Not all business metrics are created equal
There are always going to be too many business metrics to track.
The sophistication of automated tools today means you could literally set-up tracking on every activity. But tracking everything is not helpful when you have specific performance goals in mind, and a limited budget to accomplish them.
What are the top business metrics to track?
To avoid following vanity metrics, a winning strategy is to set specific parameters around what you want to achieve and determine which metrics are most consequential in helping you get there. Here are five business metrics that reveal the true underlying state of your companies financial heath, both today and in the future:
Customer Acquisition Cost (CAC)
The cost of acquiring new customers is one of the benchmark metrics by which to measure growth. In general terms, it indicates how well your sales and marketing strategy is working. Like all the metrics in this list, CAC is relative and time-specific. In other words, a healthy CAC depends on how much money you are spending, over a certain time period, to acquire new customers. The equation looks like this:
CAC = Net sales and marketing cost divided by the number of newly acquired customers
Like every metric in this list, the outcomes of this metric should influence how you spend money. Based on what it costs to acquire 1 new customer it will become clear what top of funnel activities are converting at a high enough rate. (The good thing about focusing on CAC is that it forces you to set up solid analytics programs and repeatable outreach processes to properly analyze the cost of acquiring one customer).
It’s important to note that CAC is relative to the cost structure of each business. For example, the CAC for a SaaS company selling a monthly subscription-based consumer application is going to be lower than an IT company selling security solutions to enterprise firms. The reason for this is the sales cycles are much shorter for consumer selling companies as compared to B2B selling situations. However, that does not mean the SaaS company has a healthier CAC. They might have a smaller cost structure yet they persist with an unstable revenue model (ie the cost of acquiring a new customer is too high relative to the revenue they receive from each customer). The underlying issues of cost and scale are why so many startups run into trouble: they cannot keep the cost of acquiring new customers low enough relative to the value each customer brings over time.
Customer Lifetime Value (CLV)
Closely related to the cost of acquiring customers is the revenue generated from each customer over their entire interaction with you – the customer lifetime value (or CLV). It can be hard to put a reliable number on this value, but as you collect more data you start to see patterns in spending and customer lifespan.
A number of key insights can be gleaned from CLV. For starters, projections of this accurately give you an idea for how much can be spent to acquire new customers. If your interested in breaking down projections for your company, use a simple formula that best applies to your situation right here.
Closely related to the cost of acquiring customers is the revenue generated from each customer over their entire interaction with you – the customer lifetime value (or CLV). It can be hard to put a reliable number to this value in the early stages, but as you collect more data you can start to trace patterns for how much revenue a single customer generates overtime.
A good way to measure CLV over time is to compare it to CAC. As a rule of thumb for startups, you want to keep a 3:1 CLV-to-CAC ratio or greater, with the caveat that it varies by industry and customer profile. If you know it costs you $100 to acquire a new customer, and that customer brings in $720 per year, and stays a customer on average for 3 years, then you can justify spending more to acquire that type of customer because they bring significantly higher revenue ($2,160) over time.
Success depends on two things: your cost structure, and conversion rates in your marketing and sales initiatives over time. In terms of a sales initiative, a SaaS company might adjust their product from a single purchase to a monthly subscription model to boost customer lifetime value. Beyond that, a healthy CLV indicates a business model with compounding revenue and steady costs. It looks good in a pitch deck – but even better on your bottom line.
Another critical gauge of success is your churn rate. This measure provides your net customer score by focusing attention on how many customers you’ve gained or lost. To calculate churn, follow these steps:
- Set a specific time period over which to measure (month-to-month is most common)
- Divide the # of customers lost from the total # of customers you added that month
- Turn it into a percentage
For example, if you added 100 customers in a month and lost 10, your churn rate is 0.1 – or 10%. Here’s how the equation looks:
10 (customer lost) / 100 (customers gained) = 0.1
It goes without saying: the lower the churn rate the better. The problem? It becomes complex to track accurately the more trials and types of customer segments you set up, and as you gain more customers over time. For example, the churn rate for an enterprise level offering is going to differ from an intro level service, and if you offer trial periods then you need to factor that in too. On top of that, deciding what day of the month to calculate the ‘total number of customers’ introduces some unwanted variability – especially as a startup approaches product-market-fit levels of growth. Ultimately, however your churn rate measurement dates are set up, it needs to be applied consistently over time in order to be an enlightening indicator of customer stickiness.