What gets measured gets done. — W. Edward Deming
Doctors monitor our personal health with metrics like blood pressure, heart rate, and temperature. Likewise, businesses have key indicators of performance (KPIs) that business leaders track. Just like starting a new fitness program, a new year is a good time to calibrate your business by making sure you’re measuring the most important things. Some business KPIs are obvious: revenue, profitability, number of units sold, etc. Others may not be so familiar.
To kick off this series of posts for this month, let’s start with some financial and marketing KPIs that I believe are fundamental to a well-operating business, and which may be new to many people. We’ll talk about other KPIs for other business functional areas, such as engineering, services, and client management and support, later in the series.
Lifetime Value / Customer Acquisition Cost ratio
The ratio of lifetime value to customer acquisition cost may be the single best marker of commercial efficiency, i.e. how investible your business is. Lifetime value (LTV) is average value of a customer once acquired, until they leave. For example, if they pay $10/month and they stay with you on average for 15 months, the LTV is $150. Customer acquisition cost (CAC) is how much, on average, you have to spend to get a new customer. It’s all your marketing and sales costs for a period (say, a year) divided by the number of customers acquired in that period.
The general rule of thumb is that you want a LTV/CAC ratio of at least 2, and some say 3 or more. This kind of ratio generally means you’ll have a healthy business, doubling each dollar you invest into marketing and sales (before considering other operational costs, such as R&D or support, etc).
If you only have one line of business (LOB) and one product, or if your marketing and sales labor are 100% dedicated to one product, this works fine. However, if marketing and/or sales cover multiple products or LOB, measuring LTV/CAC on a product or LOB basis can be incredibly difficult. Having a time tracking system that enables allocation of marketing and sales time to different products and LOBs makes this a very practical proposition, enabling you to manage your portfolio with clarity — seeing which LOBs and products are outperforming the others in terms of ROI efficiency.
A related, but discrete, set of metrics revolve around your company’s revenue that recurs. Recurring revenue – e.g. subscription, recurring service fees, software maintenance/renewal, etc. — is exceedingly valuable because it can be counted upon in the next financial period with little or no additional cost to your company. We don’t have the space to go into all the details of creating a strong recurring revenue model, but here are some metrics that will help you measure your recurring revenue.
- Recurring revenue exit rate – This is the actual dollar amount of revenue that – at the end of a year, because it’s recurring – you can rely on to get in the next year. That is, this is the revenue going into the new fiscal year before any new revenue from sales, account growth, etc. This is a critical number from an enterprise value standpoint.
- Recurring revenue proportion – This is the proportion (of actual, and of new sales) that is recurring by nature, rather than one-time. Generally, the higher the proportion, the better, although this varies greatly by market and company type. In my experience, software companies with 70% recurring revenue are doing very well.
- Growth rate of recurring revenue – how much you are actually increasing the recurring revenue, year over year. This is one of the key things investment bankers use in valuing your company.
By using these financial and marketing KPIs, you can assess the health of your business and improve it over time, with a focus on increasing the enterprise value of your company.