding, training and activating reps
8	Hold any candidate vehicle to the bar: 80 percent or more kept; where you sell once, look in the places on SOP 283
9	Know whether you chose advice or service, and what that trade costs you later

11. What this page does not cover

Churn and retention tactics are not covered on this page. Pay for sales reps is on SOP 251 — Set sales comp and a career path for reps.