Why KPIs are important for early stage businesses
Key Performance Indicators (KPIs) are an established performance management tool utilised by most successful businesses to monitor their performance and ensure they deliver on their strategic goals. Graham Welsh, Portfolio Manager at Maven, discusses why it is important for early stage businesses to set up KPIs, but also why it is critical to measure what really matters in terms of the organisation’s core objectives.
The well-used phrase ‘What gets measured gets done’ contains a level of truth. Where we set goals and measure outcomes we have the ability, through data, to accurately determine what was successful and what was not. However, the phrase could also be considered too simplistic as it is important that you measure the right things in the right way. What can be easiest to measure is often of little real value, whilst the metrics which actually matter can often be more difficult to track.
A key building block in agreeing strong and robust KPIs is ensuring that the strategy of the business is fully understood by all employees. This will help secure their buy-in and lead to a clear linkage between the agreed KPIs and the achievement of the company’s strategic goals.
I am a firm believer in the importance of KPIs and take the time with the investee companies I oversee to develop effective KPIs which will help Maven, as the investor, to really understand corporate performance. To provide value, KPIs need to be (a) well defined and measurable, (b) simple to understand and compute, (c) communicated clearly throughout the business or business unit to which they relate, and (d) aligned to achieving the ultimate objective or goal. It is also important to prioritise, as there is a real danger in missing the wood for the trees when the dashboard of KPIs tracks too many variables. Developing effective KPIs is both art and science and typically a balance is required between lagging indicators (monitoring performance during an historical trading period) and leading indicators (providing guidance around future results).
With established businesses there is usually a financial bias to the suite of KPIs employed. This will typically include a focus on gross profit margin, EBITDA, cash conversion and debtor days etc. More established businesses may also track customer, process and people metrics. A customer KPI, for example, may measure lifetime value. Process metrics are commonly used to evaluate business efficiency, whilst people KPIs can help measure employee turnover rate or satisfaction and provide valuable benchmarks against industry norms. The sector in which a company operates may also have a significant bearing on what other metrics are applicable.
There are countless performance metrics which a business can choose to measure; however, it is vital to remember that agreed KPIs must have a ‘key’ link to delivering core objectives and the business strategy, or they are likely to be largely meaningless.
Whilst many of the most commonly used KPIs will also be relevant to younger businesses, their earlier stage of development may demand the use of more fundamental indicators. Businesses in the development or growth phase will typically be investing heavily in their infrastructure, most often people, ahead of the subsequent revenue pull through and a key consideration for any funder structuring an investment into an early stage company is understanding the monthly cash burn. The sales pipeline, and the number of times this covers budgeted revenue, together with conversion and attrition rates through the stages of the sales cycle, will also be analysed.
A funder will also analyse the key elements, and sensitivities, within the management plan, to assess its likelihood to deliver profitable and cash generative trading. As a result of this analysis, they will often adjust the means by which they monitor an earlier stage investment, taking care to ensure that they identify and then refine KPIs which best promote positive behaviours.
For example, KPIs for a typical ecommerce B2C company will focus on ensuring that the funds invested are not poorly spent on marketing and pay per click (PPC) activity which provides a short term, but unsustainable, uplift in demand – a ‘sugar rush’. Private equity backers like Maven will therefore develop KPIs which help to ensure that the business establishes a sustainable and viable business model. This will include measures such as controlling the cost per click, maximising search engine optimisation, identifying causes of leakage along the sales funnel and generally enhancing the customer experience.
Clearly the number of website visits and or leads generated can be easily measured; however in terms of a KPI, a more important and relevant measure is the cost of attracting each such new lead, and whether this is reducing as the business matures and the marketing strategy is refined. KPIs can also be structured to measure how many leads culminate in a sale. Here again, as the quality of leads is improved over time and the marketing message is finessed, the KPI is likely to be targeting a reduction in the net cost of achieving each sale.
With a focus on the correct KPIs, early stage businesses can reduce the time required to get to the inflexion point where the fixed business costs and the variable cost of attracting each new client are exceeded by revenue.
It is my experience that identifying the most useful and relevant KPI’s (both financial and non financial), and constantly monitoring and reviewing them, will play a crucial role in helping your business to scale at pace, achieve operational leverage, and deliver stakeholder and shareholder value.