KPIs, aka Key Performance Indicators, are important for a number of reasons:
1. Measuring progress: By tracking KPIs over time, you can see whether you are making progress, stagnating, or falling behind.
2. Identifying areas for improvement: By tracking KPIs that relate to specific business processes or activities, you can pinpoint areas that need attention and take action to improve them.
3. Focusing on what matters: KPIs help you focus on what really matters in your business. By identifying and tracking the most important metrics, you can ensure that everyone in your organization is working towards the same goals and priorities.
4. Providing accountability: KPIs provide a way to hold individuals, teams and the whole organization accountable for their performance. By tracking KPIs and linking them to specific individuals or teams, you can ensure that everyone is taking responsibility for their work and contributing to the overall success of the business.
5. Making data-driven decisions: Choosing relevant KPIs for your business provide more objective insights and allow you to make data-driven decisions about where to focus your resources and efforts.
Overall, KPIs are essential for measuring performance, improving processes, and achieving business objectives.
If you would like to learn more about main analysis types and KPIs for e-commerce business with full detailed explanations and practical examples, you can do so by clicking here.
1. User engagement: DAUs, WAUs, MAUs
Definition. User engagement - the amount of ‘active’ users during a certain time period.
‘Active’ may have different meanings in different companies, i.e. logging into an app, accessing a website, signing to a newsletter, etc. Examples are, DAU - daily active users, WAU - weekly active users, MAU - monthly active users, etc.
Why use/track it? In addition to user acquisition, user engagement reflects how many of those users actually engage and stick around. Ideally, a company would acquire users of whom a significant portion would stay in future periods.
It is necessary to have a clear definition of what an ‘active user’ is for your company. Different companies use different definitions.
Facebook defines active users as ‘registered and logged-in users of Facebook, Instagram, Messenger, and/or WhatsApp who visited at least one of these products through a mobile or desktop device on a given day’.
Snap defines active users as individuals who open the Snap app during a 24 hour period.
Etsy tracks active buyers, as the name implies, considering a user ‘active’ if they make a purchase in a selected time period.
2. Conversion rate (CR)
Definition. Conversion rate is the chosen action, aka ‘conversion’ (i.e. a sale) divided by the total amount of interactions. It shows the percentage of users that convert from the initial amount of total user interactions.
Why use/track it? CR reflects the effectiveness of various aspects of your selling process. For instance, how people convert from your ads to your website; or how many people that landed on your homepage convert to make a sale, etc.
It is necessary to define the objective and what you want to measure with your CR. For example, for lead generation you might want to calculate conversion as the amount of individuals who left their contact details with your website. One of the most common CR types is to calculate how many of the visitors converted into a customer (made a purchase).
Formula. CR = number of purchases / total interactions
The above formula is used to measure sale conversions. However, there are numerous different possible CR variations depending on what is the goal or the target.
3. Customer acquisition cost (CAC)
Definition. CAC is a measure of how much it costs for a company to acquire a user.
Why use/track it? Tracking CAC allows one to identify how much it costs to acquire a user, compare and evaluate costs of acquisition amongst different channels and their effectiveness.
CAC is also part of calculating the return on investment relating to the acquisition of users.
With the introduction of the Internet, it is now possible to track CAC based on certain groups of customers as well as different channels of acquisition.
Formula. To calculate CAC you need to take into account sales and marketing expenses, which can include: salaries of sales and marketing people, marketing campaign expenses (i.e. Google Ads, Influencers, Affiliate marketing, etc.) and any potential tools/service providers that may be used for customer acquisition.
CAC = Sales & Marketing expenses / new customers
4. Return on Ad Spend (ROAS)
Definition. ROAS - a metric that measures the revenue earned from the amount of advertising spent.
Why use/track it? It is a very common metric used within marketing, which allows measuring the effectiveness of a marketing campaign. However, general rules of thumb such as ‘a ROAS of 3 is good’ should be avoided, as it is very industry and company specific. A ROAS higher than 1 means that at least all the marketing expenses are covered.
ROAS in isolation may not represent the full picture in terms of the effectiveness of an ad campaign, which can sometimes turn into a vanity metric. All else being equal, the higher the ROAS, the better. However, when digging deeper we need to take into account cost of sales, which for e-commerce often consist of cost of payment, shipping, etc. Such variable costs have a meaningful impact on a gross-profit level for e-commerce businesses. Therefore, taking into account such variable costs would provide more accurate and actionable insights regarding marketing channel effectiveness, as different campaigns might promote different products of varying margins.
Formula. ROAS = Revenue from ad campaigns / marketing expenses
ROAS taking into account variable costs = (Revenue - cost of sales) / marketing expenses
OR
Revenue / marketing expenses * gross profit margin, %
5. Average revenue per user (ARPU)
Definition. ARPU - as the name implies used to calculate the average revenue per user.
Why use/track it? It is a relatively easy and quick to measure metric that shows the general trend of a company’s growth. It can be used to evaluate the average customer spending characteristics over time, amongst different regions or countries or other attributes.
Formula. ARPU = total revenue / total number of users
6-7. Churn & Retention
Churn and retention are closely related. You can think of churn & retention as opposite sides of the same coin.
Definitions:
Churn - shows how many customers become inactive or abandon your website or services. Represents ‘lost’ customers.
Retention - reflects how many customers remain active and engaged with the website or services. Represent ‘active’ or retained customers.
Why use/track it? It is essential for a company to know what part of the customers return each time period. High retention rates can represent product-market fit, meaning that you are solving a need or providing a solution for the customers’ problem. Higher retention rate could also reflect stickiness. For instance, it may require more effort, time or money for the customer to switch between products or service providers and as a result the client stays with the current service/product provider. In e-commerce stickiness is not as prevalent as in other industries, such as SaaS. However, if you offer something unique for the customer, for example, like Amazon offers Amazon Prime same day delivery, it could result in higher retention or stickiness. Some users might find it inconvenient to switch to another retailer, which takes more than 1 day to deliver and may be willing to pay a higher price for it.
Similarly, churn is the other side of the same coin. Churn can be used to investigate further, if for example, in one period the churn rate was significantly higher than in others. While the aim is to have a high retention rate, as in general it is cheaper to retain a customer rather than acquire new ones, it is important to realize that user retention rate will never be 100% and some customer churn is inevitable.
Finally, retention and churn have an inverse relationship. If retention increases - churn declines, and vice versa. When added together churn and retention should equal 100%.
Formula. Churn = churned customers / total starting period customers;
Churn = (customers at the beginning of the period - (customers at the end of the period - new customers)) / customers at the beginning of the period;
Churn = 1 - Retention rate
Retention = retained customers / total starting period customers
Retention = (customers at the end of the period - new customers) / starting period customers
Retention = 1 - Churn rate
8. Customer life-time value (LTV or CLV)
Definitions. LTV - interchangeably known as life-time value or customer life-time value, it provides insights on how valuable a customer is to the company over its lifetime.
Why use/track it? LTV is one of the key metrics not only for e-commerce but many other industries such as SaaS, marketplaces, etc. All else being equal, every company’s goal is to increase its customer LTV. LTV reflects the value of a customer to the company, generally after deducting direct costs. Direct costs can also be referred to as variable costs, which are associated with servicing a customer. In e-commerce such costs often are cost of payment, shipping fees, cost of producing the product, etc. It is necessary to include such variable costs into the LTV calculation. Otherwise, if a company chooses to calculate LTV purely on a revenue level rather than gross-profit level, while the revenue-LTV might be increasing, the company, on average, might still be losing money with every user due to higher direct costs associated with servicing a customer. Therefore, this might lead to erroneous business and strategic decisions.
While a broad company-level LTV can provide high-level insights on how valuable the average customer is, the really beneficial insights come from digging deeper into LTV by dividing it into certain attributes (segments). For instance, LTV can be looked at a country level, demographics, top/bottom quantiles, etc.
Formula. Average order value * nr. of transactions during a customer’s lifespan * gross profit margin
9. Payback
Definitions. Payback period - the time period it takes to break even concerning the amount of expenses that have been used for customer acquisition or new revenue generation.
Why use/track it? Knowing the payback period is essential for setting customer acquisition or new revenue generation campaigns, as it provides guidelines and strategy for such spending. Payback period is the most useful when used in conjunction with customer cohorts and LTV, rather than in isolation. For instance, if the company’s payback period is 15 months but the average life-time of customers is 12 months after which the majority of customers churn, that means the company would be destroying value. Conversely, if the entity’s payback period is too short, it means that the company may not be using the most optimal strategy for customer acquisition.
Formulas:
ROAS payback = 1/ gross profit margin;
CAC Payback = Sales & Marketing expenses / (revenue from acquired users * gross profit margin);
CAC Payback = CAC / LTV
10. Cash burn & Runway
Definitions:
Cash burn - the amount of cash losses (usually calculated on a monthly basis) a start up incurs.
Runway - the time period that is left for the start up before it runs out of cash.
Why use/track it? These two metrics are crucial for start ups, as generally young companies are loss making and have very finite amounts of cash to sustain the process of burning cash. By understanding and closely tracking the funding needs and liquidity the company can prepare in advance regarding raising additional capital or reducing growth and switching to profitability (if that is a possibility).
It is important to consider that cash burn & runway should be calculated using actual cash inflows and outflows.
Formulas:
Cash burn = the easiest way is to look at the beginning period cash balance and ending period cash balance, and measure the difference.
Runway = ending period cash balance / (cash burn * -1)
Multiplying by -1 as cash burn is negative, without this the runway period would be provided in a negative value.
If you would like to learn more about main analysis types and KPIs for e-commerce business with full detailed explanations and practical examples, you can do so by clicking here.