What is the Flywheel Model in Business?

Want to build unstoppable momentum in your business? Start with the flywheel. In this video, Steve breaks down the flywheel model and reveals three powerful flywheels every business should be tracking: LTGP to CAC, Return on Labor, and ROIC.

You’ll learn how these flywheels drive efficiency, boost profitability, and increase long-term company value—plus the KPIs that make them work. If you're ready to create compounding results and scale smarter, this is your blueprint.

TRANSCRIPT:

If you're a business owner, I don't need to tell you that it's really hard to keep everything in check. So in this video, I'm going to explain to you the three flywheels that you can leverage and what metrics you need to put in place in order to maximize value in your company. Let's go ahead and jump in.

So Jim Collins in his book, Good to Great, excellent book, by the way, he talks about this concept of a flywheel. It's not just proprietary to Jim Collins. Flywheels have existed for years, right? For millennia, right? And the reason why they're so effective is because once you get a flywheel going, right? Think about a train on a track.

This is a terrible train here, but you have a train with all these train cars. Like I said, terrible train. But in order to get the train going, it just takes so much momentum. It's like, chk, chk, chk. Right? And it's like, barely moving, barely moving. The wheels start turning, the wheels start spinning, and then it picks up steam. And next thing you know, these wheels are spinning on the train and it's reaching maximum velocity and the same thing is true in your business.

So I'm going to talk about three flywheels that I like to pay attention to when I'm growing in scaling businesses. All right.

So the first one has to do with sales and marketing. And really, when I look at flywheels, I look at efficiencies. So I'm just gonna label this sales and marketing efficiency. All right, and here's the flywheel. And once you get the flywheel going, when it comes to sales and marketing, then all of a sudden you're gonna be getting more leads, you're gonna be closing more of those leads, you're gonna be retaining more of those leads, getting more referrals, et cetera, and this flywheel's gonna be spinning quite nicely.

Now, in order to measure your sales and marketing efficiency, you're gonna wanna look at LTGP to CAC. You're like, what the heck is LTGP to CAC? Let me explain. If you look this up, a lot of people talk about lifetime value, LTV. The reason why I like LTGP is because it cuts right to the point and eliminates any confusion. Because with LTV, sometimes people talk about the lifetime value of a customer in terms of revenue, and that's not correct. You wanna look at the lifetime value of a customer in regards to the gross profit that you generate off them.

So if you go to the income statement, you have revenue, you have cost of goods sold, and if you take revenue minus cost of goods sold, you end up with gross profit. We're not done yet. If you take OPEX, and OPEX is made up of sales and marketing cost, GNA, and R&D. We'll come back to that here in a minute. And if you take gross profit minus OPEX, you end up with operating profit. I'm just simplifying. Sometimes this is referred to as EBITDA, just depends on what's in these numbers here. All right, earnings before interest, taxes, depreciation, and amortization.

All right, so to compute your lifetime gross profit of a customer, what you're gonna do is you'll take gross profit, and you'll just divide it by the number of customers in the same period. And that will tell you the gross profit per customer. But then you may be wondering, well, how do you compute LT, right, the lifetime? Well, I would say to be conservative, you can just use one year. That's the most conservative approach if you can't figure out the lifetime of your customers. The other way to figure out the lifetime of a customer is to look at your churn rate. So this is the rate at which you lose customers.

So let's say your churn rate is 10%. That means you're gonna lose 10% of your customers each year. Or if you do the reverse math, it means that customers will stick around for 10 years. All right? Now, you could do it like that. And maybe you're thinking to yourself, 10 years seems a little aggressive. Then you could adjust it from there. But I would just say one is gonna be your baseline, one year, and then go from there two, three years out. If you wanna be a little bit more aggressive, but you still wanna stay conservative, just whatever is best for your business. Make sure you don't confuse the LT part of the formula because that could screw everything up. All right?

So that's how you compute your LTGP. And then your CAC just stands for customer acquisition cost. In order to find this, you're gonna go under OPEX on the income statement, take all of your spend in sales and marketing. So it's all the salaries, all the sales and marketing spend, content creation, paid ads, print material, everything that goes into sales and marketing, take all those costs and divide these costs by the number of new customers.

So see that? Up top here, I just divided gross profit by the total number of customers in the period. For CAC, you wanna compute it based on the number of new customers. So new customers is gonna be in the denominator versus total customers up above. All right.

So then you will figure out your CAC and this will show you what does it cost your business to acquire a new customer. Now, when I'm working with businesses, oftentimes they're like, Steve, how much money should I budget for sales and marketing? And I'm like, you shouldn't have a budget if this ratio is working. If this flywheel is in check, then why would you have a budget? The reason why most companies have a budget is because they don't understand this, right? So they see sales and marketing as an expense rather than an investment, or the ratio is so terrible, they intuitively know something's off and therefore they wanna cap the amount of spending that's going on.

So I like a ratio right here of at least three to one. All right, that's what you wanna shoot for when it comes to your LTGP to CAC. The reason why I say three to one is because think about it. You spend $1, you get $3 in return. One third of that is gonna go to fulfillment costs, typically, another third is gonna go to overhead and then the other third is gonna go to profit and taxes and reinvestment in your business.

The other thing to understand is that over time, this LTGP to CAC ratio compresses because you start cannibalizing the market, it's harder to find customers, your costs increase, et cetera, so this is gonna shrink over time. So some of the best companies that we work with, they're like 10 to one or greater, and as they scale, they have a lot of runway to get down to this minimum three to one, and that's a great business. So that's the first flywheel that you need to measure your sales and marketing efficiency and that's the KPI that corresponds with it.

So that's the first flywheel that you need to measure your sales and marketing efficiency and that's the KPI that corresponds with it.

All right, the next flywheel has to do with operational efficiency. I'll abbreviate here. And so the same thing, you have this flywheel, you get it going, sometimes it's slow going, but once you get it, it's reinforcing itself and it's just spinning over and over again. The KPI to measure operational efficiency is ROL, return on labor.

Now there's so many different ways to do this, there's so many different nuances, but I'm just gonna keep things high level for the sake of this video. What you could do is you can take your net operating profit after tax, that's what I would recommend. Just go to your income statement and remember this line right here, your operating profit, just account for taxes.

So if you're an LLC or an S corporation, obviously your entity is not paying taxes, but you can just take an effective tax rate either off your tax return or you just use 30 to 35% to come up with this net operating profit after tax, because remember, even if the entity doesn't pay taxes, somebody's gonna have to pay taxes, right?

So I take NOPAT here, I like to look at profit after tax, and then I'll divide that by my total labor. Now this is where it becomes very nuanced because maybe you wanna look at net operating profit after tax as a function of your cost of goods sold labor. In other words, your production labor or your manufacturing labor only, or you may wanna do some other things with your total labor, I think you get the point though.

You wanna see what is the return on your labor. Now if you do the math like this, you're gonna get a percentage, or you can flip it and you can take your total labor and divide that by your NOPAT here. Either one is fine to come up with a factor, it's just whatever you find is best for your business.

Now when it comes to putting some numbers and benchmarks to this return on labor, you can look at it from a revenue standpoint, and it's just easy to remember this three to one ratio, but this isn't profit to labor spend, this is revenue. So I look at it the same way. So if I pay somebody, let's say $100,000, I'm gonna want $300,000 in revenue at least, because remember, a third is gonna go to fulfillment cost, third's gonna go to overhead, and then a third's gonna go to profit and taxes and reinvestment.

Or if this is too confusing and you don't wanna focus on three to one in relation to revenue compared to your labor cost, then you can follow this formula down here, which I recommend. And a good benchmark is plus 100% is exceptional, so exceptional companies earn over 100% return on their total labor spend. 50 to 100, I would say, is strong. And then 20 to 50 is average.

So most companies right here live in this world, if you're below a 20% return, that could be problematic, and you may have issues with your operational efficiency and the flywheel. And if you could fix this, then guess what? You're gonna get this flywheel spinning faster, and this ugly train down here is gonna move quicker at velocity, and you're gonna drive more value in a more effective manner.

Okay, there you go. Number three, are you ready for it? This is the last flywheel, and this is value efficiency. Can't even write here, my handwriting is terrible. That is so ugly, especially for a type A person. You would never guess that I'm type A, like with my financial models, by looking at my diagrams. Oh my gosh, they're terrible, but they're fun, all right? They're a little bit different.

I talk a lot about value efficiency in the cashflow book. I just call it value efficiency for short. It's really value creation. Same kind of thing here is you have this flywheel, so you're gonna deploy capital, you're gonna earn returns on capital, you're gonna adjust your strategy, and this flywheel's gonna be working really well if you can improve and increase your return on invested capital. And that's the KPI to measure value efficiency, and it's computed by taking, use a different color here, NOPAT...

That's why I like to take NOPAT over here versus revenue. Revenue's just a quick and dirty way of doing this three-to-one revenue to your labor costs, but I like to look at NOPAT because I'm gonna use the same number over here in this calculation, and it just makes it easier to compute my flywheel across the board.

So NOPAT, Net Operating Profit After Tax, remember this comes from your income statement, and invested capital comes from your balance sheet, right? So you're gonna have to go to your balance sheet, hi, balance sheet, and BS does not stand for what you're thinking, it's actually balance sheet. Go to your asset section, and you're gonna find your current assets. Go to your liability section, you're gonna find your current liabilities. Do the math, current assets minus current liabilities, and you will get...

That's just simplistic. There may be some other adjustments like excluding excess cash and interest-bearing liabilities, but that's just the simple math. Then you'll also wanna find your net property, plant, and equipment. This is just your investment in things like your building, your trucks, your vehicles, your machinery, et cetera, to run the business, and I say net because you're gonna wanna take out depreciation.

So take your working capital and your net PP&E, add it together, and you get working capital. Do the math, and let's just say you're earning a 20% return on invested capital. That's good because the S&P 500 in the United States over the last 50 years has returned about 10%. So you wanna be beating the S&P 500 in your business, otherwise you're underperforming, and you're better off just putting your money in stocks.

Don't sell your business off that advice. I'm just saying, if you're earning like a 5% return, it's like, dang, what are you doing in your company, and how do you improve that? No shame, no harm, no foul. If you are, just don't stay stuck there.

All right, so a good return on invested capital. The best companies that we work with, they're like 25% plus. Strong, I'd say, is 15 to 25. Anything below 15 is okay, but if you're below like 10, that can be problematic.

So these are the three flywheels that I like to pay attention to and leverage in business. Sales and marketing efficiency, operational efficiency, and value efficiency. I gave you the three KPIs to measure each of these flywheels so you know whether or not these are functioning well in your business, and if they're functioning well in your business, guess what, you're gonna make a lot of money, and you're gonna increase your firm value.

If any of these flywheels are broken, guess what? You could be driving a lot of people to your business, but you may not be serving them well, and you may be losing money, and guess what? These two, they actually combine to drive higher return on invested capital, and that's how they all fit together.

All right, what are your comments? Leave them down below. Did you like this video? Are there other topics you want me to dive deeper into? Your comments will help me to plan future episodes. I wanna make sure I'm always driving value to you. As a business leader, business owner, and entrepreneur, I want to make sure you are maximizing the value of your business, and you're following sound strategies that will help you to get there.

All right, that's all I have for you. Until next time, take care of yourself. Cheers.