The 40% Rule

[toast76]

I'd never heard of this rule, so I can't say it was planned but I've just done the maths on our startup (http://macropod.com) and we're exactly on 40%.

I certainly didn't use this equation, but our monthly expenditure is controlled quite heavily by our growth rate. So maybe there's something in that....I think I'll go work out whether this hold true for various growth rates using our method...

FWIW:

- I have a spreadsheet which maps out our revenue and expenses over the past 2 years.

- It estimates our future growth

- It combines that with our bank balance and our expenses to work out an "optimum burn rate".

- We use this number as a guide to how much we should be spending.

The "optimum burn rate" is the spend that will see us use as much of our cash as possible without us dropping below a certain threshold (which at the moment 3x our monthly burn).

[fragsworth]

Maybe I'm missing something important, but I don't see any rationale behind this. What makes 35% or 45% worse than 40%?

[GICodeWarrior]

I would guess he is suggesting that less than 40% means you are over-spending or under-performing and more than 40% means you are under-spending (eg. you should invest more in growth).

[xacaxulu]

I think it's because 60% of the time it works every time.

[golemotron]

It might be better seen as an observation of a quality of a good SAAS business. Maybe no one knows.

Why is pi ~3.14159?

[hammock]

You could apply the 40% rule to personal finances as well. If your income/salary is increasing 20% a year, put 20% into savings. If your income is increasing 5% a year, put 35% into savings.

[brd]

I disagree, in personal finances you aren't afforded the same kind of burn rates because there isn't an investor model for individuals. If my salary has increased 100% YoY for the last 3 years, I would be in a troubling amount of debt.

This applies in reverse as well, if you take a salary cut you likely aren't going to be able to save more money as a result.

For personal finances I think its better to tease out a baseline amount for expenses and save everything above that, re-calibrating occasionally as required.

[ukigumo]

I think this rule is a nice generalization overall but for my money I would discount natural segment growth from the company's year on year.

So, if the market (ie mobile payments) is growing 50% YoY and the company is only growing at a rate of 25% that's actually pretty bad.

[pc86]

Would you always expect to grow at a rate higher than natural segment growth for a "good" company?

[dazne]

This works as a good "rule of thumb".

[cperciva]

Your annual revenue growth rate + your operating margin should equal 40%

My immediate reaction: So I guess I need to cut Tarsnap's prices and slow its growth rate?

On further thought, I suspect "should equal" should be "should equal or exceed".

[applecore]

It means Tarsnap isn't spending enough on growth.

[mathattack]

They key is this applies for mature companies. He quotes $50mm or higher in revenue. It breaks down earlier.

[petercooper]

I wondered that as well as I'm in the same situation, but then I wondered if it works as a target if it means we should be spending more on staff and reinvestment to grow even more? But that'd mean the %age gets even higher so.. maybe not ;-)

I also don't really understand why having a higher margin is useful in a declining business. It's either a lost cause or one should be reinvesting in reversing the growth problem, no..?

[ukigumo]

From the original article: "If you are doing better than the 40% rule, that’s awesome."

Tarsnap is doing awesome. Keep up the good work!

[garrettlarson]

He means "should equal or exceed":

> If you are doing better than the 40% rule, that’s awesome.

[phamilton]

Or I think he means you should be spending more on R&D and marketing.

[csomar]

It means there is more room for growth that you are missing. So you should spend more, but not much so that you keep at the 40% rule.

[michaelochurch]

This literally means that you can lose as much money as you want as long as you grow at a stupid-fast rate. It doesn't matter what you're building or whether anyone wants to pay for it, as long as you get what the monkeys call a "hockey-stick curve".

You're OK even if you literally win at losing. Good to know.

This explains so much.

[mmastrac]

It's not user growth -- it is revenue growth.

If you've got a hockey-stick curve for revenue and you're losing money, that's not necessarily a problem (within reason). At some point you can start spending less on user acquisition/marketing and you'll go from losing money/growing fast to profitable/growing slower.

[chucksmart]

When I was in school the professor said something about interest rates and opportunity costs that was more algebraic than arithmetic; but I guess that is all academic.