Startup Stories Part 15: Metrics that Matter for Your Startup (and Investors)

By cherylpa, August 19, 2015

Unit Economics of Your Business Model

Here’s the 15th part of my bi-weekly column with The Star Metrobiz. Read the original post here. Hope this helps.  

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We recently launched the MaGIC Accelerator Program (MAP) on 27 August with a first intake of 52 high-growth startups (of which 40% were foreign) and 25 social enterprises, making it the largest accelerator cohort in Asia. One of the primary differences of our accelerator is that MaGIC doesn’t take an equity stake in the startups.

Our goal is to build an ASEAN-focused community of startups that will leverage on each other’s strengths and connections. By the end of the 4-month program, startups are expected to be investor-ready or on the path to be financially self-sustainable. In November, we will unveil these startups to over 400 investors from the region who would potentially invest in their companies.

Essential Startup Metrics

On Day 3 of the program, I gave a talk on “Goal & Metric Setting,” since one of core aspects of MAP is to keep startup founders accountable to a “week-over-week growth” of a particular metric they choose to focus on – be it number of users, conversions, sign-ups, sales/revenue, or anything that is important to their business’ growth. It’s surprising how many entrepreneurs do not have enough analytical rigor or understanding of the importance of these metrics in any business (social enterprises included).

There’s a saying in the startup community that “anything worth building, is worth measuring.” If entrepreneurs are not tracking the performance of their products or understanding their business model unit economics, then they’re missing a big piece of what it takes to run a successful startup.

The following AARRR metrics (originally coined by Dave McClure of 500Startups) are essential for any startup to start tracking to assist in making informed decisions about their product:

1. Acquisition: What are the different marketing channels you’re using for customers to find your product? Which channels drive the best results or conversions?
   • Example: Cost to acquire a user via Facebook Ads is RM5 versus cost to print a flyer is RM1. However, since someone who clicked on the Facebook ad is 10x more likely to download your app than someone who saw a physical flyer at a restaurant, Facebook Ads is a better customer acquisition channel than flyers. The real cost to acquire a user via flyer is 10x more than RM1, which is RM10.
2. Activation: Are your customers doing what you’d expect them to do when they find your product? Do they have a first great user experience?
   • Example: When your customers come to your booth at an exhibition, do they stay long enough to learn about your product offerings? What’s the ratio of customers who walk by your booth versus those who eventually stop by to check it out? For example, if 100 people walk by your booth and only 10 people stop by, then your “activation rate” is only 10%. What can you do to increase that to 50%? Can you improve the messaging or presentation of your booth such that more potential customers will drop by? This also applies to whether users use your mobile app after it’s downloaded, or sign up for an account.
3. Retention: Do they become repeat customers after using your product for the first time? Do they renew their interest in your product?
   • Example: Say your website sells books, after your customer makes that first purchase, how often do they come back to your website for their next purchase, and when do they stop coming back? For example, you can assume that people buy books 4x per year, so they should come back to your website 4x over the next 12 months. When you have real data, you can change your assumptions.
4. Revenue: How do you make money? Are your customer acquisition costs (CAC) lower than what your customer will spend on your product in a given timeframe i.e. your customer lifetime value (CLTV)? This ensures the growth and sustainability of your company.
   • Example: How much are your customers spending per average order size? Say for an online bookstore, if one book is RM20 and customers buy on average 2 books each visit, then their average order size is RM40. If they come back 4x per year, then your customer spends RM40 x 4 = RM160 per year on your website. That’s how much each customer is worth to you per year, which is your CLTV.
5. Referral: Will your customers love your product so much that they’ll refer friends and subsequently drive you customers for free.
   • Example: If you sent an email out to your customers asking them to share your product if they love using it, would they do it and when they do share, do their friends find it compelling and sign up to use the product as well? What is your product’s viral coefficient (rate at which your customers’ referrals are successful).

It doesn’t matter whether your startup focuses on consumers (B2C) or enterprise (B2B), entrepreneurs should know the five AARRR metrics above very well to demonstrate a good understanding of how their customers are interacting with their products.

Unit Economics of Your Business Model

Once you understand how to measure all the metrics above and start doing small experiments to obtain an estimate of these numbers, you can calculate whether the unit economics of your business model makes sense.

Lets use the online bookstore model mentioned earlier as an example. If the Customer Acquisition Cost (CAC) using Facebook Ads (which you’ve found is your most efficient marketing channel) is RM5 per customer, and your overhead (employee costs) and other expenses are another RM10 per customer, then your total cost to acquire a customer is RM15.

Say a customer who comes to your website spends RM40 per order and comes back 4x a year with an average 2 books per order, then the Customer Lifetime Value (CLTV) is RM160. Assuming the customer never comes back after one year, then for every RM15 you spend to acquire a customer, he/she brings you RM160 in revenue.

if the cost price of a book is RM10, the assumed total cost for 8 books per customer per year (2 books per order x 4 visits) is RM80. So the total annual profit (revenue minus cost) per customer is RM65.

Hence, now you know that your CAC (RM15) + Cost (RM80) < CLTV (RM160). As long as the left side of the equation is less than the right side, you’re on the right track. This is called the unit economics of your business model and ideally, you want the ratio to be 1:3. You can work on ways to get better unit economics, perhaps by lowering customer acquisition channel costs or raw material costs, or increasing the frequency of order per lifetime or average order size by upselling the customer products with higher margins. Since referrals get you free customers, it’s one of the best way to lower the left side of the equation.

If you truly understand this section, you’re on the right path to monetizing your product or startup in the right fashion. Too many startups these days do not care enough about startup metrics and fail to raise money because investors do not trust that the founders understand the fundamentals of business math. If you’re starting a company and are confused by this, I suggest taking up an accounting or finance class to learn how to calculate profit margins. I’m also going to be teaching a workshop on this very topic at the MaGIC Academy Symposium (MA2015) on Thursday, 10 September 2015. You can check it out and buy tickets here: academy.mymagic.my/ma2015

Remember, the only way to find out if your product is solving a real problem or have a viable business model, is to start measuring and tracking the right metrics. If you don’t know how you’re acquiring customers, what channels are most effective, whether customers are returning, how much it costs to acquire a new customer, and how much you’re going to make from a customer over a lifetime, then you need to make sure that you learn the basics before doing anything else or spending money any further. If you can clearly demonstrate mastery of these metrics, you’re going to find it much easier to raise funding for your product.

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Categories: Entrepreneurs, Startup, startup skills