How to Set KPIs: Avoid KPI Challenges
In previous blog posts, we reviewed the most important features of proper startup metrics or kPIs and five indicators that you should not neglect to observe. Here, we intend to discuss setting appropriate KPIs considering the challenges ahead. In other words, in this article, we examine the challenges that affect selecting a key performance indicator. By recognizing and avoiding them, we can find the most appropriate key performance indicators for the startup.
The First Challenge In Setting the Startup KPIs: The Small and Flat Structure
Usually, in the early stages, the number of startup team members is less than four people. This number rarely gets more than 20 in the post-acceleration and mid-stage stages. Even, it may remain the same for several years.
Under the above circumstances, tasks are usually shared between members. Work processes are performed by a variable mix of most team members, and responsibilities are less independent. For example, a marketing campaign may be planned and implemented by all members of the ideation team.
Such a startup has a flat structure, and this flatness will be the first challenge for setting key performance indicators.
In such cases, we can not attribute the activities success or failure directly to a specific person or task. That means the overall performance of a startup is affected by all team members’ performance. Consequently, the line between individuals and responsibilities is quite blurred. In contrast, in large companies with independent internal units, the impact of each unit on the final result is clearly measurable.
In flat startups, it’s not possible to assess each individual’s performance using key performance indicators. Therefore, we need to measure the overall performance of the startup by setting appropriate key performance indicators. Correct results do not accompany the use of partial KPIs in the early stages of a startup. So, the key performance indicators related to the company’s overall performance have enough credibility to measure and apply.
As the startup gets bigger and moves from a flat structure to hierarchy, it is feasible to define and use vertical key performance indicators related to the performance of each unit.
Fundamental changes in startups usually occur at irregular and short-term intervals. That’s why sometimes there is not enough time to adapt key performance indicators with recent changes.
The Second Challenge In Setting the Startup KPIs: Changes
Every startup has changes to make. Pivot or change is an integral part of startup development and the root of an important challenge in setting KPIs. The primary startup mission is to learn and adapt appropriately based on the feedback it receives from the market. These changes may even lead to a fundamental change in the business model. Major changes usually occur at irregular and short-term intervals. So, most of the time there is not enough time to adapt key performance indicators to these changes.
Suppose a SaaS startup defines several key indicators of financial performance based on its “sales per user” revenue model and sets its long-term goals accordingly. After a while, the startup team concludes that they need to change their revenue model to a “shared model”. Under the new circumstances, previous KPIs lose their credibility. Management must define new key performance indicators for performance targeting and measurement and institutionalize them in the business process.
The Third Challenge: Startup Growth Stages
In addition to the flat structure and continuous changes, going through the growth stages also affects key performance indicators’ suitability. A startup is usually expected to grow rapidly within three years. The initial, intermediate and final stages of growth each impose specific priorities and conditions on the startup.
In the early stages, KPIs related to the product, such as validation of problems and solutions, are essential. However, in the middle stages, key performance indicators related to the customer, such as adhesion, virality, etc., become important. Finally, in the last step, user lifetime value, profit margin, etc., are the most important.
A startup should select key performance indicators tailored to its growth stage and review them at short intervals. In any review, startups must ensure that key performance indicators continue to have a direct impact on process growth and optimization and that they have not lost their credibility.
The fourth Challenge In Setting the Startup KPIs: Changes in Startup Success Metrics
Another challenge that affects determining the startup key performance indicator is changing the startup success criteria. Different actors enter or exit. Competitors’ innovation changes users’ tastes. Economic fluctuations increase or decrease people’s purchasing power. Business policies vary under the impact of political, cultural and economic factors. In these circumstances, the startup criteria of success or failure constantly change.
Without setting goals to achieve them, key performance indicators are meaningless. These goals are usually ideal values to be achieved within a certain period of time. Market changes, over time, may create different criteria for the success of these key performance indicators. Therefore, startup teams should always review and redefine the target values of key performance indicators.
The Fifth Challenge: Mutual understanding of KPIs in founders and investors
Both before and after raising capital, startups have long lasting interactions with investors. Meanwhile, key performance indicators are usually one of the most critical tools to make a common language between two parties. For investors, KPIs provide a quantitative and objective framework that facilitate the process of managing and monitoring startups. It is also possible for the founders to focus on the startup’s goals through key performance indicators.
Thus, key performance indicators create a common language between the startup and the venture capitalist. As one of the challenges in setting KPIs, the lack of common and correct understanding may turn the terms of a contract between a startup and an investor into a loss-making one. So it is necessary to avoid this challenge, to design correct and understandable indicators.
To avoid this hurdle, investors and founders must first agree on a startup growth approach. Based on that, in the next step, they can select the appropriate key performance index.
Suppose the venture capitalist prefers an aggressive approach to conquering the startup target market, but the founders want to grow conservatively and slowly. In that case, it is challenging to select key performance indicators that can bring the most coordination between the two groups.
Such investors typically focus on key performance indicators related to target market penetration. In contrast, the founders’ focus is the KPIs related to the efficiency and suitability of the product with the target market.
Correct targeting of KPIs value
After setting key performance indicators, the next step is to target them correctly. In many cases, KPIs are used to fulfil the clauses of the contract between the startup and the investor. Therefore, the type and value of the key performance indicators directly impact the founders’ motivation and monitoring of the startup’s growth by venture capitalists.
If the parties to the contract don’t agree on the valuation and percentage of the investor share, conditioning the contract will help reach an agreement faster. In this case, the investor accepts the founders’ claim, provided that the values of the key performance indicators are met. This claim may be about the startup’s future value, turnover, market share, or anything else.
For example, a startup claims to have a turnover of $ 1 million in the third year. At the same time, the investor estimates a turnover of $ 500,000. In this case, the investor makes his percentage conditional on the fulfilment of the founders’ claim. If the turnover reaches $ 1 million, based on the capital injected and the pre-capital value of the startup, 20% of shares transfer to the investor. However, if the turnover is $ 500,000, 33% of the startup shares belong to the investor. In this case, the startup founders will be encouraged to fulfil the promise of $ 1 million in revenue to keep their shares less diluted.
Key performance indicators act as a common language between startups and venture capitalists.
Investors are well aware that if a startup promises to be high and refuses to make it conditional on setting key performance indicators, it is trying to hide its inefficiency. Investing in such a startup is risky.
However, It is not easy to make the terms of the contract conditional on key performance indicators. As in this case, the KPIs to condition the agreement must have all three of the following characteristics:
- Be compatible with the conditions, business model and growth stage of the startup.
- Both the founders and the investor agree on it.
- It should be clear, explicit, and understandable enough to avoid any problems or ambiguities.
The sixth Challenge In Setting the Startup KPIs: Lack of sufficient data of the startup history
Lack of sufficient data of the startup history is another challenge in setting a key performance indicator. Startups usually have a little track record. Therefore, their data is minimal initially and is generally insufficient to calculate some KPIs. Sometimes this leads to key performance indicators showing very high or very low error values.
In particular, key performance indicators related to growth rate can show high numbers because the initial figures are minimal. These high rates may confuse the startup team in setting targets for future growth rates. The benchmark values of similar KPIs in similar markets and business models should be referred to, in order to compensate for such errors.
The seventh Challenge:Parameters correlation or causal relationship
Statistical research has shown that the number of people drowning at sea is directly related to the number of ice creams sold! What conclusions can you draw from this finding?
The direct relationship between the number of ice cream sales and drownings at sea can be interpreted in two ways:
First, ice cream upsets people’s balance and reduces their ability to swim. As a result, more and more people are drowning whenever ice cream sales go up.
However, the second interpretation is that both of these statistics are related to another root cause: increased heat.
People are more inclined to buy ice cream during the hot seasons, while at the same time more people swim in the sea. As a result, the number of drownings is rising.
In the first interpretation, there is a causal relationship between these two parameters. One parameter (eating ice cream) is the reason for changing the second parameter (drowning). A causal relationship includes an independent factor and a variable that depends on the independent factor. Making a change in the independent factor will cause a difference in the second factor.
In the second interpretation, both are the defective parameters of a third cause. Therefore, by changing the reason, both of them change simultaneously and in proportion to each other. This relationship is “correlation”.
Correlation between two factors is a relationship in which both change independently and possibly depend on a third independent factor. In this regard, a change in one factor does not lead to a change in the second factor. However, we can predict that the second factor will change soon by observing a change in one element.
Control the future and predict it!
The causal relationship allows future control and changes. At the same time, the correlation relationship will enable us to predict the future. If we find a causal relationship between the two key performance indicators, the “key performance indicators of disability” can be changed by changing the “key performance indicators of the cause.”
For example, there is a causal relationship between increasing the number of users in one month and increasing sales in the next month in many businesses. So one way to increase or control next month’s sales is to improve or manage the number of users attracted through the current month. In contrast, there is a correlation between social acceptance or virality and the number of bug reports from an application. Both of these factors are because of a third reason that can be the number of applications installed. Therefore, as virality increases, we can predict that error reporting contacts will increase soon.