Why Ratios Trump Raw Numbers in Business Health
Imagine you're a farmer with two apple orchards. One day, you decide to count the apples in each orchard. Orchard A has 1,000 apples, while Orchard B has only 500. At first glance, it seems like Orchard A is the clear winner. But what if I told you that Orchard A has 10,000 trees, while Orchard B has only 500? Suddenly, Orchard B doesn't look so bad, does it?
This is the power of proportions. In business, as in farming, raw numbers can be deceiving. To truly understand the health of your business, you need to look at proportions.
You are probably looking at absolute numbers every day, e.g. your business has made $10K in revenue this week. There are 250 customers who placed orders today, while it was 200 yesterday and 100 on the same day last week etc.
Proportions, on the other hand, are like the fine print. They might not be as immediately eye-catching as absolute numbers, but they provide a more accurate picture of your business's health.
Take profit margin, for example. This is a proportion that compares your profit to your revenue. A high profit margin indicates that you're effectively controlling your costs and generating a healthy profit. This is a much more meaningful measure of success than revenue alone.
Now let's look at another example. Assume that you see the trend of the number of daily customers after your increase in search spend is going up and doubled. Sounds great, right? But what if your daily visitors have actually tripled? Suddenly, it doesn't look so good. Figure 1 and figure 2 are a toy example I made up for demonstration purpose.
The ratio of customers out of daily visitors tells a different story from looking at the daily active customers alone. The visitor to customer conversion rate goes down dramatically. Something is not right. You want to further investigate and diagnose the issue. It could be one of the following:
- Fraud or bot traffic has increased significantly.
- Something is wrong with your purchase funnel. Maybe the recent revision of the checkout process you rolled out had some glitches and customers cannot carry out the purchase to the payment successfully.
- The traffic you gained does not fit your typical customer profile. Suppose your typical customers are young male, while somehow your search campaign attracted young females more than males. The new groups of visitors are not likely to convert.
Ratios are a type of proportion that compare one quantity to another. They can provide valuable insights into various aspects of your business.
One important ratio that growth businesses want to examine and keep track of is the customer acquisition cost (CAC) to lifetime value (LTV) ratio. It compares the cost of acquiring a new customer to the revenue that customer will generate over their lifetime. A high LTV:CAC ratio indicates that your marketing efforts are cost-effective.
The Power of Time-Based Proportions
YoY, MoM, and WoW percentages are like the movie reel, showing you the full motion picture of your business's performance over time.
Year-over-year percentages allow you to compare your performance this year to your performance the same period last year. This helps you account for seasonal trends and gives you a long-term view of your business's health.
Month-over-month and week-over-week percentages, on the other hand, give you a more immediate view of your business's trajectory. They allow you to spot recent trends and react quickly to changes.
Looking at YoY, MoM, and WoW percentages can help you spot trends that snapshot metrics might miss. For example, if your sales are up 10% this month compared to last month, that's a positive trend. If they're up 10% this week compared to last week, that's an even more immediate positive trend.
But what if your sales are down 20% this year compared to last year? That's a negative trend that you might miss if you're only looking at MoM or WoW percentages. By looking at all three – YoY, MoM, and WoW – you can get a comprehensive view of your business's performance.
The Art of Proportional Thinking
So, how can you cultivate a proportional mindset? Start by asking the right questions. Instead of asking "How much?", ask "How much relative to what?" Instead of looking at your numbers in isolation, compare them to other relevant numbers.
Business is all about context. A $1 million profit might be a triumph for a small startup, but a disappointment for a Fortune 500 company. By looking at proportions instead of absolute numbers, you can better understand the health of your business and make more informed decisions.
In conclusion, while absolute numbers might be the stars of your business reports, proportions are the unsung heroes. They provide the context, clarity, and insight you need to truly understand your business's health. So, the next time you're faced with a flashy absolute number, remember to look for the proportion behind it. Your business will thank you.
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Note: Unless otherwise noted, all images are by the author.