KPIs - but Why?
At work, one of our main focuses is probably generating revenue: we spend time and energy on acquiring customers. We develop strategies, test, improve, modify, adjust, repeat, or delete. We all strive to make and keep our businesses profitable and sustainable. From large companies to independent creators, the bottom line is simple: we must be profitable to keep doing what we do.
Growth and profitability are not a mere result of our effort; they're the fruits of steady and constant work following specific business processes. The topic is vast; therefore, we will focus in this post on one of its subsegments: monitoring e-commerce acquisition strategies.
To grow online revenue, you need a way to measure our strategies' performances. Although it may seem evident to many of us, it is still a good reminder. Success comes from trying, learning, and implementing the lessons learned. These steps are one of the reasons why we use key performance indicators, or in short, KPIs.
Before diving into which KPIs are the most useful for e-merchants, let’s consider another essential idea, making the use of KPIs necessary to avoid costly mistakes.
The field of behavioral economics has grown massively in the past few decades, helping us understand the laws of economics from a human standpoint. It reveals that humans face serious challenges when it comes to decision-making. Moreover, it defines what we call fallacies and biases. We all have them, and they are responsible for many of our business mistakes.
Our lazy brain
In his book "Thinking, Fast and Slow", the Nobel Prize in economy Daniel Kahneman explains some of his discoveries about the functioning of our brain when we face a choice. We all have two brain functions that operate differently. On the one hand, our intuitive brain thinks fast and uses shortcuts to make decisions. On the other hand, our rational brain computes, calculates, and uses logic. We need both of these functions, but challenges appear when we misuse them - which we often do, as you probably guessed, without even being aware of it!
For example, if you need to make a rational decision based on data or probability, you should use your rational brain. However, research has shown that we tend to use the intuitive brain because it needs less power to function. In other words, we're being lazy to save energy, and it causes us to make decisions based on false intuition. Yet, strangely enough, when we do so, we feel as if we were right. And there you have a recipe for making bad business decisions with the best of intentions!
You may think you know how to avoid biases, but remember, it is our default behavior. Therefore, we need to apply considerable energy and put measures in place to prevent our brain from falling into its default mode of operation. Do you see where we're going with that? Implementing the proper KPIs for your business will help with rational decision-making.
The sunk cost fallacy
Let's bring an example to make it more tangible; the sunk cost fallacy.
The sunk cost fallacy is defined as follows:
Rather than consider the odds that an incremental investment would produce a positive return, people tend to "throw good money after bad" and continue investing in projects with poor prospects that have already consumed significant resources. In part, this is to avoid feelings of regret.
In other words, let's say you invest in a new campaign to bring customers to your website, for example, paying for ads on social media. You invest significant money, resources, and time, and the return is not meeting your expectations after a few months. So it would be best if you stopped, but you're so far into the campaign and have invested so much already that you decide to invest even more. The more you invest, the more the potential return decreases. Logically you know it, yet you keep going. The sunk cost fallacy is at play!
Have you ever looked back at a campaign and asked yourself why you didn't stop it earlier? Decision-making errors happen all the time in every organization. So, as we mentioned earlier, we need to be aware of the phenomenon and implement measures to avoid falling for it as much as possible.
And that's the other fundamental reason for proper KPIs to monitor your business strategies.
By the way, we are not implying that intuition has no place in business. On the contrary, following your intuition can be a great source of creativity, connection, and new ideas you would never access with rational thinking. But you must use analytical thinking and logic alongside intuition!
KPIs - How and what?
Now that we know and understand KPIs' importance let's look at monitoring acquisition strategies.
There are a lot of exciting and relevant metrics, and all of them will give us great insight into performance. And with so much data lies the risk of drowning in the ocean of metrics. To avoid getting lost in too many numbers, we recommend the following:
- Express your goal in writing first, then translate it into numbers.
- Keep it simple, like really simple.
As we get to work on our day-to-day tasks, complexity arises naturally, and when it does, if you don't have a clear and simple statement to remind you of your goal, you increase your chances of getting lost.
When discussing business profitability and sustainability, you only need two KPIs, CAC and CLV. This will tell you everything you need about your strategy; all other relevant information will derive from them.
CAC is the customer acquisition cost. You calculate all sales and marketing expenses and divide them by the number of customers acquired. So, CAC gives you the average cost of acquisition per customer.
Knowing your CAC for a strategy allows you to project accurately expected profit, measure the investment needed, etc.
CAC = All sales and marketing costs / # of customers acquired.
CLV, or customer lifetime value, represents the value a customer brings to your business on top of the first purchase.
"Lifetime" is a length that varies depending on the type of operation. Usually, for an e-commerce strategy, it is one year, but it can be longer if you can measure your customers’ foreseeable behavior.
One of the advantages of looking at CLV is to start thinking about long-term value per customer. It will also drive you to look for ways to increase value, which is a good practice.
When you know how much it costs to bring a customer (CAC) and how much value a customer will bring, you know pretty much everything you need about your business's health, sustainability, and profitability. As a rule of thumb, you should aim for a CAC/CLV ratio above 1/3 😊
Of course, you will need many metrics to estimate or calculate these two KPIs; some will be relevant to track but make sure to separate the complexity. Don't mix up all the required information with the ultimate performance to monitor. There is a reason why companies invest so much time and consulting fees to come up with a concise mission statement. Keeping it simple is not easy, but it will significantly help you!
Here's a story taken from Jake Knapp’s "Sprint…" book. It's a graphic and inspiring example of the proper use of KPIs. We hope it will help you keep your thinking clear as you establish KPIs to monitor your acquisition strategy.
Everybody knows the story of Apollo 13, but just in case, it goes like this: Astronauts head to moon, explosion on spacecraft, nail-biting return to earth. In Ron Howard's 1995 movie version, there's a scene where the team at Mission Control gathers around a blackboard to form a plan. Gene Kranz, the flight director, wears a white vest, a flattop haircut, and a grim expression. He grabs a piece of chalk and draws a simple diagram on the blackboard. It's a map showing the damaged spacecraft's path from outer space, around the moon, and (hopefully) back to the earth's surface—a trip that will take more than two days. The goal is clear: To get the astronauts home safely, Mission Control has to keep them alive and on the right course for every minute of that journey.
Throughout the film, Kranz returns to that goal on the blackboard. In the chaos of Mission Control, the simple diagram helps keep the team focused on the right problems. First, they correct the ship's course to ensure it won't veer into deep space. Next, they replace a failing air filter so the astronauts can breathe. And only then do they turn their attention to a safe landing.
In conclusion, for each e-commerce acquisition strategy you implement, keep the ratio CAC/CLV on top of your dashboard and work to keep it high! Then, later with a ratio for each of your strategies, you can compare them and make rational, data-driven, focused decisions to keep your business profitable!