Importance of tracking KPIs

“What is not tracked is not maintained”. As your team goes through the opportunity pipeline you need to take note of relevant KPIs, use them to track, and provide feedback to your team. Here’s why!

• They will help you make better decisions. You must have timely and accurate information about all aspects of the performance of your team members in order to plan and coach effectively. As an owner-manager, you can’t rely on hope and assumptions; you must be assessing real data in real time that will reveal what is going on so you can take action now before it is too late.
• This leads to better execution. Identifying, measuring and – most of all – coaching to the right KPIs leads directly to behaviour change and skill improvement across the entire team.
• KPIs set expectations and improve communication. Defining KPIs clarifies for sales-makers the activities upon which they should be spending their time, and provides a context for sales managers to interact with sales-makers regarding their performance.
• A clear focus on KPIs will change sales-maker behaviour. Once sales-makers understand the activities they are supposed to be concentrating on, they will devote more time and energy to these areas, especially if they know their compensation will be tied to their performance in these areas.
• Focusing on a core set of KPIs will keep sales-maker activities consistent. There is an old saying; “People don’t do what is expected, they only do what is inspected.” When sales-makers understand what you are going to inspect every week, they are much more likely to do them every week.
• Tracking KPIs is the best way to identify and qualify sales-maker performance. Sales teams might be staying busy and giving 100% effort every day, which can be confused with real productivity. However, if they aren’t giving that effort to the right activities, all that effort is wasted. Tracking KPIs helps sales managers make sure sales-makers are spending the right amount of time on the right activities.
• Tracking KPIs takes the guesswork out of evaluation and coaching. This is related to the previous point. Sales managers who don’t regularly track sales-maker performance against a set of standard KPI metrics don’t have any objective basis for evaluating performance. The sales-maker may be a great person and hard worker, or they may be a disagreeable know-it-all, but those aren’t the most important behaviours for a sales manager to evaluate. The only thing that matters is how they are performing against the KPIs.
• Effective coaching begins with KPIs. Most sales managers understand that coaching is important, but coaching is useless if it is not based on quantifiable, actionable skills and behaviours. The greatest value of tracking KPIs is the information they reveal about where each sales-maker is doing well, and where they might need help to do better. Sales managers can quickly access KPIs from their CRM for every sales-maker and use this data to customise coaching conversations that will address gaps and boost performance.

Software KPIs

Recurring Revenue (RR)

• Software recurring revenue (RR) refers to the business model of generating revenue from ongoing subscriptions to software products or services. In this model, customers pay a fixed fee or variable price regularly, such as monthly, quarterly, or annually, for access to the software or services. This contrasts with a traditional one-time purchase model (perpetual license), where customers pay a single fee for the software and do not make any further payments.
• Recurring revenue does not include revenue from a) implementation (or setup fees), b) perpetual software licensing, c) transaction-based revenue (e.g., customers pay on % of transactions processed), d) revenue share or e) highly predictable repeat revenue
• RR is measured over a period of time.

Contracted RR

• Defined as all RR across all customers based on their contractual position measured at a point in time. Examples:
• Customer on monthly rolling contact = count only one month of recurring revenue
• Customer on annual contract but pays quarterly = count remainder of the contract until the annual renewal point
• Customers on a two-year contract and have paid two years in advance = count the remainder of the contract until the next renewal point.

ARR

• ARR is measured at a point in time, based on known wins, losses, RR expansion or RR contraction on existing customers
• Assume we are measuring ARR as of 31 Dec 2023. See below examples of what is included or excluded in ARR.
• Include in ARR
• The customer’s support or annual license expired on 30 Apr 2023. The customer is still planning to raise a PO but is hamstrung by internal processes. There is no reason to suggest that the customer will not be renewing.
• The customer has awarded a tender to us. Implementation does not start until 30 Sep 2024 and contracts have not been signed. Given that the tender has been awarded, this should be included in ARR regardless of the implementation start date.
• We are considering giving notice to a customer to terminate their contract (e.g. legacy services) but we haven’t officially done this. Include this in the ARR until notice is provided.
• Exclude from ARR
• The customer has sent a notification via email that they will not be renewing on 7 Nov 2023
• The customer purchased a trial solution where they paid for the first-year license. If the trial goes successfully, then the customer will transition to a full-blown solution. Given that we don’t have certainty that the trial will succeed, we should not include this number in the ARR.
• The customer has provided verbal confirmation that they want to proceed with a new order and we are still waiting for a PO. Don’t include this in ARR as there is no contract cover.
• Borderline cases
• The customer is planning to move away from our current solution but they want an interim support contract but the end date is not clear on when they will move away. If the worst-case customer end date is more than a year, include it in ARR; if it is less than a year, exclude it from ARR
• The customer has agreed to a price increase on the next renewal but the PO hasn’t arrived. Include the original price in ARR before PO; change to the new price after PO.
• Customers have notified us that they want to terminate some of their services or ‘downscale’ the usage (number of users, number of sites, API hits, etc.). Use the revised smaller ARR number.
• Other ARR metrics
• New Customer ARR: Tracks the revenue generated from new customers, providing insights into the growth of the customer base.
• Existing Customer Upsell ARR: Measures the additional revenue gained from existing customers through up-selling products or services.
• Existing Customer Contracted ARR: Measures the lost revenue from existing customers through downscaling users, services, etc.
• ARR growth: This tracks the percentage change in ARR from one period to the next (current vs previous period). It allows you to measure how quickly the ARR base is growing.
• Active vs Inactive ARR
• Active ARR is where the customer has agreed for a billing to start for RR to count. The vast majority of ARR would be active.
• Inactive ARR is where the customer has contracted with us but the ARR has not commenced due to various reasons (e.g. project not started, implementation not complete, implementation complete from our side but the customers is still testing or not ready to go live). If the customer billing for RR commences regardless of project completion status, this should be considered Active ARR.

Churn/retention rate

Churn rate measures the percentage of customers who stop using the company's product or service over a specific period. It is a significant indicator of customer satisfaction and retention and can have a substantial impact on a company's overall revenue and profitability. This is typically measured only for recurring revenue as churn doesn’t make a lot of sense for non-recurring revenue.

Recurring Revenue Churn

• OpenRR: Total recurring revenue from all customers in Year X
• Definitions
• ERRGrowth: Recurring revenue from customers in Year X* where the RR has grown in Year X+1
• ERRShrinkage: Recurring revenue from customers in Year X* where the RR has shrunk in Year X+1
• ERRLost**: Recurring revenue from customers in Year X* where we have lost the customer as of end of year X+1
• NewRR: Recurring revenue from new customers won in Year X+1

• Three types of Churn
• Gross Revenue Churn
• = (ERRShrinkage + ERR Lost) / OpenRR
• Focuses on the financial impact of churn, helping to assess the business's revenue stability. It is a more comprehensive measure than logo churn as it accounts for the revenue generated from each customer.
• Net Revenue Churn
• = (ERRShrinkage + ERR Lost + ERRGrowth) / OpenRR
• Offers a more nuanced view of the financial impact by accounting for up-sells, cross-sells, and expansion revenue offsetting lost revenue.
• Customer churn
• = (Customers lost during year X+1*** / Customers during Year X) * 100.
• This metric measures the percentage of customers who cancel their subscriptions or fail to renew their contracts. It provides an overall view of customer retention and the health of your customer base.

Notes:

• *Total recurring revenue from the same customers in Year X where they were also customers in year X+1. If the customer was a new customer in the year X+1, exclude from this value.
• **Customer lost is defined by customers that were with us during Year X but were not with with us at the end of Year X+1
• ***Customers that existed in Year X. Excludes new customers won in Year X+1.
• Each of the three measures has its importance and use case. In our experience, a gross revenue churn of less than 10% is considered acceptable. If it is more than 10% consistently, then you might want to carefully evaluate the reasons and resolve them.

We sometimes see business report on retention rate which is the opposite of churn rate. Retention rate measures the percentage of customers who continue using the company's product or service over a specific period. It is a key indicator of customer satisfaction and loyalty and can have an impact on a company's overall revenue and profitability.

Just like churn, retention rate can be customer logo or revenue retention rate. And revenue retention rate can be calculated gross and net of growth in the existing customer base.

CAC & LTV

1. Customer Acquisition Cost (CAC) is a metric that measures the average amount of money a company spends to acquire a new customer. It reflects the overall efficiency of a company's sales and marketing efforts. A lower CAC indicates that the company is effectively attracting new customers at a lower cost, while a higher CAC suggests that the company may need to refine its acquisition strategies. The formula for calculating CAC is:
1. CAC = (Total sales and marketing expenses) / (Number of new customers acquired)
2. Total sales and marketing expenses: This encompasses all expenditures incurred for acquiring new customers, including salaries for sales and marketing personnel, marketing campaigns, content creation, and advertising costs.
2. Lifetime value for a single customer: Calculates the total value a customer brings during their entire engagement with the business, guiding long-term relationship strategies.
3. Average LTV for a business
1. Customer Lifetime Value (LTV) represents the average revenue a company generates from a single customer throughout their entire relationship with the company. It helps to understand the financial health and sustainability of a B2B software business. The formula for calculating LTV is
1. LTV = (Average revenue per customer) x (Average customer lifetime)
2. Average revenue per customer - This refers to the average revenue generated from each customer each month or year. It considers factors such as subscription fees, add-on services, and up-selling opportunities.
3. Average customer lifetime - This represents the average length of time a customer remains a paying customer of the company. It considers factors such as customer churn rates, renewal rates, and customer expansion.
4. Payback period: Determines the time required for a customer's profitability to exceed the cost incurred in acquiring them, influencing investment decisions.
5. CAC Payback: This is the amount of time it takes to recoup the cost of acquiring a new customer. It shows how efficient the company is at acquiring new customers. A shorter CAC payback period indicates that the company is investing its money wisely in acquiring profitable customers. It is calculated as CAC divided by the average revenue per customer.
6. LTV / CAC: This is the ratio of lifetime value to customer acquisition cost. A higher LTV / CAC ratio indicates that the company is acquiring and retaining profitable customers.

Financial KPIs

1. Recurring revenue as % of total revenue: It is important to track recurring revenue as a percentage of total revenue because it shows how reliant the company is on recurring revenue streams. This can help to assess the long-term stability of the business.
2. Gross profit: Gross profit is the difference between revenue and COGS (Cost of Goods Sold). It is important to track gross profit because it shows how much money the company is making after paying for the COGS. Gross Margin % is Gross profit divided by Sales.
3. EBITDA Margin: EBITDA is earnings before interest, taxes, depreciation and amortisation based on expensing all R&D costs. EBITDA is the most commonly used measure of profitability for software businesses and is considered as a good proxy for cash.
4. Rule of 40: This is a commonly used metric to assess the overall financial health and performance of a software company. It suggests that a healthy company should have a combined revenue growth rate and EBITDA margin of 40% or more. This means that the company is not only growing its revenue but also generating profits at a sustainable rate. The Rule of 40 is not rigid, but rather a guideline that companies can use to benchmark their performance against industry peers. A score above 40 suggests that the business is likely to be in the top quartile of valuation.
5. Return on Invested Capital (ROIC): ROIC is a measure of how effectively a company is using its capital to generate returns. To track ROIC, you can divide net income by invested capital.
6. Revenue / employee: This is the total revenue generated by a business in a given year divided by the average number of employees during the year. See more here.

Forecast KPIs:

1. 12-month qualified sales pipeline: This metric serves as a foundational indicator, as it showcases the potential revenue streams and the overall health of future sales prospects. In our experience, a good indicator is when the pipeline is at least four times the annual quota.
2. Current quarter forecast pipeline: Aiming for a pipeline at least 1.5 times the quarterly sales quota ensures short-term stability and the likelihood of meeting sales targets.
3. Worst-case and best-case scenarios: Evaluating both worst and best-case scenarios (considering Won, Commit, and Upside) against the pipeline period target helps in assessing risk and growth potential respectively. As a thumb rule, the best-case pipeline period target should be well above one and the worst-case pipeline period target should always be greater than one.

Pipeline KPIs:

1. % of pipeline created and closed: measures the efficiency of converting leads into actual sales and helps in refining the sales process.
2. Pipeline created won: shows the success rate in converting created pipelines into actual won deals.
3. Average deal size: identifies the most profitable products or services and informs resource allocation strategies.
4. Win/loss ratios: provides insights into sales performance by comparing the proportion of won deals to lost ones.
5. Sales cycle length: evaluates the efficiency of the sales process by measuring the time taken from qualified prospect to deal closure (only count wins).
6. Activity level: measures the productivity and engagement of sales teams, providing insights into their effectiveness.

Conclusion

Tracking these diverse KPIs offers a comprehensive view of the business's performance across diverse aspects and informs you of your sales effectiveness. Wherever possible you should try and benchmark your KPIs to the specific market that you are addressing. Regularly monitoring and analysing these KPIs empowers owner-managers to make data-driven decisions, identify areas for improvement, capitalise on opportunities, and steer towards sustained growth and success.

Footnotes

1. Notion - Write, plan, organize, play. Turn ideas into action
2. Super - Create Websites with Notion
3. Tern Capital - Hands-on technology investor