Understanding important direct to consumer metrics.
Identifying the metric to monitor should always be determined by your business goals and product strategy. However, here's a short primer on important DTC business metrics.
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For product managers who are execution oriented, who focus on product delivery, it’s sometimes challenging to unpack metrics. There are so many things we measure. Each metric can be aggregated or sliced, creating more metrics. Second, different companies and product organizations define “product” metrics differently. This confusion is exacerbated when “product” metrics easily overlaps with business metrics, financial metrics, marketing metrics, or even system performance metrics. Where does one draw the line for which metrics PMs should monitor? So today, I’m spending some time identifying the important metrics for a direct to consumer business.
Breaking down DTC metrics into four areas.
How much do you spend to acquire paid customers?
How much do paid customers spend on your product/service?
How much does the product or service cost to make and sell?
How many of those paid customers will buy something next month, in month 3, and so forth.
Area 1: How much are you spending to acquire paid customers?
As background, marketing efforts can be categorized as:
paid (i.e. advertising)
owned (i.e., content you create such as a blog, website, or social media post)
earned (i.e., when someone else forwards your blog, re-shares a social media post, or you get featured in the news for free). Any re-shares that involve a monetary reward is categorized under “paid”
While marketing cares about all three, I’ll focus on the paid category for this article. What you want to know is how much you spend on advertising by different channels.
An example
You advertising both online and offline (two channels: online and offline)
You spend certain amounts of money advertising within each
Offline channel
TV
Radio
Direct mail
Online channel
Google Adwords
Youtube Ads
Pandora Radio
Facebook Ads
Affiliate Marketing
X number of paid customers are acquired from each channel.
If you sum total marketing spend for all channels and divide by the total number of paid customers, you have average CAC (Customer Acquisition Cost). As you can imagine, the lower the CAC, the better.
While PMs don’t usually have control over the marketing channel and budget, you do have some control over the conversion funnel, which is the steps it takes when a customer sees an advertisement to the moment they become a paying customer. This is how conversion funnel metrics tie into CAC.
Area 2: How much do paid customers spend?
While lower CAC is good, another important piece to understand is how much a paid customer is spending.
To calculate this, you take the total revenue from paid customers and divide by total number of customers, which gets you AOV (Average Order Value). If you have lots of outliers, maybe you want to calculate by using the median, but I’m digressing.
While PMs may not control pricing for product or services directly, you may be able to increase AOV by increasing the number of items per order via cross-sell or up-sell to a higher price product/service via recommendations. Understanding how changes to the order basket affects changes to conversion funnel is something PMs monitor.
Now, with CAC and AOV, you know on “average”, how much it costs to find a paying customer and how much that customer will spend.
Area 3: How much does the product or service cost to make and sell?
In the end, it’s about margins, not revenue. Earning revenue is good, but if it costs you more to create the product than the revenue you collect, you’re losing money and that’s not easy to sustain forever. Anyone remember the failed startup MoviePass?
This is what their auditor said in 2018.
MoviePass currently spends more to retain a subscriber than the revenue derived from that subscriber and MoviePass other sources of revenue are currently inadequate to offset or exceed the costs of subscriber retention. This results in a negative gross profit margin.
Thus, there are three important costs to understand:
Cost of goods (COGS) -> The direct cost of producing the goods.
Cost of sales (COS)-> COGS + indirect cost such as packaging or shipping required to make the sale. For example, services usually have no COGS.
Sales discount -> Any pricing discounts offered to make the sale
Again, PMs may not directly control COGS, COS, or sales discounts, but PMs could explore opportunities to streamline sales, find manufacturing efficiencies, or reduce sales promotions in efforts to lower COGS, COS, and the need for sales discounts.
If the AOV (i.e., revenue from a customer) is less than the average COS, you get a negative gross profit margin, which is what was happening with MoviePass.
Area 4: How many of those paid customers will buy something again?
Once you’ve acquired a customer, the hope is that customer will come back and purchase again and again. For example, a customer could spend $100 one time and never buy anything ever again. Or, that customer could spend $100 and come back every month and spend another $100.
To understand this metric, you need to track paid customers as a cohort over time to see how many return the next month and purchase again.
For example, to calculate 1 month retention rate:
Take 78 customers.
How many of that 78 customers, but something again 1 month later?
When you do this over time with different cohorts, you’ll be able to create a graph.
And when you track retention rate + AOV, you can calculate the LTV (Lifetime Value) of a paid customer. So in the above example, if the AOV is $50, then the LTV for Dec. 31, 2013 cohort at period 9 = (50*78)+(50*78*.96)+ (50*78*.90) + … + (50*.78*.82) / 78=$443.5. Note that this calculation is using AOV (i.e., revenue only) so this is revenue LTV. You can do the same math but replace 50 with AOV minus your costs. Then, you have margin LTV.
Again, PM’s don’t directly control LTV, but you can influence LTV by its underlying components:
Refer back to AOV in Area 2, such as cross-sell or up-sell.
Improve retention (e.g., communicating with paid customers)
Increase order frequency
One reason LTV is important is that in many cases, the average CAC is significantly higher than the AOV. Thus, the only way to make money back is if over time, that customer buys something again the next month and so on. Over time, the LTV will increase, hopefully, above the CAC.
Request the DTC Business Metric Template if you want to see all calculations in one spreadsheet.
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