Imagine that you’re sailing across the South Pacific on a yacht. You sip champagne as you slice silently through tropical seas and watch epic sunset after epic sunset. Congratulations, you’ve made it.
Your big challenge is that you rely on a satellite internet connection to get information about your business Every week your general manager emails you a short update with a handful of metrics.
What metrics are in that email?
This is the role of KPI’s- to provide an at a glance set of numbers that reflect performance.
Most business owners understand the idea that KPI’s are leading indicators.
In this post, we’ll build on that understanding, by examining three questions that determine what makes for an effective KPI for measuring overall business success.
Performance Changes the Equation
Every business tracks performance in the form of profit. We even say about things that represent the most important aspect of a decision, that it’s the “bottom line.”
But profitability is probably not the only measure of performance in your business.
For example, each of these may be more important to you than profit:
- Market value of the business
If you’re optimizing for profit, then you will limit your resources to grow.
If you’re optimizing for sustainability, growth might be sub-optimal.
If you’re optimizing for market value, your sustainability may be irrelevant.
None of this is to diminish the importance of profit, just to say that in choosing KPI’s, it’s important for them to align with your goals.
What metrics align with performance for your goals?
The Real Point of Leading Indicators
I just watched a MMA championship bout between Petr Yan and Cory Sandhagen. In the first round, Sandhagen took a significant step ahead- peppering Yan with hard shots, seemingly coming from every angle as he dove in and out of reach. For his part, Yan threw some punches but mostly didn’t land anything significant.
The second round was more even and by the third, Yan was the one landing and knocked Sandhagen down with a hard combination. Sandhagen spent the rest of the fight trying to come back while Yan pulled steadily ahead. What had happened?
Yan had adapted quicker to Sandhagen’s style than vice versa. He’s known for starting slow and spending the first part of the fight learning how to read his opponent. His real advantage wasn’t in power, endurance, or speed- it was in information.
The reason it’s important for KPI’s to be leading indicators is so that you can make better decisions faster. KPI’s enable you to adapt early in the fight rather than months too late when you’re reviewing the tape.
Which brings us to our first question:
What data would help you learn about the impact of decisions fastest?
River otters are categorized by biologists as an “indicator species.” They are an apex predator of the river and if there is a disruption anywhere in the food chain beneath them, their relative health will be the first to show the change. Additionally, otters are sensitive to pollution changes in the river and are the first to show changes of heavy metal accumulation like mercury poisoning.
What gauges in your business are most sensitive in indicating changes in a multitude of its systems and environment?
The point of a KPI isn’t to know where the problem is, it’s to know when there is a problem.
You could track lots of deep metrics in a business, but what we want to identify are a few metrics that are sensitive to many systems.
Micro Case Study
Beyond championship bouts and river predators, how does this actually look in practice?
I’m setting up a spreadsheet to track performance in a new brand I’m building.
The model is subscription based with a one month trial to start. This distorts the relative success for a couple of months. Month one is under-represented for profit and any sort of growth is cumulative.
Here’s the three questions:
1. What metrics align with performance for your goals?
We’re pursuing sustainable growth as a primary goal. What I’m mostly looking for is an increase in cash landing in our bank account over time. We could run negative for several months as long as it eventually turns around and we have more cash profit than at an earlier state.
Some numbers for this:
- Annual revenue
- Monthly revenue
- Monthly recurring revenue (core service)
- Number of customers on our service
- Monthly profit
- Trial conversions
- Sales conversations
- Customer LTV
- Customer first year value
- Gross costs
- Fixed costs
For sustainable growth as the performance goal, we’re really looking at profit increases over time. Both revenue and costs in the right ratio.
2. What gauges in your business are the most sensitive indicators of changes in a multitude of its systems and environment?
From the above list, all of them provide data. But in terms of the question, I like these:
- Trial conversions
- Fixed costs
I like trial conversions because it tells us how the market, our sales process, our product fit, and our pipeline systems are performing. If any of them change, it will show up here. It’s a river otter metric.
Churn tells us a lot about customer value, customer fit, and sustainability. There is probably a more sensitive measurement that we’ll be able to identify in the future that signals churn.
Fixed costs gives us something to measure our overall sustainability against and it is more indicative of systemic changes than gross costs.
3. What data would help you learn about the impact of decisions fastest?
Trial conversions and churn are two gateways on the customer journey. They’ll tell us in close to real time whether we’re growing our customer base or shrinking it.
The metrics here would be:
- Relative trial growth, month-to-month
- Ratio of trial conversions to churn each month.
These two tell us a lot- but not the whole picture.
For example, it doesn’t tell us anything about how this growth is impacting our bank account. If customer profitability is net negative, then growing quickly will just ensure we’re out of business faster.
Monthly profit looks like a good metric here, but it’s not super sensitive and a bit of a lagging indicator. The costs part of the equation meets our criteria, but the revenue side plays out over time.
Unfortunately, I don’t think there is a better solution. But because of the inconsistency of revenue month-to-month, what I’m going to track is a 3 month rolling margin. I.e. What’s the average profit of the last 3 months, this month?
You Are Watching
Even if you feel like you’re running the business from the seat of your pants, you are currently tracking indicators.
For example, have you happened to look at your bank account today?
Your balance is just a number, but it indicates something about your business.
Whatever it is, you’re gathering information of some sort because as humans we’re designed to monitor our environment.
Where we run into problems is that we gather data ad hoc and arbitrarily. What we’re paying attention to may matter, but not be an effective criteria to initiate a change in your behavior.
Choosing KPI’s is an exercise in being thoughtful about where you put your attention so that the information you see has the maximum utility.
When you open that email from your GM on your boat in the South Pacific, it should tell you if you need to change course and head to the nearest airport.