Thursday, September 16, 2010

eCommerce RULE #3: The 6 “Cs” are your vital signs: Ignore them at your peril!

These 6 “Cs” are metrics that provide an unparalleled window into the health of your online retail business.

1.  Company Net Promoter Score, or NPS, is a customer loyalty metric developed by Satmetrix, Bain & Company, and Fred Reichheld. This score is determined by posing a simple question to consumers; it’s a query designed to screen for customer loyalty. Consumers are asked, “On a scale of 0 to 10, how likely is it that you would recommend our company to a friend or colleague?” Consumers offering a rating of 9 or 10 are anointed “promoters”, implying they could heavily promote the company to others. Those who give a rating of 7-8 are “passives”—maybe they might not do anything. Those at the lower end of the scale, with ratings of 0-6, are dubbed “detractors,” since they might speak ill of a company and hurt its prospects with other potential customers.

A company calculates its overall net-promoter score by subtracting its percentage of detractors from its percentage of promoters. So, if 65% of an e-commerce firm’s customers rank as promoters, and 15% as detractors, the firm’s overall NPS would be 50. You should ask every customer this simple NPS question after they’ve received their shipment. 

Track and monitor your NPS every month and discuss it in your management and board meetings. Slice and dice the metric to study specific people who have interacted with your customer-service team or who processed a product return. You’ll be surprised by the insights that will jump out. Check out to compare your score against the best brands on the planet, like Amazon, Apple and Google. Tracking NPS is invaluable.

2.  Customer lifetime value, or CLTV. As discussed in Rule #2, CLTV is the net present value (NPV) of the profit from a customer’s purchases. A profitable customer will have a CLTV in excess of its CAC (see next metric).

3.  Customer acquisition cost (CAC). This is quite simply your fully-loaded average cost to acquire a new customer. You should track this over time. However, averages can be misleading; not all customers are created equal. You’ll always have one group of customers that come back to your site multiple times and are profitable to you. Others may come once, perhaps pick up some of your lower-margin SKUs—and never return. Remember: Your goal is to optimize CLTV minus CAC. This means that trying to keep your CAC down is not always your best bet: Sometimes your better customers (those that return and/or buy higher margin SKUs) are a little more expensive to acquire. But they’re worth it. If your current average CLTV is at least 2X your average CAC, and most of that comes in year one, you’ve got enormous upside potential.

4.  Conversion rate. For most e-tailers, the relevant conversion rate is the percentage of new visitors that convert to buyers. Here, traditional blocking-and-tackling concepts like streamlined landing pages and fast page-load times are king. If you want to take this metric to the next level, you should think of your conversion rate as a conversion of visitors to revenue producers (not necessarily to buyers)—or, better yet, to gross profit contributors. Essentially, what you are trying to measure is how much money you make from each visit to your website. It’s the equivalent of the eRPM (effective revenue per thousand impressions) most Web publishers use to measure their businesses. But here, we suggest eGPV (effective gross profit per visit). Compare the eGPV for all of your visits, and tweak the site paths that are falling below the average. Adding additional revenue streams such as on site advertising may help to optimize this metric.

5.  Churn. Yes, e-commerce businesses have churn too! This is the percentage of visitors to your site that don’t come back to buy anything else. You should also, of course, track the number of monthly visitors who are returning customers.

6.  Cash-conversion cycle and return on invested capital. Only the simple-minded focus on the P&L statement. No one cares what your profits are if you don’t generate any cash flow. Online retail can be tricky because there are lots of ways to burn cash even when you’re generating income-statement profits. Inventory and warehouse equipment can consume a lot of cash, particularly during periods of high growth. The best online retailers actually boast a negative cash-conversion cycle. In other words, they get paid by their customers before they have to pay their suppliers. Amazon and Blue Nile have negative cash-conversion cycles, so it’s perhaps not surprising that these companies have the most attractive valuation metrics in the online retail industry. For example, below, we plotted all the pure-play online retailers, with their cash conversion cycle on the X-axis and their TEV/LTM Gross Profit on the Y-axis. You can see that Blue Nile, with its average -47 day cash conversion cycle for the past four quarters, is valued at a multiple of almost 12X, and Amazon, with its –26 day cash conversion cycle is valued at a little over 8X. Leading competitors, with much longer, less attractive cash conversion cycles, most have valuations hovering around just 3X. 

Be aware of this, and make smart tradeoffs between vendor-discounts and stretching payables whenever you can. If you want to get really sophisticated, measure cash conversion on a SKU-by-SKU basis.

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