Thursday May 19, 2011 by Brian Zimmerman - Managing Director, OpenView Venture Partners
When startup and expansion stage companies are courting venture capitalists and seeking investments, it’s easy for them to get caught up in mind-numbing metrics that show the soundness of their economic model and the business’s sharp growth trajectory.
Venture capital firms want to see tons of data, models, and information that speak to a company’s long-term health. Metrics can certainly do that. They can also help companies scale their teams, act on low performers, drive toward revenue goals, and predict and influence outcomes.
But when you’re focusing on day-to-day operations, the best practice is to keep it simple.
Yes, I know there are a lot of important metrics and that each one has a specific purpose. But I’m a simple man looking for simple answers. With that in mind, I’ve boiled the myriad metrics out there down to the three that tell a great story and indicate that something great is happening.
If your new business exceeds your sales and marketing expenses, then you know that you’re building a sound model. That sort of proportion generally means that you have a sound sales process and you’re getting closer to the opportunity to build a scalable model.
MarketingProfs president Roy Young examines the principle of this metric in far greater detail on his blog. But here’s the simple truth: you must make more money from a customer than you spend to acquire them. Otherwise, it’s going to be tough to succeed.
This metric is particularly important to software companies that execute a SaaS model. If that’s you, this metric will help gauge customer service and the health of your company’s annual revenue. If your renewal rates are greater than 85 percent and your customers like you, then you’re probably in good shape.
As John Warrilow argues at Built to Sell, businesses with a subscription model must live and die by their renewal rate. If it’s between 80 and 90 percent, then they can spend less time scrambling to replace customers and more time focusing on new customer acquisition. For SaaS companies, a renewal rate of greater than 85 percent means they’ll at the very worst tread water and very likely experience rapid growth.
This is the ultimate metric. In my experience, companies that reach a gross margin of 70 percent are really beginning to emerge and put their foot on the throttle. Nevertheless, the higher your gross margin, the healthier the company is bound to be.
Investors tend to pay a lot of attention to gross margin as one of a company’s vital signs. As Harry Domash explains at MSN Money, rising gross margins indicate that a company is either reducing costs or raising prices to meet market demand. Either way, high gross margin generally translates to a higher profit margin and allows a company to invest in growing the business.
Ted Hurlbut at Inc.com goes into greater detail about gross margin, listing several reasons why it’s critical that small businesses focus on it. Managing and monitoring gross margin on a regular basis will cut down on monthly and quarterly budget surprises, and allow companies to better predict profitability, cash flow, and productivity.
As with any business metric, it’s obviously important to make sure the information you gather on all of the metrics above is timely and accurate.
Barry Trailer at CSO Insights explains why on his blog, using data from a sales optimization survey he executed last year. In every single area of his survey, managers who relied on accurate metrics vastly exceeded expectations and were able to propel the company forward.
I realize that the three metrics I mentioned above aren’t the only important ones. But when it comes to monitoring a business’s overall performance, I just want simplicity. So, if you want reassurance that you’re building something great, make sure you measure and analyze those three.