Among the few fundamental marketing metrics eCommerce startups should pay particular attention to, there is one KPI which I find widely under reported by most eCommerce entrepreneurs: repurchase rate(s) on the acquisition cohorts.
The inspiration to write about it came after reading the brilliant article by Mark Suster on Why Misunderstanding Startup Metrics Can Cost You Your Business, in which he explains the importance of a few fundamental marketing metrics (CAC / LTV / Payback period).
Why is retention so important?
Let’s start by understanding why retention is key, especially in the early phases of a company growth.
1) It’s the best single metric to assess product / market fit
As Alex Schultz, VP of Growth at Facebook, in his lecture on at Sam Altman’s How to Start a Startup class at Stanford University, puts it:
“Retention comes from having a great idea and a great product to back up that idea, and great product market fit. The way we look at, whether a product has great retention or not, is whether or not the users who install it, actually stay on it long-term, when you normalise on a cohort basis. […]Before you begin any growth tactics, you first need to get a consistent amount of users consistently using your product. If you don’t have that, you don’t have product/market fit and you should first focus on making a product people want. [..]The number one problem I’ve seen for startups I’ve advised has been that they don’t actually have product/market fit when they think they do.”
Alex Schultz
Or to quote Fred Wilson, from Union Square Ventures, in his Growth vs. Retention article
You might think you have product market fit and so you scale up your hiring, your marketing, your sales, and your capital raising and spending. But if you can’t retain a healthy percentage of your users past ninety days, you don’t have product market fit yet and all the investment you make in your business is just money down the drain.
Fred Wilson
2) It allows you to estimate your path to profitability and funding needs
Assuming you are acquiring part of your users through paid channels, knowing your retention rates will allow you to estimate your payback period. Payback period being the time it takes to pay off your Customer Acquisition Cost (CAC).
I am referring here to the paid CAC and not the blended CAC. The former considers only customers acquired through paid channels, whereas the latter includes also users acquired organically. The paid CAC is normally a better metric to refer to, as it can tell you whether you can scale up your user acquisition efforts profitably, or more in general at which cost.
Payback period = CAC / ((annual revenue per customer) * (Gross margin in %))
with:
- CAC = (full marketing spend) / (# of new customers acquired through paid channels)
- Annual revenue per customer = average cumulative revenue brought by customers acquired through paid channels, in the first 12 months after their first order
- Gross margin in % = profit contribution per customer. For eCommerce, it’s the profit after COGS and fulfillments costs and before marketing costs. In Rocket Internet jargon, it’s equivalent to the PC 2 (%)
Assuming a CAC of $100, an Annual revenue of $500 and a Gross margin of 40%, your Payback Period would be equal to 100/(500 x 40%) = 0.5 years = 6 months.
Retention is the most important factor to improve your annual revenue per customer, assuming your basket size and gross margin won’t fluctuate heavily, which is a fair assumption for most online retailers. If you don’t know what your repurchase rate look like, you won’t be able to improve it.
Bottom line, the longer your payback period the more funding you will need to fuel the acquisition of your new customers and the riskier your overall path to profitability.
Defining the repurchase rate
In its simplest definition:
Repurchase rate is the percentage rate of a cohort having placed another order within a certain period of time, typically calculated within 30/60/90/180/360 days from the first order.
With a cohort being the number of customers who do their first order in a given month (as cohorts are typically calculated on a monthly basis).
As an example, assuming that 20 customers of the 100 that completed their first transaction in March, made a second order again later in March or in April, as long as they ordered within 30 days from their first order, the 30 days repurchase rate for the March cohort would be 20% (20/100).
The longer the interval considered, the higher the repurchase rate will be.
360 days RR > 180 days RR > 90 days RR > 60 days RR > 30 days RR.
Choosing the “right” RR intervals really comes down to the kind of vertical you are in. The above are the most common ones, especially for fashion eCommerce. Keep in mind that the longer the interval, the longer you will need to wait beforehaving some data to play with.
Repurchase rate can be calculated in two different ways, depending on whether you take into account just the first customer reorder or also the subsequent ones. We can call RR1 the former and RR2 the latter.
As an example, if out of the 20 customers previously considered, 10 of them made two orders and 5 made three orders within 30 days from their first order, the 30 days repurchase rate will be:
- 20% for RR1 ((20*1)/100)
- 40% for RR2 ((10*2+5*3+5*1) / 100)
Both metrics are equally important, with RR1 being a quicker and simpler way to measure the stickiness of your service and RR2 to be used to calculate the LTV of your customers. In the next paragraphs, and in the step-by-step guide to calculate it, I will refer to the former.
What about the percentage of new vs. repeat orders?
A metric which I hear reported far more often by eCommerce is the percentage of orders coming from new vs. existing customers in any given month.
“Last month, 60% of our total orders were coming from repeat customers. Our customers love us!”
The problem with such metric is that it doesn’t tell you anything about the quality or LTV of your customers, the stickiness of your product and more in general your product / market fit, which is exactly what you should focus on, especially in the early stage of your eCommerce journey.
Imagine two companies growing at very different speed:
- Company A growing their customer base at 30% m-to-m
- Company B growing at 5% m-to-m
Given the difference in # of new customers acquired, after six months Company A could have a much lower % of repeat customers despite having a much better repurchase rate than Company B.
Why do you always hear about it then?
I believe it comes down to three main reasons:
- it’s easier to calculate
- it’s easier to understand
- it hides any fundamental product / market fit flaws of the business
To further elaborate on the third point, achieving a nice looking % of repeat orders after the first 12 month, say above 40–50%, is much much easier, especially when the business is not growing that fast (as seen from the example above).
RJ Metrics has published an interesting study with some benchmarks on repeat orders percentages for eCommerce businesses.
On the other hand, calculating your repurchase rates, especially if you are doing it for the first time, can be a pretty (negative) eye-opener experience.
“How come only 20% of our customers ever make a second purchase? We are getting more and more orders coming from repeat customers, it’s not possible!
So I get why founders often prefer to refer to the former.
What I have a hard time understanding, is why so many early stage VCs, at least here in South East Asia, avoid asking about repurchase rates and more in general don’t ask the hard questions when it comes to marketing metrics.
A simple step-by-step approach to calculate your repurchase rates for the first time
Here is a simple way to calculate them without the need of any sophisticated analytics software (which you will need past a certain size of your marketing team or once your marketing budget will be big enough to justify it). Excel for now will be more than enough.
Step 1 — Download your historical transactions
For each orders you will need to extract:
- the unique ID identifier of the customer who placed the order
- the transaction date
That’s all you need to get started.
Step 2 — Assign a cohort date and repurchase date to each transaction
- Start by sorting your orders by customer ID and transaction date.
For each transaction assign:
- the incremental # of purchase coming from the same customer ID (if any)
- the cohort date
- the repurchase date (in the below example for RR of 30/60/90/180/360 days)
Step 3- Compile your cohort table
You can now build your table by pivoting the previous xls sheet, using the cohort months as row labels and the cohort size + your repurchase date as column labels.
This is what your final cohort table should look like:
What is a ‘good’ repurchase metric?
“It really depends on the vertical you’re in. What you need to do is have the tools to think, ‘who out there is comparable’ and how you can look at it and say, ‘am I anywhere close to what real success looks like in this vertical? [..]For social media, you’ll need to retain at least 80% of users. eCommerce companies are much different. If you can get 20–30% of your customers coming back every month and making a purchase from you, then you should do pretty well.”
Alex Schultz, VP of Growth at Facebook — “How to Start a Startup”
Even among eCommerce companies, repurchase rates heavily differ depending on the vertical you are in. If you are in a vertical which has high structural purchase frequency, such as a online grocery service, you should benchmark your metrics with similar businesses. Same if you are offering a subscription model in a specific vertical.
For fashion eCommerce, a company with exceptional retention metric is Stitch Fix, an online personal stylist platform which claims a 80% retention rate for its 90 days RR. Offering the option to subscribe for a shipment each months certainly help them to achieve such number, but it’s nonetheless an impressive metric, which proves the perfect product-market fit they have obtained (which certainly helped them to get Benchmark to lead their Series B).
My previous company, TATE & TONIC, offered a very similar service for men in Singapore, but we were nowhere close to such phenomenal metrics. Zaloraor any ‘traditional’ fashion eCommerce I’ve had the chance to work for, are also pretty distant for achieving such metrics.
Although the absolute numbers are per se very important, what is even more critical is to monitor the improvement / deterioration of your repurchase rate per cohorts. A progressive improvement over time, especially with growing cohort sizes, is an excellent signal which proves you are going into the right direction.
Conclusion
Knowing your repurchase rate is critical to measure your product market fit and the quality of your user acquisition strategies.
If you have been measuring until now the percentage of repeat orders as a quick proxy to assess the stickiness of your product, you should start focusing on your repurchase rate instead and optimise towards it.
Improving it will not only allow you to grow faster, but most importantly will drastically improve your bottom line profitability.
Retain and Conquer!