We use a variety of metrics to assess the startup performance and determine how healthy a business is. At the same time, it would be a mistake both to ignore the indicators completely and to track too many of them.
Focusing on key metrics helps to identify the weak spots of the company at any stage of its development. It makes you understand when and where it all got worse, so you can change business strategy immediately. The investor also uses metrics to see if their investments were feasible, as well as to assess the startup’s potential and further tactics.
Key Metrics to Assess the Effectiveness of a Startup
There are many indicators to help you analyze your business’s activities. But in order to understand the current state of a startup and whether it has prospects, it is enough to use only a few of them.
The main business metrics are:
- growth rate;
- Gross profit.
It is also advisable to estimate the burn rate and the runway, i.e. how fast your startup will run out of money.
The importance of metrics changes as the company develops. For example, at an early stage, there’s no point in estimating LTV when a startup has just acquired some customers and profitability. However, this parameter becomes essential later.
Product and Engagement Metrics
The following indicators can be calculated at the early stages of a company’s development (if there are income and customers). They might be useful to assess the demand for a product and market response. At later stages, metrics show the quality of supply, the effectiveness of the business’ operation, and if the company has chosen a correct strategy.
MRR (Monthly Recurring Revenue)
Any successful startup aims at rapid exponential growth. A steady increase in monthly revenue indicates a good development dynamic, showing that the product satisfies customer and market needs. A decrease, however, indicates significant problems with the business strategy. At the same time, even an unchanged MRR with no decrease indicates that the company performs unsatisfactorily.
MRR Growth Rate = (MRRt – MRRt-1) / MRRt-1 * 100
For example, if the company received $ 2000 MRR in July and $ 2500 in August, the result is: (2500 – 2000) / 2500 * 100 = 20%. The startup has a good growth rate and is not experiencing difficulties.
5–7 % week growth is considered great. 1 % week growth (or less) predicts a startup’s lack of development and loss. <1% MRR requires you to analyze the key metrics.
CR (Churn Rate)
CR shows how many customers abandoned a product over a given period (in percents). A significant monthly CR leads to being quickly deprived of income: MRR stagnates, stopping the development of a startup.
CR is a ratio of the number of lost clients to the total number of customers.
For example, at the beginning of July, the company had 100 clients. As July passed, another 60 came in while 20 left. CR = 20 / (100 + 60 – 20) = 14 %. In this case, the metric indicates significant customer churn and ineffective startup work.
The optimal CR should not exceed 5% per month. Otherwise, all possible measures should be taken to reduce it; 1–2% is what you should strive for.
When analyzing the current state of a startup, it is important not only to evaluate metrics but also to correlate them with each other. For example, if the CAC grows, this indicates a decrease in LTV and the company’s profit. In this case, the startup needs to reconsider the customer acquisition channels and abandon the unprofitable ones.
When assessing metrics, it is useful to compare them with metrics of organizations from the same market segment or industry. Competitors should be as close to the startup in question as possible both in size and stage of development.
CAC (Cost of Customer Acquisition)
This metric primarily indicates the effectiveness of a startup’s marketing. It shows the cost of attracting one customer.
CAC = Marketing costs / Number of new customers
An important indicator is the payback (return) period of CAC. To calculate it, you need to divide the CAC by ARPU.
If the cost of attracting a customer exceeds LTV, the company’s economic activity has to be optimized. To do that, you can either reduce marketing costs (remove less profitable marketing channels), or increase its effectiveness, or increase the price of the product. The company is considered successful when its LTV is 3 times bigger than CAC.
LTV (Lifetime Value)
This is one of the most important metrics. It shows how much net profit one client brings for the entire period of the product’s use.
You should calculate LTV from the moment when you return the CAC. It would be impractical to determine the metric in 1–3 months since the product was launched: it still has no sufficient income or customer base. Otherwise, the CAC will be a component of the LTV.
LTV = customer’s margin multiplied by their average life expectancy.
To calculate the monthly margin, you should take income from a user and subtract variable costs from it, such as administrative and operational maintenance. Life expectancy is calculated as 1 / CR.
The lower the target, the worse the economic situation of the startup. Even with substantial revenue and a large customer base, a negative LTV shows that a business is at loss.
MRR (Monthly Recurring Revenue)
MRR indicates the total revenue from consumers per month. To calculate it, you should add up all income from users or multiply ARPU by the number of paying customers.
The steady decline or the MRR not covering costs indicates that the startup is unprofitable. However, the analysis should take into account the business specifics and nuances of reporting. For example, a company provides service with monthly payments, but you can also pay for the whole year:
- annual payment — $ 360;
- monthly fee — $ 30.
In July 2020, 10 users bought a year subscription; 10 users paid monthly fees. MRR was $ 3900 ($ 3600 + $ 300). In August 2020, there were no new customers, so the MRR can be calculated as 10 * $ 30 = $ 300. When comparing cash receipts for 2 months, we see a significant negative trend. But in fact, income over this period is more or less stable since the customer base did not really decrease.
ARPU (Average Revenue Per User)
This metric determines the monthly revenue per customer or the average check. It predicts profit, shows how willing consumers are to pay and whether the marketing channels are efficient, and indicates the value of the product.
ARPU = RR / N, where:
- RR is a recurring (monthly) revenue;
- N is the number of consumers per month.
For example, the company’s service was used by 500 people per month. This metric includes all the customers, even those who used the product for free during the test period and continued with a paid plan. The resulting income is $ 2,500. This means ARPU = 2500 / 500 = $ 5.
APRU has no established rule, but tracking it allows you to predict the development of a startup. If there is a downward trend, this indicates the inefficiency of the enterprise. Since the metric depends on the number of consumers, the decrease in APRU shows that you need to expand the customer base.
This metric measures the profitability of a business and is calculated as revenue minus product cost. The latter includes the costs of production, delivery, and technical support of a product or service.
A positive gross profit or its increase indicates successful business development. The negative dynamics speak about the unprofitability of a startup.
Burn rate shows how much money the organization spends over a certain period (month, quarter, year). To calculate it, you should divide the costs of a startup into:
- recurrent costs (independent of the production volume) — i.e. rent, salaries of administrative personnel, loan interests, and so on;
- variables (depending on the production volume) — i.e. production costs, the salary of salesforce, partnership commissions, and so on.
There are two types of burn rates: Gross Burn Rate (all costs of the company) and Net Burn Rate (all costs minus revenue). At the same time, a positive Net Burn Rate indicates that the startup is unprofitable.
The indicator is directly related to the burn rate. It shows the period for a company to run out of money. It is a monthly metric. To calculate the runway, you need to divide the remaining cash by monthly expenses.
If the result shows less than 12 months, it’s not good. It should be more than one year, preferably 18 months. A short runway period speaks of a short-sighted business strategy.
To Summarize: How Key Metrics Help
Assessing key metrics allows you to determine whether it is time to wind up a startup or there is still a chance. Analyzing them will reveal the flaws and mistakes of the business strategy; eliminating such flaws may keep the company afloat.
At the very beginning of the startup development, you need a high-quality assessment of the product and its relevance to the market. Insufficient or complete absence of demand, as well as user dissatisfaction, are both signs of loss. In this case, you need to either replace (improve) the product or look for a different target audience.
At a later stage of development, when the company is already receiving income and has a customer base, you should resort to financial calculations. The unsatisfactory results are generally indicated by the following signs:
- the startup didn’t find ways to constantly attract customers;
- few or no regular consumers regularly purchase the product;
- monthly income is reduced or absent;
- consumers abandon the product — if the churn rate is more than 5%, an urgent effort is required to retain customers.
In later stages of development, the company aims to constantly increase monthly income, maintain and expand the client base.