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The Law Of Compounding

Jun 3, 2008
"It's the most powerful force in the universe... "

At least that is what Albert Einstein is rumored to have said of compounding. Why would the father of atomic energy, a man who certainly knows something about real power, say that about something so intangible? The power of this mysterious force is best told in the following legend.

Once upon a time a Mogul king wished to reward a local peasant for saving his daughter's life. "You can have anything you want," offered the king. The peasant asked merely for one grain of rice to be placed on a chessboard. Courtiers began to laugh at the meagerness of this request, but the suddenly audacious peasant held up his hand for silence. "I ask for one more thing", he said. "Each day the amount of grains will be doubled and placed in the next box, and so on, for all the places on the board." The king thought this trifle a bit ridiculous, but agreed. The story does not end well, for on the 64th place there was not enough rice in the entire kingdom to satisfy the request. The embarrassed king had the peasant hanged.

This little story illustrates well the effects of sequentially adding, or more accurately, multiplying; the impact of growth on top of some previous impact of growth. Most people think of compounding in relation to compound interest, and consider it, like Einstein, to be the most powerful force in finance.

In business acceleration we think of compounding in altogether different terms, although the effects will once again be felt on your personal finance. We call it the Law of Compounding and use it to describe how a business can grow dramatically by making a series of incremental changes to various elements of that business. This magic works reliably as long as the various elements are interrelated.

For instance, since lead generation and lead conversion are interrelated, an increase in the number of leads your company attracts each month compounds on top of an increase in how well you convert those leads into customers. An increase in your average price compounds on top of that. An increase in the size of your average sales transaction would compound on top of those previous increases, as would an increase in how often the same customer buys a service or product from your company.

To find out how fast your business will grow when you make these types of changes, we'll use something called the Rule of 72. Divide 72 by the number of separate but interrelated elements on hand, to get the amount of change needed to double.

For example, if you have seven elements (lead generation, lead conversion, price, etc.), 72 divided by 7 is approximately 10, (10.28), which means your business will double by increasing each element 10%. Have six elements? You must increase each one by exactly 12%. (72/6 = 12) Five? Doubling will take an increase of around 15% each. (72/5 = 14.4)

How hard do you think it would be to improve just a few aspects of your business by ten, twelve or even fifteen percent? Not that hard, right? If your company generates 25 new leads each month, then a 15% increase means 4 more. And, if your company closes 20 leads out of 200, then a 15% increase means closing 23.

Of course, you don't have to make these changes all at once. You can do them in sequence over time, the effect of one change compounding on top of the previous change. By following the Law of Compounding examples above you can see how relatively small changes in your business can add up to substantial business acceleration; dramatically increasing revenues and profits over a short period of time.
About the Author
Find out more about how to put the Law of Compounding to work increasing revenues and profits in your business. Contact Paul Lemberg, CEO of Axcelus: Business Coaching for Business Acceleration. http://www.axcelus.com/acceleration_request.html
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