“To get ARR, you have to have A HEART”
Visualization of cascading metrics
Introduction
How do you demonstrate how the efforts of your product, marketing, design, and engineering teams impact the business? A few years ago I was asked to help develop a method for showing ROI of product initiatives to the board of a venture-backed company where the FP&A process wasn’t mature enough yet to use disciplined financial approaches such as NPV and IRR. In researching how to demonstrate ROI for product initiatives, I came across this article by Profitientz on how to calculate ROI easily without needing to forecast revenue streams:
Their model is simple: 1) group projects into growth or retention buckets, 2) estimate the impact of the growth projects, 3) estimate the impact of the retention initiatives, and 4) add growth revenue to the potential saved revenue from retention and divide by the team cost to complete those projects.
Team cost is reasonably straightforward: get the cost of the entire team from the Finance department. But how do you calculate the impact to growth and retention using this model in a way that scales as your financial management matures? To do this, I combined the ROI calculation from Profitientz with the HEART metrics (Happiness, Engagement, Adoption, Retention, and Task Success) framework by Kerry Rodden, Hilary Hutchinson, and Xin Fu of Google, and Acquisition from Dave McClure’s Pirate Metrics (AARRR). For a subscription company, the core ROI is increased annual (or monthly) recurring revenue (ARR or MRR).
In keeping with the fun names, I generally articulate this mashup of frameworks as “To get ARR, you have to have A HEART”. In this article, I’ll include a brief overview of each metric category (A and HEART). For a detailed description of HEART, I recommend Tomer Sharon’s writeup.
Annual Recurring Revenue = Growth + Retention
ARR = Growth + Retention
Growth = Acquisition + Adoption + Happiness
Retention = Happiness + Adoption + Engagement + Task Success
While this version of the model is designed for companies whose revenue streams come primarily from subscriptions, it can be readily modified to fit other business models and even organizations that may not directly impact customer growth or retention. For example, an HR team may have the top metric of employee engagement, with appropriate engagement metrics cascaded into the various functions of HR.
ARR is the total subscription revenue of all your customers in a year, meaning increased and sustained subscriber count, or growth and retention, are generally what lead to increased and sustained revenue. While there are other ways of adding revenue, such as up selling a current customer to a higher tier subscription plan or adding services with additional fees, I will show that those activities are a factor of either growth or retention.
Growth = Acquisition + Adoption + Happiness
For the purpose of this conversation, I use growth to mean adding new customers as measured by gross customer growth rate. Subtract your churn from growth and that gets you net growth. This might mean new subscribers or new users, whichever makes sense for your business model. While financial growth is important, it should be looked at through the lens of financial management. Finance professionals can calculate sustainable growth rates and create revenue forecasts based on forecasting subscriber growth and retention. Customer growth is a factor of acquisition, adoption, and happiness (A and A&H of A HEART).
Acquisition
These efforts are intended to bring more people to the marketing pages, especially highly qualified leads, who can then sign up for a trial or be contacted by sales. These metrics cover the first two steps of the purchase funnel: awareness and interest. Many marketing activities, including brand awareness campaigns, SEO, and SEM, are intended to impact acquisition metrics. Acquisition metrics may include customer acquisition cost (CAC), customer lifetime value (CLTV), ad spend, brand awareness measures, or marketing page views.
Adoption
Adoption in growth (as opposed to adoption in retention) measures things like trial starts or sign-ups. In other words, adoption in this case measures how many acquired leads start a trial, reach out to a sales representative, or sign up to be contacted. In the purchase funnel, these are the consideration, intent, and evaluation phases. An example of an adoption measure is how many of the people coming to your marketing pages through SEM sign up for a trial.
Happiness
Although the happiness metric category mostly belongs in the retention metric category, I include it here because happiness can be a driver of growth. If your customers are happy with your product or service, they are more likely to tell others about it, and therefore drive down CAC. Regardless of which type of happiness measure you use (CSAT, NPS, etc.), it is important to consider happiness as part of your growth strategy. The growth of businesses such as ride sharing platforms are especially dependent on delighting users with some key element of the experience, as they often rely on word of mouth to grow.
Retention = Happiness + Adoption + Engagement + Task Success
Retention is keeping the customers you have or upgrading current customers to higher-level plans, and is a factor of happiness, adoption, engagement, and task success measures. Like growth, retention can be measured as its own metric. Retention, or it’s opposite, churn, are metrics every company needs to pay close attention to. Having more customers leaving than you gain can lead to spending yourself out of business.
Happiness
Happy customers are more likely to stick around. Happiness increases CLTV, decreases CAC, and increases brand loyalty. Happiness can be due in part from the quality of the product or service, including how well it meets functional, social, and emotional customer needs; however, the product and service are only part of the equation. Happiness can also come from the quality of customer service (e.g., Zappos) and the brand image in relation to the individual (e.g., Apple).
Adoption
Adoption is a factor of retention because the more people use a product or service, the more likely they are to stick around and keep using it. This is the initial use of a thing, from signing up for a newsletter to trying a new product feature. This is also where the product and marketing teams overlap on the retention side of this equation. Product marketing from the marketing team helps increase adoption of new features, and product teams try to make products that people will use.
Engagement
Engagement measures the ongoing usage of the product. Once customers adopt a product, feature, or service, you may want to measure how often they interact with it. An oft cited engagement metric is daily active users (DAU), such as how many people sign into Facebook every day, how many people return to read articles on newyorktimes.com, or how many people view photos on Flickr every day.
Task Success
Task success is a measure of a customer's ability to get something done effectively and efficiently. How long does it take them to get a photo posted on Flickr, or how long does it take them to start organizing a project on Trello? This is generally a more traditional usability group of metrics, such as time on task, task success rate, or lostness. Task success is not only related to a product; also, it can relate to how many steps it takes to reach a customer support agent, return an item, or find what they are looking for.
Growth + Retention / Team $ = ROI
Now that we have a way of understanding what goes into growth and retention, let’s reexamine the ROI calculation. To calculate the ROI for a group of projects, you can add up the projects that drive growth, retention, or both, and tally up the estimated impact. For example, say you are trying to increase customer growth by 5%, and that would net you $250k in revenue. A team might set an objective around improving brand awareness in a specific marketing channel for the quarter, with key results being an increase in growth from that channel and an increase in brand awareness in that channel (measured through a survey, potentially). The team then does a series of projects related to that channel, and you can calculate their ROI by the impact of the projects divided by the cost of the team over that period.
For another example, suppose your company has set a goal of 10% growth and there are multiple teams working on initiatives that might impact that metric. First calculate the ROI of each team by the impact intended. If two teams are tackling growth projects, each with an 8% growth target (assuming they won’t hit the target but the total will be the 10% corporate goal), the ROI for each team is calculated based on the 8%, or, if the teams come in under the total 10%, split the ROI between them. The point is to have a logical flow of team effort to business impact.
As your financial management matures, you can use the cascaded metrics to estimate impact to customer growth or retention from which your head of finance can calculate NPV. As your data analysis capabilities mature, you can get a more accurate picture of the impact of initiatives. And as your business matures, you will be able to forecast impact with increasing precision.
Conclusion
The usefulness of this model is determined by the accuracy and sophistication of your data. Before any model will be of use, you need to start with building discipline around accurately measuring customer data through analytics, market research, and user research. Disciplined measurement allows for disciplined analysis, forecasting, and reporting.
There is no perfect way to measure ROI and this model has its flaws. There are always variables that might impact growth other than the projects a particular team is working on. This also doesn’t allow a finance team to do forecasting because it doesn’t take into account future value of a project. However, this gives most companies a starting point for thinking about how to cascade metrics and derive a rough ROI calculation for the work they are doing. Companies will find this more or less difficult, depending on the scale and how many teams work on projects impacting similar measures.
I’ll include more examples, approaches to selecting target goal metrics, using this to establish objectives & key results (OKRs), and thoughts on leveling up this model to include FP&A in future posts. For a primer on OKRs, I recommend reading Measure What Matters by John Doerr, and Radical Focus and the blog of Christina Wodtke.
OKRs & Metrics: Putting this framework to use with examples (coming soon)
Advanced ROI: Using future value and cost to calculate net present value ROI (coming soon)