Important Metrics for Small and Mid-Market Companies — Part 2: Customers
In an average month, my organization explores around 50 companies for possible investment. We review everything from organizational structure, culture, and financial performance, to sales systems, competitive position, and leadership style. This gives us an unusual vantage point from which to recognize patterns of success, and failure.
Getting data is never the problem. In fact for most executives, information can be overwhelming. Getting accurate data and interpreting it appropriately is an entirely different story.
In The Ceiling of Brute Force, we discussed what operational areas impede a company from continued growth. In a series of posts, we’re going to break down 19 of the most important key performance indicators (KPIs), which demonstrate how effectively the business is being run. Think of KPIs as the canaries in your coal mines. If one starts going south, you know it’s time to take a closer look.
Presented in a five-part series, here’s our take on what you should pay attention to, allowing you to focus your time, effort, and dollars. The five parts are: Basics, Customers, Team, Operational Efficiency, and Investment. It’s all things customer-oriented in Part 2: customer profitability, average acquisition costs, and concentration.
1. YOUR CUSTOMER AND THE AVERAGE CUSTOMER
KPI Objective: Know what a profitable customer looks like, and understand how that’s reflected in both quantity and quality in your current customer population.
All customers aren’t created equal. As Mr. Pareto would argue, it’s likely that a small group of your customers represent the bulk of your success, or failure. You must understand who is high-value, or high-maintenance, and how those differences affect the company.
But before you do that, you must understand your average customer. How much do they buy and in what frequency? What percentage of revenue does the average customer represent? To what degree do these numbers vary 95% and 99% of the time?
These basic metrics can be used to understand the value of individual customers, concentration risk, and whether marketing and acquisition costs are aligned.
2. AVERAGE COST TO ACQUIRE A CUSTOMER
KPI Objective: Know how, and how much it takes, to acquire profitable customers. Then rank them by effort, and prioritize based on resources available.
While it may seem like greater sales efforts would always be better, there exists a point of diminishing return. Acquisition costs can be complicated to calculate because so many efforts, called co-factors, can influence the customer conversion process (i.e. prospective customers heard about the company from a friend, later saw an ad online, went to the website to learn more, and ultimately reached out to a salesperson).
To calculate total average acquisition costs, take the sum of all sales and marketing efforts — not just those that result in a new customer — over a defined period (i.e. quarterly, annually), and divide by the number of new customers successfully converted. The same calculation can be used on a per channel basis if proper tracking is in place.
Remember that unless you convert 100% of all prospective customers, acquisition costs exceed per-client costs. Taking online advertising as an example, it would be comforting to assume that if you pay $4.15 for the customer to click on your ad and buy, your acquisition cost is just that; however, the accurate acquisition cost must account for all the people who click and don’t buy, as well as the labor cost in setting up and running the advertising program.
While tracking pure dollars spent on sales and marketing will provide a baseline metric, assessing total effort may prove more valuable long-term. Dollars spent to acquire a lead through a channel that takes 6 months to convert are not equivalent to spending on one that takes less than a week. To the same end, a channel that produces customers with a lifetime value of $100 is not equivalent to one that results in customers with a lifetime value in excess of $1,000.
3. CUSTOMER CONCENTRATION
KPI Objective: Know your dependency on specific clients.
A general rule of thumb is no one client should account for more than 20 percent of business, and the top three to five clients should not account for more than 50 percent of business. When high customer concentration exists, there are usually issues with power dynamics, margins, and risk.
Diversification is an ongoing challenge for every company, but beyond that, you should be analyzing the quality of each influential relationship. Does their product mix include more high or low margin items? Are they extremely high-touch, requiring an inordinate amount of internal resources dedicated to their account? How predictable is their ordering? Are you able to grow the account over time? Digging below just revenue-by-client, creating a ratio of revenue to allocated resources, can paint a much stronger picture of your customer portfolio.
4. CUSTOMER TENURE
KPI Objective: Know how long to expect clients to remain customers, and what causes them to leave.
Apart from emergency healthcare, long customer tenure indicates market differentiation, offering quality, and strong customer satisfaction. There are exceptions, such as an iron-clad contract under which a customer enjoys 1980s pricing in 2016 and may actually be costing the company money. Generally, however, customer longevity translates to a stronger brand reputation, higher customer lifetime value, better revenue predictability, stronger customer intelligence and relationships, and greater likelihood of low-cost customer acquisition via referral/reputation.
As a side note, recognition of relationship tenure rarely goes unappreciated by loyal customers.
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Brent Beshore is the founder and CEO of adventur.es, a family of companies throughout North America. Read more of Brent’s writings on investing, operating, risk, and not being an asshole. Connect with him on Twitter or LinkedIn.