Mostly metrics is launching a new segment - it’s called “Mostly experts.”
From time to time we’ll tap into the minds of Mostly metrics subscribers for their opinions on metrics related questions.
Next month’s question (for your input):
What’s a common mistake you see companies making with financial metrics?
If you want to get in on the action, simply reply back to this email with your response including either your first name or twitter handle for a shout out. We’ll feature all the good ones.
Today’s question we’ll be tackling:
What is your favorite metric for businesses with network effects?
Airbnb, PayPal, and Uber. All built billion dollar empires using network effects. From talking to our friends, these are the metrics they recommend tracking for any platform, aggregator, or marketplace business model:
1/ Gross Merchandise Value (GMV)
GMV is commonly used for marketplaces (Etsy) and payment gateways (Stripe) that charge a fee or take rate. @KurtisHanni points out that GMV is not a true reflection of a company's revenues, but rather its through-put, as most of the revenue goes to the original seller.
2/ Take Rate
This is your commission from each transaction
Take rate = Net Revenue / Gross Merchandise Volume
In general, intermediaries that facilitate frequent, lower-cost transactions tend to charge a lower take rate across a lot of transactions, like Uber. While intermediaries that facilitate infrequent, high-cost transactions, like Airbnb, charge a lower take rate on a higher order value.
Some general ranges:
Marketplaces: 10% to 30%
Platforms: 5% to 15%
Aggregators: 0.5% to 5%
You are rewarded for the level of work you have to do, the risk you take on, and the network effects you generate.
Keep an eye on take rate - it defines the power dynamic between company and customer.
@InvestmentTalkk says: "Early on, increasing fees is gravy, but there comes a time when the take rate begins to taint the relationship between company and customer."
3/ Net Revenue
This is what the company recognizes as revenue post supplier payouts. Manipulating our formula for Take Rate above we get:
Net Revenue = GMV * Take Rate Net
Net Revenue is what valuation will be based on. It's difficult to value marketplaces using a multiple of GMV, since it varies depending on take rate from biz to biz.
4/ Gross Margin
Gross Margin = Net Revenue less Cost of Goods Sold
GM is what you have left over to run the biz after paying out the costs to maintain your customer base. Cloud hosting, critical infra, customer support, customer success, and any raw materials to produce your product are tied up here.
Per @MT_Capital1 you can analyze fixed cost structures as a way to gauge barrier to entry, as well as scalability. At the end of the day, the higher your gross margin is, the more money you have to run the rest of the business.
Examples of what goes into Gross Margin:
Zillow: Listing fees for houses and hosting fees for their database of houses
Meta: The cost to store pictures and the bandwidth costs to add applications to the platform
Spotify: Artist royalties, credit card processing fees, and streaming costs
5/ Average Revenue per User (ARPU)
ARPU = Total revenue / Total users
It should be measured for both sides of the marketplace:
Average revenue per supplier
Average revenue per customer
@heysamir likes this metric because it shows how much you can get from a customer by getting them to buy more of the same product or additional products.
It also points out any supplier risk you may have - a large portion of your sales may be reliant on just a few nodes in your network.
6/ Average Order Value (AOV)
AOV = Total revenue / Number of transactions
AOV indicates how much a business can afford to spend on customer acquisition and per-transaction expenses.
7/ Monthly Active Users
Total unique users who have visited your site at least once during a certain time period indicates how well you are keeping your audience engaged.
If this number is not growing, it means you are either:
Not attracting new users, or
Losing old ones faster than you gain new ones.
8/ Liquidity
This is defined as the reasonable expectation of selling something you list or finding what you are looking for.
This means you actually have two different liquidity numbers to track:
Provider liquidity
Customer liquidity.
Example of supplier liquidity: On Airbnb it would be the % of nights available vs booked on the site over a week
Example of customer liquidity: On Etsy it would be how many visits resulted in a completed transaction
9/ Supplier-to-customer ratio
How many customers can each supplier service? There is no single ratio that all marketplaces should strive for. But this metric shows you which side of your marketplace is the constraint and where you should focus on growing liquidity.
@itsnivt thinks about it as Buyer Concentration & Seller Concentration. "You don’t want to be beholden to either at any point, and you also want to balance the ability to get deals done"
Examples:
Airbnb: 1:70
Uber: 1:50
eBay: 1:5
10/ Repeat Purchase Ratio
How many of your customers come back to make another purchase? It's cheaper to keep an existing customer around than to pay to acquire a new one. A higher repeat purchase ratio denotes a higher LTV (lifetime value) and LTV to CAC (customer acquisition cost).
You can also justify paying more for a new customer if you know they will keep buying from you. It's all relative in that sense.
Etsy has mastered the art of repeat purchases, with 78% of its sales coming from existing customers. This compare’s favorably to Airbnb's repeat purchase ratio of 22%.
11/ Customer Acquisition Cost
This is what you pay to go and get a new customer. It includes what you spend on sales and marketing.
@BrianFOConnor pointed to the high CAC required to attract initial Airbnb hosts to join.
Here's the formula:
12/ Customer Lifetime Value Customer Lifetime Value (LTV)
CLTV estimates the total amount of money you’ll get from a customer before they churn out.
Here's the formula:
You'll want to measure CAC and LTV on both User and Supplier sides.
For Uber - How much does it cost to hire a new driver? How much GMV will they be responsible for? And how much goes into the marketing costs to get a new rider? How many rides will they purchase over time?
13/ LTV to CAC
Now that you have a grip on LTV, you’ll want to compare it to your Customer Acquisition Cost (CAC). Knowing your LTV is great, but it’s not very useful in a vacuum.
In other words, LTV and CAC go hand in hand. You don’t really know what good LTV is without knowing your CAC.
Here’s how you calculate Customer Acquisition Cost:
You'll want to measure this on both sides as well: What's the ratio of value to cost that the supply side drives? What's the ratio of revenue to cost you get from a user over time?
@InvestiAnalyst broke down LTV:CAC for Upwork and Fiverr:
14/ Switching or multi-homing costs
How easy is it for users to switch to a different network entirely, or to toggle between networks. For example - lots of riders compare prices between Uber and Lyft. Similarly, on the supply side, drivers may work for both companies
Distilling switching or multi-homing costs into a quantifiable metric can be tricky. Any metric will be quite specific to that exact business and market.
Potential metrics could be:
Time required to complete a competitor’s onboarding flow
Ease of getting to the minimum threshold or “magic number” for a product to be useful (e.g., 10 friends for Facebook)
@10kdiver provides a useful example: Substack connects newsletter readers to writers. But Medium used to do it before Substack. People switched from one to the other very easily. The experience is pretty much the same for readers (an email in their inbox) as well as writers. So the platform itself is more or less a commodity service at this point, unless one can drive more network effects than the other. That’s a risky business and can be a race to whoever offers the lowest price.
15/ Retention Cohorts
You'll want to look at user stickiness and activity by:
Geography
Product
Start date
From talking to @polak_jasper, analyzing retention by cohort is crucial, since it can vary so widely from market to market and product to product.
For local network effect businesses, the network effects exist on a per-market basis, and “resets” for new geographies. An Uber drive in Oakland isn't useful to a rider in Boston. A babysitter listed on Care.com in Houston isn't useful to a parent in LA.
As each geography matures and builds network density, retention should improve in those markets. Thus, the oldest or most established markets tend to have better retention than newer markets.
For marketplaces like Ebay that offer multiple product categories you’d want to analyze:
Are users who buy Beanie Babies as valuable as users who buy car parts?
Do they stick around as long?
Do they buy from both categories?
16/ Buyer/Seller Overlap
This is the number of buyers who are also sellers. A high overlap decreases CAC because you get both a buyer and a seller for each acquisition. Some Airbnb hosts are also Airbnb customers when they vacation. Some Lyft riders become Lyft drivers.
17/ Growth in listings
How active are your suppliers? How often are they adding new products?
@lukesophinos points to apps in a hypothetical marketplace. Growth in number of apps tells you how sticky your marketplace is.
18/ Activation rate
Your product activation rate is the number of users who do something specific to extract value out of your product. Following user acquisition, product activation is one of the most important concerns you should have when running a marketplace.
You want to make users "successful" as fast as possible, since 66% of new users abandon apps within the first week of install.
Etsy encourages brand new users to begin browsing and favorite items they find interesting. Etsy’s onboarding flow is centered around doing this particular action. The flow makes it clear to the user that favoriting items is linked to better recommendations.
The faster a user is to book a ride, update their user profile, and make a purchase, the lower the probability they'll churn (or forget about you). Define your "aha" moment and get users there as fast as possible.
Smart stuff I Read at 2AM (sources):
a16z - Marketplace metrics
Sharetribe - Marketplace metrics
Amplitude - User Engagement
NFX - Network Effects
What I’ve Been Reading
It’s funny how the internet helps likeminded people find each other. I used to think the universe of SaaS metrics aficionados was miniscule. I’ve realized that’s certainly not the case while writing Mostly metrics. I recently had the pleasure of expanding my network to include Ben Murray, a fellow SaaS metrics practitioner.
He writes The SaaS CFO, a great resource for decomposing SaaS metrics.
Ben offers free templates you can download to help with your calculations, and also offers some courses.
It’s read by over 43,000 SaaS professionals. I actually downloaded his template on CAC Payback Period for business models with blended subscription and variable revenue last week.
Quote I’ve Been Pondering
“I come from a family of disciplinarians where you better follow the rules, until you’re man enough to break em.”
-Matthew McConaughey, Green Lights
Great breakdown and great read. A must know for any marketplace founder and I love how you broke everything down nice and easy.
I love this topic, great breakdown!