Top ten metrics for digitally native brands
Digitally native brands, also referred to as Direct to consumer brands (D2C) and digitally native vertical brands (DNVB). This business model has flourished over the past 5 years — disrupting nearly every consumer category and shows no signs of slowing down.
Having been fortunate enough to have reviewed 1,000+ brands and have invested and been involved with some of the leading brands across categories globally in this space (Bloom & Wild, Gousto, Heist Studios, Mgemi, Rockets of awesome, Fenton & Co, Urban Jungle, Wool & The Gang) Jon and myself often get asked what metrics we look for when evaluating digitally native brands. Below we have outlined the KPI’s (key performance indicators) that we review when evaluating whether to make an investment in a direct to consumer brand/digitally native brand.
When evaluating a brand we are trying to answer four main questions — the answers to these questions are partially informed by the metrics that we look at :
- What scale can this business get to?
- How profitable is the business going to be at scale?
- How defensible is the business going to be at scale?
- How capital efficient is the business going to be on the journey to scale?
Top Ten Metrics for digitally native brands
What scale can the business get to?
- Gross sales: Gross sales looks at the overall throughput of your business. It is sometimes referred to as turnover or revenue. Gross sales is the full priced value of items * the number of items sold.
- Net sales: Most businesses receive returns. Net sales is the gross sales minus the value of the returned sales. In certain business models, for example fashion e-commerce where return rates can be 80% of an order value, monitoring the return rate and the associated costs of returns is key.
How profitable is the business going to be at scale?
3. Gross Margin: Gross margin, also commonly referred to as product margin is the Net sales minus all variable costs. The easiest way to think about variable costs is any cost that is directly associated with an individual sale. Typically variable costs will include: Raw materials/product costs, payments and other transaction costs, packaging costs and delivery costs
The variable costs should include the costs associated with items that have been returned.
Gross margin is typically looked at both as a £ number and as a % of net sales. As a rule of thumb product businesses typically have 50%+ gross margins.
4. Contribution Margin: In addition to variable costs there are typically costs that can be referred to as ‘semi-variable’. These costs are costs that scale in a linear way but are not directly related to an individual transaction. These costs typically include costs that can be allocated on a ‘per transaction basis’, but will vary over time and hopefully will decline on a per transaction basis as a company scales These costs include customer service costs and factory overhead
It is important to monitor the semi-variable costs as these costs if not managed carefully can spiral out of control especially during periods of high growth.
5. Cost of acquiring a customer (CPA): The average cost to acquire a customer is your new customer sales and marketing spend divided by the number of new customers that you acquire. This metric is an important metric to track. It is also sensible to track your cost of acquisition by different marketing channels as the cost by channel is typically very different and some marketing channels scale better than others.
One thing to pull out is discount codes. Discount codes can either be viewed as reducing the sales value or as a marketing spend. For example a £5 discount on a £20 item can either be shown as an item sold at £15 or as an item sold at £20 with £5 of marketing spend associated with the sale. We believe this should be seen as part of marketing spend, and hence cost of acquisition but there are advantages and disadvantages to both methods. When you come to doing your statutory accounts the correct way is to take the discount off the revenue. It is important to track the ‘fully loaded cost of acquisition’ being the actual cost to acquire a customer plus any cost associated with the discount. For example, if it costs you £20 to acquire a customer on Facebook and you give that customer a £5 discount code then the cost of acquiring the customer will be £25
How defensible is the business going to be?
6. Customer Advocacy: Measuring customer advocacy and the health of your customer base is critical and is a good leading indicator of whether your offering is truly differentiated vs competitors. It can be measured in a number of ways and is intended to reflect the health of your long term business. Customer advocacy metrics to track include:
a. Net Promoter Score: A net promoter score gives you an indication of the health of the overall customer base.
b. Customer review scores: Independently verified review scores such as Trustpilot, Feefo or Reevo can be useful to understand what your customers think of your product
c. Customer referral rate: The rate at which your customers refer your product or service to other customers. This can be measured using the Viral co-efficient formula. This metric is particularly valuable because it enables you to understand the multiplier effect that you can achieve by investing in new customer acquisition. If a new customer brings 5 other new customers then you can spend more on acquiring that one new customer than if the customer only brings themselves.
7. Cost of retaining a customer (RC): Whilst CPA is discussed a lot as a business scales the retention or reactivation cost becomes incredibly important and in some cases can be a similar level of cost to the cost of acquiring a new customer. It is important to track which channel your returning customers are coming to you from and whether this is a ‘paid’ channel (For example, google adwords) or a ‘free channel’ (For example, e-mail with no discount code)
8. Lifetime value of a customer: The lifetime-value of a customer is the gross margin a customer makes you over a period of time (No of purchases*Gross margin per purchase) minus the cost of acquiring that customer and cost of retaining that customer. For example: If a customer has a net average order value (net sales) of £20 and they order 5 times in a year their 1-year net sales value is £100. If the gross margin is 50% then their 1-year value is £50. If it costs you £10 to acquire that customer and £5 for each subsequent ‘reactivation’ then your 1 year lifetime value is £20. The lifetime value is often expressed as a multiple of the cost of acquiring a customer, this number is calculated in a range of different ways so if presenting it to other people then it makes sense to be clear on how you have calculated it. Our preferred method of calculation is to look at it on a 1 and 3-year basis. We take the gross margin value (minus the re-activation costs) and then divide it by the CAC. In this case the 1-year LTV/CAC ratio would be 1-year value of £100 (£20 net AOV*5 orders) at a gross margin of 50% = £50 minus the re-activation costs of £20 (£5 per order*4 orders) to get to a net 1-year LTV of £30. This £30 is then divided by the initial CAC of £10 to give you a 3x ratio. As a rule of thumb a 3x LTV-CAC is the minimum target ratio you should be aiming for.
How capital efficient is the business going to be on the route to scale?
9. Inventory Management: Capital efficiency which partly comes from effective inventory management is critical to be monitoring. Digitally native brands have the advantage of having a lot of data, this data can be used to aggressively manage inventory and cash in a way that gives you a competitive advantage over traditional brands. For example, data can be used to predict what demand you are going to have in a given week, if you get very good at this prediction you can order inventory close to ‘on demand’ and reduce inventory write off to close to 0%. Inventory needs to be considered both as the investment needed in inventory to drive sales and the holding cost associated with the inventory. Key metrics include:
a. Inventory turnover: This measures how quickly you can sell inventory in a given time period. Calculated by dividing sales by inventory.
b. Inventory write off: This is stock that no longer has a value to a business. For example, in a fresh food business the cost of food that has gone off and can no longer be sold.
c. Holding costs: These are similar to factory overhead above. These are costs such as warehouse space, insurance and other storage related costs that go up as you hold more inventory. It is important to understand what the holding cost per item of inventory is. This is true both in a content business (where you have the computing cost) as well as in a more traditional product business (where you have the cost of storing physical goods)
d. Average days to sell inventory: Knowing how long it typically takes to sell inventory improves your ability to forecast future inventory demands and adjust your customer demand levers if you need to speed up the throughput.
10. Cash Management: Cash is king, knowing what your net cash position is critical. If you are a loss making business tracking months until you cash out or months until you break even is important. Generally an investment process takes no less than 6 months from when you start planning, it is helpful to kick off a fund raise when you have at least 6 months of cash in the bank.
Good luck! If you are building a digitally native brand, in particular a full stack consumer brand with a positive societal impact (social or environmental) please get in touch with as at email@example.com, firstname.lastname@example.org or email@example.com