Good post by David Jaxon (not surprising) about Eric Schonfield’s, “Don’t Be fooled By Vanity Metrics”:

Vanity metrics are things like registered users, downloads, and raw pageviews. They are easily manipulated, and do not necessarily correlate to the numbers that really matter: active users, engagement, the cost of getting new customers, and ultimately revenues and profits. The latter are more actionable metrics. As First Round Capital’s Josh Kopelman recently advised on Founder Office Hours, “The real data is retention and repeat usage.” Startups that focus on the real metrics can make their products better, attract more customers, and make them happier.

It is important for startups to properly instrument the data they track so that they can get a handle on the true health of their business. If they track only the vanity metrics, they can get a false sense of success. Just because a startup can produce a chart that is up and to the right does not mean it has a great business. A mobile app could have millions of downloads but only a few hundred thousand active users, or a freemium website might see exploding traffic growth but barely any conversions to paying users.

I see this in the Margin trading Products (“MTP”) industry every day.  Firms, especially smaller firms, tend to trumpet their Monthly Volume (meaning the total notional USD of client trading).  It has been this way for a while.  There are a number of problems with this metric.  The first problem is the lack of validation of the number.  They are completely self reported numbers and therefore most observers would read these numbers and discount them significantly.  Also, Monthly Volume is highly correlated to market volatility which no broker has control over.  So the bigger problem is that Monthly Volume is not a great way to track the two valuable metrics of a brokerage; their growth and their profitability.

A single metric that encompasses the performance of the major drivers of growth would actually be “active client assets on deposit“.    That metric, which I do not see publicly noted for any firms, shows the results of the sales and marketing teams efforts.  Note that it is active client accounts as opposed to client accounts.  There are too many client accounts with small deposits that are no longer trading and therefore no longer generating any revenues for the firm.  So lets call an active client account an account that executes at least one trade per week.  Maybe if/when interest rates climb again and those aggregate client deposits are generating interest revenues we should revisit the definition of active client accounts.

Profitability is the next valuable metric.  And this is not a standalone, net income number.  Rather it is a measure of revenues as a percentage of the total assets in the active client accounts.  This percentage shows the effectiveness of the broker in generating revenues.  This metric would help an outsider value a company.  For a large broker with $20 mio in Net Income, but a Profitability Percentage of 5% may not be as valuable as a smaller broker with Net Income of $5 mio but a Profitability Percentage of 10%.

I will post a follow up article on this Profitability Percentage metric in the near future.