In the last post, we delved into key financial metrics such as Bookings, Revenue, and Gross Profit. Today, we’ll further explore the domain of financial metrics, which are indispensable for the growth and development of startups. We’ll be focusing on Contract Value, Lifetime Value, and Gross Merchandise Value.
Contract value
Total Contract Value (TCV) represents the complete value of a contract, which can vary in duration. It’s crucial to ensure that TCV encompasses one-time charges, professional service fees, and recurring charges.
Annual Contract Value (ACV), conversely, quantifies the contract’s value over a 12-month period. When considering ACV, you might want to ask:
- Size: What is the monetary value you’re receiving from your customers on a monthly basis? Are you securing small amounts or closing substantial deals? Naturally, this will depend on your target market (Small and Medium-sized Businesses (SMB) vs. mid-market vs. enterprise).
- Growth: Is your ACV increasing (or at least not decreasing)? If it’s growing, it indicates that customers are paying more on average for your product over time. This could suggest that your product is either expanding its features and capabilities to justify the increase, or it’s delivering such significant value (improved functionality over alternatives) that customers are willing to pay more for it.
Lifetime Value
The Lifetime Value (LTV) is a measure of the net profit that a customer will contribute to your business over the length of their relationship with you. It’s a crucial metric that helps you understand the long-term worth of a customer and the net value they bring to your business after accounting for Customer Acquisition Costs (CAC).
A common pitfall is to calculate the LTV as the present value of a customer’s revenue or even gross margin, rather than as the net profit they generate over the duration of their relationship.
Here’s a simplified method to calculate LTV:
- Monthly Revenue per Customer: This is calculated by multiplying the average order value by the number of orders.
- Monthly Contribution Margin per Customer: This is obtained by subtracting the variable costs associated with a customer from the revenue generated by them. Variable costs include selling, administrative, and operational costs related to serving the customer.
- Average Lifespan of a Customer (in months): This is calculated as 1 divided by your monthly churn rate(Also known as the rate of attrition or customer churn, is the rate at which customers stop doing business with an entity.).
- LTV: This is calculated by multiplying the contribution margin from a customer by their average lifespan.
If you only have a few months of data, a conservative approach to measure LTV is to look at historical value to date. Instead of predicting average lifespan and estimating retention curves, it’s preferable to measure 12-month and 24-month LTV.
Another key calculation is LTV in relation to margin. This is significant because an LTV based on revenue or gross margin suggests a higher limit on what you can spend on customer acquisition. The ratio of Contribution Margin LTV to CAC is also a useful measure for determining CAC payback and managing your advertising and marketing spend effectively.
Gross Merchandise Volume
In the context of marketplace businesses, terms like Gross Merchandise Volume (GMV) and revenue are often used interchangeably. However, it’s important to note that GMV does not equate to revenue!
GMV, or Gross Merchandise Volume, represents the total sales dollar volume of merchandise transacted through the marketplace within a specific period. It essentially reflects the top line, indicating what the consumer side of the marketplace is spending. GMV serves as a valuable measure of the marketplace’s size and can be used as a “current run rate” measure by annualizing the most recent month or quarter’s data.
On the other hand, revenue refers to the portion of GMV that the marketplace retains. This consists of various fees that the marketplace earns for providing its services. These fees typically include transaction fees based on the GMV successfully transacted on the marketplace, but can also encompass ad revenue, sponsorships, and more. Generally, these fees constitute only a fraction of the GMV.
Basically, revenue refers to the income that a business accrues from selling its own products or services. It’s a direct reflection of a company’s primary operations. On the other hand, Gross Merchandise Volume (GMV) quantifies the total value of all goods sold through a platform or marketplace. It doesn’t necessarily reflect the income of the platform itself, but rather the total transactional value it facilitates.
As said last time, if you can not measure it, you can not improve it. So, keep a close eye on these metrics, understand what they signify, and use them to steer your startup towards success. Happy entrepreneuring!😊
Have a nice day😊