Key Performance Indicators (KPIs) For Start-ups
In 2015, Layer Vault, which created the version-control software for developers, ran into a problem. It shut down. The fact that it appeared, externally at least, to be a healthy startup, the company struggled to find product-market fit and had to close as a result of its inability to do so.
When Layer Vault failed, Kelly Sutton, co-founder of the startup, decided to take stock of what went wrong and what the company might have done differently. One critical issue that stood out was that they did not define and track startup metrics. What Sutton said was that he thought one of their biggest mistakes was not checking the key performance indicators (KPIs) regularly enough. That would have greatly helped them identify problem points in their business.
Startup CEOs and founders (whether or not the startup was successful) should be able to offer useful advice to help you identify your company’s key startup metrics. From our wealth of experience and from the experiences of other startup executives, we have been able to build this list of KPIs you should be looking out for to help your business succeed.
1. Customer Lifetime Value
Customer lifetime value (LTV) is an estimate of the revenue any given customer will bring in over their life time. Compare it to CAC and see if you’re getting a return on your initial marketing and sales investment. This KPI may be more useful for mid-or late-stage startups than for early-stage. The moment you have more long-term customers, you can more precisely predict the LTV for new customers, and your average LTV won’t be as skewed by high numbers of customers who churn quickly after signing on.
How To Calculate LTV:
The formula for LTV is slightly different depending on the nature of the business you run.
For SaaS businesses, the formula is:
Average monthly revenue per customer X Average customer lifetime = Average customer lifetime value
For e-commerce businesses, you will need to look at order value rather than monthly revenue.
Average Lifetime Value = Repeated Sales X Average Order Value X Average Retention Time
These formulas are for basic estimates of LTV.
2. Customer Acquisition Cost
Customer acquisition cost (CAC) is the amount you spend to gain a new customer. It includes marketing and sales costs as well as salaries and overhead for teams involved in attracting new customers. CAC helps you see if your marketing and sales costs are on the high side or if you can invest more in those efforts.
CAC is most useful when broken down by drivers. This will show you the specific marketing and sales activities that have the lowest CAC and therefore are the most profitable. Knowing the most profitable channels can help you make a business case when prioritizing marketing and sales resources.
How To Calculate CAC:
Total sales & marketing expenses / New customer acquired = Customer Acquisition Cost
To calculate CAC by drivers, use the same set of formulas but look at expenses and customers acquired through each specific channel rather than at total spend or new customers.
3. Daily Active Users (DAU) TO Monthly Active Users (MAU) Ratio
The ratio of DAU to MAU looks at the proportion of monthly active users who engage with your product on a single day. It measures the stickiness of your product—how often people engage with it. For example, say on an average day you have 200 unique active users, and in a month you have 1000 unique active users. Your DAU-to-MAU ratio would be 1:5, meaning that one out of five monthly active users comes back to your product on a daily basis.
The DAU-to-MAU ratio gives a snapshot of user engagement, and it gives you more insight than just tracking overall numbers of users. Looking at the ratio rather than concentrating solely on the numbers of either DAU or MAU, you get a better idea of how often people are engaging with your product. It shows how many of your regular users are coming back every day versus once a month or less often.
How To Calculate DAU-to-MAU Ratio:
Average DAU / MAU = DAU to MAU ratio
To find your ratio of DAU to MAU, take the average DAU for a month, and divide it by the MAU for that month.
4. First Response Time
First response time measures how long it takes customer support staff to follow up after a customer submits a ticket. Quick response times are important for keeping customers happy and making a positive first impression on new clients. Not only that, but it’s also what customers expect. Zendesk found that a majority of survey respondents expected a company to follow up less than an hour after contacting the business, especially if phone or chat was used.
A quick response is especially crucial for young startups trying to build a customer base from scratch. The quicker you follow up to solve a customer’s problem, the less likely they are to get frustrated and seek out alternative products.
The same principle holds true for sales. Having a short lead response time is vital for keeping a potential customer interested in your company and prevents them from seeking out competitors.
How To Calculate First Response Time
Total initial response time for all tickets / No. tickets = Average First Response Time
To find the total response time for all support tickets, add up the number of minutes, hours, or days between the initial outreach from each customer and the time your support rep followed up.
5. Burn Rate
The burn rate indicates how quickly your startup is spending (burning up) money. It helps you evaluate your cash runway and determine whether to cut costs or invest more in your business, such as in hiring or marketing and development. Check your burn rate regularly to watch for any fluctuations that might indicate unexpected expenses.
Fred Wilson, partner at Union Square Ventures, said, “Assuming a constant burn rate can be very dangerous. Always know if your burn rate is going up or down and include that fact in your analysis. “
How To Calculate Burn Rate:
Burn Rate = total cash at the beginning of the month – total cash at the end of the month.
Tracking burn rate is useful for monitoring spending and watching for sudden increases that might indicate unexpected expenses.
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6. Cash Runway
Cash runway takes the burn rate a step further and tells you how long your money will last. Startup metrics (KPIs) such as cash runway help you see if you need to step up or adjust your fundraising efforts. It can also help you decide whether to be more aggressive with sales, cut expenses, or enact other measures to extend your runway.
Typically, businesses will calculate runway in terms of how many months their current cash balance will last.
Bear in mind that this is only a snapshot. Your cash runway will change as your cash balance and burn rate change. It also does not account for upcoming revenue currently in the sales pipeline. If you want a more accurate and reliable estimation, you should do a model of your expected spending and revenue.
How To Calculate Cash Runway
Cash balance / Monthly burn rate = Cash Runway
Monitor your sales pipeline alongside your current cash runway to get a more complete idea of your company’s current cash flow. The pipeline will give you an idea of upcoming deals and potential revenue growth that would extend your runway.
7. Gross Profit Margin
Gross profit margin (GPM) looks at the difference between revenue and the cost of goods sold (COGS). If you look at the GPM for each product, it can help you identify high-margin items you might want to promote in your marketing efforts. It can also show you if your COGS are too high.
GPM should remain fairly steady over time. If not, it might mean either expenses or sales (or both) are fluctuating more than they should. There are some exceptions to this, such as seasonal businesses.
How To Calculate Gross Profit Margin
[Total revenue – Cost of goods sold] / Total revenue X 100 = Gross Profit Margin (%)
Calculate your GPM weekly, monthly, or yearly, or by a combination, based on your average sales cycle length.
8. Revenue Churn Rate
Revenue churn rate is the percentage of revenue lost in a set period due to downgrades or cancellations. It shows the amount of income lost through churning, which can help you determine if the churn is coming from small or large accounts.
SaaS companies typically measure this KPI as monthly recurring revenue (MRR) churn because much of SaaS customer churn is from cancelled subscriptions.
“Having our monthly churn percentages hanging over our heads would have kept those problems (and our customers’ problems) more top of mind,” Sutton said in his discussion of Layer Vault.
How To Calculate MRR Churn Rate
You will need to track gross MRR churn to see the amount of revenue lost through churn in a month:
[MRR churn for the month / MRR churn at beginning of the month] X 100 = Gross MRR Churn Rate (%)
If you want to see how lost revenue is balanced by new revenue from expansions, net MRR churn rate would be a better metric to track:
[MRR churn for the month / Expansion MRR for the month] / MRR at the beginning of the month]] X 100 = Net MRR Churn Rate (%)
9. Revenue Growth Rate
Revenue growth rate measures the month-over-month percentage increase in revenue. It is an indicator of how quickly your startup is growing. A high revenue growth rate can help you measure increasing demand for your product.
Similar to revenue churn rate, SaaS companies typically measure this startup metric as MRR growth rate.
How To Calculate Revenue Growth Rate
[Revenue this month – Revenue last month] / Revenue last month]] X 100 = Revenue Growth Rate (%)
Compare MOM and year-over-year (YOY) revenue growth rate to see the short- and long-term growth trajectory of your business.
This article was created by Adekunle Adebimpe, Product Manager Start-up/Investor Relation at GetFundedAfrica. He produces a weekly column titled “Financial Intelligence,” which provides start-up founders and entrepreneurs with a deep dive into the investment world as well as the information they need to operate a successful business.