As a part of the venture development team at Accel, we engage with multiple companies to help build sustainable and efficient value to customers. Over the course of working with hundreds of startups, we have found that collecting and observing the right metrics can help leaders build great value creation engines.
In this post we will talk about why metrics are needed, where the current frameworks fall short and what kind of a new framework is needed. This post is a part of the Growth Spiral series, read more about it here.
Most of us invest our time, effort, money on successful (and to-be-successful) businesses for disproportionate returns. Warren Buffet popularised the principles of value investing, which spoke about how to determine the competitive advantage and the durability of that advantage of any given company. He called them ‘economic moats’.
Over time, many have detailed out the types of moats a business can have. However, what doesn’t have a lot of literature (even in the days of information overload) is how to choose and build a moat for your business. We have seen in this post by Dr. Ajay Sethi; how we can choose the right moat/value creation mechanism to build for the nature of our business.
Growth Spiral is a process that helps companies to create increasingly more value and build stronger defensibility in an efficient and sustainable way.
Imagine being an Air Force pilot in World War 1 flying over thousands of kilometres over the oceans without GPS or any sophisticated navigation systems. You could use only the classic navigational tools: a map, a compass, radio navigation from nearby ships and some intuition.
Over the years navigation systems have become so advanced that militaries now have to train their pilots on how to fly when GPS is shut off. The navigation systems help pilots navigate to their destination and perform course corrections as soon as it is necessary.
Similarly, we need navigation systems for our business to help us get to the right destination in the fastest way possible. So how do we know if we’re on the right path towards business success or if we need a course correction? After all, financial metrics are in most cases so lagging in nature, that we simply cannot look at them in isolation to determine if course correction is needed — it’ll take a few months to see intended impact.
What we need are superior systems (what we will call as ‘leading indicators’) which can notify us the instant we are deviating from the set course so that we do not waste any time or fuel and head to the right destination.
While we want our metrics to be the navigation systems on our journey of building a successful business, there are a few other things running in our head when thinking of what metrics to choose. In our development of a quantitative framework to help companies build value creation mechanisms, we realised accounting has done one of the best jobs here so far when it comes to creating a global language of metrics. Learning from accounting, the set of metrics we choose should be –
Many countries around the world have adopted the International Financial Reporting Standards (IFRS). IFRS is designed to provide a global framework for how public companies prepare and disclose their financial statements. Adopting a single set of world-wide standards simplifies accounting procedures for international countries and provides investors and auditors with a cohesive view of finances. Similarly, the US SEC adopts an accounting standard called Generally Accepted Accounting Principles (GAAP).
In 2016, Social Capital wrote about ‘GAAP for Startups’ in this article. They introduce ‘8-ball’ in order to create a GAAP-like standard for understanding product-market fit for early stage companies.
Absolute benchmarks (as opposed to relative benchmarks from past numbers) are needed to understand what the maximum limit the offering can reach and also to understand where we stand in the overall ecosystem. This in turn helps us identify our strengths and weaknesses and eventually initiatives to double down on the former and fix the latter. In other words, standardisation simplifies things and helps us collectively move forward faster, similar to a common language.
What are these metrics systems which help us both in course correction when needed and give us a standardised framework to benchmark against?
Over the years, many people have built frameworks to serve as navigation systems for businesses. Dave McClure coined the famous ‘Pirate metrics’ or ‘AARRR’ metrics in 2007 which outlined the five most important aspects of a business: acquisition, activation, retention, referral and revenue. Fast forward 10 years in 2017, owing to the rise of ‘social’ apps that required long term retention to deliver and extract value and the increasing saturation of the applications market, Gabor Papp re-ordered this linear funnel into RARRA to tell the world retention is much more important and acquisition should come in the end: retention, activation, referral, revenue and acquisition.
However, these frameworks are often described as prescribing a lot of ‘vanity metrics’ and they don’t give companies actionable insights in the journey of building sustainable moats. For example, AARRR doesn’t help us answer questions like ‘How many times should user use our product in a day/week’, ‘Which conversion has been improved by the learnings from previous cohorts and by how much’, ‘Are my metrics above or below industry standard’, etc.
Over the course of working with hundreds of companies across models, domains and stages (many of them who use existing frameworks) we have realised two core insights are not fully layered into these metrics –
While we might have a metrics framework already in place, layering in natural frequency and the spirality of growth, will help in building exceptional offerings.
Natural frequency is the frequency at which the activity happens organically. Observing the natural frequency of an activity will tell us how frequently we can solve a problem/use-case for our target audience in that domain.
Fundamentally, every business is a monetisation byproduct of an offering which solves a use case occurring at a natural frequency. The existing metrics frameworks do a great job in helping us think of ‘how many’ are using our offering (acquisition, activation) and for ‘how long’ (retention). However ‘how frequently’ defines the core business strategy of whether we should focus on acquiring more user fast or on building trust with users.
In 2017, Greylock’s Casey Winters in an episode of the Inside Intercom Podcast mentions natural frequency in the format of a question –
I always try to answer, “What is the offline analog to this product?”
In other words, if we eat food roughly thrice a day, the natural frequency of a food business is 3 food orders a day per user. If we commute every day and travel roughly once on the weekend, then the natural frequency of a transportation business is 12 rides (10 commute rides and 2 personal rides) a week. If we buy a house only once a decade, then the natural frequency of a real estate business is 1 successful purchase in 10 years.
Given that the ‘frequent problems’ are not very important (in the sense that there are alternatives — even though inferior — available), startups solving frequent problems often need to focus on acquiring more users and iterating quickly to ensure that the company is able to improve quickly in order to meet their customers’ needs. On the other hand ‘important problems’ — due to their very nature — require more trust to be built with users. Therefore, it is important to focus on activities (such as curation of service providers, emotions-aware design, end-to-end customer experience, etc.) that help build trust with potential users.
Typically, when the natural frequency is high, we unlock and capitalise on scale as a moat. When the natural frequency is low and the importance of the activity is high, we unlock and capitalise on brand connect as a moat. The image below shows the 2 types of businesses, one solving ‘frequent problems’ and the other solving ‘important problems’.
Let’s consider a single user’s journey in a business that solves ‘frequent problems’ –
For a business that solves ‘important problems’, the sales cycles are typically longer and hence would involve a complex/longer selling environment. Here, it makes more sense to measure our paying customers since they will typically constitute the majority of our offering’s users. This is in contrast to businesses solving ‘frequent problems’ which have simpler sales cycles and would have a large number of users using the offering for free, and in most cases have a smaller number of paying customers. In other words, the journey for businesses solving ‘important problems’ would be — lead, activated customer, active customer, super customer and involved customer.
As you might have guessed, the user journey from activated to active user is the ‘Invite’ phase, from active to power user is the ‘Engage’ phase, and from super to involved user is the ‘Connect’ phase. As we take a cohort of users through this journey, we do a lot of experiments to understand what works and what doesn’t. As we take the next cohort of users through this updated journey, the linear funnel actually starts becoming a continuous and gradually widening spiral in motion. If we have successfully implemented the learnings from the first cohort, we should be better off with similar activities in the future.
For example, say we spend $100 on acquiring the first 100 users. Some users out of this 100 will convert to active users, some to super users and maybe some to involved users. Throughout this journey, the team typically will do a lot of quick experiments to validate multiple hypotheses. If some of these experiments are successful, we will have success stories from users, a better understanding of what part of our offering is being valued by the target audience and maybe even users who will invite other users to be their fellow users. Because of these factors, the next 100 users should ideally be acquired at lesser than $100. If this is not happening, there is a problem in the updated journey. This example of costs can be applied across all the 3 phases of the journey — cost of retention in ‘engage’ and cost of expansion in ‘connect’.
The spirality of growth emphasises on how the success of the value creation mechanisms built will be reflected in the subsequent cohorts.
How do we design metrics systems which layers in both natural frequency and spirality of growth? Read on in the following post which gives a tactical guide (with examples) on setting up metrics for your startup