Measuring the Product - Product KPIs - Financial Metrics

In a previous blog post, I described some of the metrics that can be used to measure the performance of a Product Manager. I described how metrics used to measure the product (I.e., MAU, CAC, LTV, ACL, MRR, ARPU, NRR, Churn, etc.) should not be used as the sole metric in assessing the performance of a Product Manager. (A common mistake). The reasoning behind this position is that there are many variables that affect product metrics, many of which are not under the direct control of the Product Manager. While the Product Manager should have some accountability for these metrics, and he/she should be fixated on them, their success or failure is determined by many teams and factors, not just the Product Manager.

Since that blog post, many of you have reached out asking about the metrics used to determine the performance of a product. See the acronym salad I served above. (Tasty!)

In this blog, I'll summarize some of the more common product KPIs. focusing on revenue metrics, based on my experience with SaaS based products. I'm sure there are other metrics, and some may be specific to a particular industry or the business model that a company is using. Most of these metrics could have their own blog post, so if you'd like more detail beyond the summation I am going to provide, check out the countless blog posts that are dedicated to each of them. (you'll even find variations on how they are calculated.)

A quick note to head off the email. These are revenue metrics only. I'll post another blog in the future on product usage metrics.

This is going to be a little dry, but you asked for it, and I'm all about that CSAT.

Unit Economics

Quite simply, this is the cost, revenue, and margin of each item that a company sells. These products fall into two broad categories, physical goods and digital goods. Physical goods typically have a high cost of producing each unit, and therefore, have a low marginal profit or just margin. Consumer packaged goods (CPG) have margins that fall in the range of 15%-25%. Electronics have an even lower margin, coming in at about 7%. Initially, costs of physical goods are higher, but those costs typically come down as more units are sold and the manufacturer applies volume discounts. (economies of scale). Digital products such as software, have a high upfront cost (fixed cost) but then have a low marginal cost for each unit sold. If you think about it, this makes sense. A significant amount of money may be invested to do the initial build of a digital product, but once it has been built and you begin selling the product, there isn't a significant cost to produce each unit. Yes, there are some costs such as server costs, salaries, etc. to support each sale and the product itself, but these costs are small (or they should be) when compared to the production costs of a physical good. Margins for a digital product are typically 80% or higher. This is why scale is so important for a digital company. To keep increasing profits, digital companies need to continually gain (and keep) customers.

ARPU/ARPA (Average Revenue Per User/Unit / Average Revenue Per Account)

This is the measure of revenue generated per user or unit (or account), typically per year or month. The difference being that "user" is used by companies that sell software or services while "unit" is used by companies that sell a physical product, but the calculation remains the same. This metric provides insight into the company's revenue generation and identifies which products are high or low revenue generators. Once the time period has been identified, typically monthly in a subscription business, the calculation is quite simple.

ARPU = Total Revenue / Total # of users

You may also choose to look at this metric by account instead of user, in which case this would be ARPA or Average Revenue Per Account.

ARPA = Total Revenue / Total # of Accounts

One final note on ARPU/ARPA. Having a high ARPU/ARPA does not necessarily mean you have a high profit margin. This is why it's so important that you monitor multiple metrics in conjunction with each other to determine the true financial health of your product.

MRR/ARR (Monthly Recurring Revenue / Annual Recurring Revenue)

Monthly Recurring Revenue (MRR) is the amount of predictable revenue that a company can expect to receive on a monthly basis. As you may have guessed, this metric is vitally important to a subscription based (SaaS) business.

MRR = Monthly ARPU x Total # of Monthly Users

Chances are your organization already calculates this value, so you should be able to obtain it from your finance department. There are a couple of things to note about MRR.

• Do not include one-time payments. (these are not recurring)
• Do not include quarterly, semi-annual, or annual contracts at full value in MRR. They should be divided into a monthly amount. (i.e., a quarterly contract should be divided by 3 to get the monthly amount.
• Do not include trials in the calculation. They haven't converted to a paid customer yet!
• Be sure that you include discounts. If your subscription is $50 per month, and you provide a 50% discount, then your MRR is $25, not $50.

If you track revenue at the account level (ARPA) then your calculation should be:

MRR = Monthly ARPA x Total # of Monthly Accounts

Depending on your contract term, you may choose to look at this metric at a yearly level. If this is the case, then ARR or Annual Recurring Revenue will be used. Same calculations as above, but for a 12 month period.

Although not as common, some organizations may choose to monitor QRR or Quarterly Recurring Revenue. Same calculations as above, but per quarter.

**Churn **

Churn rate refers to the number of customers that stop using your product each year (or month, depending on how you measure it). The greater the churn percentage, the faster customers are leaving. (no bueno) Below are three metrics related to churn that I like to follow.

Churn Count

The count of accounts that canceled or did not renew their subscription during the period.

Churn Percentage

The churn (percentage) of accounts that canceled or did not renew their subscription. The churn percentage should be calculated as the number of accounts that canceled or did not renew their subscription(s) as a percentage of all active subscriptions during the period.

Accounts lost in period / accounts at beginning of period = churn

Churn Revenue

The total amount of subscription revenue lost for all accounts that churned in the specified period. (See churn count above.)

NRR (Net Revenue Retention)

This is the percentage of recurring revenue retained from existing customers within the specified period. It is essentially looking at churn on a "net" basis, after accounting for expansions and upsells/cross sells.

NRR = (MRR at start of month + Expansions + Upsells + Cross sells - Churn - Contractions) / MRR at start of month

As an example, consider the following:

· The period is 1 month.

· A company has 1000 customers each paying $5000 per month. (MRR = $500,000)

· 10 customers add an additional $5000 product.

· 5 customers downgrade their package by $1000.

· 5 customers cancel their subscription.

NRR = ($500,000 + ($5000 * 10) – ($1000 * 5) – ($5000 * 5)) / $500,000

NRR = 1.04 or 104%

A word of caution on this one. I've seen many organizations fixate on this metric, and pat themselves on the back when they exceed 100%. But what they've completely ignored is the churn part of this equation. They're growing right, so life is good. But churn reduced the growth that they would have realized had they focused some effort on reducing it. It makes a huge difference. In the example above, if churn and downgrades were eliminated, the NRR would be 110%, instead of 104%. Not to mention other benefits like CSAT, brand perception, LTV, lost cross sell opportunities, and eventually, the pendulum may swing in the other direction and customers are churning faster than they are being added. Don't ignore churn is the takeaway here.

ACL (Average Customer Lifetime)

I don't know of any company that doesn't lose some amount of customers. (churn). But how long do customers continue to use your product before they churn out? This is the Average Customer Lifetime or ACL. Once you know the churn rate, calculating the ACL is straightforward:

ACL = 1 / churn rate

As an example, if your churn rate is 25%, then your ACL will be 4 years. (ACL = 1 / .25)

Average Profit Per User Per Year

As the metric name implies, this is the amount of profit that an average user generates for the company each year. This value is also used in the LTV calculation.

Average Profit Per User Per Year = ARPU per year x gross margin %

You may also choose to look at this metric by account instead of user.

LTV (Life Time Value)

Also known as CLV, CLTV, LCV. (Customer Lifetime Value, Customer Life Time Value, Lifetime Customer Value)

In my opinion, this is one of the top metrics that a Product Manager should be measuring. However, it's also one of the metrics that many companies ignore or do a poor job in calculating. In a study done by Criteo, 100% of respondents were aware of Customer Life Time Value, and 93% of those respondents are attempting to measure it, which is great. But when digging in deeper, 69% believe that their company could be doing a better job at calculating and measuring this.

LTV is the total amount of profit that an average customer will generate over their lifetime as a customer. (continue to use your product). Simply put, LTV is the sum of marginal profits that you will earn from every action that the average customer takes.

The calculation of LTV is relatively straightforward, and leverages some of the metrics I shared previously. (there is a method to my madness.)

LTV = average profit per user per year x average customer lifetime

CAC (Customer Acquisition Cost)

On the opposite side of LTV is how much it costs to acquire the customer. This is Customer Acquisition Cost or CAC. It is the cost of sales and marketing activities to bring a new customer to your product. I'll start with the formula first, and then follow up with an example because this can be tricky due to the time period you are analyzing.

CAC = (cost of sales + marketing costs + cost of tools over X months) / (number of new users added over the same X months)

If you wanted to be really accurate with the formula above, you could add salaries as well. However, it's difficult to know how much of the salaries to allocate to CAC unless you happen to know how much of their time they will be spending on the campaign or project.

For example, if you spend $50,000 on your sales and marketing efforts, and acquire 1000 customers through those efforts, then your CAC would be $50. ($50,000 / 1000)

LTV:CAC Ratio

The rule is that your LTV should always be greater than your CAC. (You always want to make more profit from the customer than you spend to acquire them.) But breaking even isn't going to make your company money or lead to growth. Therefore, when it comes to tech companies, analysts and investors look for a LTV:CAC ratio of around 3:1. That is, the LTV of the customer is 3 or more greater than the amount spent to acquire the customer. There's also a school of thought that if your LTV:CAC ratio is greater than 5:1, you may not be spending enough on customer acquisition and could be missing a revenue opportunity.

Customer Payback Period

This is the average amount of time that is required, in months, to earn back your customer acquisition costs. Targeting a payback period of ~12 months is a good rule of thumb, which makes sense when you think about selling annual subscriptions.

Rule of 40

I mention the rule of 40 here because working in a SaaS company that's owned by a Private Equity firm, it's continually monitored. The rule of 40 states that a successful company's growth rate and profit margin should add up to 40% or greater.

The calculation considers two financial metrics, growth rate and profitability margin. Revenue growth and EBIDTA margin are the most commonly used in the calculation. The rule of 40 formula is:

Rule of 40 = Revenue Growth + EBIDTA Margin

There is a preference to growth over profitability, and as such, many companies are switching to a weighted Rule of 40. In this formula, growth is given 2x the weighting of profitability. This Weighted Rule of 40 formula is:

Weighted Rule of 40 = (1.33 x Revenue Growth) + (.67 x EBIDTA Margin)

Wrapping It Up

Kudos to you if you've made it through to this point. It's a lot to take in and admittedly it's not the most exciting of reads. But, as a Product Manager, it's extremely important that you are aware of these metrics and that you pay very close attention to them. They are indicators of the success or failure of your products. The good news is that your financial team will be able to provide most of them to you, so there's usually no need for you to become a "bean counter". But watch them closely, and watch them often.

Speaking of watching them, most Product Managers that I've spoken with do this in a haphazard way. They request data from various teams as needed, or pull it from disparate systems, and then try to make sense of it all. If you don't already have an automated, consolidated view of product performance metrics, I would strongly urge you to work toward it. Not only will it make your Product Manager life easier, but having a holistic and timely view of your products enables you to make much better decisions. Plus, a consolidated view should allow you to look at your product across different segments or slices of your customer base or product portfolio. You can gain some tremendous insights by looking at your data through different lenses.

As always, I'd love to know your thoughts. If you use additional metrics, feel free to leave a comment below (or on LinkedIn/Twitter) to engage in a conversation.

Wishing you all the best

Mike