Impress yourself with your own METRICS
When it comes to measuring startups, there is an alphabet soup of acronyms that we use to determine how well a venture is doing. Today’s post covers common and important metrics that VCs want to know. At the end of the day, VCs use these numbers to find answers to three sets of questions:
- What will it cost the company to generate revenue? In this case, we’re looking at how much it costs for obtaining paying users.
- Is the business scalable? Can it grow exponentially? At the risk of stating the obvious, VCs want to see a big return on their investment, and they want to see proof that the payoff will be exponentially larger than their investment.
- When will the company reach the breakeven point? Remember, for each infusion of capital that a VC leads, they want to know how the company’s new (greater) expenses will facilitate faster growth for the business.
SIZE OF MARKET
It’s an unfortunate situation when you ask a founder, “Who is your target market?” and they answer, “Everyone.” While most new founders have a basic understanding of market segmentation, there are actually three components to a well-defined market for a particular startup.
Total Addressable Market or TAM – This is the overall number of people in your target market. For example, there are 18 million basketball players in the United States.
Serviceable Available Market or SAM – This is the number you are capable of reaching at present. Let’s say you are focusing on the market in New York City to begin with, and there are 350,000 basketball players in NYC. Some quick math tells us this represents 1.94% of your TAM.
Serviceable Obtainable Market or SOM – You are not the only company targeting basketball players in New York City. You are likely not the only company offering a product of a certain type. Let’s say we are aware of a few competitors in NYC that already have more than 100,000 users combined. The good thing about learning this number is it tells you that there is a demand for products like yours. A good goal would be to gain the same number of users as your competition in 3 years. Your SOM in this case would be 28.57% of your SAM and 0.6% of your TAM.
CUSTOMER ACQUISITION COST
If I had to choose one generic metric that every startup should measure from day one it would be their Customer Acquisition Cost, or CAC. Nearly every industry has a benchmark CAC to aim for. How do you find your CAC? For a given period of time, calculate the following:
Total $ spent acquiring customers (primarily marketing costs)
————— Divided by —————-
Number of customers acquired (during that period of time)
Knowing your CAC helps you determine if your company is profitable. It also helps you know how many customers you need to reach in order to get profitable. Furthermore, it helps you understand which marketing efforts are resulting in customers. For example, if you measure your CAC from day one, and in month two you launch a certain marketing tactic, you can compare your efforts before and after to see if that marketing effort is really paying off. If over 6 months you spent 100,000 on content writing, search engine marketing, public relations, and advertising, and you acquired 1000 users, then your CAC would be $100 per user.
CUSTOMER LIFETIME VALUE
Another great metric is your Customer Lifetime Value, or CLV. The CLV describes the amount of revenue or profit a customer has generated over the entire lifetime of the product. In other words, how much revenue have you derived from one user? There are many factors to include: users who make multiple purchases over a number of years, subscription renewals, fees, upgrades/premiums, et al. Your CLV can help you understand your profitability, and it can influence your strategy for marketing. For example, consider the CAC in relation to the CLV – which customers cost less to acquire, but have a larger lifetime value? Which customers make more purchases over a long period of time versus one big purchase only to disappear?
MONTHLY REVENUE GROWTH
This one is easy, once you have revenue. What is the rate of change in your revenue month over month? For investors, a growth rate of 40% monthly is very good. A growth rate less than 40% can be considered good if you can convince investors that additional capital used for sales and marketing will drive that growth rate higher.
COHORT ANALYSIS AND CHURN
Cohort Analysis is a measurement that helps you understand what’s working and what’s not. For a given time period (usually over a week), count the new users who joined/purchased/subscribed, or who have taken another critical action. On a running basis, take this cohort of users and track how many of them engaged with your product or service each week. You’ll begin to get a measure of how “sticky” your company is to its users.
In the same vein as Cohort Analysis, Churn is another measurement to determine how interested your users are in coming back to your product/service. While Cohort Analysis is a positive association with your product, Churn looks at the interactions that are lost. To calculate Churn, first determine what an inactive user means (how long will you wait for a user to take an action that means they are engaged?) Count the number of inactive users and divide by the number of total users, regardless of when they signed up or started using your product. Churn is also calculated weekly, and you will want to compare each week to the previous ones on an ongoing basis.
For social media applications, 80% one-week churn is very high, 40% is good, and 20% is phenomenal – another indication of a sticky product. For paid products like SaaS applications, Churn and other conversion metrics speak louder than just cohort analysis alone. A SaaS churn rate in single digits (1–3%) indicates a strong product.
Your gross margin helps you determine your breakeven point. To calculate your gross margin, follow this equation:
Revenue – Cost of Sales = X / Revenue
Your Gross Margin helps investors assess the business risk and profitability. With a low gross margin (10-30%) it can be hard to build a large, scalable business because you need to make a lot of sales to cover your operating costs. Contrast that with an 80% Gross Margin, the margin of many software companies, and you’ll see why investors value software companies so highly.
The key take away from all of these metrics is that companies who scale up quickly in revenue, who have a high Gross Margin, should invest as much capital in growth as they can. If you’re lucky enough to be in this boat, spend your money wisely in the places that you KNOW to affect your growth rate.
Don’t chase these metrics in order to impress investors. Chase this metric in order to reach your own goals, understand your strength and be aware of your weakness.