In preparation for the last post on pricing, I was reviewing the annual reports and presentations from a wide variety of Industry in the Cloud (IC) providers. Doing so reminded me of the importance to ICs of tracking the right metrics and, equally important, ignoring the clutter.
Great ICs, marketplaces, networks, etc. are laser-focused on what drives their profitability and are crystal clear in how they measure and communicate these metrics to employees, investors, and platform participants. When you evaluate the financials of these great performers–including all of the payment networks (e.g., Amex, MasterCard, Visa), to DealerTrack, to eBay, they transparently report on the operational metrics that drive the financial results. Often the metrics are a liquidity measure like Gross Merchandise Volume (GMV), sometimes the key metric is payment volume, sometimes it is the number of trading relationships, or volume/transaction per relationship. For each successful IC there are slightly different metrics, but what stands out is the clarity by which these metrics are communicated.
For example, take a look at the investor presentation for DealerTrack, an IC in auto retailing that I have previously written about. (In full disclosure, I have since bought the stock.) They lay out every key metric that drives aggregate demand and separate transaction from subscription revenue. They report every key operational metric over a long period of time, so you can see their progress.
By the same token, I see annual reports and presentations from struggling ventures and very often they either intentionally obfuscate the operational metrics, or seem unable to settle on which metrics are the keys drivers of profitability. This is, of course, a huge red flag. In the case of some the very small venture capital deals I see this is entirely understandable. A new venture often has a hypothesis of 2-3 possible ways to extract value from its platform and is not sure which will work until it tests the proposition with customers. As long as the venture’s management team recognizes that getting this learning is the next step, and treats the next phase of growth as a learning experiment, this issue can be managed. But for mature platforms, not being able to articulate the core operational metrics that drive the financials and show them over time is unacceptable. It means management does not know what it is doing, or more likely that they do not like what they see and do not want you to see it.
ICs extract value from their platforms in a variety of ways (including subscriptions, transaction fees, relationship fees, advertising, etc.) and from multiple sides of the platform. On the surface, this may make ICs hard to compare. A useful, simple technique for evaluating the health of an IC’s business is simply to add up the IC’s revenues from all sources and divide this the best aggregate measures of the IC’s activity. This aggregate measure could be $$ throughput, documents transacted, or a measure of active relationships. The resulting measure is basically the IC’s “gross yield” per dollar, per doc, or per relationship, as the case may be. Understanding where this gross yield has been, or is projected to go, is a great indicator of the IC’s health. Yield may come from buyers, suppliers, intermediaries, etc., but the total of “take” of the IC is a great bottom line.
It could be argued that many public companies or private ventures do not like to disclose their key operational metrics publicly for fear of over-sharing their secrets to success with competition. Perhaps the best ICs, networks and platforms are able to disclose these metrics because they have reached a size and strength where they can “afford” to be clear on these metrics–as their positions are now less assailable. In other words, clear metrics may not be the cause of an IC’s strength–they may be the result! Perhaps there really is only correlation, but no causation.
This is certainly possible, but my experience has been that it is very difficult to have one set of metrics for investors/the public and a different one internally. Employees and managers start to read the press clippings, lose focus, and get confused very easily. Too many metrics, or not enough, spoils the broth. I can’t prove that having clear operational metrics causes success and not vice versa, but it sure feels that way!