Do you want to drive up the value of your startup using just two North Star Metrics?
Every startup uses KPIs, but we see many problems with the KPIs that startups are using.
- The KPI is too remote for employees to directly influence. For example, drive up ARR or bring me more sales. How does the average employee in the organization actually impact that?
- There are way too many KPIs. We have to remember, KPI stands for *key* performance indicator, not just any old performance indicator or anything you can measure for that matter. Know what are the key performance indicators. In other words, there is a prioritization exercise that we need.
- Very common, we have silo KPIs. Here are the marketing KPIs, here are the engineering KPIs and here are the product KPIs and so forth. But who actually looks at whether the business overall is performing? Nobody.
- Many KPIs are being measured, although they’re not actually part of the core business model of the company. For example, a company that is completely in growth phase, just raised a series a, and the Finance person is very worried about the profitability. There are many other examples where that came from.
So the real problem with KPIs is they are not actually aligning people in the company. That should be the real goal here.
What if everybody in the company where it towards the same goal, just like rowers in a race. Here are a few examples of companies that did that better.
First of all, Facebook, not necessarily the best reputation these days, but they are very famous for having one metric that aligned the whole company. The number of user minutes or engagement that they generated. So how many users do they have times how many minutes do they stay on the platform, and then also how profitable is that.
In other words, what are the earnings, how much revenue are they making per user. And that’s directly tied to the business model, which of course is based on advertising. Second, let’s look at Google, a similar business model perhaps, but still a completely different, KPI.
Now compare Facebook to what, in many people’s eyes, is their direct competitor: Google. Google and Facebook both live off digital advertising. But Google’s North Star metric is completely different. They are focused on generating as many clicks as possible. Where Facebook is trying to keep people on their site for as long as possible, Google is almost trying to chase them away as fast as possible. The more clicks they have, the more revenue they generate. And so they look at number of clicks as the growth metric and the profit per click as the efficiency metric.
A third example, also from digital advertising, is the company I used to work for: Rocket Fuel. Rocket Fuel had a different model since they were much more focused on the service to customers. The North Star impact metric inside the company was the number of campaigns and the North Star efficiency metric was the gross margin per campaign.
Now, how can you define the North Star metrics for your own company? We have a tool that we’ve developed, a worksheet that you can get at the end of this article.
We have defined the North Star Metrics based on a concept developed by Jim Collins in his famous book “Good to Great”. You may have read about the hedgehog concept in that book. The hedgehog concept says you should focus all your efforts on the intersection between three circles. One, what are you passionate about? Second, what are you best in the world at? And third, and this is the important one, what is your economic engine? Or what Jim Collins also called the Profit per X. That profit Per X is the basis of what we’re trying to explain with these North Star Metrics, but we strive to make it a little bit simpler for people who often get stuck in trying to define the profit per x metrics.
As Jim Collins described them, we think of North Star metrics as two sides of the same coin. One is the growth side of the coin and that simply is counting the number of key units you bring into the world. In other words, the impact that you generate. Typically for a growth company, we want to maximize that. number. Second, we also want to make a profit. We want to make money, so in other words, we look at the earnings per unit that we bring into the world. That one is not one we necessarily want to maximize when we are a growth company, but we want to keep it above zero and then typically we want to keep it stable.
So coming back to the examples we just gave:
- Facebook, the impact metric or growth metric is the number of user minutes. Their earnings metric or efficiency metric is the revenue per user minute.
- Google it was: growth metric = number of clicks, efficiency metric = profit per click.
- Rocket Fuel it was number of campaigns. Then gross margin per campaign.
All of these are two sides of the same coin. The promise here is that if you tell your organization “all we’re trying to do is maximize the growth metric and keep stable the efficiency metric” everyone in the company will know which initiatives make sense and which initiatives don’t. Also, these become the North Star Metrics or what we would call the “Mothers of all Metrics.” In other words, all these “silo metrics” or the “too many KPIs” or the “KPIs that are not aligned with the business model” suddenly become of secondary order because the first order metrics are the North Star metrics — what is our impact and what is our efficiency?
Now, if you start working with the tool, typically I recommend that the leadership team splits up in at least two, maybe three groups depending on its size. Take the team that is most savvy on the financial side and in financial knowledge to focus on defining the earnings metric. The other team or other teams can focus on the impact metric.
Here is some guidance to make that exercise worth your while. After setting up these parallel tracks, I recommend to start simple. Many people come up with these great examples of how Walgreens or Southwest Airlines came up with the most advanced Profit per X. I find that it really confuses the issue. Why don’t you just start counting what you are already counting? What is today, the way you measure your impact in the world? And do not start from a financial metric, start from something that is a widget or a unit or a user or a customer — it doesn’t matter. But take something that is non- monetary because it will inspire your team much more to actually drive that impact number up than if it’s just about filling the pockets of your shareholders. That is why we take a non-monetary metric for the impact and the growth metric and then we put the monetary dimension on the efficiency side.
For Earnings, every finance person will typically prefer to go as far down to income statement as possible. Because how else would you cover for all the money being spent in overhead? But we have to look if this metric is actually something relevant for the growth phase of the company?
- If you’re very early, the only earning that may matter is simply revenue per user, or per product, or whatever your impact metric is.
- A little bit more down the line, gross margin becomes important.
- A little bit down the line, we start looking at margin after sales and marketing.
- And then over time at operating margin
- Only when the company is really mature, do we start looking at earnings before interest and taxes, maybe even return on invested capital.
So, it’s up to the finance people to say what the proper earnings metric for this phase of the company is. The rest of the teams will look at impact and take a simple metric that inspires everyone in terms of illustrating the impact that you’re making into the world. Do not look for the best theoretical solution. Look for what is most practical practicable at this stage…
This worksheet determining your North Star Metric is available for download here.