If you work for a SaaS company, you probably boast a good understanding of funnel metrics, which you can probably recite backwards — acquisition, user activation, retention, referrals, and revenue. You might even remember where they came from, but how deep do you really understand these metrics? Do you know which metric you are ignoring, or which metric is costing you the most?
Most small, growing SaaS companies focus first on acquiring users and bringing them down the funnel. They then work to retain those users and convert them into loyal long-term users. This is good.
But many companies ignore the importance of the second A in McClure's AARRR model - user activation.
Helping new users reach their first aha moment and find product success early on has major downstream implications. In order to understand how to best optimize the user experience, you first need to understand exactly how "activation" affects the growth of the product.
What is Pirate Indicator?
Let's briefly go over the basics: what is a pirate indicator?
The Pirate Index is a nickname for a series of SaaS indicators. It constitutes a 5-step framework for SaaS growth. It was first proposed by David McClure, an angel investor and founder of 500Startups (Silicon Valley Venture Capital Organization).
Part of what makes this framework so powerful is that it encourages product people to look beyond some vanity metrics:
"McClure takes people out of vanity: How many people are looking at my page, how many people think deeply about the entire user life cycle, what is the most effective way to break it down, and, how to optimize each part? This changes the thinking of all product founders way of doing business.”
— Archana Madhavan, product marketing manager, data analytics firm Amplitude
In our model, we define the pirate indicator (also called AARRR indicator) as:
- Acquisition — the number of users who interacted with your product
- Activation — Percentage of users who had an "aha moment"
- Income Retention — the average monthly payment value of users
- Retention Revenue — the percentage of users who continue to use the product each month
- Referral — Percentage of current users who referred new users
Compare Pirate Metrics
The order of the original Pirates metrics is similar to the freemium revenue model — McClure referenced the model of freemium apps, placing revenue after retention and referrals.
However, the pay-for-free revenue model is becoming increasingly popular, where businesses offer free trials and then convert users to paying customers. Subscribers to SaaS are often acquired through some kind of free plan or free trial. Then, when those users sign up for a paid subscription plan and become paying users, the cash flow comes.
In our model, we put revenue after activation to represent this process.
Activation, or the moment a user realizes the promised value of a product, reflects the efficiency with which you invest in the cost of user acquisition.
A higher activation rate means higher efficiency. Activation also directly determines revenue, because you need to be able to show the value of the product to free trial users to convince them to pay for it.
In short, activation is an incredibly important metric to measure and optimize.
For subscription-based businesses, the impact of percentage optimization is compounded over time. For example, if you increase the user retention rate by 10%, having 10,000 users will have a greater impact on user retention than having 100 users.
To demonstrate the ongoing impact of each Pirate metric, we built a computational model that simulates the impact of each metric on MRR (Monthly Recurring Revenue) after 12 months.
We chose to calculate MRR instead of ARR (annual recurring revenue) because small changes can make a big difference for both startups and growing businesses, and MRR is essential for maintaining a certain frequency of incremental changes in business activities very useful.
Here is our computational model:
To simulate the impact of each metric on MRR, let's first calculate what MRR would look like 12 months from now when each Pirate metric is at the industry benchmark:
- Acquisition: 5,000 users/month
- Activation: 30% of users successfully use the product
- Revenue: $100/user/month
- Retention: 97% monthly user retention rate
- Referrals: 22% of users refer new users each month
Then, one by one, we adjusted each Pirate metric up by 25% and calculated the change in MRR after 12 months. Again, that is:
The percentage difference in revenue between the reference baseline and the reference baseline after a 25% lift.
Let's use these hypothetical numbers together to simulate how these different metrics might affect your bottom line.
Some notes on our methodology
This model is designed to give you a better idea of the direct impact of each Pirate indicator on profits.
That said, our model is a simplified representation of a hypothetical small but growing SaaS company.
In this model, we imagined that we could control for all other factors and isolate each pirate indicator individually. Of course, in a real company, these changes don't happen in a vacuum, and affect each other.
It's also worth noting that the relative importance of each metric will vary depending on where you are in your industry, your product, and your stage of growth. For example, for retention rates to increase by the same rate, a user base with a large user base will have a greater impact on this change than a user base with a small user base. Because we use percent change as equal weighting, the relative importance of each indicator is not absolute.
We strongly recommend putting in your own business metrics as a benchmark to accurately calculate how important each metric is to the growth of your SaaS company.
Let's take a closer look at these metrics so you can start using our model.
Acquisition determines user funnel size
Activation metrics include everything from page views to sales of qualified leads (SQLs). In our model, "acquisition" measures the number of users who are on a free trial. As a reference value for our "acquisition", let's say 5000 free trial users sign up. You can use this number, or enter a custom number if you don't know the number of free monthly subscription trials, it's just an estimate.
According to a study of SaaS companies by Groove CEO and founder Alex Turnbull, an average of 8.4% of traffic converts to trial users.
Using our estimate — 5,000 free trial signups, we’ll calculate how a 25% increase in the “acquisition” parameter would affect the 12-month MRR after one year:
As you can see, a 25% increase in acquisition results in a 25% increase in MRR. These increases are reasonable and proportional, since acquisition determines the size of the user funnel.
So if you have ten times the "acquisition", you will get ten times the MRR. It's very boring. But don't worry, other metrics have a bigger impact on MRR.
User activation is an upstream bottleneck
Activation happens when the user first reaches the value you promised. It represents the percentage of users who have been activated out of the total acquired users.
As a benchmark for activation rates, we settled on 30% based on the bleak reality of mobile app user logins and our own experience helping businesses improve their users' experience.
You can use your own data as a parameter, or enter the average monthly active user ratio. The impact of activation on different products, based on the "aha moment" of the product is very different. Make sure you define exactly what determines to activate a user, that way, you know what to do with the data you're looking at!
Increase activation by 25%, can increase MRR by 34.3% after one year. It turns out that metrics you ignore can give you outsized returns.
In our free-to-pay model, activation directly determines your earnings. This makes activation an important upstream metric, affecting not only how much revenue you can generate from new users, but also how much recurring revenue you can generate from existing users.
Keep in mind that in our simple model, we did not calculate the impact of each additional indicator on the other indicators. In reality, increasing activation is likely to lead to an increase in retention and referral rates, resulting in an even greater increase in MRR.
Extra: How to Measure User Activation
Activation causes are different for each product. In order to truly understand what leads to a user’s first “aha moment,” you need to carefully study the user experience map, communicate with the user, and implement tracking around the user.
Examples of activations: when a user completes an Uber or Lyft ride for the first time, when a customer receives a delivery from Instacart, when a new Gmail user sends their first email, etc.
The amount of income determines the size of the user funnel
In our model, revenue represents the average contract value, which is what users pay each month.
For simplicity, we simulated a medium-sized subscription contract for an SMBSaaS company, setting the revenue to $100. In your own calculations, you can enter your own average contract value into the income parameter.
In our model, income and acquisition function similarly. Both metrics are fixed values, not percentage values like the others. They have an approximate one-to-one impact on profits. Acquisition determines the size of the user funnel based on the number of users, and revenue sets the size of the user funnel based on USD.
Retention is a downstream bottleneck
Retention rate measures the number of users who continue to pay for a product each month. Retention is usually a larger percentage value than activation because it's easier to get users to keep a habit than to get them started.
Based on observations by Tomasz Tunguz (VC) and confirmation by Clement Vouillon (VC), we set the retention rate parameter for SMB companies at 97% per month. If you have your company's monthly customer retention data, you can enter it as a parameter in the calculation model.
Let’s calculate the MRR impact of a 25% increase in retention:
The impact of retention on MRR is closest to the impact of activation on MRR—they are both percentage-based bottlenecks. They can both expand or shrink the size of the funnel.
In our model, activation happens when the user pays. Activation has less of an impact on revenue if paid for by users in a reserved group. If your business uses a pay-for-free model, you can use your own data to see the relative difference in the revenue impact of boost activation and retention.
Bonus: How to measure retention
Use cohort analysis to drill down on retention and churn rates to find out why churn is happening. Depending on your business model, you may wish to measure daily churn. But for products that don't require daily use, monthly retention and monthly churn are more useful.
Recommendations are the icing on the cake
Referrals measure the percentage of existing users who successfully bring new users into the user funnel. So referrals measure existing users as a percentage of your total user base, not just new users.
Based on the recommendation parameters, we did some calculations and finally decided that 22% is a good recommendation rate parameter value for a successful SaaS company. You can always replace this parameter with existing data.
As you can see, improving retention by 25% only resulted in a 7.4% increase in MRR. For someone whose minds are on growing their business and firmly believes that viral growth is the holy grail, that number might carry some punch.
Why User Activation Is the Most Important Pirate Metric
In our model, the MRR increase brought about by a 25% activation boost:
- 9.3% more MRR growth than a proportional "acquisition" increase
- 3.3% more than the increase in MRR brought about by the same proportion of "retention rate" increase
In our simple model these values are parameter independent. But when comparing the impact of each Pirate metric on MRR, the downstream impact of activation on profit is quite evident. If you continue to ignore SaaS metrics, you will be missing out on untapped revenue and growth opportunities.
Extra: How to Measure Referrals
- Pay close attention to the NPS score to understand the current user satisfaction with the product.
- Track virality — the number of users who recommend a product. A higher viral factor will lead to exponential growth.
what's next
Now that you understand the importance of these metrics, what should you do? How do you increase activation rates and gain growth?
For starters, you can look at users from another angle. Ask yourself: Are these first user experiences leading new users to their "aha moment". Can we accelerate their “aha moment” with better in-app messaging or a more streamlined login process (the answer to that last question is almost always “yes”).
Here are some ways you can improve Pirate Metrics using in-app messaging:
- For revenue, try optimizing your subscription alerts with understated and well-timed tooltips or swipes.
- For retention, focus on making announcements about new features or helping existing customers unlock new features.
- For referrals, push premium users to refer friends through invite-a-friend mode
- For activation, lead users to their "aha moment" with an easy user login flow.
Go beyond the Pirate metrics calculation model and crunch the numbers. In order to achieve the greatest improvement, find the part of the user experience in your product that needs to be improved. Then optimize it!
Original link :
Why is user activation the metric that product managers need to focus on the most?
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