Startup Scaling: Key Metrics to Know

Achieving Go-to-Market Fit and Determining Scalability

Reaching go-to-market fit (GTM) signifies a crucial turning point for any startup. It indicates the discovery of a replicable process for attracting and converting leads, one that can be formalized into a consistent GTM playbook. However, prior to expanding sales and marketing efforts, a thorough evaluation of key metrics is essential to confirm readiness.

Assessing Readiness for Scale with Key Metrics

Determining when a startup is poised for scaling requires analyzing three fundamental metrics: gross churn rate, the magic number, and gross margin. These indicators collectively reveal the health and profitability of the business.

By integrating these metrics into a straightforward calculation, the LTV:CAC ratio (lifetime value to customer acquisition cost) is obtained. This ratio serves as a gauge of the business’s long-term financial viability. A ratio exceeding 3 suggests the business is prepared to scale.

Understanding the Core Metrics

Let's delve into each of the three foundational metrics:

Gross Churn Rate (GCR)

Gross churn rate (GCR) functions as a measure of product-market fit (PMF). It represents the percentage of recurring revenue lost due to customer non-renewal. Essentially, it answers the question: Are customers continuing to utilize your product or service?

A high churn rate suggests a lack of PMF. The calculation is as follows:

GCR = Lost monthly recurring revenue / Total MRR.

Example: If a company generated $60,000 in MRR at the start of March, and $15,000 in contracts were not renewed by month's end:

GCR = $15,000 / $60,000 = 0.25, or 25% GCR.

The Magic Number (MN)

The magic number (MN) evaluates your go-to-market fit. It is calculated by dividing new ARR (Annual Recurring Revenue) by the total marketing and sales expenditure.

This metric addresses the question: For every dollar invested in sales and marketing, how much new revenue is generated? A positive result, where revenue exceeds expenditure, indicates a strong position. However, the magic number is a trailing indicator, and observable improvements may require several quarters.

MN = New ARR / S&M.

Example: In March, a company invested $25,000 in sales and marketing, resulting in $65,000 in New ARR.

MN = $65,000 / $25,000 = 2.6.

Overall growth is determined by subtracting churned revenue (based on GCR) from new revenue (based on MN).

Gross Margin (GM)

Gross margin (GM) assesses your unit economics. It is expressed as net revenue as a percentage of total revenue, revealing the gross profit earned relative to the cost of producing each unit sold.

GM = (Revenue – COGS) / Revenue.

Example: In March, a company generated $170,000 in service revenue with a cost of goods sold (COGS) of $85,000.

GM = ($170,000 – $85,000) / $170,000 = 0.5, or 50%.

Typically, scaling operations will enhance the GM, diminish the MN, and have a limited effect on the GCR.

The LTV:CAC Ratio – The Ultimate Indicator

If gross churn, the magic number, and gross margin represent individual components, the LTV:CAC ratio serves as the unifying metric – the “One Ring” – for evaluating financial sustainability.

The LTV:CAC ratio answers the fundamental question: Is the business model financially viable in the long term?

It can be calculated using the following equation:

LTV:CAC = (MN x GM) / GCR.

Generally, an LTV:CAC ratio of 3 or higher indicates a robust financial foundation, signaling readiness for accelerated growth.

Illustrative Example

Considering the previously calculated metrics for a company’s March performance:

GCR = 0.25.

MN = 2.6.

GM = 0.5.

The resulting LTV:CAC is:

LTV:CAC = (2.6 x 0.5) / 0.25 = 5.2.

This value, exceeding 3, confirms the business is prepared to scale.

Target Values and Business Models

Naturally, the optimal values for GCR, MN, and GM will vary depending on the specific business model. The following table illustrates combinations of the magic number and gross churn rate that would yield an LTV:CAC ratio of 3 for businesses with gross margins ranging from 40% to 80%.

	Subscription	Marketplace
GCR	10%			25%			80%			90%
GM	40%	60%	80%	40%	60%	80%	40%	60%	80%	40%	60%	80%
MN	0.8	0.5	0.4	1.9	1.3	0.9	6.0	4.0	3.0	6.8	4.5	3.4
LTV:CAC	3	3	3	3	3	3	3	3	3	3	3	3

Subscription-based businesses, characterized by low GCR (e.g., 0.1), can sustain a lower magic number due to revenue generated from renewals. Conversely, marketplace businesses, lacking renewal revenue, typically exhibit a higher GCR, necessitating a significantly higher magic number to maintain an LTV:CAC of 3.

Regardless of the business model, diligent monitoring and adjustment of these metrics to achieve an LTV:CAC ratio exceeding 3 is crucial. Failure to do so could jeopardize the business’s long-term sustainability.