The ‘what, why and how’ of 10 fundamental KPIsSep 12, 2018
Understanding your company’s Key Performance Indicators (KPIs) is essential. This information can be used to show off your business potential to educated investors.
This article will highlight a number of fundamental KPIs with a brief explanation of their significance. Be aware that not every KPI will be relevant to your company. The key is to identify those KPIs that can determine how your business is performing against your objectives, allowing you to showcase growth to investors.
Customer acquisition cost (CAC)
CAC is as simply the average cost to your company each time you acquire a new customer. Measuring CAC requires you to understand how much you are spending on acquisition in terms of marketing and related expenses such as salaries. Dividing this cost by the number of new customers acquired within a given time frame produces your CAC.
CAC cannot be simply understood alone, to understand it’s true value it needs context which a number of the other KPI metrics lists below provide.
An educated investor will recognise that a newer company will need to invest more in initial acquisition and brand awareness, so make sure your business plan addresses projected as well as current CAC in comparison to your competitors.
Lifetime value (LTV)
LTV is a prediction of the net profit which a customer will provide your business during their lifetime (with the company). This metric allows you to estimate how much repeat business you can expect from an average customer and use this to understand the overall value they can bring you as a customer.
LTV is particularly important in order for you to justify your CAC. In other words, the higher the LTV of a customer, the more money it is worth putting into acquisition. Proving that your LTV exceeds your CAC provides an indicator of sustainability for your business.
Customer acquisition costs (CAC) recovery time
Knowing your average LTV exceeds your CAC is a great start. However, it can make a big difference if it takes 6 months compared to 6 years for a customer to generate enough revenue to cover the initial CAC. CAC recovery time is a measurement of this metric.
Keeping your CAC recovery time low (typically under 12 months) ensures you have enough capital to allow future growth. This can be an essential KPI for investors as they will expect you to be able to both explain and justify that you have fully considered the amount of investment you are asking for.
Customer retention rate
The customer retention KPI reflects your businesses long term ability to retain customers and generate repeat business. Customer retention is absolutely vital for long term success. Whilst a successful plan can be developed, if customers do not see value in the product itself then there is little value to the business. Investors want to see a positive track record that a business has the ability to generate recurring revenue from existing customers.
Churn is the number of existing customers who you lose and will negatively correlate with your customer retention rate. Whilst losing customers must be expected, it is important to monitor the number and rate at which you do.
As well as analysing this KPI in terms of numbers, a good business owner will look to work out why. Establishing why you lose customers allows you to learn from past experiences and create personalised retention plans for the future.
The product metabolism KPI measures the speed at which your business evolves and makes decisions. Understanding the positives and negatives of product metabolism can be less clean-cut than other KPIs. Maintaining product metabolism is a balancing act, moving quick enough to keep up with the trends but not so fast as to create instability and negatively affect retention rates.
It is generally accepted that a younger company will have a high product metabolism starting out, but will be expected to slow down as the company matures and the processes become more refined.
If nothing else, understand your own product metabolism and be able to argue your case to potential investors.
Activation, also known as conversion rate, is a KPI used to establish how likely it is for a potential customer to be acquired. This could be reflected by an e-commerce transaction or signing up for an account. Activation is expressed as a percentage, for example, the number of visits to a website that result in a product being purchased would reflect the conversion rate KPI.
It is likely that a higher activation KPI will correspond to a lower CAC, as less marketing expense will need to be exerted to gain new customers. A high conversion rate means new users had a positive first experience with your product, whereas a low activation rate is a sign that it was either too complicated or not engaging enough to lead to a sale.
Revenue, overheads and monthly burn
We have grouped these together as you cannot consider one without the others. Revenue is the pure income that your company brings in, whereas your overheads are a combination of your fixed and variable expenses.
Your monthly burn, or burn rate KPI is the rate at which your company is losing money. Taking in to account the combination of your revenue and your expenses for a given month provides your burn rate.
When you are looking for investment, any educated investor will find a clear understanding of runway imperative to their decision to invest. Runway relates to the number of months until a company will run out of money, in other words, your cash flow divided by your monthly burn.
Your business plan should confidently show investors that you are looking to raise a sensible amount of money in order to ensure a conservative estimate of your runway. Investors want to be assured that your business is not just a great idea, but can last the test of time. A new business needs time to grow, so a runway of fewer than 6 months may be an indication of an inefficient or desperate business.
Your profit margin KPI is a clear sign of return on investment (ROI) allowing investors to see exactly how much profit your business is making over your bottom line costs.
This metric is again a good predictor of long term success but must be coupled with a strong set of KPIs to match ensuring acquisition and retention rates are high enough to ensure continued profit.
It is clear to see that the majority of KPIs are connected and it is a holistic understanding of your company’s KPIs which will help you to make wise decisions for your business and allow investors to analyse their impact.
We realise it can be difficult to monitor all of these KPIs at once. We recommend that you begin by pinpointing those metrics which directly affect your bottom line such as revenue, CAC and churn. Once you have established your current KPIs, you can create your business plan and goals around these.
Remember the majority of investors are business professionals and will spot an amateur a mile off.