Last week, we posted what qualitative characteristics we look for when evaluating eCommerce companies. This week, we thought we'd get to the real fun and talk about the quantitative stuff.
The Quantity:
When looking at financial projections, the earlier the deal, the more likely the projections will be wrong. Thus, we put most weight in you understanding your financial model, not just your projections. Within that, you should know what your key performance indicators (KPIs) are and which are most critical to the success of your business.
Key metrics to track as an eCommerce company:
1. Cost of customer acquisition (CAC)
How much do you have to spend to get one new customer? You should take into account anything you spend to bring in new clients, including share partnerships, paid marketing and cost of direct sales.
2. Conversion rate (CR)
Of your site traffic, how many are actually buying? Depending on source, this varies from ~0.75% from social media to ~2% from search and ~3% from email. Desktop and tablets get double or triple the CRs than smartphones.
3. Shopping card abandonment
How many potential customers put products in their shopping cart but didn’t place the order? The average is 67 percent of shopping carts are abandoned.
4. Average Order Value (AOV)
What’s the average size of a single transaction? Of course, this is variable, but we see averages between $80-$120.
5. Life time value (LTV)
How much profit will a single customer generate over the entire span that they are a user? Use this formula:
(# of months they will be a customer x average order value/month) – customer acquisition cost
6. Churn
What is the rate at which you are losing customers? If you have 100 customers in April but only 80 in May, that means 20 percent of them have churned. Churn rates below 5-8 percent are ideal, but the lower the better. By dividing 100 by your churn rate, you can also estimate expected number of months as a user. For instance, a churn rate of 20 percent indicates your customer will only stick around for five months (100/20), which is not very long.
Rules of thumb we use when evaluating metrics:
1. Gross margins near 50 percent
Because eCommerce businesses are so capital intensive, we want to make sure you still have at least half of your revenue remaining for operating expenses, selling, general and administrative expenses (SG&A), etc. after taking out the cost of goods.
2. Lifetime value of at least three times the cost of customer acquisition
In another words, the amount of revenue a single customer will generate for your business over the entire span of them being your customer should be at least three times greater than how much you have to spend to get that customer.
3. Size of your raise that lasts at least 12 months, if not 18
For example, if your net burn (revenue minus total expenditures) is $50,000 per month, you would need to raise $600,000 for a 12-month runway.
4. Reasonable conversion rates
You should have reasonable expectations for conversion down each step of the purchasing funnel. If they’re much different, you should have solid reasoning to justify why they’re different. Reasonable rates for email marketing are as follows, partially from Monetate reporting.
- 15% email open rates
- 20% click through on those opens
- 8-10% add to cart rates
- 67% cart abandonment (meaning 33% follow through with purchases)
- Following that entire funnel through = ~1% traffic to sale conversion
5. Realistic revenue expectations
Unrealistic expectations are a red flag for us. Anything greater than 20 percent month over month top line revenue growth is often unrealistic, with the exception of the occasional extreme outlier.