GitLab aspires to using The Hypergrowth Rule by November 18, 2023. Until that time as a percent of revenue, we are spending at a higher rate in all groups (except G&A and cost of sales) compared to companies at similar stages of growth. We do this to advance the product, increase our TAM, and increase market share through a new channel strategy. We believe this investment will result in higher growth rates compared to similar companies.
The hypergrowth rule is a standard for measuring and thinking about profitability at any growth rate.
It's inspired, in part, by the Rule of 40, a SaaS rubric for growth that
Revenue Growth % + Free Cash Flow % = 40.
There is a high correlation between level of attainment of this combined metric and company valuation - although data suggests that current investor valuations models are more highly correlated with revenue growth rate. We view the Rule of 40 not as target but a threhsold that should be surpassed and recognize companies that exceed the Rule of 40 have better valuations.
We believe that strong correlation is a result of the importance of capturing market share. Spend is high when you grow quickly because you have to pay now for the org you want to have in 12 months, as it takes time to ramp up. Using the Rule of 40 as an example, when Revenue growth is greater than 40%, there is an implication that negative profitability is encouraged, but this fails to answer key questions, such as:
The below hypergrowth rule can help answer the questions that the Rule of 40 doesn't answer.
Division expense target = (Revenue Delta * Growth Lever * Model Percent ) + Model Percent
Division Expense Targets are the optimal percent of revenue for each functional group in a given period, this is the output of this formula.
Revenue Delta is the difference between Revenue Growth and Eventual Profit Margin. For GitLab the Eventual Profit Margin is 20% because our target costs are 80%.
The growth lever is equal to
1 / (sum of target divisional % of revenue for divisions that should be variable based on growth).
For GitLab, it is:
1 / (Sales + R&D + G&A + Marketing % of Rev), which would equal 1.25, but because cost of sales and hosting don’t increase with faster revenue growth, we can remove those (17%), and what's left is
1/(80%-17%) which ~ 1.5.
This makes the full formula for the growth lever:
1 / (Sales + R&D + G&A + Marketing % of Rev - Variable Non-Delayed Costs).
The growth lever is about to 1.538.
Our model percent is our long term profitability target for each division.
Long term in this case means the time when the combination of your long term profitability target and your growth equals 40%. So if your long term profibility target is 20% it is the year your growth declines to 20% year over year.
Below is an illustrative example, using the hypothetical case of revenue growth being 150%:
|Eventual profit margin||20%|
|Revenue delta||150% - 20% = 130% = 1.3|
|Division expense target as a % of revenue||(Revenue Delta * Growth Lever * Model Percent ) + Model Percent)|
|Division expense target as a % of revenue||(1.3 * 1.538 * 0.23) + 0.23 = 68 %|
Watch this Q&A with CEO Sid Sijbrandij with VP, Finance Craig Mestal and Senior Director, Investor Relations Tony Righetti: